kci2qtr10q2010.htm

10-Q 1 kci2qtr10q2010.htm KINETIC CONCEPTS, INC. 2ND QTR 2010 10-Q kci2qtr10q2010.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2010

Commission File Number: 001-09913

KINETIC CONCEPTS, INC.

(Exact name of registrant as specified in its charter)

Texas		74-1891727
(State of Incorporation)		(I.R.S. Employer Identification No.)


8023 Vantage Drive San Antonio, Texas		78230
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (210) 524-9000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes X No ____

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes X No ____

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	X		Accelerated filer

Non-accelerated filer		(Do not check if a smaller reporting company)	Smaller reporting company

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ____ No X

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Common Stock: 71,844,132 shares as of August 2, 2010

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KINETIC CONCEPTS, INC.

			Page No.
PART I.	FINANCIAL INFORMATION		4
	Item 1.	Financial Statements	4
		Condensed Consolidated Balance Sheets	4
		Condensed Consolidated Statements of Earnings	5
		Condensed Consolidated Statements of Cash Flows	6
		Notes to Condensed Consolidated Financial Statements	7
	Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	20
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	31
	Item 4.	Controls and Procedures	33
PART II.	OTHER INFORMATION		33
	Item 1.	Legal Proceedings	33
	Item 1A.	Risk Factors	35
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	36
	Item 6.	Exhibits	36
	SIGNATURES		37

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which are covered by the "safe harbor" created by those sections. The forward-looking statements are based on our current expectations and projections about future events. Discussions containing forward-looking statements may be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Risk Factors," and elsewhere in this report. In some cases, you can identify forward-looking statements by terminology such as "may," "will," "should," "could," "predicts," "projects," "potential," "continue," "expects," "anticipates," "future," "intends," "plans," "believes," "estimates," or the negative of those terms and other variations of them or by comparable terminology.

These forward-looking statements are only predictions, not historical facts, and involve certain risks and uncertainties, as well as assumptions. Actual results, levels of activity, performance, achievements and events could differ materially from those stated, anticipated or implied by such forward-looking statements. The factors that could contribute to such differences include those discussed under the caption "Risk Factors." You should consider each of the risk factors and uncertainties in our Annual Report on Form 10-K for the fiscal year ended December 31, 2009 and in our Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2010, among other things, in evaluating our prospects and future financial performance. The occurrence of the events described in the risk factors could harm our business, results of operations and financial condition. These forward-looking statements are made as of the date of this report. We disclaim any obligation to update or alter these forward-looking statements, whether as a result of new information, future events or otherwise.

TRADEMARKS

All trademarks appearing in this report are proprietary to KCI Licensing, Inc., its affiliates and/or licensors. The absence of a trademark or service mark or logo from this report does not constitute a waiver of trademark or other intellectual property rights of KCI Licensing, Inc., its affiliates and/or licensors.

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PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

KINETIC CONCEPTS, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(in thousands)


	June 30,		December 31,
	2010		2009
	(unaudited)
Assets:
Current assets:
Cash and cash equivalents	$	247,068	$	263,157
Accounts receivable, net		393,485		425,042
Inventories, net		157,495		121,044
Deferred income taxes		11,606		11,715
Prepaid expenses and other		41,523		37,330

Total current assets		851,177		858,288

Net property, plant and equipment		276,151		296,055
Debt issuance costs, net		27,970		35,191
Deferred income taxes		17,929		17,513
Goodwill		1,328,881		1,328,881
Identifiable intangible assets, net		464,568		489,213
Other non-current assets		12,998		13,424

	$	2,979,674	$	3,038,565

Liabilities and Shareholders' Equity:
Current liabilities:
Accounts payable	$	62,384	$	63,301
Accrued expenses and other		200,595		226,823
Current installments of long-term debt		156,250		132,353
Income taxes payable		3,231		18,484

Total current liabilities		422,460		440,961

Long-term debt, net of current installments and discount		1,035,354		1,173,808
Non-current tax liabilities		25,204		29,074
Deferred income taxes		184,014		212,257
Other non-current liabilities		4,066		4,994

Total liabilities		1,671,098		1,861,094

Shareholders' equity:
Common stock; authorized 225,000 at 2010 and 2009, issued and outstanding 71,847 at 2010 and 71,256 at 2009		72		71
Preferred stock; authorized 50,000 at 2010 and 2009; issued and outstanding 0 at 2010 and 2009		-		-
Additional paid-in capital		832,537		804,111
Retained earnings		463,668		357,350
Accumulated other comprehensive income, net		12,299		15,939

Shareholders' equity		1,308,576		1,177,471

	$	2,979,674	$	3,038,565

See accompanying notes to condensed consolidated financial statements.

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KINETIC CONCEPTS, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Earnings
(in thousands, except per share data)
(unaudited)


	Three months ended						Six months ended
	June 30,						June 30,
	2010			2009			2010			2009
Revenue:
Rental	$	283,084		$	292,023		$	563,075		$	574,378
Sales		214,688			199,326			420,502			387,052

Total revenue		497,772			491,349			983,577			961,430


Rental expenses		155,622			161,276			308,841			322,443
Cost of sales		62,307			59,437			123,231			117,805

Gross profit		279,843			270,636			551,505			521,182

Selling, general and administrative expenses		147,212			125,802			282,591			252,473
Research and development expenses		21,718			21,265			46,502			43,402
Acquired intangible asset amortization		9,556			10,158			19,715			20,316

Operating earnings		101,357			113,411			202,697			204,991

Interest income and other		143			154			279			488
Interest expense		(22,264	)		(26,227	)		(45,826	)		(54,721	)
Foreign currency loss		(2,657	)		(1,878	)		(5,267	)		(7,079	)

Earnings before income taxes		76,579			85,460			151,883			143,679

Income taxes		22,974			27,363			45,565			45,877

Net earnings	$	53,605		$	58,097		$	106,318		$	97,802

Net earnings per share:

Basic	$	0.76		$	0.83		$	1.50		$	1.40

Diluted	$	0.75		$	0.82		$	1.48		$	1.39

Weighted average shares outstanding:

Basic		70,836			70,069			70,678			69,984

Diluted		71,805			70,432			71,657			70,294

See accompanying notes to condensed consolidated financial statements.

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KINETIC CONCEPTS, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)


	Six months ended
	June 30,
	2010			2009
Cash flows from operating activities:
Net earnings	$	106,318		$	97,802
Adjustments to reconcile net earnings to net cash provided by operating activities:
Amortization of convertible debt discount		10,443			9,669
Depreciation and other amortization		80,511			75,292
Provision for bad debt		4,139			5,088
Write-off of deferred debt issuance costs		1,928			1,628
Share-based compensation expense		15,434			13,954
Excess tax benefit from share-based payment arrangements		(1,392	)		(215	)
Change in assets and liabilities, net of business acquired:
Decrease (increase) in accounts receivable, net		30,932			(5,814	)
Increase in inventories, net		(36,102	)		(2,122	)
Decrease (increase) in prepaid expenses and other		(4,193	)		6,030
Decrease in accounts payable		(632	)		(7,511	)
Decrease in accrued expenses and other		(20,687	)		(30,103	)
Increase (decrease) in tax liabilities, net		(18,692	)		12,465
Decrease in deferred income taxes, net		(30,107	)		(15,517	)
Net cash provided by operating activities		137,900			160,646

Cash flows from investing activities:
Additions to property, plant and equipment		(46,192	)		(40,430	)
Decrease in inventory to be converted into equipment for short-term rental		7,265			5,356
Dispositions of property, plant and equipment		1,067			3,131
Business acquired in purchase transaction, net of cash acquired		-			(173	)
Increase in identifiable intangible assets and other non-current assets		(2,091	)		(16,475	)
Net cash used by investing activities		(39,951	)		(48,591	)

Cash flows from financing activities:
Proceeds from revolving credit facility		-			20,000
Repayments of long-term debt, revolving credit facility and capital lease obligations		(125,054	)		(148,948	)
Excess tax benefit from share-based payment arrangements		1,392			215
Proceeds from exercise of stock options		10,185			358
Purchase of immature shares for minimum tax withholdings		(1,108	)		(204	)
Proceeds from the purchase of stock in ESPP and other		3,451			3,336
Net cash used by financing activities		(111,134	)		(125,243	)

Effect of exchange rate changes on cash and cash equivalents		(2,904	)		695

Net decrease in cash and cash equivalents		(16,089	)		(12,493	)
Cash and cash equivalents, beginning of period		263,157			247,767

Cash and cash equivalents, end of period	$	247,068		$	235,274

Cash paid during the six months for:
Interest, including cash paid under interest rate swap agreements	$	28,215		$	37,289
Income taxes, net of refunds	$	94,306		$	40,581

See accompanying notes to condensed consolidated financial statements.

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KINETIC CONCEPTS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

NOTE 1. Summary of Significant Accounting Policies

(a) Basis of Presentation

The unaudited condensed consolidated financial statements presented herein include the accounts of Kinetic Concepts, Inc., together with its consolidated subsidiaries. All inter-company balances and transactions have been eliminated in consolidation. The consolidated entity is referred to herein as "KCI®." The unaudited condensed consolidated financial statements appearing in this quarterly report on Form 10-Q should be read in conjunction with the financial statements and notes thereto included in KCI's latest Annual Report on Form 10-K for the fiscal year ended December 31, 2009 and our Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2010.

We have three reportable operating segments which correspond to our business units: Active Healing Solutions™ (“AHS”); Regenerative Medicine; and Therapeutic Support Systems (“TSS”). We have two primary geographic regions for which we provide supplemental information: North America, which is comprised principally of the United States and includes Canada and Puerto Rico; and EMEA/APAC, which is comprised principally of Europe and includes the Middle East, Africa and the Asia Pacific region.

In June 2009, the Financial Accounting Standards Board (“FASB”) issued a new pronouncement which established the single source of authoritative U.S. generally accepted accounting principles (“GAAP” or “the Codification”). The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with GAAP for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information necessary for a fair presentation of results of operations, financial position and cash flows in conformity with GAAP. Operating results from interim periods are not necessarily indicative of results that may be expected for the fiscal year as a whole. The unaudited condensed consolidated financial statements reflect all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation of our results for the interim periods presented. Certain prior-period amounts have been reclassified to conform to the 2010 presentation.

(b) Income Taxes

We compute our quarterly effective income tax rate based on our annual estimated effective income tax rate plus the impact of any discrete items that occur in the quarter. The effective income tax rate for the second quarter and the first six months of 2010 was 30.0%, compared to 32.0% and 31.9%, respectively, for the corresponding periods in 2009. The lower effective income tax rate for the second quarter and first six months of 2010 was due primarily to a higher percentage of income earned in lower tax jurisdictions and the favorable resolution of certain tax contingencies during 2010.

We use derivative financial instruments to manage the economic impact of fluctuations in interest rates. We do not use financial instruments for speculative or trading purposes. Periodically, we enter into interest rate protection agreements to modify the interest characteristics of our outstanding debt. We designated our interest rate swap agreements as cash flow hedge instruments. Each interest rate swap is designated as a hedge of interest payments associated with specific principal balances and terms of our debt obligations. These agreements involve the exchange of amounts based on variable interest rates, for amounts based on fixed interest rates over the life of the agreement, without an exchange of the notional amount upon which the payments are based. The differential to be paid or received, as interest rates change, is accrued and recognized as an adjustment to interest expense related to the debt.

We also use derivative financial instruments to manage the economic impact of fluctuations in currency exchange rates on our intercompany balances and corresponding cash flows and to manage our transactional currency exposures when our foreign subsidiaries enter into transactions denominated in currencies other than their local currency. We enter into foreign currency exchange contracts to manage these economic risks. These contracts are not designated as hedges; as such, we recognize the fair value of these instruments as an asset or liability with income or expense recognized in the current period. Gains and losses resulting from the foreign currency fluctuations impact on transactional exposures are included in foreign currency loss in our condensed consolidated statements of earnings.

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As required, all derivative instruments are recorded on the balance sheet at fair value. The fair values of our interest rate swap agreements and foreign currency exchange contracts are determined based on inputs that are readily available in public markets or can be derived from information available in publicly-quoted markets, which represent level 2 inputs as defined by the Codification. We estimate the effectiveness of our interest rate swap agreements utilizing the hypothetical derivative method. Under this method, the fair value of the actual interest rate swap agreement is compared to the fair value of a hypothetical swap agreement that has the same critical terms as the portion of the loan being hedged. Changes in the effective portion of the fair value of the remaining interest rate swap agreement will be recognized in other comprehensive income, net of tax, until the hedged item is recognized into earnings.

(d) Concentration of Credit Risk

KCI has a concentration of credit risk with financial institutions related to its derivative instruments and the note hedge described in Note 3. As of June 30, 2010, Bank of America and JP Morgan Chase collectively held equity hedges related to our convertible note hedge, as described in Note 3, in notional amounts totaling $352.9 million. Bank of America was also the counterparty on some of our interest rate protection agreements and our foreign currency exchange contracts in notional amounts totaling $48.2 million and $7.4 million, respectively. Additionally, JP Morgan Chase was a counterparty on some of our foreign currency exchange contracts in notional amounts totaling $8.0 million. We use master netting agreements with our derivative counterparties to reduce our risk and use multiple counterparties to reduce our concentration of credit risk.

(e) Other Significant Accounting Policies

For further information on our significant accounting policies, see Note 1 of the Notes to the Consolidated Financial Statements included in KCI's Annual Report on Form 10-K for the fiscal year ended December 31, 2009.

NOTE 2. Supplemental Balance Sheet Data

(a) Accounts Receivable, net

Accounts receivable consist of the following (dollars in thousands):

	June 30,			December 31,
	2010			2009
Gross trade accounts receivable:
North America:
AHS and TSS	$	337,185		$	370,563
Regenerative Medicine		38,215			34,773

Subtotal North America		375,400			405,336

EMEA/APAC		101,261			114,146

Total trade accounts receivable		476,661			519,482

Less: Allowance for revenue adjustments		(86,842	)		(96,640	)

Gross trade accounts receivable		389,819			422,842

Less: Allowance for bad debt		(7,530	)		(8,851	)

Net trade accounts receivable		382,289			413,991

Other receivables		11,196			11,051

	$	393,485		$	425,042

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North America trade accounts receivable consist of amounts due directly from acute and extended care organizations, third-party payers (“TPP”), both governmental and non-governmental, and patient pay accounts. Included within the TPP accounts receivable balances are amounts that have been or will be billed to patients once the primary payer portion of the claim has been settled by the TPP. EMEA/APAC trade accounts receivable consist of amounts due primarily from acute care organizations.

The domestic TPP reimbursement process requires extensive documentation, which has had the effect of slowing both the billing and cash collection cycles relative to the rest of the business, and therefore, could increase total accounts receivable. Because of the extensive documentation required and the requirement to settle a claim with the primary payer prior to billing the secondary and/or patient portion of the claim, the collection period for a claim in our homecare business may, in some cases, extend beyond one year prior to full settlement of the claim.

We utilize a combination of factors in evaluating the collectibility of our accounts receivable. For unbilled receivables, we establish reserves to allow for expected denied or uncollectible items. In addition, items that remain unbilled for more than a specified period of time, or beyond an established billing window, are reserved against revenue. For billed receivables, we generally establish reserves using a combination of factors including historic adjustment rates for credit memos and cancelled transactions, historical collection experience, and the length of time receivables have been outstanding. The reserve rates vary by payer group. In addition, we record specific reserves for bad debt when we become aware of a customer's inability or refusal to satisfy its debt obligations, such as in the event of a bankruptcy filing.

(b) Inventories, net

Inventories are stated at the lower of cost (first-in, first-out) or market (net realizable value). Inventories consist of the following (dollars in thousands):

	June 30,			December 31,
	2010			2009

Finished goods and tissue available for distribution	$	91,031		$	71,620
Goods and tissue in-process		17,356			13,418
Raw materials, supplies, parts and unprocessed tissue		78,726			65,910

		187,113			150,948

Less: Amounts expected to be converted into equipment for short-term rental		(11,273	)		(18,538	)
Reserve for excess and obsolete inventory		(18,345	)		(11,366	)

	$	157,495		$	121,044

Inventories increased $36.5 million as of June 30, 2010 compared to our inventory balance as of December 31, 2009. This increase was due primarily to planned increases in our tissue inventory to meet the increasing demand for our AlloDerm and Strattice tissue matrix products.

Our reserve for excess and obsolete inventory increased by $7.0 million. This increase was primarily related to portfolio rationalization within our TSS business approved and implemented by management in the second quarter of 2010. Total expense associated with this effort was $7.4 million, or $0.06 per diluted share, and was recorded within selling, general and administrative expenses in our condensed consolidated statements of earnings.

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NOTE 3. Long-Term Debt

Long-term debt consists of the following (dollars in thousands):

	June 30,			December 31,
	2010			2009

Senior Credit Facility – due 2013	$	625,000		$	750,000
3.25% Convertible Senior Notes due 2015		690,000			690,000
Less: Convertible Notes Discount, net of accretion		(123,396	)		(133,839	)

		1,191,604			1,306,161
Less: Current installments		(156,250	)		(132,353	)

	$	1,035,354		$	1,173,808

The fair value of our senior credit facility and convertible senior notes is estimated based upon open-market trades at or near quarter- or year-end. The fair value of our senior credit facility and the convertible senior notes was $621.9 million and $665.5 million, respectively, at June 30, 2010 and $729.4 million and $676.5 million, respectively, at December 31, 2009.

Senior Credit Facility

In May 2008, we entered into a $1.3 billion senior secured credit facility due May 2013. The senior credit facility consists of a $1.0 billion term loan facility and a $300.0 million revolving credit facility. At June 30, 2010 and December 31, 2009, we had no revolving loans outstanding and had outstanding letters of credit in the aggregate amount of $10.5 million and $11.4 million, respectively. The resulting availability under the revolving credit facility was $289.5 million and $288.6 million at June 30, 2010 and December 31, 2009, respectively. As of June 30, 2010 and December 31, 2009, we were in compliance with all covenants under the senior credit agreement.

For further information on our senior credit facility, see Note 5 of the Notes to the Consolidated Financial Statements included in KCI's Annual Report on Form 10-K for the fiscal year ended December 31, 2009.

3.25% Convertible Senior Notes and Related Note Hedge and Warrants

In 2008, we issued $690 million aggregate principal amount of 3.25% convertible senior notes due 2015 (the “Convertible Notes”). The notes are governed by the terms of an indenture dated as of April 21, 2008 (the “Indenture”). Concurrently with the issuance of the Convertible Notes, we entered into convertible note hedge (the “Note Hedge”) and warrant transactions (the “Warrants”) with affiliates of the initial purchasers of the notes. These consist of purchased and written call options on KCI common stock. The Note Hedge and Warrants are structured to reduce the potential future economic dilution associated with conversion of the notes and to effectively increase the initial conversion price to $60.41 per share, which was approximately 50% higher than the closing price of KCI’s common stock on April 15, 2008. As of June 30, 2010 and December 31, 2009, we were in compliance with all covenants under the Indenture for the Convertible Notes.

Conversion. The initial conversion price of the Convertible Notes is approximately $51.34 per share of common stock. Upon conversion, holders will receive cash up to the aggregate principal amount of the notes being converted. For any conversion obligation in excess of the aggregate principal amount of the notes being converted, holders will receive shares of our common stock. The conversion rate and the conversion price are subject to adjustment upon the occurrence of certain events, such as distributions of dividends or stock splits.

For further information on our Convertible Notes and related Note Hedge and Warrants, see Note 5 of the Notes to the Consolidated Financial Statements included in KCI's Annual Report on Form 10-K for the fiscal year ended December 31, 2009.

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NOTE 4. Derivative Financial Instruments and Fair Value Measurements

We are exposed to credit loss in the event of nonperformance by counterparties to the extent of the fair values of the outstanding interest rate swap agreements and foreign currency exchange contracts, but we do not anticipate nonperformance by any of the counterparties. For further information on our Derivative Financial Instruments, see Note 6 of the Notes to the Consolidated Financial Statements included in KCI's Annual Report on Form 10-K for the fiscal year ended December 31, 2009.

Interest Rate Protection

In July 2010, we entered into seven additional interest rate swap agreements, which become effective in September and December 2010, to convert $200.0 million of our variable-rate debt to a fixed-rate basis at a weighted average interest rate of 0.7426%, exclusive of the Eurocurrency Rate Loan Spread as disclosed in the senior credit agreement.

We are required under the senior credit facility to enter into interest rate swaps to attain a fixed interest rate on at least 50% of our aggregate outstanding indebtedness through February 2011. As a result of the interest rate swap agreements in effect as of June 30, 2010 and December 31, 2009, approximately 95.1% and 93.9%, respectively, of our long-term debt outstanding, including the Convertible Notes, was subject to a fixed interest rate.

The interest rate swap agreements have quarterly interest payments, based on three-month LIBOR, due on the last day of March, June, September and December. The fair value of the swap agreements was zero at inception. At June 30, 2010 and December 31, 2009, the aggregate fair value of our interest rate swap agreements was negative and was recorded as a liability of approximately $4.0 million and $8.4 million, respectively. This amount was also recorded in other comprehensive income, net of tax. No asset derivatives were held as of June 30, 2010 and December 31, 2009 related to our interest rate swap agreements. The ineffective portion of these interest rate swaps was not significant for the three months or six months ended June 30, 2010 and 2009. As of June 30, 2010 and December 31, 2009, the amount of hedge loss to be reclassified from Accumulated Other Comprehensive Income over the next 12 months was $4.0 million and $8.0 million, respectively.

Foreign Currency Exchange Risk Mitigation

At June 30, 2010 and December 31, 2009, we had foreign currency exchange contracts to sell or purchase approximately $96.9 million and $99.9 million, respectively, of various currencies. The periods of the foreign currency exchange contracts generally do not exceed one year and correspond to the periods of the exposed transactions or related cash flows.

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Fair Value Measurements

The following tables set forth the location and aggregate fair value amounts of all derivative instruments with credit-related contingent features (dollars in thousands):

	Asset Derivatives					Liability Derivatives
	Balance	Fair Value				Balance	Fair Value
	Sheet	June 30,		December 31,		Sheet	June 30,		December 31,
	Location	2010		2009		Location	2010		2009

Derivatives
designated as
hedging instruments

Interest rate swap agreements	Prepaid expenses and other	$	-	$	-	Accrued expenses and other	$	3,983	$	8,436


Derivatives not
designated as
hedging instruments

Foreign currency exchange contracts	Prepaid expenses and other		5,025		995	Accrued expenses and other		440		1,905

Total derivatives		$	5,025	$	995		$	4,423	$	10,341

The location and net amounts reported in the Statements of Earnings or in Accumulated Other Comprehensive Income (“OCI”) for derivatives designated as cash flow hedging instruments under the Derivatives and Hedges topic of the Codification are as follows (dollars in thousands):

	Three months ended June 30,
	Effective portion
							Location of gain	Amount of gain
Derivatives	Amount of gain						(loss) reclassified	(loss) reclassified
designated as cash flow	(loss) recognized						from accumulated	from accumulated
hedging instruments	in OCI on derivative						OCI into income	OCI into income

	2010			2009				2010			2009

Interest rate swap agreements	$	85		$	(762	)	Interest expense	$	(1,736	)	$	(1,173	)



	Six months ended June 30,
	Effective portion
							Location of gain	Amount of gain
Derivatives	Amount of gain						(loss) reclassified	(loss) reclassified
designated as cash flow	(loss) recognized						from accumulated	from accumulated
hedging instruments	in OCI on derivative						OCI into income	OCI into income

	2010			2009				2010			2009

Interest rate swap agreements	$	(793	)	$	(1,493	)	Interest expense	$	(3,687	)	$	(2,921	)

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The location and net amounts reported in the Statements of Earnings for derivatives not designated as hedging instruments under the Derivatives and Hedges topic of the Codification are as follows (dollars in thousands):

Derivatives not	Location of gain
designated as	(loss) recognized in	Amount of gain (loss)
hedging instruments	income on derivative	recognized in income on derivative

		Three months ended June 30,					Six months ended June 30,
		2010		2009			2010		2009

Foreign currency exchange contracts	Foreign currency gain/(loss)	$	2,248	$	(6,066	)	$	8,812	$	(5,724	)

Certain of KCI’s derivative instruments contain provisions that require compliance with the restrictive covenants of our credit facilities. For further information on our senior credit facility, see Note 5 of the Notes to the Consolidated Financial Statements included in KCI's Annual Report on Form 10-K for the fiscal year ended December 31, 2009.

If we default under our credit facilities, the lenders could require immediate repayment of the entire principal. If those lenders require immediate repayment, we may not be able to repay them which could result in the foreclosure of substantially all of our assets. In these circumstances, the counterparties to the derivative instruments could request immediate payment or full collateralization on derivative instruments in net liability positions. All of our derivative counterparties are also parties to our credit facilities.

No collateral has been posted by KCI in the normal course of business. If the credit-related contingent features underlying these agreements were triggered on June 30, 2010, KCI could be required to settle or post the full amount as collateral to its counterparties.

NOTE 5. Earnings Per Share

Net earnings per share was calculated using the weighted average number of shares outstanding during the respective periods. The following table sets forth the reconciliation from basic to diluted weighted average shares outstanding and the calculations of net earnings per share (in thousands, except per share data):

	Three months ended				Six months ended
	June 30,				June 30,
	2010		2009		2010		2009

Net earnings	$	53,605	$	58,097	$	106,318	$	97,802

Weighted average shares outstanding:
Basic		70,836		70,069		70,678		69,984
Dilutive potential common shares from stock options and restricted stock (1)		969		363		979		310

Diluted		71,805		70,432		71,657		70,294

Basic net earnings per share	$	0.76	$	0.83	$	1.50	$	1.40

Diluted net earnings per share	$	0.75	$	0.82	$	1.48	$	1.39


(1) Potentially dilutive stock options and restricted stock totaling 3,619 shares and 5,473 shares for the three months ended June 30, 2010 and 2009, respectively, and 3,723 shares and 5,746 shares for the six months ended June 30, 2010 and 2009, respectively, were excluded from the computation of diluted weighted average shares outstanding due to their antidilutive effect.

Holders of our Convertible Notes may convert the Convertible Notes into cash, and if applicable, shares of our common stock at the applicable conversion rate, at their option any day prior to October 15, 2014 if specific conditions are satisfied. (See Note 3.) The Convertible Notes will have no impact on diluted earnings per share unless the price of our common stock exceeds the conversion price (initially $51.34 per share) because the principal amount of the Convertible Notes will be settled in cash upon conversion. Prior to conversion, we will use the treasury stock method to include the effect of the additional shares that may be issued if our common stock price exceeds the conversion price. The convertible note hedge purchased in connection with the issuance of our Convertible Notes is excluded from the calculation of diluted earnings per share as its impact is always anti-dilutive. The warrant transactions associated with the issuance of our Convertible Notes will have no impact on EPS unless our share price exceeds the $60.41 exercise price.

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NOTE 6. Incentive Compensation Plans

Share-based compensation expense was recognized in the unaudited condensed consolidated statements of earnings as follows (dollars in thousands):

	Three months ended						Six months ended
	June 30,						June 30,
	2010			2009			2010			2009

Rental expenses	$	800		$	745		$	2,317		$	2,102
Cost of sales		133			144			444			481
Selling, general and administrative expenses		5,023			4,706			12,673			11,371

Pre-tax share-based compensation expense		5,956			5,595			15,434			13,954
Less: Income tax benefit		(2,167	)		(2,076	)		(5,369	)		(4,633	)

Total share-based compensation expense, net of tax	$	3,789		$	3,519		$	10,065		$	9,321

A summary of our stock option activity, and related information, for the six months ended June 30, 2010 is set forth in the table below:

					Weighted
					Average
			Weighted		Remaining	Aggregate
			Average		Contractual	Intrinsic
	Options		Exercise		Term	Value
	(in thousands)		Price		(years)	(in thousands)

Options outstanding – January 1, 2010	5,398		$	38.45
Granted	1,135		$	40.82
Exercised	(360	)	$	28.27
Forfeited/Expired	(495	)	$	41.75

Options outstanding – June 30, 2010	5,678		$	39.28	7.46	$	18,018

Exercisable as of June 30, 2010	2,438		$	43.53	6.34	$	3,743

The following table summarizes restricted stock activity for the six months ended June 30, 2010:

	Number of		Weighted
	Shares		Average Grant
	(in thousands)		Date Fair Value

Unvested shares – January 1, 2010	992		$	37.96
Granted	426		$	41.05
Vested and distributed	(92	)	$	46.06
Forfeited	(153	)	$	41.74

Unvested shares – June 30, 2010	1,173		$	37.99

KCI has a policy of issuing new shares to satisfy stock option exercises and restricted stock award issuances. In addition, KCI may purchase shares in connection with the net share settlement exercise of employee stock options for minimum tax withholdings and exercise price and the withholding of shares to satisfy the minimum tax withholdings on the vesting of restricted stock.

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NOTE 7. Other Comprehensive Income

The components of total comprehensive income are as follows (dollars in thousands):

	Three months ended June 30,						Six months ended June 30,
	2010			2009			2010			2009

Net earnings	$	53,605		$	58,097		$	106,318		$	97,802
Foreign currency translation adjustment, net of taxes		(4,779	)		4,634			(6,534	)		502
Net derivative gain (loss), net of taxes		85			(762	)		(793	)		(1,493	)
Amount of loss reclassified from accumulated OCI into income, net of taxes		1,736			1,173			3,687			2,921

Total comprehensive income	$	50,647		$	63,142		$	102,678		$	99,732

NOTE 8. Commitments and Contingencies

Patent Litigation

Although it is not possible to reliably predict the outcome of U.S. and foreign patent litigation described below, we believe that our claims are meritorious. However, if any of our key patent claims were narrowed in scope or found to be invalid or unenforceable, or we otherwise do not prevail, our share of the advanced wound care market for our V.A.C.® Therapy Systems could be significantly reduced in the United States, Europe or Australia, due to increased competition, and pricing of V.A.C. Therapy Systems could decline significantly, either of which would negatively affect our financial condition and results of operations. We derived approximately 50% of total revenue for the six months ended June 30, 2010 and 51% of total revenue for the year ended December 31, 2009 from our domestic Negative Pressure Wound Therapy (“NPWT”) products relating to the U.S. patents at issue. In continental Europe, we derived approximately 12% of total revenue for the six months ended June 30, 2010 and the year ended December 31, 2009 from AHS revenue relating to the patents at issue in the ongoing litigation in Germany, France and the United Kingdom.

U.S. NPWT Patent Litigation

KCI and its affiliates, together with Wake Forest University Health Sciences (“Wake Forest”) are involved in multiple patent infringement suits involving patents licensed exclusively to KCI by Wake Forest. In May 2007, KCI, its affiliates and Wake Forest filed two related patent infringement suits: one case against Smith & Nephew and BlueSky and a second case against Medela, for the manufacture, use and sale of negative pressure devices which we believe infringe U.S. Patent Nos. 5,645,081 and 7,216,651 licensed exclusively to KCI by Wake Forest. These cases are being heard in the Federal District Court for the Western District of Texas. In March 2010, the jury hearing the case against Smith & Nephew returned a verdict finding that the patent claims asserted against Smith & Nephew were valid, and that Smith & Nephew’s foam-based NPWT products infringed those patent claims. KCI is seeking an injunction in Federal District Court in post-trial proceedings to prevent further infringement by Smith & Nephew. In June 2010, certain KCI plaintiffs were dismissed from the case, including KCI USA, Inc., leaving Kinetic Concepts, Inc. and Wake Forest as plaintiffs. KCI has filed motions to reconsider and for leave to file a Supplemental Complaint to add the dismissed plaintiffs back to the suit. In July 2010, the Court heard arguments on our request for a permanent injunction, in addition to other post-trial motions. By mutual agreement, the case against Medela’s and Smith & Nephew’s gauze-based devices will be tried at a later time.

Related to the U.S. NPWT litigation, the U.S. Patent and Trademark Office (“USPTO”) has issued certificates of re-examination confirming the validity of three separate patents licensed to KCI by Wake Forest University Health Sciences in re-examination proceedings. The patents associated with these decisions include U.S. Patent Nos. 5,636,643 (“the ‘643 Patent”), 5,645,081 (“the ‘081 Patent”), and 7,198,046 (“the ‘046 Patent), which all relate to KCI’s NPWT technologies. The USPTO also issued a formal Office action confirming the validity of all claims of U.S. Patent No. 7,216,651 (“the ‘651 Patent”) and formally closed prosecution of the reexamination. Smith & Nephew has filed an appeal of the decision on the ‘651 Patent with the Board of Patent Appeals and Interferences at the USPTO.

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In September 2007, KCI and two affiliates were named in a declaratory judgment action filed in the Federal District Court for the District of Delaware by Innovative Therapies, Inc. (“ITI”). In that case, the plaintiff alleged the invalidity or unenforceability of four patents licensed to KCI by Wake Forest and one patent owned by KCI relating to V.A.C. Therapy, and has requested a finding that products made by the plaintiff do not infringe the patents at issue. In 2008, the District Court dismissed ITI’s suit based on a lack of subject matter jurisdiction. ITI appealed the dismissal of the suit to the Federal Circuit Court of Appeals. In April 2010, the Federal Circuit affirmed the dismissal.

In January 2008, KCI, its affiliates and Wake Forest filed a patent infringement lawsuit against ITI in the U.S. District Court for the Middle District of North Carolina. The federal complaint alleges that a NPWT device introduced by ITI in 2007 infringes three Wake Forest patents which are exclusively licensed to KCI. We are seeking damages and injunctive relief in the case. Also in January and June of 2008, KCI and its affiliates filed separate suits in state District Court in Bexar County, Texas, against ITI and several of its principals, all of whom are former employees of KCI. The claims in the state court suits include breach of confidentiality agreements, conversion of KCI technology, theft of trade secrets and conspiracy. We are seeking damages and injunctive relief in the state court cases.

In December 2008, KCI, its affiliates and Wake Forest filed a patent infringement lawsuit against Boehringer Wound Systems, LLC, Boehringer Technologies, LP, and Convatec, Inc. in the U.S. District Court for the Middle District of North Carolina. The federal complaint alleges that an NPWT device manufactured by Boehringer and commercialized by Convatec infringes Wake Forest patents which are exclusively licensed to KCI. In February 2009, the defendants filed their answer, which includes affirmative defenses and counterclaims alleging non-infringement and invalidity of the Wake Forest patents. A jury trial in the case is set for November 2010.

International NPWT Patent Litigation

In June 2007, Medela filed a patent nullity suit in the German Federal Patent Court against Wake Forest’s German patent corresponding to European Patent No. EP0620720 (“the ‘720 Patent”), which is licensed to KCI. In March 2008 and February 2009, Mölnlycke Health Care AB and Smith & Nephew, respectively, joined the nullity suit against the ‘720 Patent. In March 2009, the German Federal Patent Court ruled the German patent corresponding to the ‘720 Patent invalid. KCI and Wake Forest have appealed that decision and the ‘720 patent remains valid and enforceable in Germany until a final ruling on appeal.

In June 2007, Medela also filed a patent nullity suit in the German Federal Patent Court against Wake Forest’s German patent corresponding to European Patent No. EP0688189 (“the ‘189 Patent”), which is licensed to KCI. In May 2009, the German Federal Patent Court ruled that the ‘189 Patent is valid as granted.

In March 2008, Mölnlycke Health Care AB filed suit in the United Kingdom alleging invalidity of the United Kingdom patent corresponding to the ‘720 Patent. Following a trial in July 2009, the trial court ruled the United Kingdom patent corresponding to the ‘720 Patent invalid. Following the denial of an appeal by the United Kingdom Supreme Court in a separate action against Smith & Nephew involving the same patent, detailed below, Wake Forest and KCI have withdrawn an appeal of the ruling in this matter.

In December 2008, KCI and its affiliates filed a patent infringement lawsuit against Smith & Nephew in the United Kingdom requesting preliminary and interim injunctive relief based on the United Kingdom patent corresponding to the ‘720 patent. In May 2009, a judgment was issued by the Court in which it determined that certain claims of the ‘720 Patent covering the use of foam dressing kits with NPWT systems were valid and infringed by Smith & Nephew's foam-based NPWT dressing kits. The court held that other claims under the patent were invalid. The Court’s judgment extended a previously-issued injunction. Smith & Nephew appealed the ruling and in July 2009, the Court of Appeal ruled the claims at issue invalid and lifted the injunction in the United Kingdom. KCI may be required to pay damages for the period of injunction. In February 2010, KCI was denied permission to appeal by the United Kingdom Supreme Court.

In March 2009, KCI and its affiliates filed a patent infringement lawsuit against Smith & Nephew in the Federal Court of Australia, requesting preliminary injunctive relief to prohibit the commercialization of a Smith & Nephew negative pressure wound therapy dressing kit. The Federal Court issued a temporary injunction in the case, which was subsequently overturned by the Full Court of Federal Court of Australia. A full trial on validity and infringement of the Wake Forest patent involved in the case was held in 2010. We expect a ruling in this case in the next several months.

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In March 2009, KCI's German subsidiary filed a request for a preliminary injunction with the German District Court of Düsseldorf to prevent commercialization of a Smith & Nephew negative pressure wound therapy system that KCI believes infringes the German counterpart of KCI’s European Patent No. EP0777504 (“the ‘504 Patent”). Following a hearing in July 2009 on this matter, the Court denied KCI’s request for preliminary injunction. Also, in April 2009, KCI's German subsidiary filed a patent infringement lawsuit against Smith & Nephew, GmbH Germany in the German District Court of Mannheim. The lawsuit alleges that the negative pressure wound therapy systems commercialized by Smith & Nephew infringe the ‘504 Patent and another German patent owned by KCI corresponding to European Patent No. EP0853950 (“the ‘950 Patent”). A trial was held in October 2009 on the ‘504 Patent claims, after which the Court dismissed KCI’s infringement allegations. A trial on KCI’s ‘950 Patent claims was held in June 2010. A decision is expected in August 2010.

In July 2009, KCI and its affiliates filed a request for a preliminary injunction with the Paris District Court in France to prevent commercialization of Smith & Nephew’s NPWT system that KCI believes infringes the French counterpart of the ‘504 Patent. A hearing on KCI’s request for preliminary injunction was held in October 2009 in France. In November 2009, the Paris District Court denied KCI’s request for a preliminary injunction. A trial in France on this matter is expected in early to mid-2011. Also in July 2009, KCI and its affiliates filed patent infringement lawsuits against Smith & Nephew in the United Kingdom and its affiliates in France alleging infringement of the ‘504 Patent and the ‘950 Patent in those countries. KCI withdrew its request for a preliminary injunction in the United Kingdom based on the ‘504 Patent and the ‘950 Patent and proceeded to trial in May 2010.

In June 2010, the Court in the United Kingdom ruled the claims at issue from the ‘504 Patent and ‘950 Patent to be valid and infringed by Smith & Nephew’s Renasys NPWT systems. In July 2010, the Court ordered that Smith & Nephew be enjoined from further infringement of the ‘504 Patent and ‘950 Patent. The Court stayed the injunction pending appeal, which has been set for October 2010.

LifeCell Litigation

In September 2005, LifeCell recalled certain human-tissue based products because the organization that recovered the tissue, Biomedical Tissue Services, Ltd. (“BTS”) may not have followed FDA requirements for donor consent and/or screening to determine if risk factors for communicable diseases existed. LifeCell promptly notified the FDA and all relevant hospitals and medical professionals. LifeCell did not receive any donor tissue from BTS after September 2005. LifeCell has been named, along with BTS and many other defendants, in lawsuits relating to the BTS donor irregularities. These lawsuits generally fall within three categories, (1) recipients of BTS tissue who claim actual injury; (2) suits filed by recipients of BTS tissue seeking medical monitoring and/or damages for emotional distress; and (3) suits filed by family members of tissue donors who did not authorize BTS to donate tissue.

LifeCell has resolved all of these lawsuits, which are in the process of being dismissed. The resolution of these lawsuits did not have a material impact on our financial position or results of operations.

We are party to several additional lawsuits arising in the ordinary course of our business. Additionally, the manufacturing and marketing of medical products necessarily entails an inherent risk of product liability claims.

Other Commitments and Contingencies

As a healthcare supplier, we are subject to extensive government regulation, including laws and regulations directed at ascertaining the appropriateness of reimbursement, preventing fraud and abuse and otherwise regulating reimbursement under various government programs. The marketing, billing, documenting and other practices are all subject to government oversight and review. To ensure compliance with Medicare and other regulations, regional carriers often conduct audits and request patient records and other documents to support claims submitted by KCI for payment of services rendered to customers.

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We also are subject to routine pre-payment and post-payment audits of medical claims submitted to Medicare. These audits typically involve a review, by Medicare or its designated contractors and representatives, of documentation supporting the medical necessity of the therapy provided by KCI. While Medicare requires us to obtain a comprehensive physician order prior to providing products and services, we are not required to, and do not as a matter of practice require, or subsequently obtain, the underlying medical records supporting the information included in such claim. Following a Medicare request for supporting documentation, we are obligated to procure and submit the underlying medical records retained by various medical facilities and physicians. Obtaining these medical records in connection with a claims audit may be difficult or impossible and, in any event, all of these records are subject to further examination and dispute by an auditing authority. Under standard Medicare procedures, KCI is entitled to demonstrate the sufficiency of documentation and the establishment of medical necessity, and KCI has the right to appeal any adverse determinations. If a determination is made that KCI’s records or the patients’ medical records are insufficient to meet medical necessity or Medicare reimbursement requirements for the claims subject to a pre-payment or post-payment audit, KCI could be subject to denial, recoupment or refund demands for claims submitted for Medicare reimbursement. In the event that an audit results in discrepancies in the records provided, Medicare may be entitled to extrapolate the results of the audit to make recoupment demands based on a wider population of claims than those examined in the audit. In addition, Medicare or its contractors could place KCI on an extended pre-payment review, which could slow our collections process for submitted claims. If Medicare were to deny a significant number of claims in any pre-payment audit, or make any recoupment demands based on any post-payment audit, our business and operating results could be materially and adversely affected. In addition, violations of federal and state regulations regarding Medicare reimbursement could result in severe criminal, civil and administrative penalties and sanctions, including disqualification from Medicare and other reimbursement programs. Going forward, it is likely that we will be subject to periodic inspections, assessments and audits of our billing and collections practices.

In February 2009, we received a subpoena from the U.S. Department of Health and Human Services Office of Inspector General (“OIG”) seeking records regarding our billing practices under the local coverage policies of the four regional DMACs. We are in discussions with the government regarding the scope of the subpoena and have provided substantial documentation to the OIG in response to their requests in a timely manner. We intend to cooperate with the OIG’s inquiry. The review is in its initial stages and we cannot predict the time frame in which it will be resolved nor the impact the findings will have on our results of operations or our financial position.

As of June 30, 2010, our commitments for the purchase of new product inventory were $22.2 million, including approximately $4.2 million of disposable products from our main disposable supplier, $4.4 million for inventory related to our Regenerative Medicine business, $2.6 million from our provider of low height medical-surgical beds and $2.9 million from our major electronic board and touch panel suppliers. Other than commitments for new product inventory, we have no material long-term purchase commitments.

NOTE 9. Segment and Geographic Information

We are engaged in the rental and sale of advanced wound care systems, regenerative medicine products and therapeutic support systems. KCI has operations throughout the United States and in 21 primary countries internationally.

We have three reportable operating segments which correspond to our business units: Active Healing Solutions™; Regenerative Medicine; and Therapeutic Support Systems. Our three operating segments also represent our reporting units as defined by the Codification. We have two primary geographic regions for which we provide supplemental revenue information: North America, which is comprised principally of the United States and includes Canada and Puerto Rico; and EMEA/APAC, which is comprised principally of Europe and includes the Middle East, Africa and the Asia Pacific region. Revenue for each of our geographic regions in which we operate is disclosed for each of our business units. In most countries where we operate, our product lines are marketed and serviced by the same infrastructure and, as such, we have allocated these costs to the various business units based on allocation methods including rental and sales events, headcount, revenue and other methods as deemed appropriate. We measure segment profit as operating earnings, which is defined as income before interest and other income, interest expense, foreign currency gains and losses, and income taxes. All intercompany transactions are eliminated in computing revenue and operating earnings.

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Information on segments and a reconciliation of consolidated totals are as follows (dollars in thousands):

	Three months ended				Six months ended
	June 30,				June 30,
	2010		2009		2010		2009
Revenue:
AHS
North America	$	266,681	$	266,348	$	516,513	$	520,989
EMEA/APAC		81,045		83,082		164,166		157,758

Subtotal – AHS		347,726		349,430		680,679		678,747

Regenerative Medicine
North America		82,188		70,803		160,162		136,884
EMEA/APAC		1,555		267		2,596		394

Subtotal – Regenerative Medicine		83,743		71,070		162,758		137,278

TSS
North America		44,563		46,027		92,963		95,275
EMEA/APAC		21,740		24,822		47,177		50,130

Subtotal – TSS		66,303		70,849		140,140		145,405

Total revenue	$	497,772	$	491,349	$	983,577	$	961,430

	Three months ended							Six months ended
	June 30,							June 30,
	2010				2009			2010				2009
Operating earnings:
AHS	$	116,689			$	111,969		$	217,281			$	204,875
Regenerative Medicine		19,819				21,168			41,871				41,849
TSS		(5,204	)	(1)		5,867			2,968		(1)		13,092

Non-allocated costs:
General headquarter expenses (2)		(14,061	)			(9,300	)		(23,361	)			(19,475	)
Share-based Compensation		(5,956	)			(5,595	)		(15,434	)			(13,954	)
Acquisition-related expenses (3)		(9,930	)			(10,698	)		(20,628	)			(21,396	)

Total non-allocated costs		(29,947	)			(25,593	)		(59,423	)			(54,825	)

Total operating earnings	$	101,357			$	113,411		$	202,697			$	204,991


(1) Includes $7.4 million of expenses associated with the TSS product portfolio rationalization recorded in the second quarter of 2010. (2) Includes costs associated with our Global Business Transformation project, including severance and other expenses of $5.3 million and $9.4 million recorded during the second quarter of 2010 and the first quarter of 2009, respectively. (3) Includes amortization of acquired intangible assets and cost to retain key employees related to our purchase of LifeCell in May 2008.

NOTE 10. Subsequent Events

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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the condensed consolidated financial statements and accompanying notes included in this report. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include, but are not limited to, those discussed in our “Risk Factors,” (Part II, Item 1A.), including those previously disseminated in KCI's Annual Report on Form 10-K for the fiscal year ended December 31, 2009.

GENERAL

Kinetic Concepts, Inc. (“KCI”) is a leading global medical technology company devoted to the discovery, development, manufacture and marketing of innovative, high-technology therapies and products that have been designed to leverage the body’s ability to heal, thus improving clinical outcomes while helping to reduce the overall cost of patient care. We have an infrastructure designed to meet the specific needs of medical professionals and patients across all healthcare settings, including acute care hospitals, extended care organizations and patients’ homes, both in the United States and abroad. Our primary business units serve the advanced wound care, regenerative medicine and therapeutic support systems markets.

Our Active Healing Solutions business (“AHS”) is focused on the development and commercialization of advanced wound care therapies based on our Negative Pressure Technology Platform (“NPTP”) which employs negative pressure in a variety of applications to promote wound healing through unique mechanisms of action and to speed recovery times while reducing the overall cost of treating patients with complex wounds. NPTP comprises three primary product categories: Negative Pressure Wound Therapy (“NPWT”), Negative Pressure Surgical Management (“NPSM”) and Negative Pressure Regenerative Medicine (“NPRM”). NPWT, through our V.A.C. Therapy portfolio, currently represents the primary source of revenue for the AHS business. In the acute care setting, we bill our customers directly for the rental and sale of our products. In the homecare setting, we provide products and services to patients in the home and generally bill third-party payers directly. We continue to develop and commercialize new products and therapies in NPSM and NPRM to broaden and diversify our NPTP revenue streams. During July 2010, our newest NPWT product, V.A.C. Via, was placed on our first patient in the U.S. In addition, during July 2010, the Company launched our Prevena Incision Management System in the U.S. Prevena is our newest NPSM product designed specifically for the management of surgically-closed incisions.

Our Regenerative Medicine business is comprised primarily of the operations of LifeCell, a wholly-owned subsidiary. LifeCell is focused on the development and commercialization of regenerative and reconstructive acellular tissue matrices for use in reconstructive, orthopedic, and urogynecologic surgical procedures to repair soft tissue defects, as well as for reconstructive and cosmetic procedures. Existing products include our human-based AlloDerm® Regenerative Tissue Matrix and porcine-based Strattice™ Tissue Matrix in various configurations designed to meet the needs of patients and caregivers. The majority of our Regenerative Medicine revenue is generated from the clinical applications of challenging hernia repair and post-mastectomy breast reconstruction, which is generated primarily in the United States in the acute care setting on a direct billing basis. We continue efforts to penetrate markets with our other regenerative medicine products while developing and commercializing additional tissue matrix products and applications to expand into new markets and geographies.

Our Therapeutic Support Systems business (“TSS”) is focused on commercializing specialized therapeutic support systems, including hospital beds, mattress replacement systems and overlays. Our TSS business rents and sells products in three primary surface categories: critical care, wound care and bariatric. Our critical care products, often used in the ICU are designed to address pulmonary complications associated with immobility; our wound care surfaces are used to reduce or treat skin breakdown; and our bariatric surfaces assist caregivers in the safe and dignified handling of patients of size. We also have products designed to reduce the incidence and severity of patient falls in the hospital setting.

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We are principally engaged in the rental and sale of our products throughout the United States and in 21 primary countries internationally. We currently have approximately 6,700 employees worldwide and are headquartered in San Antonio, Texas. We have research and development facilities in the United States and the United Kingdom, and we maintain manufacturing and engineering operations in the United States, the United Kingdom, Ireland and Belgium.

A significant majority of our revenue is generated by our AHS business unit, which accounted for approximately 69.2% of total revenue for the six months ended June 30, 2010, compared to 70.6% for the same period in 2009. The sale of our Regenerative Medicine products accounted for 16.6% and 14.3% of our total revenue for the six months ended June 30, 2010 and 2009, respectively. Our TSS business accounted for approximately 14.2% and 15.1% of our total revenue for the six months ended June 30, 2010 and 2009, respectively. Operations for our North America geographic region accounted for 78.2% revenue for the first six months of 2010, while our EMEA/APAC operations represented 21.8% of total revenue.

Historically, we have experienced a seasonal slowing of AHS unit demand beginning in the fourth quarter and continuing into the first quarter, which we believe has been caused by year-end clinical treatment patterns, such as the postponement of elective surgeries and increased discharges of individuals from the acute care setting around the winter holidays. Regenerative Medicine has also historically experienced a similar seasonal slowing of sales in the third quarter of each year. Although we do not know if our historical experience will prove to be indicative of future periods, similar slow-downs may occur in subsequent periods.

RECENT DEVELOPMENTS

In the U.S., we have now received FDA clearance and have launched Prevena commercially. This follows the previous launch of Prevena in Europe and Canada in the first quarter of 2010. This product is the first powered negative pressure product designed specifically for management of surgically-closed incisions. In addition, our next-generation NPWT product, V.A.C. Via, received FDA clearance in the first quarter of 2010 and has now been placed on our first patient in the U.S.

As our AHS business continues to expand globally, we have now entered the Japan market with our core NPWT product, the V.A.C. Therapy System and related disposables. In April 2010, we launched NPWT commercially in Japan following the receipt of all necessary approvals.

RESULTS OF OPERATIONS

We have three reportable operating segments which correspond to our three business units: AHS; Regenerative Medicine; and TSS. We have two primary geographic regions for which we provide supplemental information: North America, which is comprised principally of the United States and includes Canada and Puerto Rico; and EMEA/APAC, which is comprised principally of Europe and includes the Middle East, Africa and the Asia Pacific region. Revenue for each of our geographic regions in which we operate is disclosed for each of our business units.

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Revenue by Operating Segment

The following table sets forth, for the periods indicated, business unit revenue by geographic region, as well as the percentage change in each line item, comparing the second quarter of 2010 to the second quarter of 2009 and the first six months of 2010 to the first six months of 2009 (dollars in thousands):

	Three months ended June 30,						Six months ended June 30,
					%						%
	2010		2009		Change		2010		2009		Change
AHS revenue:
North America	$	266,681	$	266,348	0.1	%	$	516,513	$	520,989	(0.9	)%
EMEA/APAC		81,045		83,082	(2.5	)		164,166		157,758	4.1

Total – AHS		347,726		349,430	(0.5	)		680,679		678,747	0.3

Regenerative Medicine revenue:
North America		82,188		70,803	16.1			160,162		136,884	17.0
EMEA/APAC		1,555		267	-			2,596		394	-

Total – Regenerative Medicine		83,743		71,070	17.8			162,758		137,278	18.6

TSS revenue:
North America		44,563		46,027	(3.2	)		92,963		95,275	(2.4	)
EMEA/APAC		21,740		24,822	(12.4	)		47,177		50,130	(5.9	)

Total – TSS		66,303		70,849	(6.4	)		140,140		145,405	(3.6	)

Total revenue	$	497,772	$	491,349	1.3	%	$	983,577	$	961,430	2.3	%

For additional discussion on segment and geographic information, see Note 9 to our accompanying condensed consolidated financial statements.

Revenue by Geography

The following table sets forth, for the periods indicated, rental and sales revenue by geography, as well as the percentage change in each line item, comparing the second quarter of 2010 to the second quarter of 2009 and the first six months of 2010 to the first six months of 2009 (dollars in thousands):

	Three months ended June 30,						Six months ended June 30,
					%						%
	2010		2009		Change		2010		2009		Change
North America revenue:
Rental	$	227,660	$	231,428	(1.6	)%	$	448,063	$	457,440	(2.0	)%
Sales		165,772		151,750	9.2			321,575		295,708	8.7

Total – North America		393,432		383,178	2.7			769,638		753,148	2.2

EMEA/APAC revenue:
Rental		55,424		60,595	(8.5	)		115,012		116,938	(1.6	)
Sales		48,916		47,576	2.8			98,927		91,344	8.3

Total – EMEA/APAC		104,340		108,171	(3.5	)		213,939		208,282	2.7

Total rental revenue		283,084		292,023	(3.1	)		563,075		574,378	(2.0	)
Total sales revenue		214,688		199,326	7.7			420,502		387,052	8.6

Total revenue	$	497,772	$	491,349	1.3	%	$	983,577	$	961,430	2.3	%

The change in total revenue compared to the prior-year periods was due primarily to increased Regenerative Medicine sales, partially offset by decreased AHS and TSS rental revenue. Foreign currency exchange rate movements had minimal impact on total revenue for the second quarter of 2010 and favorably impacted total revenue by 1.0% for the first six months of 2010 compared to the corresponding periods of the prior year.

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Revenue Relationship

The following table sets forth, for the periods indicated, the percentage relationship of each item to total revenue in the period, as well as the changes in each line item, comparing the second quarter of 2010 to the second quarter of 2009 and the first six months of 2010 to the first six months of 2009:

	Three months ended June 30,					Six months ended June 30,

	2010		2009		Change	2010		2009		Change
Total revenue:
AHS revenue	69.9	%	71.1	%	(120 bps)	69.2	%	70.6	%	(140 bps)
Regenerative Medicine revenue	16.8		14.5		230 bps	16.6		14.3		230 bps
TSS revenue	13.3		14.4		(110 bps)	14.2		15.1		(90 bps)

Total revenue	100.0	%	100.0	%		100.0	%	100.0	%

North America revenue	79.0	%	78.0	%	100 bps	78.2	%	78.3	%	(10 bps)
EMEA/APAC revenue	21.0		22.0		(100 bps)	21.8		21.7		10 bps

Total revenue	100.0	%	100.0	%		100.0	%	100.0	%

Rental revenue	56.9	%	59.4	%	(250 bps)	57.2	%	59.7	%	(250 bps)
Sales revenue	43.1		40.6		250 bps	42.8		40.3		250 bps

Total revenue	100.0	%	100.0	%		100.0	%	100.0	%

AHS Revenue

The following table sets forth, for the periods indicated, AHS rental and sales revenue by geography, as well as the percentage change in each line item, comparing the second quarter of 2010 to the second quarter of 2009 and the first six months of 2010 to the first six months of 2009 (dollars in thousands):

	Three months ended June 30,						Six months ended June 30,
					%						%
	2010		2009		Change		2010		2009		Change
North America revenue:
Rental	$	189,076	$	190,403	(0.7	)%	$	368,069	$	372,937	(1.3	)%
Sales		77,605		75,945	2.2			148,444		148,052	0.3

Total North America revenue		266,681		266,348	0.1			516,513		520,989	(0.9	)

EMEA/APAC revenue:
Rental		37,773		40,667	(7.1	)		77,137		77,258	(0.2	)
Sales		43,272		42,415	2.0			87,029		80,500	8.1

Total EMEA/APAC revenue		81,045		83,082	(2.5	)		164,166		157,758	4.1

Total rental revenue		226,849		231,070	(1.8	)		445,206		450,195	(1.1	)
Total sales revenue		120,877		118,360	2.1			235,473		228,552	3.0

Total AHS revenue	$	347,726	$	349,430	(0.5	)%	$	680,679	$	678,747	0.3	%

Worldwide revenue from AHS products increased from the first half of 2009 due primarily to higher global sales volumes, which were offset by unfavorable foreign currency exchange rate movement and lower realized pricing. North America AHS revenue for the second quarter of 2010 was comparable to the prior-year quarter, while revenue for the first half of 2010 decreased 1% from the prior-year period. Second quarter 2010 AHS revenue from the United States was $254.0 million, which was flat to the period one year ago. However, rental revenue declined 1% this period resulting from a combination of factors including (i) reductions in chronic wounds treated outside the hospital, (ii) unfavorable wound and payer mix and (iii) higher usage of lower-priced advanced wound care therapies other than NPWT. Foreign currency exchange movements favorably impacted second quarter and first half North American AHS revenue by 1% compared to the prior-year periods.

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Foreign currency exchange rate movements negatively impact EMEA/APAC AHS revenue by 3.4% in the second quarter of 2010, but had a 2.4% favorable impact on the first six months of 2010 compared to the prior-year periods. EMEA/APAC AHS revenue, excluding the impact of foreign currency exchange rate movements, increased due largely to the successful launch of V.A.C. in Japan. Increased rental and sales volumes were offset by lower realized pricing associated with an increasingly competitive environment and our offering of longer-term, lower-priced rental arrangements.

Regenerative Medicine Revenue

The following table sets forth, for the periods indicated, Regenerative Medicine revenue by geography, as well as the percentage change in each line item, comparing the second quarter of 2010 to the second quarter of 2009 and the first six months of 2010 to the first six months of 2009 (dollars in thousands):

	Three months ended June 30,						Six months ended June 30,
	2010		2009		Change		2010		2009		Change

North America	$	82,188	$	70,803	16.1	%	$	160,162	$	136,884	17.0	%
EMEA/APAC		1,555		267	-			2,596		394	-

Total revenue	$	83,743	$	71,070	17.8	%	$	162,758	$	137,278	18.6	%

Regenerative Medicine revenue generated from the use of AlloDerm, Strattice, and other acellular tissue matrix products in reconstructive surgical procedures, including challenging hernia repair and breast reconstruction, accounted for 93.2% of total Regenerative Medicine revenue for both the second quarter and first six months of 2010. Revenue from Strattice, our porcine-based tissue matrix product, accounted for 39.6% and 38.3% of total Regenerative Medicine revenue for the second quarter and first six months of 2010, respectively, compared to 30.8% and 27.8%, respectively, in the prior-year periods. The growth in Regenerative Medicine revenue over the prior year was due primarily to increased demand for our tissue matrix products due to continued market penetration and geographic expansion.

TSS Revenue

The following table sets forth, for the periods indicated, TSS rental and sales revenue by geography, as well as the percentage change in each line item, comparing the second quarter of 2010 to the second quarter of 2009 and the first six months of 2010 to the first six months of 2009 (dollars in thousands):

	Three months ended June 30,						Six months ended June 30,
					%						%
	2010		2009		Change		2010		2009		Change
North America revenue:
Rental	$	38,584	$	41,025	(6.0	)%	$	79,994	$	84,503	(5.3	)%
Sales		5,979		5,002	19.5			12,969		10,772	20.4

Total North America revenue		44,563		46,027	(3.2	)		92,963		95,275	(2.4	)

EMEA/APAC revenue:
Rental		17,651		19,928	(11.4	)		37,875		39,680	(4.5	)
Sales		4,089		4,894	(16.4	)		9,302		10,450	(11.0	)

Total EMEA/APAC revenue		21,740		24,822	(12.4	)		47,177		50,130	(5.9	)

Total rental revenue		56,235		60,953	(7.7	)		117,869		124,183	(5.1	)
Total sales revenue		10,068		9,896	1.7			22,271		21,222	4.9

Total TSS revenue	$	66,303	$	70,849	(6.4	)%	$	140,140	$	145,405	(3.6	)%

Worldwide TSS revenue decreased from the prior-year period due primarily to lower rental volumes globally, resulting from the economic downturn and its impact on acute care facilities, partially offset by slightly higher levels of capital sales. Foreign currency exchange movements unfavorably impacted worldwide TSS revenue by 1% for the second quarter of 2010 while favorably impacting revenue by 2% for the first six months of 2010, compared to the corresponding prior-year periods.

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North America TSS revenue decreased from the prior-year periods due primarily to lower hospital therapy days and reduced hospital spending on higher cost therapies, partially offset by increased levels of wound care capital sales and favorable foreign currency exchange rate movements. Foreign currency exchange rate movements favorably impacted North America TSS revenue by 2.0% and 2.4% for the second quarter and first six months of 2010, respectively, compared to the prior-year periods. EMEA/APAC TSS revenue decreased from the prior-year periods due primarily to foreign currency exchange rate movements and the loss of a few tenders in this market due to our continued focus on profitable growth. Foreign currency exchange rate movements negatively impacted EMEA/APAC TSS revenue by 5.5% for the second quarter of 2010 but had a minimal impact on the first half of 2010, compared to prior-year periods.

Rental Expenses

The following table presents rental expenses and the percentage relationship to AHS and TSS revenue comparing the second quarter of 2010 to the second quarter of 2009 and the first six months of 2010 to the first six months of 2009 (dollars in thousands):

	Three months ended June 30,								Six months ended June 30,
	2010			2009			Change		2010			2009			Change
Rental expenses	$	155,622		$	161,276		(3.5	)%	$	308,841		$	322,443		(4.2	)%
As a percent of total AHS and TSS revenue		37.6	%		38.4	%	(80	bps)		37.6	%		39.1	%	(150	bps)

Rental, or field, expenses are comprised of both fixed and variable costs including facilities, field service, sales force compensation and royalties associated with our rental products. Rental expenses as a percent of total AHS and TSS revenue during the second quarter and first six months of 2010 decreased from prior-year periods due primarily to increased field service productivity and lower product royalty expense.

Cost of Sales

The following table presents cost of sales and the sales margin (calculated as sales revenue less cost of sales divided by sales revenue for the period indicated) comparing the second quarter of 2010 to the second quarter of 2009 and the first six months of 2010 to the first six months of 2009 (dollars in thousands):

	Three months ended June 30,								Six months ended June 30,
	2010			2009			Change		2010			2009			Change
Cost of Sales	$	62,307		$	59,437		4.8	%	$	123,231		$	117,805		4.6	%
Sales margin		71.0	%		70.2	%	80	bps		70.7	%		69.6	%	110	bps

Cost of sales includes manufacturing costs, product costs and royalties associated with our “for sale” products. The increase in sales margins over the prior-year periods was due primarily to lower product royalty costs and higher sales margins associated with our Regenerative Medicine business unit.

Gross Profit Margin

The following table presents the gross profit margin (calculated as gross profit divided by total revenue for the periods indicated) comparing the second quarter of 2010 to the second quarter of 2009 and the first six months of 2010 to the first six months of 2009:

	Three months ended June 30,					Six months ended June 30,
	2010		2009		Change	2010		2009		Change
Gross profit margin	56.2	%	55.1	%	110 bps	56.1	%	54.2	%	190 bps

The gross profit margin increase was due primarily to lower product royalty expenses, increased productivity of our service operations, higher gross margins associated with the Regenerative Medicine business unit and reduced levels of marketing expenditures related to delays in new product launches resulting from a longer regulatory approval process.

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Selling, General and Administrative Expenses

The following table presents selling, general and administrative expenses and the percentage relationship to total revenue comparing the second quarter of 2010 to the second quarter of 2009 and the first six months of 2010 to the first six months of 2009 (dollars in thousands):

	Three months ended June 30,								Six months ended June 30,
	2010			2009			Change		2010			2009			Change
Selling, general and administrative expenses	$	147,212		$	125,802		17.0	%	$	282,591		$	252,473		11.9	%
As a percent of total revenue		29.6	%		25.6	%	400	bps		28.7	%		26.3	%	240	bps

Selling, general and administrative (“SG&A”) expenses include administrative labor, incentive and sales compensation costs, insurance costs, professional fees, depreciation, bad debt expense and information systems costs, but excludes rental compensation costs. Second quarter SG&A expenses included $12.7 million in expenses related to our TSS portfolio rationalization and employee separation costs related primarily to our Global Business Transformation project. Other SG&A expense increases in the period consisted of launch costs associated with our market entry in Japan and increased selling costs associated with the increase in Regenerative Medicine revenue.

Research and Development Expenses

The following table presents research and development expenses and the percentage relationship to total revenue comparing the second quarter of 2010 to the second quarter of 2009 and the first six months of 2010 to the first six months of 2009 (dollars in thousands):

	Three months ended June 30,								Six months ended June 30,
	2010			2009			Change		2010			2009			Change
Research and development expenses	$	21,718		$	21,265		2.1	%	$	46,502		$	43,402		7.1	%
As a percent of total revenue		4.4	%		4.3	%	10	bps		4.7	%		4.5	%	20	bps

Research and development expenses relate to our investments in clinical studies and the development of new and enhanced products and therapies. Our research and development efforts include the development of new and synergistic technologies across the continuum of wound care, including tissue regeneration, preservation and repair, new applications of negative pressure technology, as well as upgrading and expanding our surface technologies in our TSS business. Our research and development program is also leveraging our core understanding of biological tissues in order to develop biosurgery products in our Regenerative Medicine business. The increase in research and development expense during the second quarter and first six months of 2010 is primarily related to increased activity in the development of our next generation of AHS and Regenerative Medicine products. During the first quarter of 2010, the Company launched its Prevena Incision Management System in Europe and Canada. In the U.S., we received FDA approval in June 2010 and have launched Prevena commercially. Prevena is the first and only powered negative pressure product designed specifically for management of surgically-closed incisions. In addition, in March 2010, the Company received 510(k) clearance from the FDA for its next generation V.A.C. Therapy device, V.A.C.Via™, a revolutionary single-patient use device utilizing novel, patent-protected technology.

Acquired Intangible Asset Amortization

In connection with the LifeCell acquisition, we recorded $486.7 million of identifiable definite-lived intangible assets during the second quarter of 2008. Amortization expense associated with these acquired intangible assets was $9.6 million and $19.7 million in the second quarter and first six months of 2010 compared to $10.2 million and $20.3 million in the corresponding prior-year periods.

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Operating Margin

The following table presents the operating margin, defined as operating earnings as a percentage of total revenue, comparing the second quarter of 2010 to the second quarter of 2009 and the first six months of 2010 to the first six months of 2009:

	Three months ended June 30,					Six months ended June 30,
	2010		2009		Change	2010		2009		Change
Operating margin	20.4	%	23.1	%	(270 bps)	20.6	%	21.3	%	(70 bps)

The decrease in operating margin during the first six months of 2010 is due primarily to expenses of $12.7 million recorded in the second quarter of 2010 related to the TSS portfolio rationalization and employee separation costs, partially offset by an improved gross profit margin.

Interest Expense

Interest expense decreased to $22.3 million and $45.8 million in the second quarter and first six months of 2010 compared to $26.2 million and $54.7 million in the corresponding prior-year periods, due to scheduled and voluntary debt payments made over the last twelve months totaling $225.0 million and lower effective interest rates. Interest expense for the second quarter and first six months of 2010 includes write-offs of $648,000 and $1.9 million, respectively, as compared to $37,000 and $1.6 million for the same periods of 2009 for unamortized deferred debt issuance costs associated with optional prepayments on our senior credit facility. On January 1, 2009, we adopted changes issued by the Financial Accounting Standards Board related to the accounting for convertible debt instruments that may be settled in cash upon conversion. As a result of the adoption of these changes, we recorded additional non-cash interest expense related to amortization of the discount on our convertible senior notes of $5.3 million and $10.4 million in the second quarter and first six months of 2010, respectively and $4.9 million and $9.7 million in the corresponding prior-year periods.

Foreign Currency Loss

We recognized foreign currency exchange losses of $2.7 million and $5.3 million for the second quarter and first six months of 2010, respectively and $1.9 million and $7.1 million in the corresponding periods of the prior year. The losses incurred during 2010 and 2009 due to continued volatility in currency exchange rates were partially offset by our foreign currency hedging program.

Net Earnings

For the second quarter of 2010, we reported net earnings of $53.6 million, a decrease of 7.7%, compared to $58.1 million in the prior-year period. For the first six months of 2010, we reported net earnings of $106.3 million, an increase of 8.7%, compared to $97.8 million in the prior-year period. Expenses associated with the TSS portfolio rationalization and employee separation costs reduced second quarter 2010 net earnings by $7.8 million. The effective income tax rate for both the second quarter and first six months of 2010 was 30.0% compared to 32.0% and 31.9%, respectively, for the same periods in the prior year. The lower effective income tax rate for the second quarter and first six months of 2010 was due primarily to a higher percentage of income earned in lower tax jurisdictions and the favorable resolution of certain tax contingencies during 2010.

Net Earnings per Diluted Share

Net earnings per diluted share for the second quarter and first six month of 2010 were $0.75 and $1.48, respectively, as compared to net earnings per diluted share of $0.82 and $1.39 in the corresponding prior-year periods. Expenses associated with the TSS portfolio rationalization and employee separation costs reduced second quarter 2010 net earnings per diluted share by $0.11 per diluted share.

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LIQUIDITY AND CAPITAL RESOURCES

General

We require capital principally for capital expenditures, systems infrastructure, debt service, interest payments and working capital. Our capital expenditures consist primarily of manufactured rental assets, manufacturing equipment, computer hardware and software and expenditures related to leasehold improvements. Working capital is required principally to finance accounts receivable and inventory. Our working capital requirements vary from period-to-period depending on manufacturing volumes, the timing of shipments and the payment cycles of our customers and payers.

Sources of Capital

Based upon the current level of operations, we believe our existing cash resources, as well as cash flows from operating activities and availability under our revolving credit facility, will be adequate to meet our anticipated cash requirements for at least the next twelve months. During the six months ended June 30, 2010 and 2009, our primary source of capital was cash from operations. The following table summarizes the net cash provided and used by operating activities, investing activities and financing activities for the six months ended June 30, 2010 and 2009 (dollars in thousands):

	Six months ended
	June 30,
	2010			2009

Net cash provided by operating activities	$	137,900		$	160,646
Net cash used by investing activities		(39,951	)		(48,591	)
Net cash used by financing activities		(111,134	)		(125,243	)
Effect of exchange rates changes on cash and cash equivalents		(2,904	)		695

Net decrease in cash and cash equivalents	$	(16,089	)	$	(12,493	)

As of June 30, 2010, our principal sources of liquidity consisted of $247.1 million of cash and cash equivalents and $289.5 million available under our revolving credit facility, net of $10.5 million in undrawn letters of credit. During the first six months of 2010, we made scheduled and voluntary senior credit facility net repayments totaling $125.0 million from cash-on-hand.

As of December 31, 2009, our principal sources of liquidity consisted of $263.2 million of cash and cash equivalents and $288.6 million available under our revolving credit facility, net of $11.4 million in undrawn letters of credit. During 2009, we made scheduled and voluntary senior credit facility net repayments totaling $229.0 million from cash-on-hand.

Working Capital

As of June 30, 2010, we had current assets of $851.2 million, including $393.5 million in net accounts receivable and $157.5 million in net inventory, and current liabilities of $422.5 million resulting in a working capital surplus of $428.7 million. As of December 31, 2009, we had current assets of $858.3 million, including $425.0 million in net accounts receivable and $121.0 million in net inventory, and current liabilities of $441.0 million resulting in a working capital surplus of $417.3 million.

As of June 30, 2010 and December 31, 2009, we had $393.5 million and $425.0 million, respectively, of receivables outstanding, net of realization reserves of $94.4 million and $105.5 million, respectively. Net accounts receivable decreased $31.5 million during the first six months of 2010 due primarily to strong cash collections and the strengthening of the U.S. dollar in relation to foreign currencies. North America receivables, net of realization reserves, were outstanding for an average of 65 days at June 30, 2010, compared to 69 days at December 31, 2009. EMEA/APAC net receivables were outstanding for an average of 85 days at June 30, 2010, up from 81 days at December 31, 2009 due primarily to weaker collection performance, partially offset by a decrease in the net accounts receivable balance due to the strengthening of the U.S. dollar compared to other currencies.

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At June 30, 2010 and December 31, 2009, we had net inventories of $157.5 million and $121.0 million, respectively, an increase of $36.5 million. This increase was due primarily to planned increases in our tissue inventory to meet the increasing demand for our AlloDerm and Strattice tissue matrix products, partially offset by the additional reserve associated with the rationalization of our TSS product portfolio.

Capital Expenditures

During the first six months of 2010 and 2009, we made net capital expenditures of $38.9 million and $35.1 million, respectively, due primarily to expanding the rental fleet and information technology purchases.

Senior Credit Facility

In May 2008, we entered into a senior credit facility, consisting of a $1.0 billion term loan facility and a $300.0 million revolving credit facility due May 2013. The following table sets forth the amounts owed under the term loan and revolving credit facility, the effective interest rates on such outstanding amounts, and the amount available for additional borrowing thereunder, as of June 30, 2010 (dollars in thousands):

		Effective					Amount Available
	Maturity	Interest			Amount		for Additional
Senior Credit Facility	Date	Rate			Outstanding		Borrowing

Revolving credit facility	May 2013	-			$	-	$	289,490	(1)
Term loan facility	May 2013	4.524	%	(2)		625,000		-

Total					$	625,000	$	289,490


(1) At June 30, 2010, amount available under the revolving portion of our credit facility reflected a reduction of $10.5 million for letters of credit issued on our behalf, none of which have been drawn upon by the beneficiaries thereunder. (2) The effective interest rate includes the effect of interest rate hedging arrangements. Excluding the interest rate hedging arrangements, our nominal interest rate as of June 30, 2010 was 3.290%.

As of June 30, 2010 and December 31, 2009, we were in compliance with all covenants under the senior credit agreement.

Convertible Senior Notes

In 2008, we issued $690 million aggregate principal amount of 3.25% convertible senior notes due 2015 (the “Convertible Notes”). The notes are governed by the terms of an indenture dated as of April 21, 2008 (the “Indenture”). As of June 30, 2010 and December 31, 2009, we were in compliance with all covenants under the Indenture for the Convertible Notes.

Interest Rate Protection

At June 30, 2010 and December 31, 2009, we had seventeen interest rate swap agreements in effect pursuant to which we have fixed the rate on an aggregate $560.0 million and $662.0 million, respectively, notional amount of our outstanding variable rate debt at a weighted average interest rate of 1.917% and 2.074%, respectively, exclusive of the Eurocurrency Rate Loan Spread as disclosed in the senior credit agreement. As of June 30, 2010 and December 31, 2009, the aggregate fair value of our swap agreements was negative and recorded as a liability of $4.0 million and $8.4 million, respectively. If our interest rate protection agreements were not in place, interest expense would have been approximately $2.7 million and $5.7 million lower for the three months and six months ended June 30, 2010, respectively, and $2.3 million and $4.5 million lower in the same periods of the prior year.

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Long-Term Commitments

The following table summarizes our long-term debt obligations, excluding the convertible debt discount, as of June 30, 2010, for each of the periods indicated (dollars in thousands):

	Long-Term Debt Obligations
Year Payment Due	2010		2011		2012		2013		2014		Thereafter		Total

Long-term debt	$	78,125	$	175,781	$	234,375	$	136,719	$	-	$	690,000	$	1,315,000

OTHER MATTERS

We continue to see signs of weakness in the U.S. and global economies. We believe the economic downturn may generally decrease hospital census and the demand for elective surgeries. Also, the global financial crisis, continuing high levels of unemployment and general economic uncertainties have made it more difficult and more expensive for hospitals and health systems to obtain credit, and may contribute to pressures on their operating margins. We believe that rising unemployment reduces the number of individuals covered by private insurance, which has resulted in a noticeable increase in our charity-care placements and may increase the cost of uncompensated care for hospitals. Rising unemployment may also result in a shift in reimbursement patterns as unemployed individuals switch from private plans to public plans such as Medicaid or Medicare. If the economic downturn persists and unemployment remains high or increases, any significant shift in coverage for the unemployed may have an unfavorable impact on our reimbursement mix and may result in a decrease in our overall average unit prices.

On March 23, 2010, President Obama signed into law major healthcare reform legislation under the Patient Protection and Affordable Care Act of 2010 (“PPACA”) which was modified on March 30, 2010 by the enactment of the Health Care and Education Reconciliation Act of 2010. Under PPACA, it is expected that expanded healthcare coverage will be made available to an additional 30 million Americans. The increased costs to the U.S. government from PPACA are expected to be funded through a combination of payment reductions for providers over time and several new taxes, including an anticipated $20 billion tax on medical devices beginning in 2013. Although details concerning this tax will not be known until specific regulations are promulgated over the coming months, PPACA is expected to impose a tax of 2.3% on qualifying products, which would include a number of products manufactured by KCI, beginning in 2013. PPACA also provides for the establishment of an Independent Medicare Advisory Board that could recommend changes in payment for physicians under certain circumstances beginning in 2014. In addition, PPACA authorizes certain voluntary demonstration projects beginning no later than 2013 around development of bundling payments for acute, inpatient hospital services, physician services, and post acute services for episodes of hospital care. While we believe many of the provisions of PPACA may potentially have an adverse impact on our business, the legislation provides additional disincentives for medical facilities that have an unacceptable number of hospital acquired conditions and excess readmissions. KCI’s products are well-positioned to reduce the incidence of hospital acquired conditions and excess readmissions. Under PPACA, increases in fraud and abuse penalties and the expansion in the scope of the reach of the Federal Civil False Claims Act and government enforcement tools may adversely impact healthcare companies, including KCI.

In addition to PPACA discussed above, the effect of which cannot presently be quantified given its recent enactment, various healthcare reform proposals have also emerged at the state level. We cannot predict whether future healthcare initiatives will be implemented at the federal or state level, or the effect any future legislation or regulation will have on us. We are continuing to evaluate the impact that PPACA is expected to have on our business. The taxes imposed by the new federal legislation and the expansion in government’s role in the U.S. healthcare industry may result in decreased profits to us, lower reimbursements by payers for our products, reduced medical procedure volumes, all of which may adversely affect our business, financial condition and results of operations, possibly materially.

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From time to time, the Center for Medicare and Medicaid Services (“CMS”) publishes reimbursement policies and rates that may unfavorably affect the reimbursement and market for our products. In the future, our AHS revenue from U.S. Medicare placements of NPWT products is expected to be subject to Medicare’s durable medical equipment competitive bidding program. Currently, the initial round of this program is expected to be effective January 1, 2011. While NPWT is not included in the initial round of this program, we anticipate NPWT will be subject to the second round of this program, which is expected to be effective in January 2013. We have communicated to CMS our strong belief that the selection of NPWT suppliers to Medicare patients under the competitive bidding program should be based on each supplier’s ability to provide prompt quality service and timely therapy to patients in areas subject to the program, which KCI has done effectively for over a decade. The importance of training and support for caregivers and patients has been validated by the recent FDA initiative focused on the migration of complex medical devices into the home. KCI has a significant body of evidence supporting the safety and efficacy of our products in the home setting, which differentiates us from other manufacturers and suppliers of NPWT products. Future inclusion of our NPWT products in the Medicare competitive bidding program could result in increased competition and reduced reimbursement for our Medicare placements. For the fiscal year ended 2009, U.S. Medicare placements of our NPWT products represented approximately 7.8% of our total revenue.

Critical Accounting Estimates

For a description of our critical accounting estimates, please see our Annual Report on Form 10-K for the fiscal year ended December 31, 2009 under the heading Part II, Item 7. “Management's Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Estimates.”

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to various market risks, including fluctuations in interest rates and variability in currency exchange rates. We have established policies, procedures and internal processes governing our management of market risk and the use of financial instruments to manage our exposure to such risk.

Interest Rate Risk

We have variable interest rate debt and other financial instruments, which are subject to interest rate risk that could have a negative impact on our business if not managed properly. We have a risk management policy which is designed to reduce the potential negative earnings effect arising from the impact of fluctuating interest rates. We manage our interest rate risk on our borrowings through interest rate swap agreements which effectively convert a portion of our variable-rate borrowings to a fixed-rate basis through June 2011, thus reducing the impact of changes in interest rates on future interest expenses. We do not use financial instruments for speculative or trading purposes.

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The table below provides information as of June 30, 2010 about our long-term debt and interest rate swaps, both of which are sensitive to changes in interest rates. For long-term debt, the table presents principal cash flows and related weighted average interest rates by expected maturity dates. For interest rate swaps, the table presents notional amounts and weighted average interest rates by expected (contractual) maturity dates. Weighted average interest rates of our interest rate swaps are based on the nominal amounts which are used to calculate the contractual payments to be exchanged under the contract (dollars in thousands):

	Expected Maturity Date as of June 30, 2010
	2010			2011			2012			2013			Thereafter			Total			Fair Value
Long-term debt
Fixed rate	$	—		$	—		$	—		$	—		$	690,000		$	690,000		$	665,505	(1)
Average interest rate		—			—			—			—			3.250	%		3.250	%
Variable rate	$	78,125		$	175,781		$	234,375		$	136,719		$	—		$	625,000		$	621,875
Weighted average interest rate (2)		4.524	%		4.524	%		4.524	%		4.524	%		—			4.524	%

Interest rate swap (3)
Variable to fixed-notional amount	$	340,500		$	219,500		$	—		$	—		$	—		$	560,000		$	(3,983	)
Average pay rate		2.038	%		1.730	%		—			—			—			1.917	%
Average receive rate (4)		0.540	%		0.540	%		—			—			—			0.540	%

(1) The fair value of our 3.25% Convertible Senior Notes due 2015 is based on a limited number of trades and does not necessarily represent the purchase price of the entire convertible note portfolio. (2) The weighted average interest rates for future periods were based on the nominal interest rates as of the specified date. (3) Interest rate swaps relate to the variable rate debt under long-term debt. The aggregate fair value of our interest rate swap agreements was negative and was recorded as a liability at June 30, 2010. (4) The average receive rates for future periods are based on the current period average receive rates. These rates reset quarterly.

Foreign Currency and Market Risk

We have direct operations in the United States, Canada, Western Europe, Australia, New Zealand, Japan, Singapore and South Africa, and we conduct additional business through distributors in Latin America, the Middle East, Eastern Europe and Asia. Our foreign operations are measured in their applicable local currencies. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in the foreign markets in which we have operations. Exposure to these fluctuations is managed primarily through the use of natural hedges, whereby funding obligations and assets are both managed in the applicable local currency.

KCI faces transactional currency exposures when its foreign subsidiaries enter into transactions denominated in currencies other than their local currency. These nonfunctional currency exposures relate primarily to existing intercompany receivables and payables arising from intercompany purchases of manufactured products. KCI enters into foreign currency exchange contracts to mitigate the impact of currency fluctuations on transactions and anticipated cash flows denominated in nonfunctional currencies, thereby limiting risk that would otherwise result from changes in exchange rates. The periods of the foreign currency exchange contracts correspond to the periods of the exposed transactions and anticipated cash flows but generally do not extend beyond 12 months.

At June 30, 2010, we had outstanding foreign currency exchange contracts to sell or purchase approximately $96.9 million of various currencies. Based on our overall transactional currency rate exposure, movements in the currency rates will not materially affect our financial condition. We are exposed to credit loss in the event of nonperformance by counterparties on their outstanding foreign currency exchange contracts.

International operations reported operating profit of $56.1 million for the six months ended June 30, 2010. We estimate that a 10% fluctuation in the value of the U.S. dollar relative to these foreign currencies as of and for the six months ended June 30, 2010 would change our net earnings for the period by approximately $5.3 million. Our analysis does not consider the implications that such fluctuations could have on the overall economic activity that could exist in such an environment in the United States or the foreign countries or on the results of operations of our foreign entities.

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ITEM 4. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures. KCI’s management, with the participation of KCI’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of KCI’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the end of the period covered by this report. Based on such evaluation, KCI’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, KCI’s disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by KCI in the reports that it files or submits under the Exchange Act and are effective in ensuring that information required to be disclosed by KCI in the reports that it files or submits under the Exchange Act is accumulated and communicated to KCI’s management, including KCI’s Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting. There have not been any changes in KCI’s internal control over financial reporting (as such term is defined by paragraph (d) of Rule 13a-15) under the Exchange Act, during the second fiscal quarter of 2010 that have materially affected, or are reasonably likely to materially affect, KCI’s internal control over financial reporting.

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Patent Litigation

U.S. NPWT Patent Litigation

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International NPWT Patent Litigation

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LifeCell Litigation

ITEM 1A. RISK FACTORS

There have been no material changes from the risk factors disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2009 and Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2010.

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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

(a) None

(b) Not applicable

Period	Total Number of Shares Purchased(1)	Average Price Paid per Share	Total Number of Shares Purchased as Part of Publicly Announced Program	Approximate Dollar Value of Shares That May Yet be Purchased Under the Program

April 1, 2010 to
April 30, 2010	19,064	$ 48.80	N/A	N/A

May 1, 2010 to
May 31, 2010	3,763	$ 40.14	N/A	N/A

June 1, 2010 to
June 30, 2010	34	$ 41.34	N/A	N/A

Total	22,861	$ 47.37	N/A	N/A


(1) During the second quarter of 2010, KCI purchased and retired 22,861 shares in connection with the withholding of shares to satisfy the minimum tax withholdings on the vesting of restricted stock.

ITEM 6. EXHIBITS

A list of all exhibits filed or included as part of this quarterly report on form 10-Q is as follows:

Exhibits		Description

3.1		Amended and Restated Articles of Incorporation of Kinetic Concepts, Inc. (filed as Exhibit 3.5 to Amendment No. 1 to our Registration Statement on Form S-1, filed on February 2, 2004, as thereafter amended).
3.2		Fifth Amended and Restated By-laws of Kinetic Concepts, Inc. (filed as Exhibit 3.1 to our Form 8-K filed on February 24, 2009).
†*10.1		Credit Agreement, dated as of May 19, 2008 among Kinetic Concepts, Inc., the lenders party thereto, and Banc of America, N.A. as administrative agent for the lenders.
†**10.2		Second Amendment to Toll Manufacturing Agreement, by and between KCI Manufacturing and Avail Medical Products, Inc., dated effective April 1, 2009.
†**10.3		Third Amendment to Toll Manufacturing Agreement, by and between KCI Manufacturing and Avail Medical Products, Inc. dated effective January 1, 2010.
31.1		Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 dated August 5, 2010.
31.2		Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 dated August 5, 2010.
32.1		Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002 dated August 5, 2010.


† Exhibit filed herewith.
* Exhibit originally filed as Exhibit 10.1 to our Form 8-K filed on May 23, 2008. Exhibit filed herewith includes all schedules and exhibits.
** Confidential treatment requested on certain portions of this exhibit. An unredacted version of this exhibit has been filed separately with the Securities and Exchange Commission.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	KINETIC CONCEPTS, INC.
	(REGISTRANT)


Date: August 5, 2010	By: /s/ Catherine M. Burzik
	Catherine M. Burzik
	President and Chief Executive Officer
	(Duly Authorized Officer)


Date: August 5, 2010	By: /s/ Martin J. Landon
	Martin J. Landon
	Executive Vice President and Chief Financial Officer
	(Principal Financial and Accounting Officer)

INDEX OF EXHIBITS

Exhibits		Description

3.1		Amended and Restated Articles of Incorporation of Kinetic Concepts, Inc. (filed as Exhibit 3.5 to Amendment No. 1 to our Registration Statement on Form S-1, filed on February 2, 2004, as thereafter amended).
3.2		Fifth Amended and Restated By-laws of Kinetic Concepts, Inc. (filed as Exhibit 3.1 to our Form 8-K filed on February 24, 2009).
†*10.1		Credit Agreement, dated as of May 19, 2008 among Kinetic Concepts, Inc., the lenders party thereto, and Banc of America, N.A. as administrative agent for the lenders.
†**10.2		Second Amendment to Toll Manufacturing Agreement, by and between KCI Manufacturing and Avail Medical Products, Inc., dated effective April 1, 2009.
†**10.3		Third Amendment to Toll Manufacturing Agreement, by and between KCI Manufacturing and Avail Medical Products, Inc. dated effective January 1, 2010.
31.1		Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 dated August 5, 2010.
31.2		Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 dated August 5, 2010.
32.1		Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002 dated August 5, 2010.


† Exhibit filed herewith.
* Exhibit originally filed as Exhibit 10.1 to our Form 8-K filed on May 23, 2008. Exhibit filed herewith includes all schedules and exhibits.
** Confidential treatment requested on certain portions of this exhibit. An unredacted version of this exhibit has been filed separately with the Securities and Exchange Commission.