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** **

 

** **

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**(Mark One)**

 

**x****  Quarterly Report pursuant to Section 13or 15(d) of the Securities Exchange Act of 1934**

 

**for the quarterly period ended June 30, 2010**

 

**or**

 

**o****   Transition Report pursuant to Section 13or 15(d) of the Securities Exchange Act of 1934**

 

**for the transition period from                  to                  **

 

**Commission File Number: 000-20086**

 

**UNIVERSALHOSPITAL SERVICES, INC.**

(Exactname of registrant as specified in its charter)

 

| **Delaware**                    | ** ** | **41-0760940**      |
|---------------------------------|------------|---------------------|
| (State or other jurisdiction of |       | (I.R.S. Employer    |
| incorporation or organization)  |       | Identification No.) |

 

**7700 France Avenue South, Suite 275**

**Edina, Minnesota 55435-5228**

(Addressof principal executive offices, including zip code)

 

**(952)893-3200**

(Registrant’stelephone number, including area code)

 

**NotApplicable**

(Formername, former address, and former fiscal year, if changed since last report)

 

Indicateby check mark whether the registrant: (1) has filed all reports requiredto be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. Yes o  No x

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 ofthis chapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files). Yes o  No o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer or a smaller reporting company.  See definitions of “large accelerated filer,”“accelerated filer” and “smaller reporting company” in Rule 12b-2 of theExchange Act (Check one):

 

| Large  accelerated filer o                     |   | Accelerated  filer o         |
|------------------------------------------------|--------|------------------------------|
|                                           |   |                         |
| Non-accelerated  filer x                       |   | Smaller  reporting company o |
| (Do  not check if a smaller reporting company) |   |                         |

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act). Yes o  No x

 

Numberof shares of common stock outstanding as of August 1, 2010:  1,000

 

 

 

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**Universal Hospital Services, Inc.**

**Table of Contents**

 
| ** **                               | ** **                                                                                                                        | **Page** |
|------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------|----------|
| ** **                               | ** **                                                                                                                        |     |
| **PART I -  FINANCIAL INFORMATION** |                                                                                                                              |
|                                     |                                                                                                                              |     |
| **ITEM 1.**                              | Financial  Statements                                                                                                             |     |
|                                     |                                                                                                                              |     |
|                                     | Balance Sheets — June 30, 2010 and  December 31, 2009                                                              | 3        |
|                                     |                                                                                                                              |     |
|                                     | Statements of Operations — Three months  ended June 30, 2010 and 2009 and Six months ended June 30, 2010 and  2009 | 4        |
|                                     |                                                                                                                              |     |
|                                     | Statements of Cash Flows — Six months  ended June 30, 2010 and 2009                                                     | 5        |
|                                     |                                                                                                                              |     |
| **ITEM 2.**                              | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                       | 17       |
|                                     |                                                                                                                              |     |
| **ITEM 3.**                              | Quantitative  and Qualitative Disclosures About Market Risk                                                                       | 31       |
|                                     |                                                                                                                              |     |
| **ITEM  4T.**                            | Controls and  Procedures                                                                                                          | 31       |
|                                     |                                                                                                                              |     |
| **PART II  - OTHER INFORMATION**    |                                                                                                                              |
|                                     |                                                                                                                              |     |
| **ITEM  1.**                             | Legal Proceedings                                                                                                                 | 32       |
|                                     |                                                                                                                              |     |
| **ITEM 1A.**                             | Risk  Factors                                                                                                                     | 32       |
|                                     |                                                                                                                              |     |
| **ITEM 2.**                              | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                      | 32       |
|                                     |                                                                                                                              |     |
| **ITEM 3.**                              | Defaults Upon  Senior Securities                                                                                                  | 32       |
|                                     |                                                                                                                              |     |
| **ITEM 4.**                              | *Removed and Reserved*                                                                                                            |     |
|                                     |                                                                                                                              |     |
| **ITEM  5.**                             | Other Information                                                                                                                 | 32       |
|                                     |                                                                                                                              |     |
| **ITEM 6.**                              | Exhibits                                                                                                                          | 35       |
|                                     |                                                                                                                              |     |
| **Signatures**                           |                                                                                                                              | 37       |

 

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**PART I - FINANCIAL INFORMATION**

 

**Item 1. Financial Statements —Unaudited**

** **

**Universal Hospital Services, Inc.**

** **

**BalanceSheets**

*(in thousands, except share and per shareinformation)*

*(unaudited)*

 
| ** **                                                                                                                        | ** ** | **June 30,  2010** | ** ** | **December 31,  2009** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| **Assets**                                                                                                                        | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Current assets:                                                                                                                   |       |                    |       |                        |       |
| Accounts receivable, less allowance for doubtful  accounts of $2,450 at June 30, 2010 and December 31, 2009             |       | $                       | 55,259     |                        | $          | 60,079 |   |
| Inventories                                                                                                                       |       | 4,673                   |       | 5,236                       |       |
| Deferred income taxes                                                                                                             |       | 8,116                   |       | 8,733                       |       |
| Other current assets                                                                                                              |       | 3,765                   |       | 2,983                       |       |
| Total current assets                                                                                                              |       | 71,813                  |       | 77,031                      |       |
|                                                                                                                              |       |                    |       |                        |       |
| Property and equipment, net:                                                                                                      |       |                    |       |                        |       |
| Medical equipment, net                                                                                                            |       | 213,068                 |       | 197,859                     |       |
| Property and office equipment, net                                                                                                |       | 20,111                  |       | 19,406                      |       |
| Total property and equipment, net                                                                                                 |       | 233,179                 |       | 217,265                     |       |
|                                                                                                                              |       |                    |       |                        |       |
| Other long-term assets:                                                                                                           |       |                    |       |                        |       |
| Goodwill                                                                                                                          |       | 280,211                 |       | 280,211                     |       |
| Other intangibles, net                                                                                                            |       | 241,719                 |       | 248,653                     |       |
| Other, primarily deferred financing costs, net                                                                                    |       | 12,718                  |       | 12,243                      |       |
| Total assets                                                                                                                      |       | $                       | 839,640    |                        | $          | 835,403 |   |
|                                                                                                                              |       |                    |       |                        |       |
| **Liabilities and Shareholders’  Equity**                                                                                    | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Current liabilities:                                                                                                              |       |                    |       |                        |       |
| Current portion of long-term debt                                                                                                 |       | $                       | 4,327      |                        | $          | 4,062 |   |
| Book overdrafts                                                                                                                   |       | 7,786                   |       | 3,302                       |       |
| Accounts payable                                                                                                                  |       | 15,617                  |       | 18,075                      |       |
| Accrued compensation                                                                                                              |       | 11,852                  |       | 10,432                      |       |
| Accrued interest                                                                                                                  |       | 3,644                   |       | 3,696                       |       |
| Other accrued expenses                                                                                                            |       | 12,161                  |       | 9,174                       |       |
| Total current liabilities                                                                                                         |       | 55,387                  |       | 48,741                      |       |
|                                                                                                                              |       |                    |       |                        |       |
| Long-term debt, less current portion                                                                                              |       | 523,631                 |       | 514,557                     |       |
| Pension and other long-term liabilities                                                                                           |       | 6,348                   |       | 6,465                       |       |
| Interest rate swap                                                                                                                |       | 20,013                  |       | 21,286                      |       |
| Payable to Parent                                                                                                                 |       | 7,032                   |       | 6,342                       |       |
| Deferred income taxes                                                                                                             |       | 59,892                  |       | 64,021                      |       |
|                                                                                                                              |       |                    |       |                        |       |
| Commitments and contingencies (Note 7)                                                                                            |       |                    |       |                        |       |
|                                                                                                                              |       |                    |       |                        |       |
| Shareholders’ equity                                                                                                         |       |                    |       |                        |       |
| Common stock, $0.01 par value; 1,000 shares  authorized, issued and outstanding at June 30, 2010 and  December 31, 2009 |       | —                  |       | —                      |       |
| Additional paid-in capital                                                                                                        |       | 248,794                 |       | 248,794                     |       |
| Accumulated deficit                                                                                                               |       | (65,585                 | )          | (58,165                     | )          |
| Accumulated other comprehensive loss                                                                                              |       | (15,872                 | )          | (16,638                     | )          |
| Total shareholders’ equity                                                                                                   |       | 167,337                 |       | 173,991                     |       |
| Total liabilities and shareholders’ equity                                                                                   |       | $                       | 839,640    |                        | $          | 835,403 |   |

 

The accompanying notes are an integral part of the unaudited financialstatements.

 

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**UniversalHospital Services, Inc.**

** **

**Statementsof Operations**

(in thousands)

(unaudited)

 
| ** **                                                                                                                      | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                                                      | ** ** | **2010**                              | ** ** | **2009**                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| **Revenue**                                                                                                                     | ** ** | ** **                            | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Medical equipment  outsourcing                                                                                                  |       | $                                     | 60,818     |                                | $          | 56,524 |   | $ | 125,992 |   | $ | 114,806 |   |
| Technical and professional  services                                                                                            |       | 11,152                                |       | 10,696                              |       | 21,965 |   | 21,108 |   |
| Medical equipment sales  and remarketing                                                                                        |       | 4,763                                 |       | 5,616                               |       | 8,950 |   | 10,852 |   |
| Total revenues                                                                                                                  |       | 76,733                                |       | 72,836                              |       | 156,907 |   | 146,766 |   |
|                                                                                                                            |       |                                  |       |                                |       |   |   |   |   |
| **Cost of  Sales**                                                                                                              |       |                                  |       |                                |       |   |   |   |   |
| Cost of medical equipment  outsourcing                                                                                          |       | 22,452                                |       | 19,760                              |       | 45,069 |   | 40,229 |   |
| Cost of technical and  professional services                                                                                    |       | 8,064                                 |       | 7,568                               |       | 15,848 |   | 14,938 |   |
| Cost of medical equipment  sales and remarketing                                                                                |       | 3,724                                 |       | 4,440                               |       | 7,071 |   | 8,826 |   |
| Medical equipment  depreciation                                                                                                 |       | 17,358                                |       | 15,904                              |       | 34,815 |   | 31,766 |   |
| Total costs of medical  equipment outsourcing, technical and professional services and medical  equipment sales and remarketing |       | 51,598                                |       | 47,672                              |       | 102,803 |   | 95,759 |   |
| Gross margin                                                                                                                    |       | 25,135                                |       | 25,164                              |       | 54,104 |   | 51,007 |   |
|                                                                                                                            |       |                                  |       |                                |       |   |   |   |   |
| Selling, general and  administrative                                                                                            |       | 20,982                                |       | 21,158                              |       | 42,052 |   | 43,173 |   |
| Operating income                                                                                                                |       | 4,153                                 |       | 4,006                               |       | 12,052 |   | 7,834 |   |
|                                                                                                                            |       |                                  |       |                                |       |   |   |   |   |
| Interest expense                                                                                                                |       | 11,855                                |       | 11,845                              |       | 23,362 |   | 23,562 |   |
| Loss before income taxes                                                                                                        |       | (7,702                                | )          | (7,839                              | )          | (11,310 | ) | (15,728 | ) |
|                                                                                                                            |       |                                  |       |                                |       |   |   |   |   |
| Benefit for income taxes                                                                                                        |       | (2,562                                | )          | (3,036                              | )          | (3,890 | ) | (6,135 | ) |
| Net loss                                                                                                                        |       | $                                     | (5,140     | )                                   | $          | (4,803 | ) | $ | (7,420 | ) | $ | (9,593 | ) |

 

The accompanying notes arean integral part of the unaudited financial statements.

 

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**Universal Hospital Services, Inc.**

**Statementsof Cash Flows**

*(inthousands)*

*(unaudited)*

 
| ** **                                                                       | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                       | ** ** | **2010**                            | ** ** | **2009** | ** ** |
| Cash flows from operating activities:                                            |       |                                |       |   |   |
| Net loss                                                                         |       | $                                   | (7,420     | ) | $ | (9,593 | ) |
| Adjustments to reconcile net loss to net cash  provided by operating activities: |       |                                |       |   |   |
| Depreciation                                                                     |       | 39,054                              |       | 35,971 |   |
| Amortization of intangibles and deferred financing  costs                        |       | 8,226                               |       | 8,709 |   |
| Provision for doubtful accounts                                                  |       | 74                                  |       | 720 |   |
| Provision for inventory obsolescence                                             |       | 116                                 |       | (113 | ) |
| Non-cash stock-based compensation expense                                        |       | 691                                 |       | 908 |   |
| Loss (gain) on sales and disposals of equipment                                  |       | (136                                | )          | 50 |   |
| Deferred income taxes                                                            |       | (3,574                              | )          | (4,271 | ) |
| Changes in operating assets and liabilities:                                     |       |                                |       |   |   |
| Accounts receivable                                                              |       | 4,746                               |       | (3,007 | ) |
| Inventories                                                                      |       | 447                                 |       | 660 |   |
| Other operating assets                                                           |       | (802                                | )          | (495 | ) |
| Accounts payable                                                                 |       | (2,996                              | )          | (1,841 | ) |
| Other operating liabilities                                                      |       | 3,792                               |       | (2,351 | ) |
| Net cash provided by operating activities                                        |       | 42,218                              |       | 25,347 |   |
| Cash flows from investing activities:                                            |       |                                |       |   |   |
| Medical equipment purchases                                                      |       | (47,250                             | )          | (15,539 | ) |
| Property and office equipment purchases                                          |       | (2,642                              | )          | (1,953 | ) |
| Proceeds from disposition of property and  equipment                             |       | 1,239                               |       | 1,828 |   |
| Net cash used in investing activities                                            |       | (48,653                             | )          | (15,664 | ) |
| Cash flows from financing activities:                                            |       |                                |       |   |   |
| Proceeds under senior secured credit facility                                    |       | 86,579                              |       | 42,000 |   |
| Payments under senior secured credit facility                                    |       | (70,379                             | )          | (52,000 | ) |
| Payments of principal under capital lease  obligations                           |       | (2,557                              | )          | (2,178 | ) |
| Payment of deferred financing costs                                              |       | (1,746                              | )          | — |   |
| Repayment of 10.125% senior notes                                                |       | (9,945                              | )          | — |   |
| Change in book overdrafts                                                        |       | 4,483                               |       | (6,011 | ) |
| Net cash provided by (used in) financing  activities                             |       | 6,435                               |       | (18,189 | ) |
| Net change in cash and cash equivalents                                          |       | —                              |       | (8,506 | ) |
|                                                                             |       |                                |       |   |   |
| Cash and cash equivalents at the beginning of  period                            |       | —                              |       | 12,006 |   |
| Cash and cash equivalents at the end of period                                   |       | $                                   | —     |   | $ | 3,500 |   |
|                                                                             |       |                                |       |   |   |
| Supplemental cash flow information:                                              |       |                                |       |   |   |
| Interest paid                                                                    |       | $                                   | 22,122     |   | $ | 22,563 |   |
| Income taxes paid                                                                |       | $                                   | 263        |   | $ | 192 |   |
| Non-cash activities:                                                             |       |                                |       |   |   |
| Medical equipment purchases included in accounts  payable (at end of period)     |       | $                                   | 5,233      |   | $ | 3,244 |   |
| Capital lease additions                                                          |       | $                                   | 5,641      |   | $ | 1,731 |   |

 

The accompanying notes are an integral part of the unaudited financialstatements.

 

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**Universal Hospital Services, Inc.**

 

**NOTES TO UNAUDITED QUARTERLY FINANCIAL STATEMENTS**

 

**1.****            ****Basisof Presentation**

 

Theinterim financial statements included in this Quarterly Report on Form 10-Qhave been prepared by Universal Hospital Services, Inc. (“we,” “our”, “us”, the“Company”, or “UHS”) without audit, pursuant to the rules and regulations ofthe Securities and Exchange Commission (the “SEC”).  Certain information and footnote disclosuresnormally included in financial statements prepared in accordance withaccounting principles generally accepted in the United States of America (“GAAP”)have been condensed or omitted, pursuant to such rules and regulations.  These condensed financial statements shouldbe read in conjunction with the financial statements and related notes includedin the Company’s 2009 Annual Report on Form 10-K (“2009 Form 10-K”), filed withthe SEC.

 

Theinterim financial statements presented herein as of June 30, 2010, reflect, inthe opinion of management, all adjustments necessary for a fair presentation ofthe financial position and the results of operations and cash flows for theperiods presented.  These adjustments areall of a normal, recurring nature.  Theresults of operations for any interim period are not necessarily indicative ofresults for the full year.

 

TheDecember 31, 2009 balance sheet amounts were derived from audited financialstatements, but do not include all disclosures required by GAAP.

 

Weare required to make estimates and assumptions about future events in preparingfinancial statements in conformity with GAAP. These estimates and assumptions affect the amounts of assets,liabilities, revenues and expenses at the date of the unaudited condensedfinancial statements.  While we believethat our past estimates and assumptions have been materially accurate, ourcurrent estimates are subject to change if different assumptions as to theoutcome of future events are made.  Weevaluate our estimates and judgments on an ongoing basis and predicate thoseestimates and judgments on historical experience and on various other factorsthat we believe to be reasonable under the circumstances.  We make adjustments to our assumptions andjudgments when facts and circumstances dictate. Since future events and their effects cannot be determined with absolutecertainty, actual results may differ from the estimates used in preparing theaccompanying unaudited condensed financial statements.

 

Adescription of our critical accounting policies is included in our 2009 Form10-K. There have been no material changes to these policies for the quarterended June 30, 2010.

 

**2.****            ****Comprehensive Loss**

 

Comprehensiveloss is comprised of net loss and other comprehensive income. Othercomprehensive income includes unrealized gains from derivatives designated ascash flow hedges. Accumulated other comprehensive loss is displayed separatelyon the balance sheets.  A reconciliationof net loss to comprehensive loss is provided below:

 

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| ** **                                     | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| **(in thousands)**                             | ** ** | **2010**                         | ** ** | **2009**                       | ** ** | **2010** | ** ** | **2009** | ** ** |
| Net loss                                       |       | $                                | (5,140     | )                              | $          | (4,803 | ) | $ | (7,420 | ) | $ | (9,593 | ) |
| Unrealized gain on cash flow hedge, net of tax |       | 674                              |       | 2,280                          |       | 766 |   | 2,902 |   |
| Comprehensive loss                             |       | $                                | (4,466     | )                              | $          | (2,523 | ) | $ | (6,654 | ) | $ | (6,691 | ) |

 

**3.****            ****Recent Accounting Pronouncement**

 

***Standard Issued Not Yet Adopted***

 

InOctober 2009, the Financial Accounting Standards Board (“FASB”) issuedAccounting Standards Update (“ASU”) 2009-13, *RevenueRecognition (Topic 605): Multiple Deliverable Revenue Arrangements — AConsensus of the FASB Emerging Issues Task Force*. This updateprovides application guidance on whether multiple deliverables exist, how thedeliverables should be separated and how the consideration should be allocatedto one or more units of accounting. This update establishes a selling pricehierarchy for determining the selling price of a deliverable. The selling priceused for each deliverable will be based on vendor-specific objective evidence,if available, third-party evidence if vendor-specific objective evidence is notavailable, or estimated selling price if neither vendor-specific or third-partyevidence is available. The Company will be required to apply this guidanceprospectively for revenue arrangements entered into or materially modifiedafter January 1, 2011. The Company is currently evaluating the impact of theprovisions of ASU 2009-13 on the Company’s Financial Statements.

 

**4.****            ****FairValue Measurements**

 

Financialassets and liabilities measured at fair value on a recurring basis as of June30, 2010 and December 31, 2009, in accordance with Accounting StandardsCodification (“ASC”) Topic 820, are summarized in the following table by typeof inputs applicable to the fair value measurements:

 
| ** **         | ** ** | **Fair Value at June 30, 2010** | ** ** | **Fair Value at December 31, 2009** | ** ** |
|--------------------|------------|---------------------------------|------------|-------------------------------------|------------|
| **(in thousands)** | ** ** | **Level 1**                     | ** ** | **Level 2**                         | ** ** | **Level 3** | ** ** | **Total** | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
| Interest Rate Swap |       | $                               | —     |                                | $          | 20,013 |   | $ | — |   | $ | 20,013 |   | $ | — |   | $ | 21,286 |   | $ | — |   | $ | 21,286 |   |
|                    |            |                                 |            |                                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Adescription of the inputs used in the valuation of assets and liabilities issummarized as follows:

 

Level1 — Inputs represent unadjusted quoted prices for identical assets orliabilities exchanged in active markets.

 

Level2 — Inputs include directly or indirectly observable inputs other than Level 1inputs such as quoted prices for similar assets or liabilities exchanged inactive or inactive markets; quoted prices for identical assets or liabilitiesexchanged in inactive markets; other inputs that are considered in fair valuedeterminations of the assets or liabilities, such as interest rates and yield curvesthat are observable at commonly quoted intervals, volatilities, prepaymentspeeds, loss severities, credit risks and default rates; and inputs that arederived principally from or corroborated by observable market data bycorrelation or other means.

 

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Level3 — Inputs include unobservable inputs used in the measurement of assets andliabilities. Management is required to use its own assumptions regardingunobservable inputs because there is little, if any, market activity in theassets or liabilities or related observable inputs that can be corroborated atthe measurement date. Measurements of nonexchange traded derivative contractassets and liabilities are primarily based on valuation models, discounted cashflow models or other valuation techniques that are believed to be used bymarket participants. Unobservable inputs require management to make certainprojections and assumptions about the information that would be used by marketparticipants in pricing assets or liabilities.

 

**Fair Value of Other Financial Instruments**

 

TheCompany considers the carrying amount of financial instruments, includingaccounts receivable, accounts payable and accrued liabilities, as theapproximate fair value due to their short maturities. On June 14, 2010, theCompany redeemed, at par value plus accrued interest to the date of redemption,all of its 10.125% Senior Notes. See additional information in Note 6, LongTerm Debt. The fair value of our outstanding PIK Toggle Notes, Floating RateNotes and 10.125% Senior Notes as of June 30, 2010 and December 31, 2009, basedon the quoted market price for the same or similar issues of debt, isapproximately:

 
| ** **           | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|----------------------|------------|--------------|------------|------------------|------------|
| **(in millions)**    | ** ** | **2010**     | ** ** | **2009**         | ** ** |
| PIK Toggle Notes     |       | $            | 226.6      |             | $          | 227.1 |   |
| Floating Rate Notes  |       | 193.2        |       | 193.8            |       |
| 10.125% Senior Notes |       | N/A          |       | 9.8              |       |
|                      |            |              |            |                  |            |  |  |

 

**5.****            ****Stock-BasedCompensation**

 

Duringthe six months ended June 30, 2010, activity under the 2007 Stock Option Planof UHS Holdco, Inc. (“2007 Stock Option Plan”), our parent company (“Parent”)was as follows:

 
| **(in thousands except exercise price)**         | ** ** | **Number of  Options** | ** ** | **Weighted  average  exercise price** | ** ** | **Aggregate  intrinsic value** | ** ** | **Weighted  average  remaining  contractual  term (years)** | ** ** |
|--------------------------------------------------|------------|------------------------|------------|---------------------------------------|------------|--------------------------------|------------|-------------------------------------------------------------|------------|
| Outstanding at December 31, 2009                 |       | 37,527                 |       | $                                     | 1.00       |                           | $          | 35,651                                                      |       | 7.5 |   |
| Granted                                          |       | 1,430                  |       | $                                     | 1.83       |                           | $          | —                                                      |       |   |   |
| Exercised                                        |       | —                 |       |                                  |       |                           |       |                                                        |       |
| Forfeited or expired                             |       | (242                   | )          | $                                     | 1.05       |                           | $          | 189                                                         |       |   |   |
|                                             |       |                   |       |                                  |       |                           |       |                                                        |       |
| Outstanding at June 30, 2010                     |       | 38,715                 |       | $                                     | 1.03       |                           | $          | 30,972                                                      |       | 7.1 |   |
|                                             |       |                   |       |                                  |       |                           |       |                                                        |       |
| Exercisable at June 30, 2010                     |       | 14,957                 |       | $                                     | 1.00       |                           | $          | 12,414                                                      |       | 7.0 |   |
|                                             |       |                   |       |                                  |       |                           |       |                                                        |       |
| Remaining authorized options available for issue |       | 5,190                  |       |                                  |       |                           |       |                                                        |       |

 

Theexercise price of each stock option award is equal to the market value ofParent’s common stock on the grant date as determined reasonably and in goodfaith by the Parent’s board of directors (the “Parent 

 

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Board”)and Parent’s compensation committee.  The exercise price of options issuedduring the six months ended June 30, 2010 was determined through a variety offactors including peer group multiples, merger and acquisition multiples, anddiscounted cash flow analyses.

 

The intrinsic value of astock award is the amount by which the market value of the underlying stockexceeds the exercise price of the award.

 

Wedetermine the fair value of options using the Black-Scholes option pricingmodel. The estimated fair value of options, including the effect of estimatedforfeitures, is recognized as expense on a straight-line basis over the options’expected vesting periods. The following assumptions were used in determiningthe fair value of stock options granted during the six months endedJune 30, 2010, under the Black-Scholes model:

 
| ** **                   | ** ** | **Six Months Ended  June 30,  2010** | ** ** |
|------------------------------|------------|--------------------------------------|------------|
|                         |       |                                 |       |
| Risk-free interest rate      |       | 3.08                                 | %          |
| Expected volatility          |       | 31.90                                | %          |
| Dividend Yield               |       | N/A                                  |       |
| Expected option life (years) |       | 6.6                                  |       |

 

Expected volatility is basedon an independent valuation of the stock of companies within our peergroup.  Given the lack of a true comparable company, the peer groupconsists of selected public health care companies representing our suppliers,customers and competitors within certain product lines.  The riskfree-interest rate is based on the U.S. Treasury yield curve in effect at thegrant date based on the expected option life.  The expected option liferepresents the result of the “simplified” method applied to “plain vanilla”options granted during the period, as provided within ASC Topic 718, *“Compensation - Stock Compensation.”* Parent used the simplified method as Parent does not have sufficient historicalexercise experience to provide a basis upon which to estimate the expectedterm.

 

Although Parent grants stockoptions, the Company recognizes compensation expense related to these optionssince the services are performed for its benefit.  For the quarters endedJune 30, 2010 and 2009, we recognized non-cash stock compensation expense of$0.3 and $0.9 million, respectively, which is primarily included in selling,general and administrative expenses.  At June 30, 2010, unearned non-cashstock-based compensation related to our fixed vesting options, that we expectto recognize as expense over the next 3.0 years, totals approximately $3.8million, net of our estimated forfeiture rate of 2.0%. Unearned non-cashstock-based compensation related to the performance vesting options totalingapproximately $5.2 million, net of our estimated forfeiture rate of 2.0%, wouldbe recognized over the next 5.5 years only if the performance targets are met. The expense could be accelerated upon the sale of Parent or the Company.

 

Effective August 11, 2010, the Compensation Committee ofour Board of Directors recommended, and the Parent Board authorized, anamendment to the vesting provisions of certain option agreements relating tooptions outstanding under the 2007 Stock Option Plan, including the accelerationof vesting of certain unvested options granted under the 2007 Stock OptionPlan. See Note 11 Subsequent Event, below.

 

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Compensation expense related to service provided by theCompany’s employees is recognized in the accompanying Statements of Operationswith an offsetting Payable to Parent liability, which is not expected to besettled within the next twelve months.

 

**6.****            ****Long-TermDebt**

 

Long-term debt consists of the following:

 
| ** **                              | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------|------------|--------------|------------|------------------|------------|
| **(in thousands)**                      | ** ** | **2010**     | ** ** | **2009**         | ** ** |
| PIK Toggle Notes                        |       | $            | 230,000    |             | $          | 230,000 |   |
| Floating Rate Notes                     |       | 230,000      |       | 230,000          |       |
| Senior secured credit facility          |       | 54,600       |       | 38,400           |       |
| 10.125% Senior Notes                    |       | —       |       | 9,945            |       |
| Capital lease obligations               |       | 13,358       |       | 10,274           |       |
|                                    |       | 527,958      |       | 518,619          |       |
| Less: Current portion of long-term debt |       | (4,327       | )          | (4,062           | )          |
| Total long-term debt                    |       | $            | 523,631    |             | $          | 514,557 |   |

 

***PIK Toggle Notes. ***Our 8.50% / 9.25% PIK Toggle Notes (the“PIK Toggle Notes”) were issued on May 31, 2007 in the aggregate principal amount of$230.0 million under a Second Lien Senior Indenture dated as of May 31, 2007,between the Company and Wells Fargo Bank, National Association, as trustee (the“Second Lien Senior Indenture”).  The PIK ToggleNotes mature on June 1, 2015.  Intereston the PIK Toggle Notes is payable semiannually in arrears on each June 1 andDecember 1.  For any interest paymentperiod through June 1, 2011, the Company may, at its option, elect to payinterest on the PIK Toggle Notes entirely in cash (“Cash Interest”), entirelyby increasing the principal amount of the outstanding PIK Toggle Notes, byissuing additional PIK Toggle Notes (“PIK Interest”) or 50% Cash Interest and50% PIK Interest.  Cash Interest on thePIK Toggle Notes accrues at the rate of 8.50% per annum.  PIK Interest onthe PIK Toggle Notes accrues at the rate of 9.25% per annum.  After June1, 2011, the Company is required to make all interest payments on the PIKToggle Notes entirely as Cash Interest.  The PIK Toggle Notes areredeemable, at the Company’s option, in whole or in part, at specifiedredemption prices (as defined in the Second Lien Senior Indenture) plus accruedinterest to the date of redemption. In addition, the PIK Toggle Notes have achange of control provision, which gives each holder the right to require theCompany to purchase all or a portion of such holders’ PIK Toggle Notes upon achange in control, as defined in the Second Lien Senior Indenture, at apurchase price equal to 101% of the principal amount plus accrued interest tothe date of purchase. The PIK Toggle Notes, subject to certain definitions andexceptions, have covenants that restrict, among other things, the incurrence ofadditional debt, the payment of dividends and the issuance of preferred stock.The PIK Toggle Notes are uncollateralized.

 

***Floating Rate Notes. ***Our~~~~Floating Rate Notes (the “Floating Rate Notes”)were issued on May 31, 2007 in the aggregate principal amount of $230.0 millionunder the Second Lien Senior Indenture. The Floating Rate Notes mature on June 1, 2015.  Interest on the FloatingRate Notes is payable semiannually in arrears on each June 1 and December 1.Interest on the Floating Rate Notes is reset for each semi-annual interestperiod and is calculated at the current LIBOR rate plus 3.375%.  At June 30, 2010, our LIBOR-based rate was4.134%, which includes the credit spread. The Floating Rate Notes are 

 

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redeemable,at the Company’s option, in whole or in part, at specified redemption prices(as defined in the Second Lien Senior Indenture) plus accrued interest to thedate of redemption. In addition, the Floating Rate Notes have a change ofcontrol provision, which gives each holder the right to require the Company topurchase all or a portion of such holders’ Floating Rate Notes upon a change incontrol, as defined in the Second Lien Senior Indenture, at a purchase priceequal to 101% of the principal amount plus accrued interest to the date ofpurchase. The Floating Rate Notes, subject to certain definitions andexceptions, have covenants that restrict, among other things, the incurrence ofadditional debt, the payment of dividends and the issuance of preferred stock.The Floating Rate Notes are uncollateralized.

 

***Interest Rate Swap.***In June 2007, we enteredinto an interest rate swap agreement for $230.0 million, which has the effectof converting the interest rate applicable to our $230.0 million of FloatingRate Notes to a fixed interest rate.  Theeffective date for the interest rate swap agreement was December 2007 and theexpiration date is May 2012.

 

Theinterest rate swap agreement qualifies for cash flow hedge accounting under ASCTopic 815,*Derivatives and Hedging.*Both atinception and on an on-going basis, we must perform an effectiveness test.  In accordance with ASC Topic 815, the fairvalue of the interest rate swap agreement at June 30, 2010 is included as acash flow hedge on our balance sheet. The change in fair value was recorded as a component of accumulatedother comprehensive loss on our balance sheet, net of tax, since the instrumentwas determined to be an effective hedge at June 30, 2010.  We expect to reclassify approximately $6.6million into earnings, net of tax, currently recorded in accumulated othercomprehensive loss, in the next 12 months.

 

Asa result of our interest rate swap agreement, we expect the effective interestrate on our $230.0 million Floating Rate Notes to be 9.065% through May 2012.

 

***Senior Secured Credit Facility.***On May 6, 2010 we enteredinto an Amended and Restated Credit Agreement with GE Business FinancialServices, Inc., as agent for the lenders, and the lenders party thereto, whichamended the senior secured credit facility dated as of May 31, 2007. The seniorsecured credit facility is a first lien senior secured asset based revolvingcredit facility. The Amended and Restated Credit Agreement increased theaggregate amount the Company may borrow from $135.0 million to $195.0 millionand extended the maturity date to November 30, 2014. Additionally, wecapitalized deferred financing costs related to the Amended and Restated CreditAgreement in the amount of $1.7 million. As of June 30, 2010, we had $116.1million of availability under the senior secured credit facility based on aborrowing base of $174.8 million, less borrowings of $54.6 million, and aftergiving effect to $4.1 million used for letters of credit.  Our obligations under the senior securedcredit facility are secured by a first priority security interest insubstantially all of our assets, excluding a pledge of our and Parent’s capitalstock, any joint ventures and certain other exceptions. Our obligations underthe senior secured credit facility are unconditionally guaranteed by Parent.

 

Thesenior secured credit facility requires our compliance with various affirmativeand negative covenants.  Pursuant to the affirmative covenants, we andParent agreed to, among other things, deliver financial and other informationto the agent, provide notice of certain events (including events of default),pay our obligations, maintain our properties, maintain the security interest inthe collateral for the benefit of the agent and the lenders and maintaininsurance.

 

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Amongother restrictions, and subject to certain definitions and exceptions, thesenior secured credit facility restricts our ability to:

 

·      incur indebtedness;

·      create or permit liens;

·      declare or pay dividends andcertain other restricted payments;

·      consolidate, merge orrecapitalize;

·      acquire or sell assets;

·      make certain investments,loans or other advances;

·      enter into transactions withaffiliates;

·      change our line of business;and

·      enter into hedgingtransactions.

 

Thesenior secured credit facility also contains a financial covenant that istriggered if our available borrowing capacity is less than $15.0 million for acertain period, which consists of a minimum ratio of trailing four-quarterEBITDA to cash interest expense, as such terms are defined in the seniorsecured credit facility.

 

Thesenior secured credit facility specifies certain events of default, including,among others, failure to pay principal, interest or fees, violation ofcovenants, 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 securitydocuments.  Some events of default will be triggered only after certaincure periods have expired, or will provide for materiality thresholds.  Ifsuch a default occurs, the lenders under the senior secured credit facilitywould be entitled to take various actions, including all actions permitted tobe taken by a secured creditor and the acceleration of amounts due under thesenior secured credit facility.

 

Borrowingsunder the senior secured credit facility accrue interest (including a creditspread varying with facility usage):

 

·      at a per annum rate equal to 1.75% above the rateannounced from time to time by the agent as the “prime rate” payable quarterlyin arrears; and

·      at a per annum rate equal to 2.75% above theadjusted LIBOR rate used by the agent, for the respective interest rate perioddetermined at our option, payable in arrears upon cessation of the interestrate period elected.

 

AtJune 30, 2010, we had borrowings outstanding that were accruing interest at ourprime rate, which was 5.000%, which includes the credit spread noted above. AtJune 30, 2010, we had borrowings outstanding that were accruing interest at ourLIBOR-based rate of 3.102%, which includes the credit spread noted above.

 

***10.125% Senior Notes.*** On June 14, 2010, we redeemed, at par value plus accrued interest to theredemption date, all of our 10.125% Senior Notes. The funds used to redeem our10.125% Senior Notes were obtained from our senior secured credit facility. The10.125% Senior Notes were redeemable, at our option, in whole or in part of, atspecified redemption prices (as defined) plus accrued interest to the date ofredemption. The transaction resulted in a redemption price of $10.0 million ofwhich $9.9 million related to principal and $0.1 million related to interest.

 

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**7.****            ****Commitmentsand Contingencies**

 

OnJuly 13, 2010, the U.S. Food and Drug Administration (“FDA”) issued a finalorder and transition plan to Baxter Healthcare Corporation (“Baxter”) to recallall Colleague infusion pumps currently in use in the United States. The FDAorder establishes the framework for the recall by providing for a cash refund,generally, $1,500 for single channel pumps and $3,000 for triple channel pumps,or a replacement pump to owners within a two-year period.

 

AtJune 30, 2010, we owned approximately 11,900 Colleague pumps. We are currentlyin the process of evaluating the course of action that best meets the infusiontechnology needs of our customers and our business. As such, while we expect torecognize gains and also expect to increase purchases of infusion pumps toreplace recalled units, the timing and extent of those gains or capitalexpenditures are not readily estimable.

 

The Company, from time to time, may become involved inlitigation arising out of operations in the normal course of business. Assertedclaims are subject to many uncertainties and the outcome of individual mattersis not predictable with assurance.

 

On October 19, 2009, FreedomMedical, Inc. filed a lawsuit against the Company and others in U.S. DistrictCourt for the Eastern District of Texas. The federal complaint allegesviolation of state and federal antitrust laws, tortious interference withbusiness relationships, business disparagement and common law conspiracy.Freedom Medical, Inc. is seeking unspecified damages and injunctive relief.Although it is not possible to reliably predict the outcome of the lawsuit, webelieve that we have meritorious defenses against the claims and willvigorously defend against them.

 

As of June 30, 2010, we were not a party to any otherpending legal proceedings the adverse outcome of which could reasonably beexpected to have a material adverse effect on our operating results, financialposition or cash flows.

 

**8.****            ****RelatedParty Transactions**

 

**Management Agreement**

 

On May 31, 2007, we and Irving Place Capital enteredinto a professional services agreement pursuant to which Irving Place Capitalprovides general advisory and management services to us with respect tofinancial and operating matters.  IrvingPlace Capital is a principal owner of Parent, and the following members of ourBoard of Directors are associated with Irving Place Capital:  John Howard, Robert Juneja, Bret Bowerman andDavid Crane. We paid Irving Place Capital professional services fees of $0.4million for each of the six-month periods ended June 30, 2010 and 2009,respectively.

 

**Business Relationship**

 

Inthe ordinary course of business, we entered into an operating lease for ourMinneapolis, Minnesota district office with Ryan Companies US, Inc. (“Ryan”),which began on May 1, 2007.  One member of our Board of Directors isalso a director of Ryan.  We made payments to Ryan totaling $181,000 and$167,000 during the six months ended June 30, 2010 and 2009, respectively.

 

Oneof our directors, who joined the Board of Directors on April 1, 2008, is also adirector of Broadlane, Inc. (“Broadlane”), a health care group purchasingorganization that serves many of our customers.

 

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Duringthe six months ended June 30, 2010 and 2009, we paid administrative fees toBroadlane of approximately $301,000 and $257,000, respectively. On June 30,2010, accounts payable includes approximately $41,000 in amounts due toBroadlane.

 

TheCompany believes that the aforementioned arrangements and relationships wereprovided in the ordinary course of business at prices and on terms similar tothose that would result from arm’s length negotiation between unrelatedparties.

 

**9.****            ****SegmentInformation**

 

Ourreporting segments consist of Medical Equipment Outsourcing, Technical andProfessional Services, and Medical Equipment Sales and Remarketing. Certainoperating information for our segments as well as a reconciliation of totalCompany gross margin to loss before income tax was as follows:

 

**Medical Equipment Outsourcing**

*(in thousands)*

 
| ** **                     | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                     | ** ** | **2010**                         | ** ** | **2009**                       | ** ** | **2010** | ** ** | **2009** | ** ** |
| Revenues                       |       | $                                | 60,818     |                           | $          | 56,524 |   | $ | 125,992 |   | $ | 114,806 |   |
| Cost of revenue                |       | 22,452                           |       | 19,760                         |       | 45,069 |   | 40,229 |   |
| Medical equipment depreciation |       | 17,358                           |       | 15,904                         |       | 34,815 |   | 31,766 |   |
| Gross margin                   |       | $                                | 21,008     |                           | $          | 20,860 |   | $ | 46,108 |   | $ | 42,811 |   |

 

**Technical and Professional Services**

*(in thousands)*

 
| ** **      | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **      | ** ** | **2010**                         | ** ** | **2009**                       | ** ** | **2010** | ** ** | **2009** | ** ** |
| Revenues        |       | $                                | 11,152     |                           | $          | 10,696 |   | $ | 21,965 |   | $ | 21,108 |   |
| Cost of revenue |       | 8,064                            |       | 7,568                          |       | 15,848 |   | 14,938 |   |
| Gross margin    |       | $                                | 3,088      |                           | $          | 3,128 |   | $ | 6,117 |   | $ | 6,170 |   |

 

**Medical Equipment Sales and Remarketing**

*(in thousands)*

 
| ** **      | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **      | ** ** | **2010**                         | ** ** | **2009**                       | ** ** | **2010** | ** ** | **2009** | ** ** |
| Revenues        |       | $                                | 4,763      |                           | $          | 5,616 |   | $ | 8,950 |   | $ | 10,852 |   |
| Cost of revenue |       | 3,724                            |       | 4,440                          |       | 7,071 |   | 8,826 |   |
| Gross margin    |       | $                                | 1,039      |                           | $          | 1,176 |   | $ | 1,879 |   | $ | 2,026 |   |

 

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**Total Gross Margin and Reconciliation to Loss BeforeIncome Tax**

*(in thousands)*

 
| ** **                          | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                          | ** ** | **2010**                              | ** ** | **2009**                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Total gross margin                  |       | $                                     | 25,135     |                                | $          | 25,164 |   | $ | 54,104 |   | $ | 51,007 |   |
| Selling, general and administrative |       | 20,982                                |       | 21,158                              |       | 42,052 |   | 43,173 |   |
| Interest expense                    |       | 11,855                                |       | 11,845                              |       | 23,362 |   | 23,562 |   |
| Loss before income tax              |       | $                                     | (7,702     | )                                   | $          | (7,839 | ) | $ | (11,310 | ) | $ | (15,728 | ) |

 

**10.****                              ****PensionPlan**

 

Thecomponents of net periodic pension costs are as follows:

 
| ** **                     | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| **(in  thousands)**            | ** ** | **2010**                              | ** ** | **2009**                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Interest cost                  |       | $                                     | 274        |                                | $          | 267 |   | $ | 544 |   | $ | 533 |   |
| Expected return on plan assets |       | (308                                  | )          | (304                                | )          | (609 | ) | (607 | ) |
| Recognized net actuarial loss  |       | 40                                    |       | 4                                   |       | 77 |   | 6 |   |
| Net periodic cost (benefit)    |       | $                                     | 6          |                                | $          | (33 | ) | $ | 12 |   | $ | (68 | ) |

 

Futurebenefit accruals for all participants were frozen as of December 31, 2002.

 

**11.****                              ****SubsequentEvent**

 

EffectiveAugust 11, 2010, the Compensation Committee of our Board of Directorsrecommended, and the Parent Board approved, an amendment (the “Amendment”) tothe vesting provisions contained in all outstanding option agreements ofparticipants in the 2007 Stock Option Plan who were employed by Parent or us asof the effective date of the Amendment, or served on our Board of Directorsthrough that date.  Performance vestingoptions granted under the 2007 Stock Option Plan vest over a six-year periodwith 16.66% vesting on December 31 of each year of the six-year period,subject to the option holder not ceasing employment with Parent or us, and toour attainment of either an adjusted EBITDA target for current fiscal year, oran aggregate adjusted EBITDA target calculated in each subsequent fiscal year,as provided in the respective form of option agreement.  The Amendment, among other things, does awaywith the requirement that the EBITDA-based performance objectives be achievedin order for performance vesting options to vest, in effect providing fortime-based vesting of these options rather than performance vesting.  The Amendment does not change the number ofoptions granted, the strike price, or any continued service requirements.  The Amendment also provides for the accelerationof vesting, for 2007 Stock Option Plan participants who were employed by Parentor us as of the effective date of the Amendment and who were granted optionsprior to December 31, 2009, of options (the “Accelerated Options”) topurchase approximately 2,996,000 shares of common stock of Parent that wereeligible for vesting on December 31, 2009, but did not vest because we didnot achieve the applicable adjusted EBITDA target for the fiscal year endedDecember 31, 2009.  At the timevesting was accelerated, the Accelerated Options remained eligible for vestingin future years based on our achievement of an aggregate adjusted EBITDAtarget.  Except as described above, allother terms and conditions applicable to the Accelerated Options remain ineffect. The Amendment also amends the provisions relating to time vestingoptions granted under the 2007 Stock Option Plan to achieve greater

 

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consistencybetween the treatment of these options and the treatment of performance vestingoptions in the event of a sale of substantially all of the assets of Parent orus. 

 

TheParent Board recognized the increased level of difficulty in achieving theoriginal performance targets relating to performance vesting options (whichwere established in 2007), taking into consideration continued economicchallenges, and authorized the Amendment in an effort to ensure that Parent continuesto provide long-term incentives that drive core operating performance, whilecreating a meaningful retention benefit.

 

Aggregateperformance vesting options affected by the Amendment, including theAccelerated Options, are detailed below by original grant date:

 

**Summary of Performance VestingOptions**

*(in thousands)*

 
| ** **               | ** ** | ** **               | ** ** | **Vested**               | ** ** | ** **        | ** ** | ** **      | ** ** |
|--------------------------|------------|--------------------------|------------|--------------------------|------------|-------------------|------------|-----------------|------------|
| ** **               | ** ** | ** **               | ** ** | **Performance**          | ** ** | ** **        | ** ** | ** **      | ** ** |
| ** **               | ** ** | ** **               | ** ** | **Options**              | ** ** | ** **        | ** ** | ** **      | ** ** |
| ** **               | ** ** | **Performance**          | ** ** | **Outstanding at**       | ** ** | ** **        | ** ** | ** **      | ** ** |
| ** **               | ** ** | **Options**              | ** ** | **August 10, 2010** | ** ** | **Options**       | ** ** | ** **      | ** ** |
| ** **               | ** ** | **Outstanding at**       | ** ** | **(Prior to**            | ** ** | **Affected by**   | ** ** | **Accelerated** | ** ** |
| **Grant Date**           | ** ** | **August 10, 2010** | ** ** | **Amendment)**           | ** ** | **Amendment (1)** | ** ** | **Options (2)** | ** ** |
| June 18,  2007      |       | 17,109                   |       | 5,707                    |       | 11,402            |       | 2,851           |       |
| December 3,  2007   |       | 283                      |       | 48                       |       | 235               |       | 47              |       |
| April 1,  2008      |       | 28                       |       | 5                        |       | 23                |       | 5               |       |
| April 1,  2009      |       | 564                      |       | —                   |       | 564               |       | 94              |       |
| April 13,  2010 (3) |       | 707                      |       | —                   |       | 707               |       | N/A             |       |
| Total                    |       | 18,691                   |       | 5,760                    |       | 12,931            |       | 2,996           |       |

 

----

(1) IncludesAccelerated Options

(2) Accelerated Optionsvesting on August 11, 2010

(3) Options issuedsubsequent to December 31, 2009 were not affected by the accelerated vesting

 

Anaggregate of approximately 2,996,000 options vested on August 11, 2010 asa result of the Parent Board’s acceleration of vesting performance vestingoptions.  The remaining unvested optionsaffected by the Amendment will vest and become exercisable on eachDecember 31, in accordance with the vesting schedule provided in theoption agreements, through the remaining term of the applicable option. We arecurrently in the process of valuing the amended performance vesting optionsaffected by the Amendment and the related impact to our financial statements.

 

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**Item 2.  Management’s Discussionand Analysis of Financial Condition and Results of Operations**

 

Thefollowing should be read in conjunction with the accompanying financialstatements and notes.

 

**BUSINESS OVERVIEW**

 

**OurCompany**

 

UniversalHospital Services, Inc. (“we”, “our”, “us”, the “Company”, or “UHS”) is aleading nationwide provider of medical equipment management and servicesolutions to the United States health care industry. Our customers includenational, regional and local acute and long-term acute care hospitals,alternate site providers (such as long-term acute care hospitals, skilled nursingfacilities, specialty hospitals, nursing homes, and home care providers) andmedical equipment manufacturers.  Weprovide our customers equipment management and service solutions across thespectrum of the equipment life cycle as a result of our position as one of theindustry’s largest purchasers and outsourcers of medical equipment. During thetwelve months ended June 30, 2010, we owned or managed over 565,000 piecesof medical equipment consisting of 370,000 owned or managed pieces in our MedicalEquipment Outsourcing segment and 195,000 pieces of customer owned equipment wemanage in our Technical and Professional Services segment. Our diverse medicalequipment outsourcing customer base includes more than 4,250 acute carehospitals and approximately 4,350 alternate site providers.  We also have relationships with more than 200medical equipment manufacturers and many of the nation’s largest grouppurchasing organizations (“GPOs”) and many of the integrated delivery networks(“IDNs”).  All of our solutions leverageour nationwide network of 84 offices and our over 70 years of experiencemanaging and servicing all aspects of medical equipment.  Our fees are paid directly by our customersrather than from direct reimbursement from third-party payors, such as privateinsurers, Medicare, or Medicaid.  Wecommenced operations in 1939, originally incorporated in Minnesota in 1954 andreincorporated in Delaware in 2001. Historically, we have experienced significant and sustained growth. Ouroverall growth strategy is to continue to grow both organically and throughstrategic acquisitions.  In 2010, theCompany has increased its focus on potential acquisitions and internationalgrowth opportunities.

 

As one of the nation’s leading medical equipmentmanagement  and service solutionscompanies, we design and offer comprehensive solutions for our customers thathelp reduce capital and operating expenses, increase equipment and staffproductivity and support improved patient safety and outcomes.

 

 

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Ourreporting segments consist of Medical Equipment Outsourcing, Technical andProfessional Services and Medical Equipment Sales andRemarketing.  We evaluate the performance of our reporting segmentsbased on gross margin and gross margin before purchase accounting adjustments.The accounting policies of the individual reporting segments are the same asthose of the entire Company.

 

Wepresent the non-generally accepted accounting principles (“GAAP”) financialmeasure gross margin, before purchase accounting adjustments, because we usethis measure to monitor and evaluate the operational performance of ourbusiness and to assist analysts, investors and lenders in their comparisons ofoperational performance across companies, many of whose results will notinclude similar adjustments. A reconciliation of the non-GAAP financial measureto its equivalent GAAP measure is included in the respective tables.

 

**MedicalEquipment Outsourcing Segment - Manage & Utilize**

 

Ourflagship business is our Medical Equipment Outsourcing segment, which accountedfor $60.9 million, or approximately 79.3% of our revenues, for the quarterended June 30, 2010 and $126.0 million, or approximately 80.3% of ourrevenues, for the six months ended June 30, 2010. As of June 30,2010, we owned or managed over 370,000 pieces of medical equipment in ourMedical Equipment Outsourcing segment, primarily in the categories ofrespiratory therapy, newborn care, critical care, patient monitors, patienthandling (such as beds, stretchers and wheelchairs), pressure area management(such as therapy surfaces) and wound therapy. Historically, we have purchased and directly owned the equipment used inour medical equipment outsourcing programs. During 2007, we entered into“revenue sharing” agreements with a select few manufacturers of equipment wherethe manufacturers retain ownership of the equipment, but UHS takes possession andmanages the rental of the equipment to customers.   We may enter into more of such arrangementsin the future.  Such arrangements areless capital-intensive for us.  InJanuary 2010, one of these agreements was modified such that we purchased$16.6 million of the manufacturer’s equipment that we previously managed, butdid not own. With this January 2010 purchase, the revenue share portion ofthe agreement was terminated and we began to recognize 100% of the revenueassociated with this equipment.

 

Weperform regular and preventative maintenance on the equipment and retaindetailed records for documentation.  Werepair, test and clean the equipment. Our service includes prompt replacementof non-working equipment and the flexibility to upgrade technology as acustomer’s product of choice changes.  Wehave three primary outsourcing programs:

 

·                  Supplemental and Peak Needs Usage;

·                  Customized Outsourcing Agreements; and

·                  Asset360TM Program(formerly Asset Management Partnership Program, or “AMPP”).

 

Wehave contracts in place with many of the leading national GPOs for both theacute care and alternate site markets. We also have agreements directly with national acute care and alternatesite providers. We expect much of our future growth in this segment to bedriven by our customers outsourcing more of their medical equipment needs andtaking full advantage of our diversified product offering, customizedoutsourcing agreements and Asset360 Programs.

 

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OnJuly 13, 2010, the U.S. Food and Drug Administration (“FDA”) issued afinal order and transition plan to Baxter Healthcare Corporation (“Baxter”) torecall all Colleague infusion pumps currently in use in the United States. TheFDA order establishes the framework for the recall by providing for a cashrefund, generally, $1,500 for single channel pumps and $3,000 for triplechannel pumps, or a replacement pump to owners within a two-year period.

 

AtJune 30, 2010, we owned approximately 11,900 Colleague pumps. We arecurrently in the process of evaluating the course of action that best meets theinfusion technology needs of our customers and our business. As such, while weexpect to recognize gains and also expect to increase purchases of infusionpumps to replace recalled units, the timing and extent of those gains orcapital expenditures are not readily estimable.

 

**Technicaland Professional Services Segment - Plan & Acquire;Maintain & Repair**

 

OurTechnical and Professional Services segment accounted for $11.2 million, orapproximately 14.5% of our revenues for the quarter ended June 30, 2010and $22.0 million, or approximately 14.0% of our revenues for the six monthsended June 30, 2010. We leverage our 70 years of experience and ourextensive equipment database in repairing and maintaining medicalequipment.  We offer a broad range ofinspection, preventative maintenance, repair, logistic and consulting servicesthrough our team of approximately 325 technicians and professionals locatedthroughout the United States in our nationwide network of offices. During thetwelve months ended June 30, 2010, we managed over 195,000 units ofcustomer owned equipment. In addition, during the twelve months endedJune 30, 2010, we serviced over 370,000 units that we own or directlymanage. Our technical and professional service offerings are lesscapital-intensive than our Medical Equipment Outsourcing segment, and provide acomplementary alternative for customers that wish to own their medicalequipment, but lack the infrastructure, expertise or scale to perform routinemaintenance, repair, record-keeping and lifecycle analysis and planningfunctions.

 

**MedicalEquipment Sales and Remarketing Segment - Redeploy & Remarket**

 

OurMedical Equipment Sales and Remarketing segment accounted for $4.8 million, orapproximately 6.2%, of our revenues for the quarter ended June 30, 2010and $9.0 million, or approximately 5.7% of our revenues for the six monthsended June 30, 2010. This segment includes three distinct businessactivities:

 

***Medical Equipment Remarketing and Disposal.*********We are one of the nation’slargest buyers and sellers of pre-owned medical equipment.  We buy,source, remarket and dispose of pre-owned medical equipment for our customersand on our own behalf. We provide our customers with the ability to sell theirunneeded medical equipment for immediate cash or credit. Customers can alsotake advantage of our disposal services, where we dispose of equipment that hasno remaining economic value in a safe and environmentally appropriate manner.

 

***Specialty Medical Equipment Sales and Distribution.*********We use our nationalinfrastructure to provide sales and distribution services to manufacturers ofspecialty medical equipment on a limited basis.  Our distribution servicesinclude providing demonstrations services and product maintenanceservices.  We act as a distributor for only a limited number of productsthat are particularly suited to our national distribution network or that fitwith our ability to provide technical support.  We currently sell

 

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equipmentin selected product lines including, but not limited to, respiratory percussionvests, continuous passive motion machines, patient monitors, patient handlingequipment and infant security systems.

 

***Sales of Disposables******.***We offer our customers single use disposableitems.  Most of these items are used in connection with our outsourced equipment. We offer these products as a convenience to customers and to complement ourfull medical equipment lifecycle solutions.

 

**RESULTS OF OPERATIONS**

 

Thefollowing discussion addresses:

 

·                  our financial condition asof June 30, 2010 and

·                  the results of operationsfor the three and six-month periods ended June 30, 2010 and 2009.

 

Thisdiscussion should be read in conjunction with the financial statements includedelsewhere in this Quarterly Report on Form 10-Q and the Management’sDiscussion and Analysis of Financial Condition and Results of Operationssection included in our 2009 Annual Report on Form 10-K, filed with theSecurities and Exchange Commission (the “2009 10-K”).

 

Thefollowing table provides information on the percentages of certain items ofselected financial data compared to total revenues for the three and six-monthperiods ended June 30, 2010 and 2009. The table below also indicates the percentage increase or decrease overthe prior comparable period.

** **
| ** **                                                                                                                      | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                                                      | ** ** | ** **                           | ** ** | ** **                         | ** ** | **Percent** | ** ** | ** ** | ** ** | ** ** | ** ** | **Percent** | ** ** |
| ** **                                                                                                                      | ** ** | **Percent of Total Revenues**        | ** ** | **Increase**                       | ** ** | **Percent of Total Revenues** | ** ** | **Increase** | ** ** |
| ** **                                                                                                                      | ** ** | **2010**                             | ** ** | **2009**                           | ** ** | **(Decrease)** | ** ** | **2010** | ** ** | **2009** | ** ** | **(Decrease)** | ** ** |
| **Revenue**                                                                                                                     |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |
| Medical equipment outsourcing                                                                                                   |       | 79.3                                 | %          | 77.6                               | %          | 7.6 | % | 80.3 | % | 78.2 | % | 9.7 | % |
| Technical and professional services                                                                                             |       | 14.5                                 |       | 14.7                               |       | 4.3 |   | 14.0 |   | 14.4 |   | 4.1 |   |
| Medical equipment sales and remarketing                                                                                         |       | 6.2                                  |       | 7.7                                |       | (15.2 | ) | 5.7 |   | 7.4 |   | (17.5 | ) |
| Total revenues                                                                                                                  |       | 100.0                                | %          | 100.0                              | %          | 5.4 |   | 100.0 | % | 100.0 | % | 6.9 |   |
|                                                                                                                            |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |
| **Cost of Sales**                                                                                                               |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |
| Cost of medical equipment outsourcing                                                                                           |       | 29.3                                 |       | 27.1                               |       | 13.6 |   | 28.7 |   | 27.4 |   | 12.0 |   |
| Cost of technical and professional services                                                                                     |       | 10.5                                 |       | 10.4                               |       | 6.6 |   | 10.1 |   | 10.2 |   | 6.1 |   |
| Cost of medical equipment sales and remarketing                                                                                 |       | 4.8                                  |       | 6.1                                |       | (16.1 | ) | 4.5 |   | 6.0 |   | (19.9 | ) |
| Medical equipment depreciation                                                                                                  |       | 22.6                                 |       | 21.9                               |       | 9.1 |   | 22.2 |   | 21.6 |   | 9.6 |   |
| Total costs of medical equipment outsourcing,  technical and professional services and medical equipment sales and  remarketing |       | 67.2                                 |       | 65.5                               |       | 8.2 |   | 65.5 |   | 65.2 |   | 7.4 |   |
| Gross margin                                                                                                                    |       | 32.8                                 |       | 34.5                               |       | (0.1 | ) | 34.5 |   | 34.8 |   | 6.1 |   |
|                                                                                                                            |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |
| Selling, general and administrative                                                                                             |       | 27.4                                 |       | 29.0                               |       | (0.8 | ) | 26.8 |   | 29.4 |   | (2.6 | ) |
| Operating income                                                                                                                |       | 5.4                                  |       | 5.5                                |       | 3.7 |   | 7.7 |   | 5.4 |   | 53.8 |   |
|                                                                                                                            |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |
| Interest expense                                                                                                                |       | 15.4                                 |       | 16.3                               |       | 0.1 |   | 14.9 |   | 16.1 |   | (0.8 | ) |
| Loss before income taxes                                                                                                        |       | (10.0                                | )          | (10.8                              | )          | (1.7 | ) | (7.2 | ) | (10.7 | ) | (28.1 | ) |
|                                                                                                                            |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |
| Benefit for income taxes                                                                                                        |       | (3.3                                 | )          | (4.2                               | )          | (15.6 | ) | (2.5 | ) | (4.2 | ) | (36.6 | ) |
| Net loss                                                                                                                        |       | (6.7                                 | )%         | (6.6                               | )%         | 7.0 |   | (4.7 | )% | (6.5 | )% | (22.7 | ) |

 

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**Resultsof Operations for the three month period ended June 30, 2010 compared tothe three month period ended June 30, 2009**

 

**Medical Equipment Outsourcing Segment — Manage &Utilize**

*(in thousands)*

 
| ** **                                                                                                             | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|------------|------------|------------|------------|
| ** **                                                                                                             | ** ** | **June 30,**      | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                                             | ** ** | **2010**               | ** ** | **2009**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| Total revenue                                                                                                          |       | $                      | 60,818     |       | $          | 56,524     |       | $ | 4,294 |   | 7.6 | % |
| Cost of revenue                                                                                                        |       | 22,452                 |       | 19,760     |       | 2,692      |       | 13.6 |   |
| Medical equipment depreciation                                                                                         |       | 17,358                 |       | 15,904     |       | 1,454      |       | 9.1 |   |
| Gross margin                                                                                                           |       | $                      | 21,008     |       | $          | 20,860     |       | $ | 148 |   | 0.7 |   |
|                                                                                                                   |       |                   |       |       |       |       |       |   |   |
| Gross margin %                                                                                                         |       | 34.5                   | %          | 36.9       | %          |       |       |   |   |
|                                                                                                                   |       |                   |       |       |       |       |       |   |   |
| Gross margin                                                                                                           |       | $                      | 21,008     |       | $          | 20,860     |       | $ | 148 |   | 0.7 |   |
| Purchase accounting adjustments, primarily  non-cash charges related to step-up in carrying value of medical equipment |       | 3,280                  |       | 3,544      |       | (264       | )          | (7.4 | ) |
| Gross margin, before purchase accounting  adjustments                                                                  |       | $                      | 24,288     |       | $          | 24,404     |       | $ | (116 | ) | (0.5 | ) |
|                                                                                                                   |       |                   |       |       |       |       |       |   |   |
| Gross margin %, before purchase accounting  adjustments                                                                |       | 39.9                   | %          | 43.2       | %          |       |       |   |   |

 

Totalrevenue in the Medical Equipment Outsourcing segment increased $4.3 million, or7.6%, to $60.9 million in the second quarter of 2010 as compared to the sameperiod of 2009.  This increase resultedprimarily from increased activity in our Asset360TM Programs(formerly AMPP), patient handling and wound therapy solutions, partially offsetby sluggish patient census and what we believe has been an increased customereffort to control outsourcing expenses. Beginning January 2010, ourpatient handling revenues reflect the benefit of recognizing 100% of therevenue previously covered under a revenue share agreement. Our Asset360Programs increased from 55 programs at June 30, 2009 to 69 programs atJune 30, 2010.

 

Totalcost of revenue in the segment increased $2.7 million, or 13.6%, to $22.5million in the second quarter of 2010 as compared to the same period of2009.  This increase is attributable tohigher employee-related, vehicle-related, and other expenses of $2.2, $0.2, and$0.3 million, respectively.

 

Medicalequipment depreciation increased $1.5 million, or 9.1%, to $17.4 million in thesecond quarter of 2010 as compared to the same period of 2009. The increase inmedical equipment depreciation primarily relates to the increase in medicalequipment purchases related to select patient handling medical equipment, whichwe previously only managed under a revenue share agreement. Medical equipmentdepreciation for the quarter ended June 30, 2010 and 2009 included $3.3million and $3.4 million, respectively, of purchase accounting adjustmentsrelated to the step-up in carrying value of our medical equipment.

 

Grossmargin percentage for the Medical Equipment Outsourcing segment decreased from36.9% in the second quarter of 2009 to 34.5% in the second quarter of 2010.Gross margin percentage, before purchase accounting adjustments, decreased from43.2% in the second quarter of 2009 to at 39.9% in the second quarter of2010.  These decreases resulted primarilyfrom an overall decrease in patient census, increased depreciation expense, andwhat we believe to be an increased customer effort to control outsourcingexpenses, partially offset by increased activity in our Asset360 Programs,patient handling and wound therapy solutions.

 

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**Technical and Professional Services Segment —Plan & Acquire; Maintain & Repair**

*(in thousands)*

 
| ** **                                                                                          | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------------------|------------|------------|------------|------------|------------|
| ** **                                                                                          | ** ** | **June 30,**      | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                          | ** ** | **2010**               | ** ** | **2009**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| Total revenue                                                                                       |       | $                      | 11,152     |       | $          | 10,696     |       | $ | 456 |   | 4.3 | % |
| Cost of revenue                                                                                     |       | 8,064                  |       | 7,568      |       | 496        |       | 6.6 |   |
| Gross margin                                                                                        |       | $                      | 3,088      |       | $          | 3,128      |       | $ | (40 | ) | (1.3 | ) |
|                                                                                                |       |                   |       |       |       |       |       |   |   |
| Gross margin %                                                                                      |       | 27.7                   | %          | 29.2       | %          |       |       |   |   |
|                                                                                                |       |                   |       |       |       |       |       |   |   |
| Gross margin                                                                                        |       | $                      | 3,088      |       | $          | 3,128      |       | $ | (40 | ) | (1.3 | ) |
| Purchase accounting adjustments, primarily  non-cash charges related to favorable lease commitments |       | 3                      |       | 5          |       | (2         | )          | (40.0 | ) |
| Gross margin, before purchase accounting  adjustments                                               |       | $                      | 3,091      |       | $          | 3,133      |       | $ | (42 | ) | (1.3 | ) |
|                                                                                                |       |                   |       |       |       |       |       |   |   |
| Gross margin %, before purchase accounting adjustments                                              |       | 27.7                   | %          | 29.3       | %          |       |       |   |   |

 

Totalrevenue in the Technical and Professional Services segment increased $0.5million, or 4.3%, to $11.2 million in the second quarter of 2010 as compared tothe same period of 2009. This increase resulted from increases in ourmanufacturer services unit of $0.6 million, partially offset by a decrease inour supplemental service programs of $0.1 million.

 

Totalcost of revenue in the segment increased $0.5 million, or 6.6%, to $8.1 millionin the second quarter of 2010 as compared to the same period of 2009.  The increase is attributable to increases inour third-party vendor costs and other expenses of $0.3 and $0.2, respectively.

 

Grossmargin percentage for the Technical and Professional Services segment decreasedfrom 29.2% for the second quarter of 2009 to 27.7% for the same period of 2010.Gross margin percentage will fluctuate based on the variability of third-partyvendor expenses in our BioMed360TM Programs(formerly Customized Healthcare Asset Management Programs, or “CHAMP”) andsupplemental service programs.

 

**Medical Equipment Sales and Remarketing Segment —Redeploy & Remarket**

*(in thousands)*

 
| ** **                                                                                                                     | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|------------|------------|------------|------------|
| ** **                                                                                                                     | ** ** | **June 30,**      | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                                                     | ** ** | **2010**               | ** ** | **2009**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| Total revenue                                                                                                                  |       | $                      | 4,763      |       | $          | 5,616      |       | $ | (853 | ) | (15.2 | )% |
| Cost of revenue                                                                                                                |       | 3,724                  |       | 4,440      |       | (716       | )          | (16.1 | ) |
| Gross margin                                                                                                                   |       | $                      | 1,039      |       | $          | 1,176      |       | $ | (137 | ) | (11.6 | ) |
|                                                                                                                           |       |                   |       |       |       |       |       |   |   |
| Gross margin %                                                                                                                 |       | 21.8                   | %          | 20.9       | %          |       |       |   |   |
|                                                                                                                           |       |                   |       |       |       |       |       |   |   |
| Gross margin                                                                                                                   |       | $                      | 1,039      |       | $          | 1,176      |       | $ | (137 | ) | (11.6 | ) |
| Purchase accounting adjustments, primarily non-cash  charges related to the step-up in carrying value of our medical equipment |       | 81                     |       | 278        |       | (197       | )          | (70.9 | ) |
| Gross margin, before purchase accounting  adjustments                                                                          |       | $                      | 1,120      |       | $          | 1,454      |       | $ | (334 | ) | (23.0 | ) |
|                                                                                                                           |       |                   |       |       |       |       |       |   |   |
| Gross margin %, before purchase accounting  adjustments                                                                        |       | 23.5                   | %          | 25.9       | %          |       |       |   |   |

 

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Totalrevenue in the Medical Equipment Sales and Remarketing segment decreased $0.9million, or 15.2%, to $4.8 million in the second quarter of 2010 as compared tothe same period of 2009.  The decreasewas primarily driven by decreases in new and other equipment sales of $1.1 and$0.3 million, respectively, partially offset by an increase in disposable salesof $0.5 million.

 

Totalcost of revenue in the segment decreased $0.7 million, or 16.1%, to $3.7million in the second quarter of 2010 as compared to the same period of2009.  The decrease was primarily due todecreases in the costs of new and other equipment of $0.6 and $0.4 million,respectively, partially offset by an increase in the cost of disposables salesof $0.3 million. During the quarters ended June 30, 2010 and 2009,purchase accounting adjustments related to medical equipment sold increasedcost of revenue by $0.1 and $0.3 million, respectively.

 

Grossmargin percentage for the Medical Equipment Sales and Remarketing segmentincreased from 20.9% in the second quarter of 2009 to 21.8% for the same periodof 2010.  Gross margin percentage, beforepurchase accounting adjustments, decreased from 25.9% in the second quarter of2009 to 23.5% for the same period of 2010. We expect margins and activity in this segment to fluctuate based on thetransactional nature of the business.

 

***Selling, General and Administrative***

 

**Selling, General and Administrative and InterestExpense**

*(in thousands)*

 
| ** **                          | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------------|------------|------------------------|------------|------------|------------|------------|------------|
| ** **                          | ** ** | **June 30,**      | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                          | ** ** | **2010**               | ** ** | **2009**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| Selling, general and administrative |       | $                      | 20,982     |       | $          | 21,158     |       | $ | (176 | ) | (0.8 | )% |
| Interest expense                    |       | 11,855                 |       | 11,845     |       | 10         |       | 0.1 |   |
|                                     |            |                        |            |            |            |            |            |  |  |  |  |  |

 

Selling,general and administrative expense decreased $0.2 million, or 0.8%, to $21.0million for the second quarter of 2010 as compared to the same period of2009.  Selling, general andadministrative expense consists primarily of employee-related expenses,professional fees, occupancy charges, bad debt expense and depreciation andamortization.  Selling, general andadministrative expense during the quarter ended June 30, 2010 benefitedfrom lower employee-related expenses, travel and entertainment, and otherexpense of $0.4, $0.3, and $0.1 million, respectively, partially offset byhigher outside service expenses of $0.6 million. Selling, general andadministrative expense as a percentage of total revenue was 27.4% and 29.0% foreach of the quarters ended June 30, 2010 and 2009, respectively.

 

***Interest Expense***

 

Interestexpense remained relatively flat at $11.9 million for the second quarter of2010 as compared to the same period of 2009.

 

**IncomeTaxes**

 

Benefitfor income taxes decreased $0.5 million to $2.6 million during the secondquarter of 2010 as compared to the same period of 2009.

 

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**NetLoss**

 

Netloss increased $0.3 million to $5.1 million in the second quarter of 2010 ascompared to the same period of 2009.

 

**Resultsof Operations for the Six Months Ended June 30, 2010 compared to the SixMonths Ended June 30, 2009**

 

**Medical Equipment Outsourcing Segment — Manage &Utilize**

*(in thousands)*

 
| ** **                                                                                                             | ** ** | **Six Months Ended  June 30,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|------------|------------|------------|------------|
| ** **                                                                                                             | ** ** | **2010**                       | ** ** | **2009**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| Total revenue                                                                                                          |       | $                              | 125,992    |       | $          | 114,806    |       | $ | 11,186 |   | 9.7 | % |
| Cost of revenue                                                                                                        |       | 45,069                         |       | 40,229     |       | 4,840      |       | 12.0 |   |
| Medical equipment depreciation                                                                                         |       | 34,815                         |       | 31,766     |       | 3,049      |       | 9.6 |   |
| Gross margin                                                                                                           |       | $                              | 46,108     |       | $          | 42,811     |       | $ | 3,297 |   | 7.7 |   |
|                                                                                                                   |       |                           |       |       |       |       |       |   |   |
| Gross margin %                                                                                                         |       | 36.6                           | %          | 37.3       | %          |       |       |   |   |
|                                                                                                                   |       |                           |       |       |       |       |       |   |   |
| Gross margin                                                                                                           |       | $                              | 46,108     |       | $          | 42,811     |       | $ | 3,297 |   | 7.7 |   |
| Purchase accounting adjustments, primarily  non-cash charges related to step-up in carrying value of medical equipment |       | 6,738                          |       | 7,125      |       | (387       | )          | (5.4 | ) |
| Gross margin, before purchase accounting  adjustments                                                                  |       | $                              | 52,846     |       | $          | 49,936     |       | $ | 2,910 |   | 5.8 |   |
|                                                                                                                   |       |                           |       |       |       |       |       |   |   |
| Gross margin %, before purchase accounting  adjustments                                                                |       | 41.9                           | %          | 43.5       | %          |       |       |   |   |

 

Totalrevenue in the Medical Equipment Outsourcing segment increased $11.2 million,or 9.7%, to $126.0 million in the first six months of 2010 as compared to thesame period of 2009.  This increaseresulted primarily from increased activity in our Asset360TM Programs (formerly AMPP), patient handling andwound therapy solutions, partially offset by sluggish patient census and whatwe believe has been an increased customer effort to control outsourcingexpenses. Beginning January 2010, our patient handling revenues reflectthe benefit of recognizing 100% of the revenue previously covered under arevenue share agreement. Our Asset360 Programs increased from 55 programs at June 30,2009 to 69 programs at June 30, 2010.

 

Totalcost of revenue in the segment increased $4.8 million, or 12%, to $45.1 millionin the first six months of 2010 as compared to the same period of 2009.  This increase is primarily related toemployee-related, vehicle-related, and other expenses of $3.9, $0.5, and $0.4million, respectively.

 

Medicalequipment depreciation increased $3.0 million, or 9.6%, to $34.8 million in thefirst six months of 2010 as compared to the same period of 2009.  The increase in medical equipmentdepreciation primarily relates to the increase in medical equipment purchasesrelated to select patient handling medical equipment, which we previously onlymanaged under a revenue share agreement. Medical equipment depreciation for thesix months ended June 30, 2010 and 2009 include $6.4 and $6.8 million,respectively, of purchase accounting adjustments related to the step-up incarrying value of our medical equipment.

 

Grossmargin percentage for the Medical Equipment Outsourcing segment decreased from37.3% in the first six months of 2009 to 36.6% for the same period of 2010.Gross margin percentage, before 

 

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purchaseaccounting adjustments, decreased from 43.5% in the first six months of 2009 to41.9% in the first six months of 2010. We believe this decrease resulted primarily from an overall decrease inpatient census and what we believe to be an increased customer effort tocontrol outsourcing expenses and increased depreciation, partially offset byincreased activity in our Asset360 Programs, patient handling and wound therapysolutions.

 

**Technical and Professional Services Segment — Plan &Acquire; Maintain & Repair**

*(in thousands)*

 
| ** **                                                                                          | ** ** | **Six Months Ended  June 30,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|------------|------------|------------|------------|
| ** **                                                                                          | ** ** | **2010**                       | ** ** | **2009**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| Total revenue                                                                                       |       | $                              | 21,965     |       | $          | 21,108     |       | $ | 857 |   | 4.1 | % |
| Cost of revenue                                                                                     |       | 15,848                         |       | 14,938     |       | 910        |       | 6.1 |   |
| Gross margin                                                                                        |       | $                              | 6,117      |       | $          | 6,170      |       | $ | (53 | ) | (0.9 | ) |
|                                                                                                |       |                           |       |       |       |       |       |   |   |
| Gross margin %                                                                                      |       | 27.8                           | %          | 29.2       | %          |       |       |   |   |
|                                                                                                |       |                           |       |       |       |       |       |   |   |
| Gross margin                                                                                        |       | $                              | 6,117      |       | $          | 6,170      |       | $ | (53 | ) | (0.9 | ) |
| Purchase accounting adjustments, primarily  non-cash charges related to favorable lease commitments |       | 6                              |       | 9          |       | (3         | )          | (33.3 | ) |
| Gross margin, before purchase accounting  adjustments                                               |       | $                              | 6,123      |       | $          | 6,179      |       | $ | (56 | ) | (0.9 | ) |
|                                                                                                |       |                           |       |       |       |       |       |   |   |
| Gross margin %, before purchase accounting  adjustments                                             |       | 27.9                           | %          | 29.3       | %          |       |       |   |   |

 

Totalrevenue in the Technical and Professional Services segment increased $0.9million, or 4.1%, to $22.0 million in the first six months of 2010 as comparedto the same period of 2009. This increase was primarily attributable to anincrease in episodic business flows in our manufacturer services unit.

 

Totalcost of revenue in the segment increased $0.9 million, or 6.1%, to $15.8million in the first six months of 2010 as compared to the same period of2009.  This increase was primarilyattributable to an increase in expenses associated with our manufacturerservices unit, third-party vendor, and other expenses of $0.4, $0.4, and $0.1million, respectively.

 

Grossmargin percentage for the Technical and Professional Services segment decreasedfrom 29.2% for the first six months of 2009 to 27.8% for the same period of2010.  Gross margin percentage willfluctuate based on the variability of third-party vendor expenses in ourBioMed360TM Programs (formerly CHAMP) and supplementalservice programs.

 

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**Medical Equipment Sales and Remarketing Segment —Redeploy & Remarket**

*(in thousands)*

 
| ** **                                                                                                                  | ** ** | **Six Months Ended  June 30,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|------------|------------|------------|------------|
| ** **                                                                                                                  | ** ** | **2010**                       | ** ** | **2009**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| Total revenue                                                                                                               |       | $                              | 8,950      |       | $          | 10,852     |       | $ | (1,902 | ) | (17.5 | )% |
| Cost of revenue                                                                                                             |       | 7,071                          |       | 8,826      |       | (1,755     | )          | (19.9 | ) |
| Gross margin                                                                                                                |       | $                              | 1,879      |       | $          | 2,026      |       | $ | (147 | ) | (7.3 | ) |
|                                                                                                                        |       |                           |       |       |       |       |       |   |   |
| Gross margin %                                                                                                              |       | 21.0                           | %          | 18.7       | %          |       |       |   |   |
|                                                                                                                        |       |                           |       |       |       |       |       |   |   |
| Gross margin                                                                                                                |       | $                              | 1,879      |       | $          | 2,026      |       | $ | (147 | ) | (7.3 | ) |
| Purchase accounting adjustments, primarily  non-cash charges related to step-up in carrying value of our medical  equipment |       | 158                            |       | 602        |       | (444       | )          | (73.8 | ) |
| Gross margin, before purchase accounting  adjustments                                                                       |       | $                              | 2,037      |       | $          | 2,628      |       | $ | (591 | ) | (22.5 | ) |
|                                                                                                                        |       |                           |       |       |       |       |       |   |   |
| Gross margin %, before purchase accounting  adjustments                                                                     |       | 22.8                           | %          | 24.2       | %          |       |       |   |   |

 

Totalrevenue in the Medical Equipment Sales and Remarketing segment decreased $1.9million, or 17.5%, to $9.0 million in the first six months of 2010 as comparedto the same period of 2009.  The decreasewas primarily driven by a decrease in new equipment and pre-owned equipmentsales of $1.8 and $0.7 million, respectively, partially offset by an increasein disposables sales of $0.6 million.

 

Totalcost of revenue in the segment decreased $1.8 million, or 19.9%, to $7.1million in the first six months of 2010 as compared to the same period of2009.  The decrease was primarily due toa decrease in the cost of new equipment, pre-owned equipment, and other salesof $1.2, $0.9 and $0.2 million, respectively, partially offset by an increasein the cost of disposables sales of $0.5 million. During the six month periodsended June 30, 2010 and 2009, purchase accounting adjustments related tomedical equipment sold impacted cost of revenue by $0.2 million and $0.6million, respectively.

 

Grossmargin percentage for the Medical Equipment Sales and Remarketing segmentincreased from 18.7% in the first six months of 2009 to 21.0% for the sameperiod of 2010.  Gross margin percentage,before purchase accounting adjustments, decreased from 24.2% in the first sixmonths of 2009 to 22.8% for the same period of 2010.  We expect margins and activity in thissegment to fluctuate based on the transactional nature of the business.

 

**Selling, General and Administrative and Interest Expense**

*(in thousands)*

 
| ** **                          | ** ** | **Six Months Ended  June 30,** | ** ** | ** ** | ** ** | ** **        | ** ** |
|-------------------------------------|------------|--------------------------------|------------|------------|------------|-------------------|------------|
| ** **                          | ** ** | **2010**                       | ** ** | **2009**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| Selling, general and administrative |       | $                              | 42,052     |       | $          | 43,173            |       | $ | (1,121 | ) | (2.6 | )% |
| Interest expense                    |       | 23,362                         |       | 23,562     |       | (200              | )          | (0.8 | ) |
|                                     |            |                                |            |            |            |                   |            |  |  |  |  |  |

 

***Selling, General and Administrative***

 

Selling,general and administrative expense decreased $1.1 million, or 2.6%, to $42.1million for the first six months of 2010 as compared to the same period of2009.  Selling, general andadministrative expense consists primarily of employee-related expenses, professionalfees, occupancy charges, bad debt expense and depreciation andamortization.  Selling, general andadministrative expense during the six months ended June 30, 2010 benefitedfrom lower amortization, bad debt expense, employee-related 

 

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expenses,and travel and entertainment of $0.6, $0.6, $0.4, and $0.4 million,respectively, partially offset by higher outside service and other expenses of$0.7 and $0.2 million, respectively. Selling, general and administrative expense as a percentage of totalrevenue was 26.8% and 29.4% for the six month periods ended June 30, 2010and 2009, respectively.

 

***Interest Expense***

 

Interestexpense decreased $0.2 million, or 0.2%, to $23.4 million during the first sixmonths of 2010 as compared to the same period of 2009.

 

**IncomeTaxes**

 

Benefitfor income taxes decreased $2.2 million to $3.9 million during the first sixmonths of 2010 as compared to the same period of 2009.  The decrease is attributable to the lowercomparable loss before income taxes.

 

**NetLoss**

 

Netloss decreased $2.2 million to $7.4 million in the first six months of 2010 ascompared to the same period of 2009. This decrease resulted primarily fromincreased activity in our Asset360 Programs, patient handling and wound therapysolutions, partially offset by an overall decrease in patient census and whatwe believe to be an increased customer effort to control outsourcing expenses.

 

**EBITDA**

 

EarningsBefore Interest, Taxes, Depreciation and Amortization (“EBITDA”) was $58.0 and$51.3 million for the quarters ended June 30, 2010 and 2009,respectively.  EBITDA for the quarterended June 30, 2010, was primarily driven by increased activity in ourAsset360 Programs, patient handling and wound therapy solutions.

 

EBITDAis defined as earnings before interest expense, income taxes, depreciation andamortization. In addition to using EBITDA internally as measure of operationalperformance, we disclose it externally to assist analysts, investors andlenders in their comparisons of operational performance, valuation and debtcapacity across companies with differing capital, tax and legalstructures.  Management also understands thatsome industry analysts and investors consider EBITDA as a supplementarynon-GAAP financial measure useful in analyzing a company’s ability to servicedebt.  EBITDA, however, is not a measureof financial performance under GAAP and should not be considered as analternative to, or more meaningful than, net income as a measure of operatingperformance or to cash flows from operating, investing or financing activitiesor as a measure of liquidity.  SinceEBITDA is not a measure determined in accordance with GAAP and is thussusceptible to varying interpretations and calculations, EBITDA, as presented,may not be comparable to other similarly titled measures of othercompanies.  EBITDA does not represent anamount of funds that is available for management’s discretionary use. Areconciliation of EBITDA to net cash provided by operating activities isincluded below:

 

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| ** **                                  | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------|------------|----------------------|------------|
| ** **                                  | ** ** | **June 30,**    | ** ** |
| **(in thousands)**                          | ** ** | **2010**             | ** ** | **2009** | ** ** |
| Net cash provided by operating activities   |       | $                    | 42,218     |   | $ | 25,347 |   |
| Changes in operating assets and liabilities |       | (5,187               | )          | 7,034 |   |
| Other non-cash expenses                     |       | 1,537                |       | 1,502 |   |
| Benefit for income taxes                    |       | (3,890               | )          | (6,135 | ) |
| Interest expense                            |       | 23,362               |       | 23,562 |   |
| EBITDA                                      |       | $                    | 58,040     |   | $ | 51,310 |   |

 
| ** **                                                         | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                         | ** ** | **June 30,**    | ** ** |
| **(in thousands)**                                                 | ** ** | **2010**             | ** ** | **2009** | ** ** |
| EBITDA                                                             |       | $                    | 58,040     |   | $ | 51,310 |   |
|                                                               |       |                 |       |   |   |
| **Other Financial Data:**                                          |       |                 |       |   |   |
| Net cash provided by operating activities                          |       | $                    | 42,218     |   | $ | 25,347 |   |
| Net cash used in investing activities                              |       | (48,653              | )          | (15,664 | ) |
| Net cash provided by (used in) financing  activities               |       | 6,435                |       | (18,189 | ) |
|                                                               |       |                 |       |   |   |
| **Other Operating Data (as of end  of period):**                   |       |                 |       |   |   |
| Medical equipment (approximate number of owned outsourcing  units) |       | 227,000              |       | 217,000 |   |
| District offices                                                   |       | 84                   |       | 84 |   |
| Number of outsourcing hospital customers                           |       | 4,250                |       | 4,150 |   |
| Number of total outsourcing customers                              |       | 8,550                |       | 8,300 |   |

 

**SEASONALITY**

 

Quarterlyoperating results are typically affected by seasonal factors.  Historically, our first and fourth quartersare the strongest, reflecting increased customer utilization during the falland winter months.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

Ourprincipal sources of liquidity are expected to be cash and cash equivalents,cash flows from operating activities, and borrowings under our senior securedcredit facility, which provides for loans in an amount of up to $195.0 million,subject to our borrowing base. See Note 6 Long-Term Debt for details related toour Amended and Restated Credit Agreement. It is anticipated that our principaluses of liquidity will be to fund capital expenditures related to purchases ofmedical equipment, provide working capital, meet debt service requirements andfinance our strategic plans.

 

Werequire substantial cash to operate our Medical Equipment Outsourcing programsand service our debt.  Our outsourcingprograms require us to invest a significant amount of cash in medical equipmentpurchases.  To the extent that suchexpenditures cannot be funded from cash and cash equivalents, our operatingcash flow, borrowing under our senior secured credit facility or otherfinancing sources, we may not be able to conduct our business or grow ascurrently planned. We anticipate an additional capital investment ofapproximately $38.0 million during the remaining six months of 2010.

 

Ifwe are unable to service our debt obligations through our cash and cashequivalents, generating sufficient cash flow from operations, and additionalborrowings under our first lien senior secured asset-

 

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basedrevolving credit facility, we will be forced to take actions such as reducingor delaying capital expenditures, selling assets, restructuring or refinancingour debt, electing to pay PIK interest on our PIK Toggle Notes, or seekingadditional equity capital.  This, to acertain 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 atmaturity, we may have to obtain alternative financing, which may not beavailable to us.

 

Netcash provided by operating activities was $42.2 and $25.3 million for the sixmonths ended June 30, 2010 and 2009, respectively. Net cash provided byoperating activities during the six months ended June 30, 2010 primarilybenefited from favorable changes in operating assets and liabilities and adecrease in net loss as compared to the same period of 2009.

 

Netcash used in investing activities was $48.7 and $15.7 million for the sixmonths ended June 30, 2010 and 2009, respectively.  Net cash used in investing activitiesincreased during the 2010 period when compared to the same period in the prioryear primarily as a result of our purchase of select patient handling equipmentthat was formerly managed under a revenue share agreement as well as medicalequipment purchases related to Asset360 Programs.

 

Netcash provided by (used in) financing activities was $6.4 and ($18.2) millionfor the six months ended June 30, 2010 and 2009, respectively.  During the six months ended June 30,2010, net cash used in financing activities was impacted by net draws under oursenior secured credit facility of $16.2 million compared to net borrowings of$10.0 million during the same period of 2009. Additionally, we redeemed our10.125% Senior Notes in June 2010 for $9.9 million.

 

Therewas no cash on-hand as of June 30, 2010 compared to $3.5 million as of June 30,2009.

 

Based on the level of operating performance expected in2010, we believe our cash and cash equivalents, cash from operations, andadditional borrowings under our senior secured credit facility, will meet ourliquidity needs for the foreseeable future, exclusive of any borrowings that wemay make to finance potential acquisitions. However, if during that period or thereafter we are not successful ingenerating sufficient cash flows from operations or in raising additionalcapital when required in sufficient amounts and on terms acceptable to us, ourbusiness could be adversely affected.  As of June 30,2010, we had $116.1 million of availability under our senior secured creditfacility, based on a borrowing base of $174.8 million, less borrowings of $54.6million and after giving effect to $4.1 million used for letters of credit.

 

Our levels of borrowing are further restricted by thefinancial covenants set forth in our senior secured credit facility agreementand the second lien senior indenture governing our PIK Toggle Notes andFloating Rate Notes.  As of June 30,2010, the Company was in compliance with all covenants under the senior securedcredit facility.

 

**RECENT ACCOUNTING PRONOUNCEMENT**

 

***Standard Issued Not Yet Adopted***

 

InOctober 2009, the Financial Accounting Standards Board (“FASB”) issuedAccounting Standards Update (“ASU”) 2009-13, Revenue Recognition (Topic 605): *Multiple Deliverable Revenue Arrangements — A Consensus of the FASBEmerging Issues Task Force.* This update provides applicationguidance on whether multiple deliverables exist, how the deliverables should beseparated 

 

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andhow the consideration should be allocated to one or more units of accounting.This update establishes a selling price hierarchy for determining the sellingprice of a deliverable. The selling price used for each deliverable will bebased on vendor-specific objective evidence, if available, third-party evidenceif vendor-specific objective evidence is not available, or estimated sellingprice if neither vendor-specific or third-party evidence is available. TheCompany will be required to apply this guidance prospectively for revenuearrangements entered into or materially modified after January 1, 2011. Weare currently evaluating the impact of the provisions of ASU 2009-13.

 

**SAFE HARBOR STATEMENT**

 

**SafeHarbor Statement under the Private Securities Litigation Reform Act of 1995:** We believestatements in this Quarterly Report on Form 10-Q looking forward in timeinvolve risks and uncertainties.  Thefollowing factors, among others, could adversely affect our business,operations and financial condition, causing our actual results to differmaterially from those expressed in any forward-looking statements:

 

·                  our history of net losses and substantialinterest expense;

·                  our substantial outstanding debt and debtservice obligations;

·                  our need for substantial cash to operate andexpand our business as planned;

·                  restrictions imposed by the terms of ourdebt;

·                  a decrease in the number of patients ourcustomers are serving;

·                  the effect of prolonged negative changes indomestic and global economic conditions;

·                  our ability to effect change in the manner inwhich health care providers traditionally procure medical equipment;

·                  the absence of long-term commitments withcustomers;

·                  difficulties or delays in our continuedexpansion into certain of our businesses/geographic markets and developments ofnew businesses/geographic markets;

·                  the impact of health care reform initiatives;

·                  changes in third-party payor reimbursementrates for health care items and services;

·                  our ability to maintain existing contractswith GPOs and IDNs and enter into new contracts with additional GPOs and IDNs;

·                  additional credit risks in increasingbusiness with home care providers and nursing homes;

·                  the impact of significant regulation of thehealth care industry and the need to comply with those regulations;

·                  impacts of equipment product recalls orobsolescence;

·                  increases in vendor costs that cannot bepassed through to our customers; and

·                  the risk factors as set forth in Item 1A of Part IIof this Quarterly Report on Form 10-Q.

 

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**Item 3.  Quantitative andQualitative Disclosures about Market Risk**

 

Weare exposed to market risk arising from adverse changes in interest rates, fuelcosts, and pension valuation.  We do notenter into derivatives or other financial instruments for speculative purposes.

 

**InterestRates**

 

Weuse both fixed and variable rate debt as sources of financing.  At June 30, 2010, we had approximately$528.0 million of total debt outstanding. After taking into account the effect of our interest rate swapagreement, we had $54.6 million of debt bearing interest at variable ratesaveraging 3.102%.  Based on variable debtlevels at June 30, 2010, a 1.0 percentage point change in interest rateson variable rate debt would result in annual interest expense fluctuating byapproximately $0.5 million.

 

InJune 2007, we entered into an interest rate swap agreement for $230.0million, which has the effect of converting the interest rate applicable to our$230.0 million of Floating Rate Notes to a fixed interest rate.  The effective date for the interest rate swapagreement was December 2007; the expiration date is May 2012.

 

Theinterest rate swap agreement qualifies for cash flow hedge accounting underAccounting Standards Codification (“ASC”) Topic 815, *Derivativesand Hedging.* Both at inception and on an on-going basis, we mustperform an effectiveness test.  Inaccordance with ASC Topic 815, the fair value of the interest rate swapagreement at June 30, 2010 is included as a cash flow hedge on our balancesheet.  The change in fair value wasrecorded as a component of accumulated other comprehensive loss, net of tax, onour balance sheet since the instrument was determined to be an effective hedgeat June 30, 2010.  We have notrecorded any amounts due to ineffectiveness for any periods presented. Weexpect to reclassify approximately $6.6 million into earnings, net of tax,currently recorded in accumulated other comprehensive loss, in the next 12months. As a result of our interest rate swap agreement, we expect theeffective interest rate on our $230.0 million Floating Rate Notes to be 9.065%through May 2012.

 

**FuelCosts**

 

Weare also exposed to market risks related to changes in the price of gasolineused to fuel our fleet of delivery and sales vehicles.  A hypothetical 10% increase in the secondquarter of 2010 average price of unleaded gasoline, assuming gasoline usagelevels for the quarter ended June 30, 2010, would lead to an annualincrease in fuel costs of approximately $0.4 million.

 

**OtherMarket Risk**

 

Ourpension obligations are also affected by market risk as discussed in Item 7A ofPart II of our 2009 Form 10-K. Continued distress in the financial markets may impact the fair value ofdebt and equity securities in our pension trust.

 

Asof June 30, 2010, we have no other material exposure to market risk.

 

**Item 4(T).  Controls andProcedures**

 

(a)           *Evaluation of disclosurecontrols and procedures*

 

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Underthe supervision and with the participation of our management, including ourChief Executive Officer and Chief Financial Officer, we evaluated theeffectiveness of the design and operation of our disclosure controls andprocedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) promulgatedunder the Securities Exchange Act of 1934 as amended (the “Exchange Act”)).  Based upon that evaluation, our Chief ExecutiveOfficer and Chief Financial Officer concluded that, as of the end of the periodcovered by this report, our disclosure controls and procedures were effective.

 

(b)           *Changes in internalcontrol over financial reporting*

 

Therewere no changes in our internal control over financial reporting during thequarter ended June 30, 2010, that have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting.

 

**PART II - OTHER INFORMATION**

 

**Item 1.    Legal Proceedings**

 

The Company, from time to time, may become involved inlitigation arising out of operations in the normal course of business,including the matters discussed in Item 3 of Part I of the 2009 Form 10-K.

 

Asserted claims are subject to many uncertainties andthe outcome of individual matters is not predictable with assurance.

 

As of June 30, 2010, we were not a party to anyother pending legal proceedings the adverse outcome of which could reasonablybe expected to have a material adverse effect on our operating results,financial position or cash flows.

 

**Item 1A.  Risk Factors**

 

Ourbusiness is subject to various risks and uncertainties.  Any of the risks discussed elsewhere in thisQuarterly Report on Form 10-Q or our other filings with the Securities andExchange Commission, including the risk factors set forth in our 2009 Form 10-K,could materially adversely affect our business, financial condition or resultsof operations.

 

**Item 2.    Unregistered Sales ofEquity Securities and Use of Proceeds**

 

None.

 

**Item 3.    Defaults upon SeniorSecurities**

 

Notapplicable.

 

**Item 5.    Other Information**

 

*Amendmentof Option Agreements and Acceleration of Options*

 

EffectiveAugust 11, 2010, the Compensation Committee of our Board of Directorsrecommended, and the board of directors (the “Parent Board”) of UHS Holdco, Inc.,our parent company ( “Parent”), approved, an amendment (the “Amendment”) to thevesting provisions contained in all outstanding option agreements ofparticipants in the 2007 Stock Option Plan (the “2007 Stock Option Plan”) of

 

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Parentwho were employed by Parent or us as of the effective date of the Amendment, orserved on our board of directors through that date.  Performance vesting options granted under the2007 Stock Option Plan vest over a six-year period with 16.66% vesting on December 31of each year of the six-year period, subject to the option holder not ceasingemployment with Parent or us, and to our attainment of either an adjustedEBITDA target for current fiscal year, or an aggregate adjusted EBITDA targetcalculated in each subsequent fiscal year, as provided in the respective formof option agreement.  The Amendment,among other things, does away with the requirement that the EBITDA-basedperformance objectives be achieved in order for performance vesting options tovest, in effect providing for time-based vesting of these options rather thanperformance vesting.  The Amendment doesnot change the number of options granted, the strike price, or any continuedservice requirements.  The Amendment alsoprovides for the acceleration of vesting, for 2007 Stock Option Planparticipants who were employed by Parent or us as of the effective date of theAmendment and who were granted options prior to December 31, 2009, ofoptions (the “Accelerated Options”) to purchase approximately 2,996,000 sharesof common stock of Parent that were eligible for vesting on December 31,2009, but did not vest because we did not achieve the applicable adjustedEBITDA target for the fiscal year ended December 31, 2009.  At the time vesting was accelerated, theAccelerated Options remained eligible for vesting in future years based on ourachievement of an aggregate adjusted EBITDA target.  Except as described above, all other termsand conditions applicable to the Accelerated Options remain in effect. TheAmendment also modifies the provisions relating to time vesting options grantedunder the 2007 Stock Option Plan to achieve greater consistency between thetreatment of these options and the treatment of performance vesting options inthe event of a sale of substantially all of the assets of Parent or us.  The foregoing description of the Amendment isnot complete and is qualified in its entirety by reference to the Amendmentitself, which is filed as Exhibit 10.4 hereto and is incorporated hereinby reference.

 

TheParent Board recognized the increased level of difficulty in achieving theoriginal performance targets relating to performance vesting options (whichwere established in 2007), taking into consideration continued economicchallenges, and authorized the Amendment in an effort to ensure that Parentcontinues to provide long-term incentives that drive core operatingperformance, while creating a meaningful retention benefit.

 

Aggregateperformance vesting options affected by the Amendment, including theAccelerated Options, are detailed below by original grant date:

 

**Summary of Performance VestingOptions**

*(inthousands)*

 
| ** **               | ** ** | ** **               | ** ** | **Vested**               | ** ** | ** **        | ** ** | ** **      | ** ** |
|--------------------------|------------|--------------------------|------------|--------------------------|------------|-------------------|------------|-----------------|------------|
| ** **               | ** ** | ** **               | ** ** | **Performance**          | ** ** | ** **        | ** ** | ** **      | ** ** |
| ** **               | ** ** | ** **               | ** ** | **Options**              | ** ** | ** **        | ** ** | ** **      | ** ** |
| ** **               | ** ** | **Performance**          | ** ** | **Outstanding at**       | ** ** | ** **        | ** ** | ** **      | ** ** |
| ** **               | ** ** | **Options**              | ** ** | **August 10, 2010** | ** ** | **Options**       | ** ** | ** **      | ** ** |
| ** **               | ** ** | **Outstanding at**       | ** ** | **(Prior to**            | ** ** | **Affected by**   | ** ** | **Accelerated** | ** ** |
| **Grant Date**           | ** ** | **August 10, 2010** | ** ** | **Amendment)**           | ** ** | **Amendment (1)** | ** ** | **Options (2)** | ** ** |
| June 18,  2007      |       | 17,109                   |       | 5,707                    |       | 11,402            |       | 2,851           |       |
| December 3,  2007   |       | 283                      |       | 48                       |       | 235               |       | 47              |       |
| April 1,  2008      |       | 28                       |       | 5                        |       | 23                |       | 5               |       |
| April 1,  2009      |       | 564                      |       | —                   |       | 564               |       | 94              |       |
| April 13,  2010 (3) |       | 707                      |       | —                   |       | 707               |       | N/A             |       |
| Total                    |       | 18,691                   |       | 5,760                    |       | 12,931            |       | 2,996           |       |

 

----

(1) IncludesAccelerated Options

(2) Accelerated Optionsvesting on August 11, 2010

(3) Options issuedsubsequent to December 31, 2009 were not affected by the acceleratedvesting

 

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Optionsissued to our named executive officers (as that term is used in the 2009 10-K)and the related impacts of the Amendment are detailed below:

 

**Summary of Stock Options for our Named Exectuve Officers**

*(inthousands)*

 
| ** **           | ** ** | ** **        | ** ** | ** **         | ** ** | ** **        | ** ** | **Time-Based**  | ** ** | **Performance-**  | ** ** | ** **      | ** ** |
|----------------------|------------|-------------------|------------|--------------------|------------|-------------------|------------|-----------------|------------|-------------------|------------|-----------------|------------|
| ** **           | ** ** | ** **        | ** ** | ** **         | ** ** | ** **        | ** ** | **Vesting**     | ** ** | **Based Vesting** | ** ** | ** **      | ** ** |
| ** **           | ** ** | ** **        | ** ** | **Vested Options** | ** ** | **Options**       | ** ** | **Options**     | ** ** | **Options**       | ** ** | ** **      | ** ** |
| **Named  Executive** | ** ** | **Total Options** | ** ** | **at December**    | ** ** | **Affected by**   | ** ** | **Affected by** | ** ** | **Affected by**   | ** ** | **Accelerated** | ** ** |
| **Officer**          | ** ** | **Granted (1)**   | ** ** | **31, 2009**       | ** ** | **Amendment (2)** | ** ** | **Amendment**   | ** ** | **Amendment**     | ** ** | **Options (3)** | ** ** |
| Gary D. Blackford    |       | 14,500            |       | 6,041              |       | 8,459             |       | 3,625           |       | 4,834             |       | 1,209           |       |
| Rex T. Clevenger     |       | 3,000             |       | 1,250              |       | 1,750             |       | 750             |       | 1,000             |       | 250             |       |
| Jeffrey L. Singer    |       | 2,500             |       | 1,042              |       | 1,458             |       | 625             |       | 833               |       | 208             |       |
| Timothy W. Kuck      |       | 2,500             |       | 1,042              |       | 1,458             |       | 625             |       | 833               |       | 208             |       |
| Diana Vance-Bryan    |       | 1,250             |       | 521                |       | 729               |       | 312             |       | 417               |       | 104             |       |

 

----

(1) Allstock option grants to our named executive officers were made on June 18,2007

(2) Representsoptions outstanding and not vested as of August 10, 2010

(3) AcceleratedOptions vesting on August 11, 2010

 

Anaggregate of approximately 2,996,000 options vested on August 11, 2010 asa result of the Parent Board’s acceleration of vesting performance vestingoptions.  The remaining unvested optionsaffected by the Amendment will vest and become exercisable on each December 31,in accordance with the vesting schedule provided in the option agreements,through the remaining term of the applicable option. We are currently in the processof valuing the amended performance vesting options affected by the Amendmentand the related impact to our financial statements.

 

*Electionof Director*

 

OnAugust 11, 2010, our Board of Directors elected John B. Grotting to serveas a new member of the Board of Directors. Mr. Grotting has served as anOperating Partner for Frazier Healthcare Ventures since 2010.  Frazier Healthcare Ventures is one of theleading providers of venture and growth equity capital to emerging biopharma,medical device and healthcare service companies.   In addition, Mr. Grotting has held avariety of executive positions in the healthcare field, including serving asCEO of medical device reprocessor Ascent Healthcare Solutions from 2004 to2009.  Prior to joining Ascent HealthcareSolutions in 2004, Mr. Grotting held senior executive positions at LegacyHealth System, Allina Health System and Bridge Medical, Inc. Mr. Grottingserves as a director of Skylight Systems, VHA Inc., Vocera Communications, Inc.and Scottsdale Healthcare.  Mr. Grottingserves as a director of Skylight Systems, the VHA Inc., Vocera Communications, Inc.and Scottsdale Healthcare.  Mr. Grottingholds a Master’s degree in Hospital and Healthcare Management from theUniversity of Minnesota and a B.A. in Economics from St. Olaf College inNorthfield, MN.

 

OurBoard has determined that Mr. Grotting is independent as defined under thecurrent rules of The NASDAQ Stock Market LLC. There is no arrangement orunderstanding between Mr. Grotting and any other person pursuant to whichMr. Grotting was elected as a director, and there are no related partytransactions involving Mr. Grotting that are reportable under Item 404(a) ofRegulation S-K.

 

Mr. Grottingwill receive compensation for his service as an independent, non-employeedirector in accordance with our existing director compensation policy.  Under this policy, each independent directorreceives cash compensation of $30,000 per year (pro-rated for partial yeardirectorship).

 

Mr. Grotting****will also be eligible to receive grants of stock optionsunder the 2007 Stock Option Plan, subject to the approval of the Parent Board.Our director compensation policy also entitles independent directors toreimbursement of all out-of-pocket expenses incurred in connection withactivities as a member of the board, provided they are expected to followtravel and expense guidelines established for all of our officers anddirectors.

 

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OnAugust 11, 2010, the Parent Board authorized the grant of options to bemade during the 2010 third quarter to purchase 300,000 shares of Parent commonstock to Mr. Grotting, with a strike price to be determined pendingvaluation of the Parent’s common stock, under the 2007 Stock Option Plan inconnection with his election to serve on our Board of Directors.  When issued, the options will vest over asix-year period of service with 16.66% vesting on December 31 of each yearof the six-year period in accordance with the provisions of the 2007 StockOption Plan and the related option agreement (which is in the new form approvedby the Parent Board as described below under “Approval of New Form ofAward Agreement”).

 

*Approvalof New Form of Award Agreement*

 

OnAugust 11, 2010, the Parent Board approved a new form of Option AgreementEvidencing a Grant of an Option Under the Employee Option Plan for grants ofnon-qualified stock options under the 2007 Stock Option Plan.  The new form is substantially similar to theprevious form of option agreement under the 2007 Stock Option Plan, except thatthe new form reflects the amendments set forth in the Amendment described above(other than the acceleration of options that were initially eligible to vest onDecember 31, 2009).  A copy of thenew form of Option Agreement Evidencing a Grant of an Option Under the EmployeeOption Plan is filed as Exhibit 10.4 hereto and is incorporated herein byreference. The foregoing description of the new form of Option AgreementEvidencing a Grant of an Option Under the Employee Option Plan is qualified inits entirety by reference to the attached form of such agreement.

 

**Item 6.    Exhibits**

 
| **Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1       |       | Amended  and Restated Credit Agreement, dated as of May 6, 2010, among Universal  Hospital Services, Inc., UHS Holdco, Inc., the lenders party  thereto, GE Business Financial Services, Inc., as administrative agent,  Bank of America, N.A., as documentation agent, and GE Capital Markets, Inc.,  and Bank of America Securities, LLC, as co-lead arrangers and co-bookrunners  (incorporated by reference to Exhibit 10.1 to Form 10-Q filed with  the Securities and Exchange Commission on May 10, 2010). |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.2       |       | Amended  and Restated Guaranty, dated as of May 6, 2010, among UHS  Holdco, Inc. and the secured parties named therein (incorporated by  reference to Exhibit 10.2 to Form 10-Q filed with the Securities  and Exchange Commission on May 10, 2010).                                                                                                                                                                                                                                                                             |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.3       |       | First  Lien Security Agreement, dated May 6, 2010, among  UHS Holdco, Inc., Universal Hospital  Services, Inc. and GE Business Financial Services, Inc., as  collateral agent (incorporated by reference to Exhibit 10.3 to Form 10-Q  filed with the Securities and Exchange Commission on May 10, 2010).                                                                                                                                                                                                        |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.4*      |       | Amendment  to Option Agreements, dated as of August 11, 2010, executed by UHS  Holdco, Inc. **                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.5*      |       | Form of  Option Agreement Evidencing a Grant of an Option Under the 2007 Stock Option  Plan. **                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 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  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |

 

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| 32.2* |   | Certification  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
|-------|--------|--------------------------------------------------------------------------------|

 

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* Filed Herewith

**Indicates management contracts, compensatory plans or arrangements required tobe filed pursuant to Item601(b)(10)(iii)(A) of Regulation S-K.

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
| Date:  August 11, 2010 |                                                       |
|-----------------------------|------------------------------------------------------------|
|                        |                                                       |
|                        | 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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