KINETIC CONCEPTS INC - FORM 10-Q

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EXCEL - IDEA: XBRL DOCUMENT - KINETIC CONCEPTS INC	Financial_Report.xls
EX-32.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER - KINETIC CONCEPTS INC	exhibit-32_1.htm
EX-31.1 - CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER - KINETIC CONCEPTS INC	exhibit-31_1.htm
EX-31.2 - CERTIFICATION OF THE CHIEF FINANCIAL OFFICER - KINETIC CONCEPTS INC	exhibit-31_2.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 September 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: 71,957,696 shares as of November 1, 2010

TABLE OF CONTENTS

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	21
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	34
	Item 4.	Controls and Procedures	35
PART II.	OTHER INFORMATION		36
	Item 1.	Legal Proceedings	36
	Item 1A.	Risk Factors	38
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	41
	Item 6.	Exhibits	41
	SIGNATURES		42

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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 Reports on Form 10-Q for the quarterly periods ended March 31, 2010 and June 30, 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)


	September 30,		December 31,
	2010		2009
	(unaudited)
Assets:
Current assets:
Cash and cash equivalents	$	263,297	$	263,157
Accounts receivable, net		406,043		425,042
Inventories, net		174,695		121,044
Deferred income taxes		21,671		11,715
Prepaid expenses and other		33,403		37,330

Total current assets		899,109		858,288

Net property, plant and equipment		269,581		296,055
Debt issuance costs, net		25,042		35,191
Deferred income taxes		20,133		17,513
Goodwill		1,328,881		1,328,881
Identifiable intangible assets, net		457,781		489,213
Other non-current assets		14,717		13,424

	$	3,015,244	$	3,038,565

Liabilities and Shareholders' Equity:
Current liabilities:
Accounts payable	$	68,326	$	63,301
Accrued expenses and other		202,927		226,823
Current installments of long-term debt		160,083		132,353
Income taxes payable		3,527		18,484

Total current liabilities		434,863		440,961

Long-term debt, net of current installments and discount		976,896		1,173,808
Non-current tax liabilities		34,386		29,074
Deferred income taxes		167,237		212,257
Other non-current liabilities		3,744		4,994

Total liabilities		1,617,126		1,861,094

Shareholders' equity:
Common stock; authorized 225,000 at 2010 and 2009, issued and outstanding 71,843 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		841,471		804,111
Retained earnings		539,441		357,350
Accumulated other comprehensive income, net		17,134		15,939

Shareholders' equity		1,398,118		1,177,471

	$	3,015,244	$	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						Nine months ended
	September 30,						September 30,
	2010			2009			2010			2009
Revenue:
Rental	$	288,970		$	298,577		$	852,045		$	872,955
Sales		217,738			205,820			638,240			592,872

Total revenue		506,708			504,397			1,490,285			1,465,827


Rental expenses		155,765			163,020			464,606			485,463
Cost of sales		61,551			59,940			184,782			177,745

Gross profit		289,392			281,437			840,897			802,619

Selling, general and administrative expenses		139,512			132,373			422,103			384,846
Research and development expenses		20,873			24,669			67,375			68,071
Acquired intangible asset amortization		8,855			10,160			28,570			30,476

Operating earnings		120,152			114,235			322,849			319,226

Interest income and other		265			158			544			646
Interest expense		(21,534	)		(25,728	)		(67,360	)		(80,449	)
Foreign currency gain (loss)		2,148			3,183			(3,119	)		(3,896	)

Earnings before income taxes		101,031			91,848			252,914			235,527

Income taxes		25,258			27,279			70,823			73,156

Net earnings	$	75,773		$	64,569		$	182,091		$	162,371

Net earnings per share:

Basic	$	1.07		$	0.92		$	2.57		$	2.32

Diluted	$	1.06		$	0.91		$	2.54		$	2.31

Weighted average shares outstanding:

Basic		70,994			70,150			70,784			70,035

Diluted		71,695			70,666			71,647			70,425

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)


	Nine months ended
	September 30,
	2010			2009
Cash flows from operating activities:
Net earnings	$	182,091		$	162,371
Adjustments to reconcile net earnings to net cash provided by operating activities:
Amortization of convertible debt discount		15,818			14,645
Depreciation and other amortization		119,188			113,869
Provision for bad debt		7,024			7,602
Write-off of deferred debt issuance costs		2,301			2,348
Share-based compensation expense		24,173			22,977
Excess tax benefit from share-based payment arrangements		(1,426	)		(515	)
Change in assets and liabilities, net of business acquired:
Decrease (increase) in accounts receivable, net		14,829			(14,419	)
Increase in inventories, net		(53,353	)		(2,725	)
Decrease (increase) in prepaid expenses and other		3,927			(1,505	)
Increase in accounts payable		5,212			18,484
Decrease in accrued expenses and other		(18,117	)		(46,415	)
Increase (decrease) in tax liabilities, net		(9,227	)		978
Decrease in deferred income taxes, net		(59,325	)		(5,212	)
Net cash provided by operating activities		233,115			272,483

Cash flows from investing activities:
Additions to property, plant and equipment		(63,255	)		(66,019	)
Decrease in inventory to be converted into equipment for short-term rental		9,771			1,969
Dispositions of property, plant and equipment		1,557			4,298
Business acquired in purchase transaction, net of cash acquired		-			(173	)
Increase in identifiable intangible assets and other non-current assets		(9,632	)		(18,206	)
Net cash used by investing activities		(61,559	)		(78,131	)

Cash flows from financing activities:
Proceeds from revolving credit facility		-			20,000
Repayments of long-term debt, revolving credit facility and capital lease obligations		(185,059	)		(198,990	)
Excess tax benefit from share-based payment arrangements		1,426			515
Proceeds from exercise of stock options		10,383			784
Purchase of immature shares for minimum tax withholdings		(1,134	)		(242	)
Proceeds from the purchase of stock in ESPP and other		3,452			3,336
Net cash used by financing activities		(170,932	)		(174,597	)

Effect of exchange rate changes on cash and cash equivalents		(484	)		2,532

Net increase in cash and cash equivalents		140			22,287
Cash and cash equivalents, beginning of period		263,157			247,767

Cash and cash equivalents, end of period	$	263,297		$	270,054

Cash paid during the nine months for:
Interest, including cash paid under interest rate swap agreements	$	35,894		$	48,577
Income taxes, net of refunds	$	139,728		$	68,168

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 Reports on Form 10-Q for the quarterly periods ended March 31, 2010 and June 30, 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 third quarter and the first nine months of 2010 was 25.0% and 28.0%, respectively, compared to 29.7% and 31.1%, respectively, for the corresponding periods in 2009. The decrease in the effective income tax rate for the third quarter and first nine months of 2010 resulted from a higher percentage of taxable income being generated in lower tax foreign 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.

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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 gain (loss) in our condensed consolidated statements of earnings.

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 September 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 $38.8 million and $9.2 million, respectively. Additionally, JP Morgan Chase was a counterparty on some of our foreign currency exchange contracts in notional amounts totaling $6.1 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) Collaborative Arrangements

In September 2010, LifeCell™ Corporation, a subsidiary of KCI, entered into an exclusive sales and marketing agreement with Novadaq® Technologies, Inc. (“Novadaq”) for the distribution of Novadaq's SPY® Imaging System in North American surgical markets. LifeCell will provide market development and commercialization activities, including professional education, clinical support, reimbursement and sales distribution. Novadaq will continue to be responsible for manufacturing, field service and research and development. We recognize revenue for transactions under this agreement in accordance with the “Collaborative Arrangements” topic of the Codification. Transactions under this agreement were insignificant for the three month and nine month periods ended September 30, 2010.

(f) 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.

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NOTE 2. Supplemental Balance Sheet Data

(a) Accounts Receivable, net

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

	September 30,			December 31,
	2010			2009
Gross trade accounts receivable:
North America:
AHS and TSS	$	332,039		$	370,563
Regenerative Medicine		36,547			34,773

Subtotal North America		368,586			405,336

EMEA/APAC		113,793			114,146

Total trade accounts receivable		482,379			519,482

Less: Allowance for revenue adjustments		(81,693	)		(96,640	)

Gross trade accounts receivable		400,686			422,842

Less: Allowance for bad debt		(8,475	)		(8,851	)

Net trade accounts receivable		392,211			413,991

Other receivables		13,832			11,051

	$	406,043		$	425,042

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.

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(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):

	September 30,			December 31,
	2010			2009

Finished goods and tissue available for distribution	$	99,944		$	71,620
Goods and tissue in-process		8,728			13,418
Raw materials, supplies, parts and unprocessed tissue		91,097			65,910

		199,769			150,948

Less: Amounts expected to be converted into equipment for short-term rental		(8,768	)		(18,538	)
Reserve for excess and obsolete inventory		(16,306	)		(11,366	)

	$	174,695		$	121,044

Inventories increased $53.7 million as of September 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 and increases in our AHS raw materials necessary to support our launch of the new V.A.C.Via™ and Prevena™ systems.

Our reserve for excess and obsolete inventory increased by $4.9 million. This increase was primarily related to a portfolio rationalization within our TSS business, reduced by disposals made during the period. 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 the second quarter of 2010 in our condensed consolidated statements of earnings.

NOTE 3. Long-Term Debt

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

	September 30,			December 31,
	2010			2009

Senior Credit Facility – due 2013	$	565,000		$	750,000
3.25% Convertible Senior Notes due 2015		690,000			690,000
Less: Convertible Notes Discount, net of accretion		(118,021	)		(133,839	)

		1,136,979			1,306,161
Less: Current installments		(160,083	)		(132,353	)

	$	976,896		$	1,173,808

The fair value of our senior credit facility and the convertible senior notes was $566.4 million and $692.1 million, respectively, at September 30, 2010 and $729.4 million and $676.5 million, respectively, at December 31, 2009. 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.

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 September 30, 2010 and December 31, 2009, we had no revolving loans outstanding and had outstanding letters of credit in the aggregate amount of $11.6 million and $11.4 million, respectively. The resulting availability under the revolving credit facility was $288.4 million and $288.6 million at September 30, 2010 and December 31, 2009, respectively. As of September 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.

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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 September 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.

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

At September 30, 2010 and December 31, 2009, we had 18 and 17 interest rate swap agreements in effect, respectively, pursuant to which we have fixed the rate on an aggregate $513.0 million and $662.0 million, respectively, notional amount of our outstanding variable rate debt at a weighted average interest rate of 1.721% and 2.074%, respectively, exclusive of the Eurocurrency Rate Loan Spread as disclosed in the senior credit agreement. The Eurocurrency Rate Loan Spread varies in reference to our consolidated leverage ratio of debt to EBITDA and ranges from 1.75% to 3.50%.

In July 2010, we entered into six additional interest rate swap agreements, which become effective in December 2010, to convert $175.0 million of our variable-rate debt to a fixed-rate basis at a weighted average interest rate of 0.758%, exclusive of the Eurocurrency Rate Loan Spread as disclosed in the senior credit agreement. In December 2010, as these agreements become effective, other interest rate swap agreements totaling $204.5 million are scheduled to expire.

In October 2010, we entered into three additional interest rate swap agreements, which become effective in March 2011, to convert $100.0 million of our variable-rate debt to a fixed-rate basis at a weighted average interest rate of 0.549%, exclusive of the Eurocurrency Rate Loan Spread as disclosed in the senior credit agreement. In March 2011, as these agreements become effective, other interest rate swap agreements totaling $140.5 million are scheduled to expire.

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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 September 30, 2010 and December 31, 2009, approximately 95.9% 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 September 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 $3.5 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 September 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 month or nine month periods ended September 30, 2010 and 2009. As of September 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 $3.5 million and $8.0 million, respectively.

Foreign Currency Exchange Risk Mitigation

At September 30, 2010 and December 31, 2009, we had foreign currency exchange contracts to sell or purchase $99.9 million 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.

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	September 30,		December 31,		Sheet	September 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	$	3,456	$	8,436


Derivatives not
designated as
hedging
instruments

Foreign currency exchange contracts	Prepaid expenses and other		540		995	Accrued expenses and other		4,583		1,905

Total derivatives		$	540	$	995		$	8,039	$	10,341

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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 September 30,
	Effective portion
							Location of loss	Amount of loss
Derivatives	Amount of loss						reclassified	reclassified
designated as cash flow	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	$	(926	)	$	(1,588	)	Interest expense	$	(1,281	)	$	(2,044	)



	Nine months ended September 30,
	Effective portion
							Location of loss	Amount of loss
Derivatives	Amount of loss						reclassified	reclassified
designated as cash flow	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	$	(1,719	)	$	(3,081	)	Interest expense	$	(4,968	)	$	(4,965	)

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 September 30,						Nine months ended September 30,
		2010			2009			2010		2009
Foreign currency exchange contracts	Foreign currency gain (loss)	$	(7,741	)	$	(4,938	)	$	1,071	$	(10,662	)

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 September 30, 2010, KCI could be required to settle or post the full amount as collateral to its counterparties.

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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				Nine months ended
	September 30,				September 30,
	2010		2009		2010		2009

Net earnings	$	75,773	$	64,569	$	182,091	$	162,371

Weighted average shares outstanding:
Basic		70,994		70,150		70,784		70,035
Dilutive potential common shares from stock options and restricted stock (1)		701		516		863		390

Diluted		71,695		70,666		71,647		70,425

Basic net earnings per share	$	1.07	$	0.92	$	2.57	$	2.32

Diluted net earnings per share	$	1.06	$	0.91	$	2.54	$	2.31


(1) Potentially dilutive stock options and restricted stock totaling 3,931 shares and 5,254 shares for the three months ended September 30, 2010 and 2009, respectively, and 4,156 shares and 5,803 shares for the nine months ended September 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.

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						Nine months ended
	September 30,						September 30,
	2010			2009			2010			2009

Rental expenses	$	1,486		$	1,547		$	3,803		$	3,649
Cost of sales		292			192			736			673
Selling, general and administrative expenses		6,961			7,284			19,634			18,655

Pre-tax share-based compensation expense		8,739			9,023			24,173			22,977
Less: Income tax benefit		(2,919	)		(3,008	)		(8,288	)		(7,641	)

Total share-based compensation expense, net of tax	$	5,820		$	6,015		$	15,885		$	15,336

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A summary of our stock option activity, and related information, for the nine months ended September 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	1,166		$	40.67
Exercised	(368	)	$	28.21
Forfeited/Expired	(604	)	$	42.33

Options outstanding – September 30, 2010	5,592		$	39.16	7.22	$	17,945

Exercisable as of September 30, 2010	2,466		$	43.00	6.15	$	4,289

The following table summarizes restricted stock activity for the nine months ended September 30, 2010:

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

Unvested shares – January 1, 2010	992		$	37.96
Granted	436		$	40.91
Vested and distributed	(94	)	$	46.36
Forfeited	(181	)	$	40.74

Unvested shares – September 30, 2010	1,153		$	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.

NOTE 7. Other Comprehensive Income

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

	Three months ended September 30,						Nine months ended September 30,
	2010			2009			2010			2009

Net earnings	$	75,773		$	64,569		$	182,091		$	162,371
Foreign currency translation adjustment, net of taxes		4,480			(679	)		(2,054	)		(177	)
Net derivative loss, net of taxes		(926	)		(1,588	)		(1,719	)		(3,081	)
Amount of loss reclassified from accumulated OCI into income, net of taxes		1,281			2,044			4,968			4,965

Total comprehensive income	$	80,608		$	64,346		$	183,286		$	164,078

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NOTE 8. Commitments and Contingencies

Patent Litigation

As the owner and exclusive licensee of patents, from time to time, KCI is a party to proceedings challenging these patents, including challenges in U.S. federal courts, foreign courts and before the U.S. Patent and Trademark Office (“USPTO”). Although it is not possible to reliably predict the outcome of these proceedings, 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 51% of total revenue for the nine months ended September 30, 2010 and the year ended December 31, 2009 from our U.S. 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 nine months ended September 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 Re-Examinations and Litigation

Multiple parties have challenged the patents that KCI exclusively licenses from Wake Forest University in the USPTO. Related to these proceedings, the USPTO has issued certificates of re-examination confirming the validity of three of these patents. 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.

Additionally, KCI and its affiliates, together with Wake Forest University Health Sciences (“Wake Forest”) are involved in multiple patent infringement suits. 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 the ‘081 Patent and the ‘046 Patent, which are licensed exclusively to KCI by Wake Forest. These cases are before 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. In October 2010, the Court entered an order invalidating the patent claims involved in the lawsuit, effectively overturning the jury verdict. This decision is appealable to the United States Court of Appeals for the Federal Circuit. KCI is currently evaluating its legal options, including appeal. The case against Medela’s gauze-based devices remains pending, but could be impacted by the decision in the Smith & Nephew case.

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, subsequent to which ITI sought permission for review by the U.S. Supreme Court. The U.S. Supreme Court declined to hear ITI’s appeal.

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. This case could be impacted by the decision in the Smith & Nephew matter, particularly if KCI is not successful on a potential appeal. 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. These cases have now been consolidated into a single case. The claims in this case 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 case. At this time, neither the patent infringement case nor the state court case against ITI is set for trial.

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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. This case is not currently set for trial. This case could be impacted by the decision in the Smith & Nephew matter, particularly if KCI is not successful on a potential appeal.

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 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.

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. KCI is appealing this decision. A trial on KCI’s ‘950 Patent claims was held in June 2010, and in September 2010, the Court issued its ruling finding that components used with Smith & Nephew’s negative pressure wound therapy systems infringe the ‘950 Patent. Smith & Nephew is appealing this decision.

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 January 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.

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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 was heard on October 18-19, 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 was named, along with BTS and many other defendants, in lawsuits relating to the BTS donor irregularities. These lawsuits generally fell 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 those lawsuits, which have been dismissed. The resolution of those lawsuits did not have a material impact on our financial position or results of operations. More recently, LifeCell was served with ten new suits filed by other family members of tissue donors who also allege no authorization was provided. These cases are in the early stages of discovery and have not been set for trial. Although it is not possible to reliably predict the outcome of the litigation, we believe that our defenses to these claims are meritorious and will defend them vigorously. We do not expect these new cases to have a material impact on our results of operations or our financial position.

In September 2010, LifeCell and KCI were served with two separate lawsuits from individuals alleging personal injury and seeking monetary damages for failed hernia repair procedures using our AlloDerm products. These cases are in the early stages of litigation and have not yet been set for trial. Although it is not possible to reliably predict the outcome of the litigation, we believe that our defenses to these claims are meritorious and will defend them vigorously. We do not expect these new cases to have a material impact on our results of operations or our financial position.

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.

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.

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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 September 30, 2010, our commitments for the purchase of new product inventory were $31.4 million, including approximately $5.1 million of disposable products from our main disposable supplier, $11.9 million for inventory related to our Regenerative Medicine business, including $8.0 million for inventory commitments under our Novadaq sales and marketing agreement, $2.9 million from our provider of low height medical-surgical beds and $3.2 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				Nine months ended
	September 30,				September 30,
	2010		2009		2010		2009
Revenue:
AHS
North America	$	275,494	$	270,848	$	792,007	$	791,837
EMEA/APAC		82,898		89,732		247,064		247,490

Subtotal – AHS		358,392		360,580		1,039,071		1,039,327

Regenerative Medicine
North America		83,213		71,248		243,375		208,132
EMEA/APAC		1,722		519		4,318		913

Subtotal – Regenerative Medicine		84,935		71,767		247,693		209,045

TSS
North America		41,788		46,542		134,751		141,817
EMEA/APAC		21,593		25,508		68,770		75,638

Subtotal – TSS		63,381		72,050		203,521		217,455

Total revenue	$	506,708	$	504,397	$	1,490,285	$	1,465,827

	Three months ended						Nine months ended
	September 30,						September 30,
	2010			2009			2010				2009
Operating earnings:
AHS	$	122,827		$	113,408		$	340,108			$	318,283
Regenerative Medicine		24,561			20,817			66,432				62,666
TSS		2,506			7,158			5,474		(1)		20,250

Non-allocated costs:
General headquarter expenses (2)		(12,194	)		(7,428	)		(35,555	)			(26,903	)
Share-based compensation		(8,739	)		(9,023	)		(24,173	)			(22,977	)
Acquisition-related expenses (3)		(8,809	)		(10,697	)		(29,437	)			(32,093	)

Total non-allocated costs		(29,742	)		(27,148	)		(89,165	)			(81,973	)

Total operating earnings	$	120,152		$	114,235		$	322,849			$	319,226


(1) Includes $7.4 million of expenses associated with the TSS product portfolio rationalization recorded in the second quarter of 2010. (2) The increase from 2009 to 2010 is primarily due to costs associated with our Global Business Transformation project, including severance and other expenses. (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. 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 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 countries internationally. We currently have approximately 6,800 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 69.7% of total revenue for the nine months ended September 30, 2010, compared to 70.9% 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 nine months ended September 30, 2010 and 2009, respectively. Our TSS business accounted for approximately 13.7% and 14.8% of our total revenue for the nine months ended September 30, 2010 and 2009, respectively. Operations for our North America geographic region accounted for 78.5% revenue for the first nine months of 2010, while our EMEA/APAC operations represented 21.5% 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 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 is being placed on patients.

In September 2010, we entered into an exclusive sales and marketing agreement with Novadaq Technologies, Inc. for the distribution of Novadaq's SPY® Imaging System in North American surgical markets. The SPY Imaging System will be marketed for use in surgical procedures, including breast reconstruction, head and neck, and colorectal surgical specialties. LifeCell will provide market development and commercialization activities, including professional education, clinical support, reimbursement and sales distribution. Novadaq will continue to be responsible for manufacturing, field service and research and development. The SPY System aids surgeons in assessing poor or inadequate tissue perfusion at the surgical site, which is critical to the success of tissue revascularization and survival. The technology can be used to assess the quality of perfusion in both autologous and biologic tissue reconstructive procedures.

In October 2010, the U.S. Federal District Court for the Western District of Texas entered an order invalidating the patent claims involved in the lawsuit against Smith & Nephew. This decision is appealable to the United States Court of Appeals for the Federal Circuit. KCI is currently evaluating its legal options, including appeal, see Part II—Other Information: Item 1: “Legal Proceedings.”

In October 2010, we launched a new TSS therapy, the SkinIQ™ Microclimate Manager (“Skin IQ”). SkinIQ is a new therapeutic surface approach for the prevention and management of pressure ulcers. It is an innovative and proprietary microclimate coverlet that controls moisture and temperature while also providing low shear and friction properties. Using Skin IQ in combination with our AtmosAir™ product family provides an alternative to the current standard of care, Low-Air-Loss therapy, and continues TSS’s market innovation in the prevention and management of pressure ulcers.

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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.

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 third quarter of 2010 to the third quarter of 2009 and the first nine months of 2010 to the first nine months of 2009 (dollars in thousands):

	Three months ended September 30,						Nine months ended September 30,
					%						%
	2010		2009		Change		2010		2009		Change
AHS revenue:
North America	$	275,494	$	270,848	1.7	%	$	792,007	$	791,837	-
EMEA/APAC		82,898		89,732	(7.6	)		247,064		247,490	(0.2	)%

Total – AHS		358,392		360,580	(0.6	)		1,039,071		1,039,327	-

Regenerative Medicine revenue:
North America		83,213		71,248	16.8			243,375		208,132	16.9
EMEA/APAC		1,722		519	231.8			4,318		913	372.9

Total – Regenerative Medicine		84,935		71,767	18.3			247,693		209,045	18.5

TSS revenue:
North America		41,788		46,542	(10.2	)		134,751		141,817	(5.0	)
EMEA/APAC		21,593		25,508	(15.3	)		68,770		75,638	(9.1	)

Total – TSS		63,381		72,050	(12.0	)		203,521		217,455	(6.4	)

Total revenue	$	506,708	$	504,397	0.5	%	$	1,490,285	$	1,465,827	1.7	%

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

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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 third quarter of 2010 to the third quarter of 2009 and the first nine months of 2010 to the first nine months of 2009 (dollars in thousands):

	Three months ended September 30,						Nine months ended September 30,
					%						%
	2010		2009		Change		2010		2009		Change
North America revenue:
Rental	$	232,314	$	234,662	(1.0	)%	$	680,377	$	692,102	(1.7	)%
Sales		168,181		153,976	9.2			489,756		449,684	8.9

Total – North America		400,495		388,638	3.1			1,170,133		1,141,786	2.5

EMEA/APAC revenue:
Rental		56,656		63,915	(11.4	)		171,668		180,853	(5.1	)
Sales		49,557		51,844	(4.4	)		148,484		143,188	3.7

Total – EMEA/APAC		106,213		115,759	(8.2	)		320,152		324,041	(1.2	)

Total rental revenue		288,970		298,577	(3.2	)		852,045		872,955	(2.4	)
Total sales revenue		217,738		205,820	5.8			638,240		592,872	7.7

Total revenue	$	506,708	$	504,397	0.5	%	$	1,490,285	$	1,465,827	1.7	%

The change in total revenue compared to the prior-year periods was due to increased Regenerative Medicine sales, partially offset by decreased TSS rental revenue. Foreign currency exchange rate movements reduced total revenue for the third quarter of 2010 by 1.2%, while having a nominal impact on total revenue for the first nine months of 2010 compared to the corresponding periods of the prior year.

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 third quarter of 2010 to the third quarter of 2009 and the first nine months of 2010 to the first nine months of 2009:

	Three months ended September 30,					Nine months ended September 30,
	2010		2009		Change	2010		2009		Change
Total revenue:
AHS revenue	70.7	%	71.5	%	(80 bps)	69.7	%	70.9	%	(120 bps)
Regenerative Medicine revenue	16.8		14.2		260 bps	16.6		14.3		230 bps
TSS revenue	12.5		14.3		(180 bps)	13.7		14.8		(110 bps)

Total revenue	100.0	%	100.0	%		100.0	%	100.0	%

North America revenue	79.0	%	77.1	%	190 bps	78.5	%	77.9	%	60 bps
EMEA/APAC revenue	21.0		22.9		(190 bps)	21.5		22.1		(60 bps)

Total revenue	100.0	%	100.0	%		100.0	%	100.0	%

Rental revenue	57.0	%	59.2	%	(220 bps)	57.2	%	59.6	%	(240 bps)
Sales revenue	43.0		40.8		220 bps	42.8		40.4		240 bps

Total revenue	100.0	%	100.0	%		100.0	%	100.0	%

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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 third quarter of 2010 to the third quarter of 2009 and the first nine months of 2010 to the first nine months of 2009 (dollars in thousands):

	Three months ended September 30,						Nine months ended September 30,
					%						%
	2010		2009		Change		2010		2009		Change
North America revenue:
Rental	$	196,775	$	193,337	1.8	%	$	564,844	$	566,274	(0.3	)%
Sales		78,719		77,511	1.6			227,163		225,563	0.7

Total North America revenue		275,494		270,848	1.7			792,007		791,837	-

EMEA/APAC revenue:
Rental		39,072		43,214	(9.6	)		116,209		120,472	(3.5	)
Sales		43,826		46,518	(5.8	)		130,855		127,018	3.0

Total EMEA/APAC revenue		82,898		89,732	(7.6	)		247,064		247,490	(0.2	)

Total rental revenue		235,847		236,551	(0.3	)		681,053		686,746	(0.8	)
Total sales revenue		122,545		124,029	(1.2	)		358,018		352,581	1.5

Total AHS revenue	$	358,392	$	360,580	(0.6	)%	$	1,039,071	$	1,039,327	-	%

Worldwide revenue from AHS products decreased slightly from the third quarter of 2009 due primarily to unfavorable foreign currency exchange rate movements and lower realized pricing, partially offset by higher global rental and sales volumes. North American AHS revenue for the third quarter of 2010 increased 1.7% from the prior-year quarter resulting from improved unit volumes. Third quarter 2010 AHS revenue from the United States increased 1.3% from the same period one year ago. North American AHS revenue for the first nine months of 2010 was comparable to the same period of the prior year. Foreign currency exchange rate movements had a negligible impact on North American AHS revenue for the third quarter and first nine months of 2010 as compared to the prior-year periods.

Foreign currency exchange rate movements negatively impacted EMEA/APAC AHS revenue by 5.7% and 0.5% in the third quarter and first nine months of 2010, respectively, compared to the prior-year periods. EMEA/APAC AHS revenue, excluding the impact of foreign currency exchange rate movements, decreased from the prior-year quarter due largely to continued pricing pressures stemming from increased levels of competitive activity and increased European Union healthcare spending austerity measures, partially offset by increased rental and sales volumes in the region due primarily to the successful launch of V.A.C. Therapy in Japan.

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 third quarter of 2010 to the third quarter of 2009 and the first nine months of 2010 to the first nine months of 2009 (dollars in thousands):

	Three months ended September 30,						Nine months ended September 30,
					%						%
	2010		2009		Change		2010		2009		Change

North America	$	83,213	$	71,248	16.8	%	$	243,375	$	208,132	16.9	%
EMEA/APAC		1,722		519	231.8			4,318		913	372.9

Total revenue	$	84,935	$	71,767	18.3	%	$	247,693	$	209,045	18.5	%

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 94.3% and 93.5% of total Regenerative Medicine revenue for the third quarter and first nine months of 2010, respectively. Revenue from Strattice, our porcine-based tissue matrix product, accounted for 42.2% and 39.6% of total Regenerative Medicine revenue for the third quarter and first nine months of 2010, respectively, compared to 33.3% and 29.7%, 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. The EMEA region contributed 2% of the Regenerative Medicine overall revenue growth for both the third quarter and first nine months of 2010 as we continued to penetrate the European markets. We have now introduced our Regenerative Medicine products into eleven European countries.

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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 third quarter of 2010 to the third quarter of 2009 and the first nine months of 2010 to the first nine months of 2009 (dollars in thousands):

	Three months ended September 30,						Nine months ended September 30,
					%						%
	2010		2009		Change		2010		2009		Change
North America revenue:
Rental	$	35,539	$	41,325	(14.0	)%	$	115,533	$	125,828	(8.2	)%
Sales		6,249		5,217	19.8			19,218		15,989	20.2

Total North America revenue		41,788		46,542	(10.2	)		134,751		141,817	(5.0	)

EMEA/APAC revenue:
Rental		17,584		20,701	(15.1	)		55,459		60,381	(8.2	)
Sales		4,009		4,807	(16.6	)		13,311		15,257	(12.8	)

Total EMEA/APAC revenue		21,593		25,508	(15.3	)		68,770		75,638	(9.1	)

Total rental revenue		53,123		62,026	(14.4	)		170,992		186,209	(8.2	)
Total sales revenue		10,258		10,024	2.3			32,529		31,246	4.1

Total TSS revenue	$	63,381	$	72,050	(12.0	)%	$	203,521	$	217,455	(6.4	)%

Worldwide TSS revenue decreased from the prior-year period due primarily to lower rental volumes globally, resulting from continued economic weakness and its impact on acute care facilities, a lower incidence of influenza and unfavorable changes in product mix, partially offset by slightly higher levels of capital sales. Foreign currency exchange rate movements unfavorably impacted worldwide TSS revenue by 2.3% for the third quarter of 2010 while having no significant impact on the first nine months of 2010 compared to the corresponding prior-year periods.

North America TSS revenue decreased from the prior-year periods due primarily to fewer hospital therapy days and reduced hospital spending on higher cost therapies, partially offset by increased levels of wound care capital sales. Foreign currency exchange rate movements favorably impacted North America TSS revenue by 0.8% and 1.9% for the third quarter and the first nine 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 impact of prior-year contract losses, as well as utilization changes in select countries and accounts. Foreign currency exchange rate movements negatively impacted EMEA/APAC TSS revenue by 7.9% and 2.4% for the third quarter of 2010 and first nine months of 2010 compared to prior-year periods.

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Rental Expenses

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

	Three months ended September 30,								Nine months ended September 30,
	2010			2009			Change		2010			2009			Change
Rental expenses	$	155,765		$	163,020		(4.5	)%	$	464,606		$	485,463		(4.3	)%
As a percent of total AHS and TSS revenue		36.9	%		37.7	%	(80	bps)		37.4	%		38.6	%	(120	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 third quarter and first nine 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 third quarter of 2010 to the third quarter of 2009 and the first nine months of 2010 to the first nine months of 2009 (dollars in thousands):

	Three months ended September 30,								Nine months ended September 30,
	2010			2009			Change		2010			2009			Change
Cost of Sales	$	61,551		$	59,940		2.7	%	$	184,782		$	177,745		4.0	%
Sales margin		71.7	%		70.9	%	80	bps		71.0	%		70.0	%	100	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 third quarter of 2010 to the third quarter of 2009 and the first nine months of 2010 to the first nine months of 2009:

	Three months ended September 30,					Nine months ended September 30,
	2010		2009		Change	2010		2009		Change
Gross profit margin	57.1	%	55.8	%	130 bps	56.4	%	54.8	%	160 bps

The gross profit margin increase was due primarily to lower product royalty expenses, increased productivity of our service operations and favorable product mix, specifically higher gross margins associated with the Regenerative Medicine business unit.

Selling, General and Administrative Expenses

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

	Three months ended September 30,								Nine months ended September 30,
	2010			2009			Change		2010			2009			Change
Selling, general and administrative expenses	$	139,512		$	132,373		5.4	%	$	422,103		$	384,846		9.7	%
As a percent of total revenue		27.5	%		26.2	%	130	bps		28.3	%		26.3	%	200	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. SG&A expense increases in the third quarter of 2010 included continued investment associated with our entry in Japan, increased selling costs associated with the growth of our Regenerative Medicine business and employee separation costs. Additionally, SG&A expenses for the nine months ended September 30, 2010 included $12.7 million in expenses related to our TSS portfolio rationalization and employee separation costs related primarily to our Global Business Transformation project. For the nine months ended September 30, 2009, SG&A expense included approximately $9.4 million related to employee separation costs associated with the Company’s workforce restructuring and other pre-tax charges.

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Research and Development Expenses

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

	Three months ended September 30,								Nine months ended September 30,
	2010			2009			Change		2010			2009			Change
Research and development expenses	$	20,873		$	24,669		(15.4	)%	$	67,375		$	68,071		(1.0	)%
As a percent of total revenue		4.1	%		4.9	%	(80	bps)		4.5	%		4.6	%	(10	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. R&D expenses during the third quarter and first nine months of 2010 decreased from prior-year periods due primarily to the timing of certain programs. 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 clearance 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, the Company has 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 new and patented technology. The V.A.C.Via is being placed on patients and we anticipate a full commercial launch during the fourth quarter of 2010.

Acquired Intangible Asset Amortization

In connection with the LifeCell acquisition, we recorded $486.7 million of identifiable definite-lived intangible assets during the third quarter of 2008. Amortization expense associated with these acquired intangible assets was $8.9 million and $28.6 million in the third quarter and first nine months of 2010 compared to $10.2 million and $30.5 million in the corresponding prior-year periods.

Operating Margin

The following table presents the operating margin, (calculated as operating earnings divided by total revenue for the periods indicated), comparing the third quarter of 2010 to the third quarter of 2009 and the first nine months of 2010 to the first nine months of 2009:

	Three months ended September 30,					Nine months ended September 30,
	2010		2009		Change	2010		2009		Change
Operating margin	23.7	%	22.6	%	110 bps	21.7	%	21.8	%	(10 bps)

The increase in operating margin during the third quarter of 2010 is due primarily to an improved gross profit margin, partially offset by employee separation costs recorded in the quarter. The decrease in operating margin during the first nine 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. For the nine months ended September 30, 2009, operating margin was impacted by approximately $9.4 million related to employee separation costs associated with the Company’s workforce restructuring and other pre-tax charges.

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Interest Expense

Interest expense decreased to $21.5 million and $67.4 million in the third quarter and first nine months of 2010 compared to $25.7 million and $80.4 million in the corresponding prior-year periods, due to scheduled and voluntary debt payments made over the last twelve months totaling $235.0 million and lower effective interest rates. Interest expense for the third quarter and first nine months of 2010 includes write-offs of $374,000 and $2.3 million, respectively, as compared to $720,000 and $2.3 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 $5.4 million and $15.8 million in the third quarter and first nine months of 2010, respectively and $5.6 million and $16.8 million in the corresponding prior-year periods.

Foreign Currency Gain (Loss)

We recognized foreign currency exchange gains of $2.1 million and $3.2 million for the third quarter of 2010 and 2009, respectively. In the first nine months of 2010 and 2009, we recognized foreign currency exchange losses of $3.1 million and $3.9 million, respectively, due to continued volatility in currency exchange rates which were partially offset by our foreign currency hedging program.

Income Taxes

The effective income tax rate for the third quarter and first nine months of 2010 was 25.0% and 28.0%, respectively, compared to 29.7% and 31.1%, respectively, for the same periods in the prior year. The decrease in the effective income tax rate for the third quarter and first nine months of 2010 resulted from a higher percentage of taxable income being generated in lower tax foreign jurisdictions and the favorable resolution of certain tax contingencies during 2010. The resolution of these tax contingencies favorably impacted net earnings by $2.9 million, or $0.04 per diluted share, in the third quarter of 2010.

Net Earnings

For the third quarter of 2010, we reported net earnings of $75.8 million, an increase of 17.4%, compared to $64.6 million in the prior-year period. For the first nine months of 2010, we reported net earnings of $182.1 million, an increase of 12.1%, compared to $162.4 million in the prior-year period.

Net Earnings per Diluted Share

Net earnings per diluted share for the third quarter and first nine months of 2010 were $1.06 and $2.54, respectively, as compared to net earnings per diluted share of $0.91 and $2.31 in the corresponding prior-year periods.

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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 nine months ended September 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 nine months ended September 30, 2010 and 2009 (dollars in thousands):

	Nine months ended
	September 30,
	2010			2009

Net cash provided by operating activities	$	233,115		$	272,483
Net cash used by investing activities		(61,559	)		(78,131	)
Net cash used by financing activities		(170,932	)		(174,597	)
Effect of exchange rate changes on cash and cash equivalents		(484	)		2,532

Net increase in cash and cash equivalents	$	140		$	22,287

As of September 30, 2010, our principal sources of liquidity consisted of $263.3 million of cash and cash equivalents and $288.4 million available under our revolving credit facility, net of $11.6 million in undrawn letters of credit. During the first nine months of 2010, we made scheduled and voluntary senior credit facility net repayments totaling $185.0 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 September 30, 2010, we had current assets of $899.1 million, including $406.0 million in net accounts receivable and $174.7 million in net inventory, and current liabilities of $434.9 million resulting in a working capital surplus of $464.2 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 September 30, 2010 and December 31, 2009, we had $406.0 million and $425.0 million, respectively, of receivables outstanding, net of realization reserves of $90.2 million and $105.5 million, respectively. Net accounts receivable decreased $19.0 million during the first nine 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 64 days at September 30, 2010, compared to 69 days at December 31, 2009. EMEA/APAC net receivables were outstanding for an average of 94 days at September 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 September 30, 2010 and December 31, 2009, we had net inventories of $174.7 million and $121.0 million, respectively, an increase of $53.7 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 and increases in our AHS raw materials necessary to support the production and launch of our new AHS products, partially offset by the additional reserve associated with the rationalization of our TSS product portfolio recorded in the second quarter of 2010.

Capital Expenditures

During the first nine months of 2010 and 2009, we made net capital expenditures of $53.5 million and $64.1 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 September 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	-			$	-	$	288,365	(1)
Term loan facility	May 2013	4.339	%	(2)		565,000		-

Total					$	565,000	$	288,365


(1) At September 30, 2010, amount available under the revolving portion of our credit facility reflected a reduction of $11.6 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 September 30, 2010 was 3.040%.

As of September 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 September 30, 2010 and December 31, 2009, we were in compliance with all covenants under the Indenture for the Convertible Notes.

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Interest Rate Protection

At September 30, 2010 and December 31, 2009, we had eighteen and seventeen interest rate swap agreements in effect, respectively, pursuant to which we have fixed the rate on an aggregate $513.0 million and $662.0 million, respectively, notional amount of our outstanding variable rate debt at a weighted average interest rate of 1.721% and 2.074%, respectively, exclusive of the Eurocurrency Rate Loan Spread as disclosed in the senior credit agreement. As of September 30, 2010 and December 31, 2009, the aggregate fair value of our swap agreements was negative and recorded as a liability of $3.5 million and $8.4 million, respectively. If our interest rate protection agreements were not in place, interest expense would have been approximately $2.0 million and $7.6 million lower for the three months and nine months ended September 30, 2010, respectively, and $3.1 million and $7.6 million lower in the same periods of the prior year.

Long-Term Commitments

The following table summarizes our long-term debt obligations, excluding the convertible debt discount, as of September 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	$	37,667	$	169,500	$	226,000	$	131,833	$	-	$	690,000	$	1,255,000

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 which 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. Higher 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. PPACA increases fraud and abuse penalties and expands the scope and reach of the Federal Civil False Claims Act and government enforcement tools.

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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.

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. Additionally, we believe selection of NPWT suppliers under the competitive bidding program should be based on each supplier’s ability to deliver NPWT systems cleared by the FDA for safe use in the home. 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.

In September 2010, we conducted a corrective field action with respect to our RotoProne product, which included clarified labeling and written notifications to existing customers regarding operational and safety features of the RotoProne. KCI reported this voluntary correction to the FDA. We do not expect that this corrective action will have a material impact on our results of operations.

Recently, the FDA issued proposed rule-making which may result in substantial changes to the 510(k) clearance process for medical devices. Among the proposed changes, the clearance of certain medical devices may be subject to facility inspections to ensure compliance with Good Manufacturing Practices rules and regulations. If the proposed rules are made final in their current form, we expect that obtaining 510(k) clearances for KCI medical devices in the future may become more difficult and time consuming. Any substantial increased requirements which are imposed on KCI as a result of new rule-making could potentially delay our development and commercialization of new medical device products.

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.”

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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 December 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.

The table below provides information as of September 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 September 30, 2010
	2010			2011			2012			2013			Thereafter			Total			Fair Value
Long-term debt
Fixed rate	$	—		$	—		$	—		$	—		$	690,000		$	690,000		$	692,139	(1)
Average interest rate		—			—			—			—			3.250	%		3.250	%
Variable rate	$	37,667		$	169,500		$	226,000		$	131,833		$	—		$	565,000		$	566,413
Weighted average interest rate (2)		3.040	%		3.040	%		3.040	%		3.040	%		—			3.040	%

Interest rate swap (3)
Variable to fixed-notional amount	$	243,500		$	269,500		$	—		$	—		$	—		$	513,000		$	(3,456	)
Average pay rate		1.932	%		1.531	%		—			—			—			1.721	%
Average receive rate (4)		0.290	%		0.290	%		—			—			—			0.290	%

(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 rate for all periods presented represents the nominal interest rate as of September 30, 2010. This rate resets quarterly. (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 September 30, 2010. (4) The average receive rates for future periods are based on the current period average receive rates. These rates reset quarterly.

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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 September 30, 2010, we had outstanding foreign currency exchange contracts to sell or purchase approximately $99.9 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 $82.0 million for the nine months ended September 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 nine months ended September 30, 2010 would change our net earnings for the period by approximately $6.5 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.

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 third fiscal quarter of 2010 that have materially affected, or are reasonably likely to materially affect, KCI’s internal control over financial reporting.

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PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Patent Litigation

U.S. NPWT Patent Re-Examinations and Litigation

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International NPWT Patent Litigation

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LifeCell Litigation

ITEM 1A. RISK FACTORS

Except with respect to the updated risk factors described below, 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.

We face significant and increasing competition, which could adversely affect our operating results.

We face significant and increasing competition in each of our businesses, which are intensely competitive and are characterized by rapid technological change. We compete with many companies, some of which have longer operating histories, better brand or name recognition, broader product lines and greater access to financial and other resources. Our customers consider many factors when selecting a product, including product reliability, clinical outcomes, product availability, price and services provided by the manufacturer, and market share can shift as a result of technological innovation and other business factors. Our ability to compete with other developers of advanced therapies and technologies will depend in large part on our ability to develop and acquire new products and technologies as well as anticipate technology advances. Product introductions or enhancements by competitors which have advanced technology, better features or lower pricing may make our products or proposed products obsolete or less competitive. Our competitive position can also be adversely affected by product problems, physician advisories and safety alerts, reflecting the importance of product quality in the medical device industry. For additional information regarding our competitive positioning, see Item 1: “Business—Information Related to Business Units—Active Healing Solutions—Competition; Regenerative Medicine—Competition; and Therapeutic Support Systems—Competition.” in KCI's Annual Report on Form 10-K for the fiscal year ended December 31, 2009.

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We expect competition in our AHS business to increase over time as competitors introduce additional competing products in the advanced wound care market. As our patents in the field of NPWT expire over time, we expect increased competition with products adopting basic NPWT technologies. In October 2010, certain patent claims licensed to KCI by Wake Forest University were held to be invalid in litigation with Smith & Nephew by the U.S. District Court for the Western District of Texas. Smith & Nephew or third parties may become more aggressive in the marketing of competitive NPWT systems in the U.S. following this ruling. For additional information regarding our patent litigation, see Part II—Other Information: Item 1: “Legal Proceedings.”

Our NPWT systems also compete with traditional wound care dressings, other advanced wound care dressings, skin substitutes, products containing growth factors and other medical devices used for wound care in the United States and internationally. With respect to our Regenerative Medicine business, any failure by us to adequately supply customers may give competitors an opportunity to increase their sales to our customers, and it may be difficult for us to win back lost accounts. In addition, consolidation and the entrance of new low-cost competitors to our TSS business has greatly increased competition in the United States and abroad. These companies have competed in all areas, but most effectively with our most price sensitive customers such as extended care facilities, and have grown in size and scale. If we are unable to effectively differentiate our products from those of our competitors, our market share, sales and profitability could be adversely impacted.

If we are unsuccessful in protecting and maintaining our intellectual property, particularly our rights under the exclusive license from Wake Forest University to the patents protecting our V.A.C. Therapy Systems, our competitive position would be harmed.

Our ability to enforce our patents and those licensed to us, together with our other intellectual property is subject to general litigation risks, as well as uncertainty as to the enforceability of our intellectual property rights in various countries. We have numerous patents on our existing products and processes, and we file applications as appropriate for patents covering new technologies as such technologies are developed. However, the patents we own, or in which we have rights, may not be sufficiently broad to protect our technology position against competitors, or may not otherwise provide us with competitive advantages. We often retain certain knowledge that we consider proprietary as confidential and elect to protect such information as trade secrets, as business confidential information or as know-how. In these cases, we rely upon trade secrets, know-how and continuing technological innovation to maintain our competitive position. Our intellectual property rights may not prevent other companies from developing functionally equivalent products, developing substantially similar proprietary processes, or otherwise gaining access to our confidential know-how or trade secrets.

When we seek to enforce our intellectual property rights, we may be subject to claims that our rights are invalid, are otherwise not enforceable or are already licensed to the party against whom we are asserting a claim. When we assert our intellectual property rights, it is likely that the other party will seek to assert intellectual property rights of its own against us, which may adversely impact our business. All patents are subject to requests for reexamination by third parties. When such requests for reexamination are granted, some or all claims may require amendment or cancellation. Since 2007, multiple requests for reexamination of patents owned or licensed by KCI relating to our AHS business were granted by the U.S. Patent and Trademark Office, or USPTO, including the Wake Forest Patents. If we are unable to enforce our intellectual property rights, or patent claims related to V.A.C. Therapy are altered or invalidated through litigation or reexamination, our competitive position would be harmed. For more information on our current intellectual property litigation and the status of USPTO re-examination proceedings, see Item 3: “Legal Proceedings.”

We have agreements with third parties pursuant to which we license patented or proprietary technologies, including the Wake Forest Patents. These agreements commonly include royalty-bearing licenses. If we lose the right to license technologies essential to our businesses, or the costs to license these technologies materially increase, our businesses would suffer.

KCI and its affiliates are involved in multiple patent litigation suits in the United States and Europe involving the Wake Forest Patents as well as other patents owned or licensed by KCI, as described in Item 3: ‘‘Legal Proceedings.” If any of our key patent claims are 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 KCI’s V.A.C. Therapy Systems could be negatively impacted in the United States or Europe, due to increased competition, and pricing of our therapy systems could decline significantly, either of which would negatively affect our financial condition and results of operations. For example, in the United Kingdom and Germany, where the Wake Forest patents were invalidated in 2009 litigation, we have experienced increased competition and reduced growth rates in AHS revenue as a result. Also, in October 2010, certain patent claims licensed to KCI by Wake Forest University were held to be invalid in litigation with Smith & Nephew by the U.S. District Court for the Western District of Texas. Smith & Nephew or third parties may become more aggressive in the marketing of competitive NPWT systems in the U.S. following this ruling. We derived approximately 51% of total revenue for the nine months ended September 30, 2010 and the year ended December 31, 2009 from our domestic NPWT products relating to the U.S. patents at issue in ongoing U.S. litigation. In continental Europe, we derived approximately 12% of total revenue for the nine months ended September 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.

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We are exposed to product liability claims which may materially and adversely affect our revenues and results of operations.

Our businesses expose us to product liability risks inherent in the testing, manufacturing, marketing and use of medical products. We maintain product liability insurance; however, we cannot be certain that (1) the level of insurance will provide adequate coverage against potential liabilities, (2) the type of claim will be covered by the terms of the insurance coverage, (3) adequate product liability insurance will continue to be available in the future, or (4) the insurance can be maintained on acceptable terms. The legal expenses associated with defending against product liability claims and the obligation to pay a product liability claim in excess of available insurance coverage would increase operating expenses and could materially and adversely affect our results of operations and financial position.

AlloDerm, GraftJacket, AlloCraft DBM and Repliform TRM contain donated human cadaveric tissue. The implantation of tissue products derived from donated cadaveric tissue creates the potential for transmission of communicable disease. LifeCell is accredited by the American Association of Tissue Banks and voluntarily complies with its guidelines. LifeCell and its tissue suppliers are registered with and regulated by the FDA and state regulatory bodies. These regulations have strict requirements for testing donors to prevent communicable disease transmission. However, there can be no assurance that our tissue suppliers will comply with such regulations intended to prevent communicable disease transmission, or even if such compliance is achieved, that our products have not been or will not be associated with disease transmission, or a patient otherwise infected with disease would not erroneously assert a claim that the use of our products resulted in disease transmission. LifeCell is currently named as a defendant in a number of lawsuits that are related to the distribution of its products, including multiple lawsuits relating to 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. Although we intend to defend against these actions, there can be no assurance that we will prevail. Any actual or alleged transmission of communicable disease could result in patient claims, litigation, distraction of management’s attention and potentially increased expenses. Also, in September 2010, LifeCell and KCI were served with two separate lawsuits from individuals alleging personal injury and seeking monetary damages for failed hernia repair procedures using our AlloDerm products. These cases are in the early stages of litigation and have not yet been set for trial. The law firms representing plaintiffs in these cases are actively soliciting and publicly advertising in an effort to recruit additional plaintiffs for hernia repair cases. The publicity around BTS cases and the active solicitation of plaintiffs in the AlloDerm cases could potentially harm our reputation with our customers and disrupt our ability to market our products, which may materially and adversely affect our results of operations and financial condition.

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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

July 1, 2010 to
July 31, 2010	181	$ 35.61	N/A	N/A

August 1, 2010 to
August 31, 2010	279	$ 34.95	N/A	N/A

September 1, 2010 to
September 30, 2010	263	$ 35.12	N/A	N/A

Total	723	$ 35.18	N/A	N/A


(1) During the third quarter of 2010, KCI purchased and retired 723 shares in connection with the withholding of shares to satisfy the minimum tax withholdings on the lapsing of restrictions on 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).
31.1		Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 dated November 2, 2010.
31.2		Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 dated November 2, 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 November 2, 2010.
*101.INS		XBRL Instance Document
*101.SCH		XBRL Taxonomy Extension Schema
*101.CAL		XBRL Taxonomy Extension Calculation Linkbase
*101.LAB		XBRL Taxonomy Extension Label Linkbase
*101.PRE		XBRL Taxonomy Extension Presentation Linkbase

		* Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934 and otherwise are not subject to liability.

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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: November 2, 2010	By: /s/ Catherine M. Burzik
	Catherine M. Burzik
	President and Chief Executive Officer
	(Duly Authorized Officer)


Date: November 2, 2010	By: /s/ Martin J. Landon
	Martin J. Landon
	Executive Vice President and Chief Financial Officer
	(Principal Financial and Accounting Officer)

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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).
31.1		Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 dated November 2, 2010.
31.2		Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 dated November 2, 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 November 2, 2010.
*101.INS		XBRL Instance Document
*101.SCH		XBRL Taxonomy Extension Schema
*101.CAL		XBRL Taxonomy Extension Calculation Linkbase
*101.LAB		XBRL Taxonomy Extension Label Linkbase
*101.PRE		XBRL Taxonomy Extension Presentation Linkbase

		* Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934 and otherwise are not subject to liability.

KINETIC CONCEPTS INC - FORM 10-Q - November 2, 2010

Attached files

KINETIC CONCEPTS INC Reports