This "Management's Discussion and Analysis of Results of Operations and
Financial Condition" is intended to assist in understanding and assessing the
trends and significant changes in our results of operations and financial
condition. Historical results may not indicate future performance. As used in
this "Management's Discussion and Analysis of Results of Operations and
Financial Condition," the words "we," "our," "us," "Lincare" and the "Company"
refer to Lincare Holdings Inc. and its consolidated subsidiaries.
Medicare Reimbursement
As a provider of home oxygen, respiratory and other chronic therapy services to
the home health care market, we participate in Medicare Part B, the
Supplementary Medical Insurance Program, which was established by the Social
Security Act of 1965. Providers of home oxygen and other respiratory therapy
services have historically been heavily dependent on Medicare reimbursement due
to the high proportion of elderly persons suffering from respiratory disease.
Durable medical equipment ("DME"), including oxygen equipment, is traditionally
reimbursed by Medicare based on fixed fee schedules.
Recent legislation, including the Patient Protection and Affordable Care Act
("PPACA"), the Medicare Improvements for Patients and Providers Act of 2008
("MIPPA"), the Medicare, Medicaid and SCHIP Extension Act of 2007 ("SCHIP
Extension Act"), the Deficit Reduction Act of 2005 ("DRA") and the Medicare
Prescription Drug, Improvement, and Modernization Act of 2003 ("MMA"), contain
provisions that directly impact reimbursement for the primary respiratory and
other DME products provided by Lincare. PPACA, as amended, is a comprehensive
health care reform law that contains a large number of health-related provisions
to take effect over the next several years, including various cost containment
and program integrity changes that will apply to the home medical equipment
industry. MIPPA delayed the implementation of a Medicare competitive bidding
program for oxygen equipment and certain other DME items that was scheduled to
begin on July 1, 2008 and instituted a 9.5% price reduction nationwide for these
items as of January 1, 2009. The SCHIP Extension Act reduced Medicare
reimbursement amounts for covered Part B drugs, including inhalation drugs that
we provide, beginning April 1, 2008. DRA provisions negatively impacted
reimbursement for oxygen equipment beginning in 2009 through the implementation
of a capped rental arrangement. MMA changed the pricing formulas used to
establish payment rates for inhalation drug therapies resulting in significantly
reduced reimbursement beginning in 2005, established a competitive acquisition
program for DME, established a Recovery Audit Contractors ("RAC") program, which
implemented a new method for recovery of Medicare overpayments by utilizing
private companies operating on a contingent fee basis to identify and recoup
Medicare overpayments, and implemented quality standards and accreditation
requirements for DME suppliers. These legislative provisions, as currently in
effect and when fully implemented, have had and will continue to have a material
adverse effect on our business, financial condition, operating results and cash
flows.
PPACA was signed into law on March 23, 2010. Together with the Health Care and
Education Reconciliation Act of 2010 (signed into law on March 30, 2010) which
amended the statute, PPACA is a comprehensive health care law that is intended
to expand access to health insurance, reform the health insurance market to
provide additional consumer protections, and improve the health care delivery
system to reduce costs and produce better outcomes through a combination of cost
controls, subsidies and mandates. Among other things, PPACA:
(1) Introduced a productivity adjustment factor that is applied to Medicare price
updates (covered item updates) for 2011 and each subsequent year.
Specifically, Medicare payment amounts are updated each year by the
percentage increase in the consumer price index for all urban consumers
(CPI-U) for the 12-month period ending with June of the previous year, reduced by a productivity adjustment (as projected by the Secretary of Health
and Human Services). The application of the productivity adjustment may
result in the covered item update being negative for a year, and may result
in payment rates being less than such payment rates for the preceding year.
The covered item update for Medicare items subject to the update and
furnished in 2012, net of the productivity adjustment has been established at
positive 2.4%.
(2) Made adjustments to the Medicare DME Competitive Acquisition Program
("competitive bidding"). PPACA expands the DME competitive bidding program to
100 markets from 79 markets under prior law. PPACA also added a requirement
to expand competitive bidding further to additional geographic markets
(certain markets may be excluded at the discretion of CMS) or use competitive
bid pricing information to adjust the payment amounts otherwise in effect for
areas that are not competitive acquisition areas by January 1, 2016.
24
--------------------------------------------------------------------------------
Table of Contents
(3) Made important changes to key fraud and abuse statutes and increased funding
for fraud and abuse enforcement. PPACA increased funding for program
integrity initiatives, improved screening of providers and suppliers before
and after granting Medicare billing privileges and established new and
enhanced penalties and procedures to deter fraud and abuse. PPACA also
specifically added a requirement that physician orders for covered items of
DME must be written by a physician and must document that a physician, a
physician assistant, a nurse practitioner, or a clinical nurse specialist had
a face-to-face encounter (including through the use of telehealth) with the
individual involved during the six-month period preceding such written order,
or other reasonable timeframe as determined by the Secretary of Health and
Human Services.
PPACA is a complex, sweeping health care reform law that will dramatically alter
the structure of health insurance markets and the practice of medicine in the
United States. Due to the complex nature of the legislation and the extended
time period over which various provisions of the new law will be implemented
(pursuant to yet unwritten regulations), we can not predict at this time what
effects PPACA and related regulations will have on our business in the future.
The MIPPA legislation imposed a 9.5% reduction in Medicare payment rates for
certain specified product categories, including oxygen, effective January 1,
2009. In addition to the 9.5% reduction, the Centers for Medicare and Medicaid
Services ("CMS"), as required by statute, subjected the monthly payment amount
for stationary oxygen equipment to additional cuts of 2.3%, thereby reducing the
monthly payment rate from $199.28 in 2008 to $175.79 in 2009. The monthly
payment amount was reduced by 1.5% in 2010, to $173.17. We estimate that this
reduction negatively impacted our annual net revenues in 2010 by approximately
$8.4 million when compared to the prior year period. The stationary oxygen
payment rate for 2011 was increased to $173.31 per month, an increase of 0.1%,
and was not material to the Company's operating results in 2011. The stationary
oxygen payment rate for 2012 has been established by CMS at $176.06 per month,
an increase of 1.6%. We estimate that this increase will favorably impact our
revenues in 2012 by approximately $10.0 million.
The SCHIP Extension Act, which became law on December 29, 2007, required CMS to
adjust the methodology used to determine Medicare payment amounts for inhalation
drugs by using volume-weighted average selling prices ("ASP") based on actual
sales volumes rather than average sales prices. CMS publishes payment rates for
inhalation drugs each calendar quarter, representing the unit reimbursement
rates in effect for inhalation drugs dispensed within that quarter. These
payment rates may be subject to volatility as a result of the underlying ASP
data used to determine the rates in effect each quarter. The quarterly ASP data
published by CMS for inhalation drugs provided in 2010 and 2011 resulted in
reductions in the Medicare payment rates for inhalation drugs that negatively
impacted the Company's annual net revenues by approximately $5.0 million and
$14.8 million, respectively. Based upon the ASP payment rates published by CMS
for the first three quarters of 2012, and assuming no changes in the volume or
mix of drugs that we currently dispense, we estimate that our annual net
revenues will be favorably impacted by approximately $11.7 million in 2012 when
compared with 2011. We can not determine whether quarterly updates in ASP
pricing data will result in future reductions in payment rates for inhalation
drugs, or what impact such payment reductions could have on our business in the
future.
Additionally, since 2011, CMS is using 103% of Average Manufacturer Price
("AMP") rather than 106% of ASP for a drug when ASP exceeds AMP by 5% for either
two straight quarters or three of the past four quarters. The policy limits
substitution of the price formula in a given quarter to only those drugs where
ASP and AMP can be compared using the same set of national drug codes. We can
not determine at this time which, if any, inhalation drugs might meet the
criteria established for substitution in a particular future quarter, nor the
impact on payment rates for such drugs in the event that the AMP formula is
utilized.
On February 1, 2006, Congress passed the DRA legislation which changed the
reimbursement methodology for oxygen equipment from continuous monthly payment
for as long as the equipment is in use by a Medicare beneficiary, which includes
payment for oxygen contents, related disposable supplies and accessories and
maintenance of equipment, to a capped rental arrangement whereby payment for
oxygen equipment may not extend over a period of continuous use of longer than
36 months. Separate payments for oxygen contents continue to be made for the
period of medical need beyond the 36th month. Additionally, payment for routine
maintenance and service of the oxygen equipment may be made following each
six-month period after the 36-month rental period ends. The oxygen provisions
contained in DRA became effective on January 1, 2006. In the case of
beneficiaries receiving oxygen equipment prior to the effective date, the
36-month period of continuous use began on January 1, 2006. Accordingly, the
first month in which the new payment methodology impacted our net revenues was
January 2009. We anticipate that these oxygen payment rules will continue
25
--------------------------------------------------------------------------------
Table of Contents
to negatively affect our net revenues on an ongoing basis, as each month
additional customers reach the 36-month capped service period, resulting in no
further rental income from these customers. During 2011, we estimate that our
sequential net revenues were reduced as a result of additional customers
reaching the payment cap by approximately $20.2 million when compared to the
prior year period. During the first half of 2012, we estimate that our net
revenues were reduced by approximately $19.7 million compared to the first half
of 2011, due to the oxygen rental payment cap.
In December 2003, MMA was signed into law. The MMA legislation directly impacted
reimbursement for the primary respiratory and other DME products that we
provide. Among other things, MMA:
(1) Established a competitive acquisition program for DME that was expected to
commence in 2008, but was subsequently delayed by further legislation. MMA
instructed CMS to establish and implement programs under which competitive
acquisition areas would be established throughout the United States for
purposes of awarding contracts for the furnishing of competitively priced
items of DME, including oxygen equipment. The program was initially intended
to be implemented in phases such that competition under the program would
occur in nine of the largest metropolitan statistical areas ("MSAs") in the
first year and an additional 70 of the largest MSAs in a second, subsequent
round of bidding.
For each competitive acquisition area, CMS is required to conduct a competition
under which providers submit bids to supply certain covered items of DME.
Successful bidders are expected to meet certain program quality standards in
order to be awarded a contract and only successful bidders can supply the
covered items to Medicare beneficiaries in the acquisition area (there are,
however, regulations in place that allow non-contracted providers to continue to
provide equipment and services to their existing customers at the new prices
determined through the bidding process). The contracts are expected to be re-bid
at least every three years. CMS is required to award contracts to multiple
entities submitting bids in each area for an item or service, but has the
authority to limit the number of contractors in a competitive acquisition area
to the number it determines to be necessary to meet projected demand.
CMS concluded the bidding process for the first round of MSAs in September 2007,
however, in July 2008, Congress enacted the MIPPA legislation which
retroactively delayed the implementation of competitive bidding and reduced
Medicare prices nationwide by 9.5% beginning in 2009 for the product categories,
including oxygen, that were initially included in competitive bidding.
In 2009, CMS reinstituted the bidding process in the nine largest MSA markets.
Reimbursement rates from the re-bidding process were publicly released by CMS on
June 30, 2010. CMS announced average savings of approximately 32% off the
payment rates then in effect for the product categories included in competitive
bidding. As of January 1, 2011, these payment rates were in effect in the nine
markets only. Lincare was offered contracts to provide oxygen equipment in just
two of the nine markets, Charlotte and Miami, and we accepted and signed those
contracts. The Company's annual Medicare revenues from the product categories in
the nine markets affected by competitive bidding were approximately $48.0
million at the time the program commenced. During 2011, we completed
acquisitions of companies that were contracted to provide home oxygen equipment
and positive airway pressure devices in all nine competitive bidding markets.
CMS is currently undertaking a second round of competitive bidding in 91
additional markets, with contracts expected to be effective in July 2013. The
bid submission period closed on March 30, 2012, and CMS is expected to announce
final pricing results in November 2012. The Company's Medicare revenues from the
product categories in the 91 additional markets to be included in the second
round of competitive bidding were approximately $267.0 million in 2011. The
PPACA legislation requires CMS to expand competitive bidding further to
additional geographic markets (certain markets may be excluded at the discretion
of CMS) or to use competitive bid pricing information to adjust the payment
amounts otherwise in effect for areas that are not competitive acquisition areas
by January 1, 2016.
We will continue to monitor developments regarding the implementation of the
competitive bidding program. While we can not predict the outcome of the
competitive bidding program on our business when fully implemented nor the
Medicare payment rates that will be in effect in future years for the items
subjected to competitive bidding, it is likely that the program will materially
adversely effect our financial position and operating results.
(2) Established a Recovery Audit Contractors ("RAC") program to identify and
recoup Medicare overpayments from providers. Started in 2005 as a
demonstration project by CMS, the RAC program was designed to test a new
method for recovery of Medicare overpayments by utilizing private companies
operating on a contingent fee basis to identify and recoup Medicare
overpayments from providers. Section 302 of the Tax Relief and Health Care
Act of 2006 made the program permanent and requires the Department of Health
and Human Services to expand the program to
26
--------------------------------------------------------------------------------
Table of Contents
all states. The RAC contractors are empowered to audit claims submitted by
health care providers and to withhold future payments, including in cases
where the reimbursement rules are unclear or subject to differing
interpretations. This activity, as well as the activity of intermediaries and
others involved in government reimbursement, may include changes in
long-standing interpretations of reimbursement rules, which could have a
material adverse effect on our future financial position and operating
results.
In October 2008, CMS announced the establishment of new Zone Program Integrity
Contractors ("ZPICs"), who are responsible for ensuring the integrity of all
Medicare-related claims. The ZPICs assumed the responsibilities previously held
by Medicare's Program Safeguard Contractors ("PSCs"). Industry-wide, ZPIC audit
activity increased substantially throughout 2010 and 2011 and that activity is
expected to continue to increase for the foreseeable future as additional ZPICs
become operational across the country. The industry trade associations are
advocating for more standardized audit procedures, contractor transparency and
consistency surrounding all government audit activity directed toward the DME
industry.
In order to ensure that Medicare beneficiaries only receive medically necessary
and appropriate items and services, the Medicare program has adopted a number of
documentation requirements. For example, the Durable Medical Equipment Medicare
Administrative Contractor ("DME MAC") Supplier Manuals provide that clinical
information from the "patient's medical record" is required to justify the
initial and ongoing medical necessity for the provision of DME. Some DME MACs,
CMS staff and government subcontractors have recently taken the position, among
other things, that the "patient's medical record" refers not to documentation
maintained by the DME supplier but instead to documentation maintained by the
patient's physician, health care facility or other clinician, and that clinical
information created by the DME supplier's personnel and confirmed by the
patient's physician is not sufficient to establish medical necessity. It may be
difficult, and sometimes impossible, for us to obtain documentation from other
health care providers. Moreover, auditors' interpretations of these policies are
inconsistent and subject to individual interpretation, leading to significant
increases in individual supplier and industry-wide perceived error rates. High
error rates lead to further audit activity and regulatory burdens. If these or
other burdensome positions are generally adopted by auditors, DME MACs, other
contractors or CMS in administering the Medicare program, we would have the
right to challenge these positions as being contrary to law. If these
interpretations of the documentation requirements are ultimately upheld,
however, it could result in our making significant refunds and other payments to
Medicare and our future revenues and cash flows from Medicare may be reduced. We
can not currently predict the adverse impact these interpretations of the
Medicare documentation requirements might have on our operations, cash flow and
capital resources, but such impact could be material.
Federal and state budgetary and other cost-containment pressures will continue
to impact the home respiratory care industry. We can not predict whether new
federal and state budgetary proposals will be adopted or the effect, if any,
such proposals would have on our business.
Government Regulation
The federal governments of the United States and Canada and all states and
provinces in which we currently operate regulate various aspects of our
business. In particular, our operating centers are subject to federal laws that
regulate the repackaging of drugs (including oxygen) and interstate
motor-carrier transportation. Our operations also are subject to state and
provincial laws, where applicable, governing, among other things, pharmacies,
nursing services, distribution of medical equipment and certain types of home
health activities. Certain of our employees are subject to state laws and
regulations governing the ethics and professional practice of respiratory
therapy, pharmacy and nursing.
As a health care provider in the United States, we are subject to extensive
government regulation, including numerous laws directed at preventing fraud and
abuse and laws regulating reimbursement under various government programs. In
Canada, we are subject to numerous similar and other laws and regulations
including anti-corruptions laws and regulations. The marketing, billing,
documenting and other practices of health care companies are all subject to
government scrutiny. To ensure compliance with Medicare, Medicaid and other
regulations, regional health insurance carriers and state agencies often conduct
audits and request customer records and other documents to support our claims
submitted for payment of services rendered to customers. Similarly, government
agencies periodically open investigations and obtain information from health
care providers pursuant to the legal process. Violations of federal and state
regulations can result in severe criminal, civil and administrative penalties
and sanctions, including disqualification from Medicare and other reimbursement
programs, which could have a material adverse effect on our business.
Numerous federal, state and provincial laws and regulations, including the
Federal Health Insurance Portability And Accountability Act of 1996 ("HIPAA")
and the Health Information Technology For Economic And Clinical Health Act
("HITECH Act"), govern the collection, dissemination, security, use and
confidentiality of patient-identifiable health
27
--------------------------------------------------------------------------------
Table of Contents
information. As part of our provision of, and billing for, health care equipment
and services, we are required to collect and maintain patient-identifiable
health information. New health information standards, whether implemented
pursuant to HIPAA, the HITECH Act, congressional action or otherwise, could have
a significant effect on the manner in which we handle health care related data
and communicate with payors, and the cost of complying with these standards
could be significant. If we do not comply with existing or new laws and
regulations related to patient health information, we could be subject to
criminal or civil sanctions.
Health care is an area of rapid regulatory change. Changes in the laws and
regulations and new interpretations of existing laws and regulations may affect
permissible activities, the relative costs associated with doing business, and
reimbursement amounts paid by federal, state, provincial and other third-party
payors. We can not predict the future of federal, state and local regulation or
legislation, including Medicare and Medicaid statutes and regulations, or
possible changes in national health care policies. Future legislative and
regulatory changes could have a material adverse effect on our business.
Operating Results
The following table sets forth, for the periods indicated, a summary of the
Company's net revenues by product category:
For The Three Months Ended For The Six Months Ended
June 30, June 30,
2012 2011 2012 2011
(In thousands) (In thousands)
Respiratory and other chronic therapies $ 445,054 $ 403,022 $ 894,598 $ 789,042
DME, infusion and enteral therapies 51,109 46,011 102,443 91,558
Total $ 496,163 $ 449,033 $ 997,041 $ 880,600
Net revenues for the three months ended June 30, 2012, increased by $47.1
million (or 10.5%), compared with the three months ended June 30, 2011 and for
the six months ended June 30, 2012, increased by $116.4 million (or 13.2%)
compared with the six months ended June 30, 2011. The Company estimates that the
10.5% increase in net revenues in the three-month period of 2012 was comprised
of approximately 11.0% internal and acquisition growth offset by approximately
0.5% negative impact from $2.1 million of Medicare payment changes (see
"Medicare Reimbursement" above). The Company estimates that the 13.2% increase
in net revenues in the six-month period of 2012 was comprised of approximately
13.7% internal and acquisition growth offset by approximately 0.5% negative
impact from $4.3 million of Medicare payment changes in 2012. The internal
growth in net revenues is attributable to underlying demographic growth in the
markets for our products and gains in customer counts resulting primarily from
our sales and marketing efforts that emphasize high-quality equipment and
customer service. Growth in net revenues from acquisitions is attributable to
the effects of acquisitions of local and regional companies and is based on the
estimated contribution to net revenues for the four quarters following such
acquisitions.
The contribution of respiratory and other chronic therapy products to our net
revenues was 89.7% during the three and six months ended June 30, 2012 and
during the three and six months ended June 30, 2011 was 89.8% and 89.6%,
respectively. Our strategy is to focus on the provision of oxygen, respiratory
and other chronic therapy services to patients in the home and to provide home
medical equipment, infusion and enteral nutrition products and services where we
believe such services will enhance our core respiratory business.
Cost of goods and services, as a percentage of net revenues, was 32.3% and
32.5%, respectively, for the three and six months ended June 30, 2012, compared
with 31.7% and 30.3%, respectively, for the comparable prior year periods. Cost
of goods and services for the three months ended June 30, 2012, increased $17.9
million, or 12.6%, when compared with the prior year period. Cost of goods and
services for the six months ended June 30, 2012, increased $57.3 million, or
21.5%, when compared with the prior year period. The increase in cost of goods
and services in 2012 is primarily attributable to the Company's acquisition of a
specialty pharmacy business with gross margins that are substantially lower than
other products and services provided by the Company and higher sale volumes of
CPAP supplies and inhalation drugs.
28--------------------------------------------------------------------------------
Table of Contents
Cost of goods and services for the three and six-month periods includes the cost
of medical equipment (excluding depreciation of $30.4 million and $59.5 million
in 2012 and $28.1 million and $54.9 million in 2011, respectively), drugs and
supplies sold to patients and certain costs related to the Company's respiratory
drug product line. These costs include an allocation of customer service,
distribution and administrative costs relating to the respiratory drug product
line of approximately $14.2 million and $28.1 million for the three and
six-month periods of 2012, respectively, and approximately $13.6 million and
$27.5 million for the three and six-month periods of 2011, respectively.
Included in cost of goods and services in the three and six months ended
June 30, 2012 are salary and related expenses of pharmacists and other service
professionals of $2.6 million and $5.4 million, respectively. Such salary and
related expenses for the three and six months ended June 30, 2011, were $3.0
million and $5.8 million, respectively.
Operating expenses, as a percentage of net revenues, were 22.5% and 22.8%,
respectively, for the three and six months ended June 30, 2012, compared with
22.8% and 23.2%, respectively, for the comparable prior year periods. Operating
expenses for the three and six months ended June 30, 2012, increased by $9.7
million, or 9.5%, and $22.8 million, or 11.2%, respectively, over the prior year
periods. The Company has been successful in achieving productivity gains that
have contributed to containment of the growth in wage expenses and in managing
the growth of its employee health benefit costs. These positive developments
were partially offset by increases in vehicle related expenses during the first
six months of 2012, most significantly fuel costs.
The Company manages 1,058 operating centers from which customers are provided
equipment, supplies and services. An operating center averages approximately
seven to eight employees and is typically comprised of a center manager, two
customer service representatives (referred to as "CSRs" - telephone intake,
scheduling, documentation), two or three service representatives (referred to as
"Service Reps" - delivery, maintenance and retrieval of equipment and delivery
of disposables), a respiratory therapist (non-reimbursable clinical follow-up
with the customer and communication to the prescribing physician) and a sales
representative (marketing calls to local physicians and other referral sources).
The Company includes in operating expenses the costs incurred at the Company's
operating centers for certain service personnel (center manager, CSRs and
Service Reps), facilities (rent, utilities, communications, property taxes,
etc.), vehicles (vehicle leases, gasoline, repair and maintenance), and general
business supplies and miscellaneous expenses. Operating expenses for the interim
periods of 2012 and 2011 within these major categories were as follows:
Operating Expenses (in thousands)
For The Three Months Ended For The Six Months Ended
June 30, June 30,
2012 2011 2012 2011
Salary and related $ 72,640 $ 67,826 $ 147,357 $ 134,256
Facilities 15,612 12,796 32,022 28,561
Vehicles 14,533 13,756 29,553 26,420
General supplies/miscellaneous 9,092 7,811 17,927 14,859
Total $ 111,877 $ 102,189 $ 226,859 $ 204,096
Included in operating expenses during the three and six months ended June 30,
2012 are salary and related expenses for Service Reps in the amount of $28.9
million and $57.8 million, respectively. Such salary and related expenses for
the three and six months ended June 30, 2011 were $28.3 million and $55.9
million, respectively.
Selling, general and administrative ("SG&A") expenses, as a percentage of net
revenues, were 18.1% and 18.4%, respectively, for the three and six months ended
June 30, 2012, compared with 19.0% and 19.1% for the comparable prior year
periods. SG&A expenses for the three and six months ended June 30, 2012
increased by $4.1 million, or 4.8%, and $14.6 million, or 8.7% when compared to
the prior year periods. SG&A expenses include costs related to sales and
marketing activities, corporate overhead and other business support functions.
Included in SG&A during the three and six months ended June 30, 2012 are salary
and related expenses of $68.6 million and $138.0 million, respectively. These
salary and related expenses include the cost of the Company's respiratory
therapists for the three and six months ended June 30, 2012 of $18.0 million and
$35.7 million, respectively. Included in SG&A during the three and six months
ended June 30, 2011 are salary and related expenses of $62.9 million and $125.1
million, respectively. These salary and related
29--------------------------------------------------------------------------------
Table of Contents
expenses include the cost of the Company's respiratory therapists for the three
and six months ended June 30, 2011 of $17.9 million and $34.5 million,
respectively. The Company's respiratory therapists generally provide
non-reimbursable clinical follow-up with the customer and communication, as
appropriate, to the prescribing physician with respect to the customer's
prescribed plan of care. The Company includes the salaries and related expenses
of its respiratory therapist personnel (licensed respiratory therapists or, in
some cases, registered nurses) in SG&A because it believes that these personnel
enhance the Company's business relative to its competitors who do not employ
respiratory therapists.
Bad debt expense as a percentage of net revenues was 2.6% and 2.3% for the three
and six months ended June 30, 2012, respectively, and 2.0% for the three and six
months ended June 30, 2011. Bad debt expense for the three and six months ended
June 30, 2012 increased by $3.9 million and $5.3 million, respectively, over the
comparable prior year period.
Included in depreciation and amortization expense in the three and six months
ended June 30, 2012 is depreciation of medical equipment of $30.4 million and
$59.5 million, respectively, and depreciation of other property and equipment of
$1.8 million and $4.3 million, respectively. Included in depreciation and
amortization expense in the three and six months ended June 30, 2011 is
depreciation of medical equipment of $28.1 million and $54.9 million,
respectively, and depreciation of other property and equipment of $1.5 million
and $3.7 million, respectively.
Operating income for the three and six months ended June 30, 2012, was $88.5
million (17.8% of net revenues) and $174.9 million (17.5% of net revenues),
respectively, compared with $80.1 million (17.8% of net revenues) and $164.7
million (18.7% of net revenues), respectively, for the comparable prior year
periods. Operating income for the three and six months ended June 30, 2012,
increased by $8.4 million, or 10.5%, and $10.2 million, or 6.2% when compared to
the prior year periods. The increase in operating income in 2012 over 2011 is
attributed primarily to the growth in net revenues and containment of costs and
expenses during the period.
Liquidity and Capital Resources
Our primary sources of liquidity have been internally generated funds from
operations and proceeds from equity and debt transactions. We have used these
funds to meet our capital requirements, which consist primarily of operating
costs, capital expenditures, acquisitions, debt service and share repurchases.
The Company also has access to borrowings under its credit facilities.
Net cash provided by operating activities was $130.1 million for the six months
ended June 30, 2012, compared with $131.8 million for the six months ended
June 30, 2011. Net cash used in investing activities was $57.7 million for the
six months ended June 30, 2012. Investing activities during the six-month period
ended June 30, 2012 included our net investment in property and equipment of
$62.2 million, $2.7 million of purchases of short-term investments and $15.9
million of business acquisition expenditures offset by the sale and maturity of
investments of $23.1 million. Net cash provided by financing activities was
$59.0 million for the six months ended June 30, 2012. Financing activities
during the six-month period ended June 30, 2012 included advances under our
revolving credit agreement of $220.0 million, proceeds from the issuance of a
$250.0 million single draw term loan facility and proceeds of $4.4 million from
the exercise of stock options and issuance of common shares offset by repayments
under the revolving credit agreement of $320.0 million, payment of $34.7 million
of dividends, payments on debt and long-term obligations of $9.1 million and
$50.0 million of repurchases of our common shares.
As of June 30, 2012, our principal sources of liquidity consisted of
approximately $146.3 million of cash and cash equivalents, $19.6 million of
short-term investments and $413.2 million available under our revolving credit
agreement. The revolving credit agreement, dated September 15, 2011, makes
available to us up to $450.0 million over a five-year period, subject to certain
terms and conditions set forth in the agreement. As of June 30, 2012, there were
no borrowings outstanding and $36.8 million of standby letters of credit issued
under the credit facility.
On July 2, 2012, the Company announced that its Board of Directors had declared
a quarterly cash dividend of $0.20 per share which was paid on July 30, 2012, to
stockholders of record as of July 16, 2012. The payment of future dividends is
dependent on our future earnings and cash flow and is subject to the discretion
of our Board of Directors.
Our Board of Directors has authorized a share repurchase plan whereby the
Company may repurchase from time to time, on the open market or in privately
negotiated transactions, shares of the Company's common stock in amounts
determined pursuant to a formula (the "share repurchase formula") that takes
into account both the ratio of the Company's
30
--------------------------------------------------------------------------------
Table of Contents
net debt to cash flow and its available cash resources and borrowing
availability. During the first quarter of 2012, the Company repurchased and
retired 1,877,670 shares for $50.0 million pursuant to the repurchase plan. The
Company did not repurchase any shares in the second quarter of 2012. As of
June 30, 2012, $273.7 million of the Company's common stock was eligible for
repurchase in accordance with the plan's formula.
On October 31, 2007, we completed the sale of $275.0 million principal amount of
convertible senior debentures, due 2037 - Series A (the "Series A Debentures")
and $275.0 million principal amount of convertible senior debentures due 2037 -
Series B (the "Series B Debentures" and together with the Series A Debentures,
the "Series Debentures") in a private placement. The Series Debentures pay
interest semi-annually at a rate of 2.75% per annum. The Series Debentures are
unsecured and unsubordinated obligations and are convertible under specified
circumstances based upon a base conversion rate, which, under certain
circumstances, will be increased pursuant to a formula that is subject to a
maximum conversion rate. Upon conversion, holders of the Series Debentures will
receive cash up to the principal amount, and any excess conversion value will be
delivered in shares of our common stock or in a combination of cash and shares
of common stock, at our option. The base conversion rate for the Debentures as
of June 30, 2012 is 31.0828 shares of common stock per $1,000 principal amount
of Series Debentures, equivalent to a base conversion price of approximately
$32.17 per share. In addition, if at the time of conversion the applicable price
of our common stock exceeds the base conversion price, holders of the Series
Debentures will receive an additional number of shares of common stock per
$1,000 principal amount as determined pursuant to a specified formula. We have
the right to redeem the Series A Debentures and the Series B Debentures at any
time after November 1, 2012 and November 1, 2014, respectively. Holders of the
Series Debentures will have the right to require us to repurchase for cash all
or some of their Series Debentures upon the occurrence of certain fundamental
change transactions or on November 1, 2012, 2017, 2022, 2027 and 2032 in the
case of the Series A Debentures and November 1, 2014, 2017, 2022, 2027 and 2032
in the case of the Series B Debentures.
Our future liquidity will continue to be dependent upon our operating cash flow
and management of accounts receivable. We anticipate that funds generated from
operations, together with our current cash on hand and funds available under our
revolving credit facility, will be sufficient to finance our working capital
requirements, fund anticipated acquisitions and capital expenditures, and meet
our contractual obligations for at least the next 12 months.
Accounts Receivable: The Company maintains payor-specific price tables in its
billing system that reflect the fee schedule amounts statutorily in effect or
contractually agreed upon by various government and commercial payors for each
item of equipment or supply provided to a customer. Due to the nature of the
health care industry and the reimbursement environment in which Lincare
operates, situations can occur where expected payment amounts are not
established by fee schedules or contracted rates, and estimates are required to
record revenues and accounts receivable at their net realizable values. Inherent
in these estimates is the risk that revenues and accounts receivable will have
to be revised or updated as additional information becomes available.
Contractual adjustments to revenues and accounts receivable can result from
price differences between allowed charges and amounts initially recognized as
revenue due to incorrect price tables or subsequently negotiated payment rates.
Actual adjustments that result from differences between the payment amount
received and the expected realizable amount are recorded against the allowance
for sales adjustments and are typically identified and ultimately recorded at
the point of cash application or account review. We report revenues in our
financial statements net of such sales adjustments. Accounts receivable are
reported net of allowances for sales adjustments and uncollectible accounts. Bad
debt is recorded as an operating expense and consists of billed charges that are
ultimately deemed uncollectible due to the customer's or third-party payor's
inability or refusal to pay.
The Company's payor mix is highly concentrated among Medicare, Medicaid and
other government third-party payors and contracted private insurance or
commercial payors. Government payment rates are determined according to
published fee schedules established pursuant to statute, law or other regulatory
processes and commercial payment rates are based on contractual line item
pricing as reflected in the respective contracts. Fee schedule updates have
historically occurred on a prospective basis and have been made available to the
Company in advance of the effective date of a change in reimbursement rates. The
Company's proprietary billing system has features that allow the Company to
timely update payor price tables within the system as changes occur in order to
accurately record revenues and accounts receivable at their expected realizable
values. Additional systems and manual controls and processes are used by
management to evaluate the accuracy of these recorded amounts. Based on the
Company's experience, it is unlikely that a change in estimate of unsettled
amounts from third-party payors would have a material adverse impact on its
financial position or results of operations.
31
--------------------------------------------------------------------------------
Table of Contents
Accounts receivable balance concentrations by major payor category as of
June 30, 2012 and December 31, 2011 were as follows:
Percentage of Accounts Receivable Outstanding:
June 30, December 31,
2012 2011
Medicare 43.3 % 37.2 %
Medicaid/Other Government 13.6 % 14.7 %
Private Insurance 32.9 % 38.4 %
Customer Pay 10.2 % 9.7 %
Total 100.0 % 100.0 %
Aged accounts receivable balances by major payor category as of June 30, 2012
and December 31, 2011 were as follows:
Percentage of Accounts Aged in Days:
June 30, 2012
0-60 61-120 Over 120
Medicare 48.3 % 16.5 % 35.2 %
Medicaid/Other Government 44.2 % 18.6 % 37.2 %
Private Insurance 50.6 % 15.2 % 34.2 %
Customer Pay 32.6 % 19.9 % 47.5 %
All Payors 46.9 % 16.7 % 36.4 %
Percentage of Accounts Aged in Days:
December 31, 2011
0-60 61-120 Over 120
Medicare 67.5 % 12.9 % 19.6 %
Medicaid/Other Government 55.1 % 18.0 % 26.9 %
Private Insurance 60.1 % 13.7 % 26.2 %
Customer Pay 30.5 % 15.0 % 54.5 %
All Payors 59.2 % 14.2 % 26.6 %
We operate 39 regional billing and collection offices ("RBCOs") that are
responsible for the billing and collection of accounts receivable. The RBCOs are
aligned geographically to support the accounts receivable activity of the
operating centers within their assigned territories. As of June 30, 2012, there
were 1,533 full-time employees in the RBCOs. Accounts receivable collections are
performed by designated collectors within each of the RBCOs. The collectors use
various reporting tools available within our proprietary billing system to
identify claims that have been denied or partially paid by the responsible party
and claims that have not been processed by the third-party payor in a timely
manner. Collections of accounts receivable are typically pursued using direct
phone contact to determine the reason for non-payment and, if necessary,
corrected claims are prepared for resubmission and further follow-up with the
responsible party. In some cases, third-party payors have developed electronic
inquiry methods that we can access to determine the status of individual claims.
We have benefited from the increasing availability of electronic funds transfers
from payors, which now account for approximately 77.4% of all payments received.
Our accounts receivable days sales outstanding ("DSO") increased to 60 days at
June 30, 2012 compared with 47 days at December 31, 2011. Our bad debt expense,
as a percentage of net revenues, was 2.3% during the six-month period ended
June 30, 2012 and 2.0% during the six-month period ended June 30, 2011.
Contributing to the increase in our
32--------------------------------------------------------------------------------
Table of Contents
accounts receivable is a significant increase in the number of Medicare claims
subject to prepayment review, primarily by the DME MACs. These reviews are
substantially delaying the collection of our Medicare accounts receivable as
well as related secondary amounts due under supplemental insurance plans. We
estimate that accounts receivable subject to Medicare pre-payment review were
approximately $59.9 million as of June 30, 2012. Also contributing to the
increase in accounts receivable and bad debt expense are copayments and
deductibles due from customers who are finding it difficult to pay their
out-of-pocket charges due to loss of insurance coverage or reductions in their
investment or employment income.
The ultimate collection of accounts receivable may not be known for several
months. We record bad debt expense based on a percentage of revenue using
historical Company-specific data. The percentage and amounts used to record bad
debt expense and the allowance for doubtful accounts are supported by various
methods and analyses including current and historical cash collections, bad debt
write-offs, aged accounts receivable and consideration of any payor-specific
concerns. The ultimate write-off of an accounts receivable occurs once
collection procedures are determined to have been exhausted by the collector and
after appropriate review of the specific account and approval by supervisory
and/or management employees within the RBCOs. Management and RBCO supervisory
and management employees also review accounts receivable write-off reports,
correspondence from payors and individual account information to evaluate and
correct processes that might have contributed to an unsuccessful collection
effort.
We do not use an aging threshold for account receivable write-offs. However, the
age of an account balance may provide an indication that collection procedures
have been exhausted, and would be considered in the review and approval of an
account balance write-off.
Income Taxes
Our effective income tax rate was 38.67% and 38.88%, respectively, for the three
and six month periods ended June 30, 2012 compared with 39.71% and 39.15%,
respectively, for the three and six month periods ended June 30, 2011. The
income tax rate decreased from the three and six month periods ended June 30,
2011 primarily due to an increase in favorable adjustments associated with the
filing of amended state returns.
We have elected to treat our portion of all foreign subsidiary earnings through
June 30, 2012 as permanently reinvested under the relevant accounting guidance
and accordingly have not provided for any U.S. federal or state tax thereon. Our
intention is to reinvest the earnings permanently or to repatriate the earnings
when it is tax effective to do so. It is not practicable to determine the amount
of incremental taxes that might arise were these earnings to be remitted.
However, the amount of cash for all foreign subsidiaries permanently reinvested,
and the amount of incremental taxes that might arise were these earnings to be
remitted, are not material.
Future Minimum Obligations
In the normal course of business, we enter into obligations and commitments that
require future contractual payments. The commitments primarily result from
repayment obligations for borrowings under our revolving credit facility and
Series Debentures as well as contractual lease payments for facility, vehicle,
and equipment leases, deferred taxes and acquisition obligations.
New Accounting Standards
In May 2011, the Financial Accounting Standards Board ("FASB") issued Accounting
Standards Update 2011-04, "Amendments to Achieve Common Fair Value Measurement
and Disclosure Requirements in U.S. GAAP and IFRS," to provide a consistent
definition of fair value and ensure that the fair value measurement and
disclosure requirements are similar between U.S. GAAP and International
Financial Reporting Standards. The guidance expands the disclosure requirements
around fair value measurements categorized in Level 3 of the fair value
hierarchy and requires disclosure of the level in the fair value hierarchy of
items that are not measured at fair value but whose fair value must be
disclosed. It also clarifies and expands upon existing requirements for fair
value measurements of financial assets and liabilities as well as instruments
classified in shareholders' equity. The guidance is effective for interim and
annual financial periods beginning after December 15, 2011 with early adoption
not permitted. The adoption of ASU 2011-04 did not have an impact on our
financial condition, results of operations or cash flows.
33
--------------------------------------------------------------------------------
Table of Contents
In June 2011, the FASB issued Accounting Standards Update 2011-05, "Presentation
of Comprehensive Income," to eliminate the current option to present the
components of other comprehensive income in the statement of changes in equity
and to require presentation of net income and other comprehensive income (and
their respective components) either in a single continuous statement or in two
separate but consecutive statements. The amendments do not alter any current
recognition or measurement requirements in respect of items of other
comprehensive income. The guidance is to be applied retrospectively and is
effective for interim and annual periods beginning after December 15, 2011, with
early adoption permitted. The adoption of ASU 2011-05 did not have an impact on
our financial condition, results of operations or cash flows.
In September 2011, the FASB issued Accounting Standards Update 2011-08, "Testing
Goodwill for Impairment," which allows an initial assessment of qualitative
factors to determine whether it is more likely than not (i.e., there is more
than a 50% likelihood) that the fair value of a reporting unit is less than its
carrying amount for purposes of determining whether it is necessary to perform
the first step of the two-step goodwill impairment test. Accordingly, the
calculation of a reporting unit's fair value is not required unless, as a result
of the qualitative assessment, it is more likely than not that fair value of the
reporting unit is less than its carrying amount. The amendments do not affect
the manner in which the first and second steps of the impairment test are
performed. The guidance is to be applied prospectively and is effective for
annual and interim goodwill impairment tests performed for fiscal years
beginning after December 15, 2011 with early adoption permitted. The adoption of
ASU 2011-08 did not have an impact on our financial condition, results of
operations or cash flows.
In December 2011, the FASB issued Accounting Standards Update 2011-11,
"Disclosures about Offsetting Assets and Liabilities," which requires
disclosures to provide information to help reconcile differences in the
offsetting requirements under U.S. GAAP and IFRS. The guidance applies to
disclosures concerning financial instruments and derivative instruments that are
either (1) offset in the balance sheet, or (2) subject to an enforceable master
netting arrangement. The guidance is to be applied retrospectively and is
effective for interim and annual financial periods beginning on or after
January 1, 2013. We will adopt the new guidance effective January 1, 2013. The
Company does not expect the adoption of this guidance to have an impact on its
financial condition, results of operations or cash flows.
In December 2011, the FASB issued Accounting Standards Update 2011-12, "Deferral
of the Effective Date for the Presentation of Reclassification Adjustments Out
of Accumulated Other Comprehensive Income," which indefinitely defers the
effective date of the provision in ASU No. 2011-05, "Presentation of
Comprehensive Income", pertaining only to the presentation of reclassification
adjustments out of accumulated other comprehensive income ("OCI"), and
reinstates the previous requirements to present reclassification adjustments
either on the face of the statement in which OCI is reported or to disclose them
in a note to the financial statements. The other requirements in ASU No. 2011-05
are not affected by ASU No. 2011-12, including the requirement to report
comprehensive income either in a single continuous statement or in two separate
but consecutive statements. The guidance is to be applied retrospectively and is
effective for interim and annual periods beginning after December 15, 2011, with
early adoption permitted. The adoption of ASU 2011-12 did not have an impact on
our financial condition, results of operations or cash flows.
Forward Looking Statements
Statements in this report concerning future results, performance or expectations
are forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995, as amended. All forward-looking statements
included in this document are based upon information available to us as of the
date hereof and we assume no obligation to update any such forward-looking
statements. These statements involve known and unknown risks, uncertainties and
other factors that may cause our actual results, levels of activity, performance
or achievements to be materially different from any results, levels of activity,
performance or achievements expressed or implied by any forward-looking
statements. In some cases, forward-looking statements that involve risks and
uncertainties contain terminology such as "may," "will," "should," "could,"
"expects," "intends," "plans," "anticipates," "believes," "estimates,"
"predicts," "potential," or "continue" or variations of these terms or other
comparable terminology.
Key factors that have an impact on our ability to attain these estimates include
potential reductions in reimbursement rates by government and other third-party
payors, changes in reimbursement policies, the demand for our products and
services, the availability of appropriate acquisition candidates and our ability
to successfully complete and integrate acquisitions, efficient operations of our
existing and future operating facilities, regulation and/or regulatory action
affecting us or our business, economic and competitive conditions, access to
borrowed and/or equity capital on favorable terms and other risks described
below.
34
--------------------------------------------------------------------------------
Table of Contents
In developing our forward-looking statements, we have made certain assumptions
relating to reimbursement rates and policies, internal growth and acquisitions
and the outcome of various legal and regulatory proceedings. If the assumptions
we use differ materially from what actually occurs, then actual results could
vary significantly from the performance projected in the forward-looking
statements. We are under no duty to update any of the forward-looking statements
after the date of this report.
Risks Related to Our Pending Merger with Parent and Purchaser and the Related
Tender Offer
COMPLETION OF THE OFFER AND THE MERGER ARE SUBJECT TO VARIOUS CONDITIONS, AND
NEITHER THE OFFER NOR THE MERGER MAY OCCUR EVEN IF WE OBTAIN STOCKHOLDER
APPROVAL.
Consummation of the Offer and Merger is subject to customary conditions,
including, in the case of the Merger, adoption of the Merger Agreement by our
stockholders in certain circumstances, the absence of legal restraints and the
receipt of requisite antitrust approval. Each party's obligation to consummate
the Merger is also subject to the accuracy of the representations and warranties
of the other party (subject to certain qualifications and exceptions) and the
performance in all material respects of the other party's covenants under the
Merger Agreement, including, with respect to us, customary covenants regarding
operation of our and our subsidiaries' respective business prior to closing. As
a result of these conditions, we cannot assure you that either the Offer or the
Merger will be completed, even if stockholder approval of the Merger is required
and obtained. If the Merger is not completed for any reason, we expect that we
would continue to be managed by our current management, under the direction of
our board of directors.
THE MERGER PROCESS COULD ADVERSELY AFFECT OUR BUSINESS, SHARE PRICE, REPUTATION
AND RESULTS OF OPERATIONS.
Our efforts to complete the Merger could cause substantial disruptions in our
business, which could have an adverse effect on our financial results. Among
other things, uncertainty as to whether a transaction will be completed with
Parent and Purchaser may affect our ability to recruit prospective employees or
to retain and motivate existing employees. Employee retention may be
particularly challenging while the merger is pending, because employees may
experience uncertainty about their future roles with Parent and Purchaser.
Uncertainty as to our future could adversely affect our business, reputation and
our relationship with customers and potential customers. For example, vendors,
customers and others that deal with us could defer decisions concerning working
with us, or seek to change existing business relationships with us. Further, a
substantial amount of the attention of management and employees is being
directed toward the completion of the Merger and thus is being diverted from our
day-to-day operations because matters related to the Merger (including
integration planning) require substantial commitments of time and resources.
If the proposed Offer and/or Merger is not completed, the share price of our
common stock will likely fall to the extent that the current market price of our
common stock reflects an assumption that a transaction will be completed. In
addition, under circumstances described in the Merger Agreement, we may be
required to pay a termination fee of up to $155,000,000 or Parent's
out-of-pocket expenses related to the Merger (up to a cap of $10,000,000) if the
Merger Agreement is terminated. Further, the failure of the proposed Merger to
be completed may result in negative publicity and/or a negative impression of us
in the investment community and may affect our relationship with employees,
vendors and other partners in the business community.
WHILE THE MERGER AGREEMENT IS IN EFFECT, WE ARE SUBJECT TO RESTRICTIONS ON OUR
BUSINESS ACTIVITIES.
While the Merger Agreement is in effect, we are subject to restrictions on our
business activities and must generally operate our business in the ordinary
course consistent with past practice (subject to certain exceptions). These
restrictions could prevent us from pursuing attractive business opportunities
that arise prior to the completion of the Merger and are generally outside the
ordinary course of business, and otherwise have a material adverse effect on our
future results of operations or financial condition.
35--------------------------------------------------------------------------------
Table of Contents
Certain Risk Factors Relating to the Company's Business
We operate in a rapidly changing environment that involves a number of risks.
The following discussion highlights some of these risks and others are discussed
elsewhere in this report. These and other risks could materially and adversely
affect our business, financial condition, operating results and cash flows.
A MAJORITY OF OUR CUSTOMERS HAVE PRIMARY HEALTH COVERAGE UNDER MEDICARE PART B,
AND RECENTLY ENACTED AND FUTURE CHANGES IN THE REIMBURSEMENT RATES OR PAYMENT
METHODOLOGIES UNDER THE MEDICARE PROGRAM COULD MATERIALLY AND ADVERSELY AFFECT
OUR BUSINESS.
As a provider of oxygen, respiratory and other chronic therapy services for the
home health care market, we have historically depended heavily on Medicare
reimbursement as a result of the high proportion of elderly persons suffering
from respiratory disease. Medicare Part B, the Supplementary Medical Insurance
Program, provides coverage to eligible beneficiaries for DME, such as oxygen
equipment, respiratory assistance devices, continuous positive airway pressure
devices, nebulizers and associated inhalation medications, hospital beds and
wheelchairs for the home setting. Approximately 63% of our customers have
primary coverage under Medicare Part B. There are increasing pressures on
Medicare to control health care costs and to reduce or limit reimbursement rates
for home medical equipment and services. Medicare reimbursement is subject to
statutory and regulatory changes, retroactive rate adjustments, administrative
and executive orders and governmental funding restrictions, all of which could
materially decrease payments to us for the services and equipment we provide.
Recent legislation, including the Patient Protection and Affordable Care Act
("PPACA"), the Medicare Improvements for Patients and Providers Act of 2008
("MIPPA"), the Medicare, Medicaid and SCHIP Extension Act of 2007 ("SCHIP
Extension Act"), the Deficit Reduction Act of 2005 ("DRA") and the Medicare
Prescription Drug, Improvement, and Modernization Act of 2003 ("MMA"), contain
provisions that directly impact reimbursement for the primary respiratory and
other DME products provided by Lincare. PPACA, as amended, is a comprehensive
health care reform law that contains a large number of health-related provisions
to take effect over the next several years, including various cost containment
and program integrity changes that will apply to the home medical equipment
industry. MIPPA delayed the implementation of a Medicare competitive bidding
program for oxygen equipment and certain other DME items that was scheduled to
begin on July 1, 2008 and instituted a 9.5% price reduction nationwide for these
items as of January 1, 2009. The SCHIP Extension Act reduced Medicare
reimbursement amounts for covered Part B drugs, including inhalation drugs that
we provide, beginning April 1, 2008. DRA provisions negatively impacted
reimbursement for oxygen equipment beginning in 2009 through the implementation
of a capped rental arrangement. MMA changed the pricing formulas used to
establish payment rates for inhalation drug therapies resulting in significantly
reduced reimbursement beginning in 2005, established a competitive acquisition
program for DME, established a Recovery Audit Contractors ("RAC") program, which
implemented a new method for recovery of Medicare overpayments by utilizing
private companies operating on a contingent fee basis to identify and recoup
Medicare overpayments, and implemented quality standards and accreditation
requirements for DME suppliers. These legislative provisions, as currently in
effect and when fully implemented, have had and will continue to have a material
adverse effect on our business, financial condition, operating results and cash
flows. See "MEDICARE REIMBURSEMENT" for a full discussion of the PPACA, MIPPA,
SCHIP Extension Act, DRA and MMA provisions.
A SIGNIFICANT PERCENTAGE OF OUR BUSINESS IS DERIVED FROM THE SALE AND RENTAL OF
MEDICARE-COVERED OXYGEN AND DME ITEMS, AND RECENT LEGISLATIVE ACTS IMPOSE
SUBSTANTIAL CHANGES IN THE MEDICARE PAYMENT METHODOLOGIES AND REDUCTIONS IN THE
MEDICARE PAYMENT AMOUNTS FOR THESE ITEMS.
DRA changed the reimbursement methodology for oxygen equipment from continuous
monthly payment for as long as the equipment is in use by a Medicare
beneficiary, which includes payment for oxygen contents, related disposable
supplies and accessories and maintenance of equipment, to a capped rental
arrangement whereby payment for oxygen equipment may not extend over a period of
continuous use of longer than 36 months. Separate payments for oxygen contents
continue to be made for the period of medical need beyond the 36th month.
Additionally, payment for routine
36
--------------------------------------------------------------------------------
Table of Contents
maintenance and service of the oxygen equipment may be made following each
six-month period after the 36-month rental period ends. The oxygen provisions
contained in DRA became effective on January 1, 2006. In the case of
beneficiaries receiving oxygen equipment prior to the effective date, the
36-month period of continuous use began on January 1, 2006. Accordingly, the
first month in which the new payment methodology impacted our net revenues was
January 2009. We anticipate that the new oxygen payment rules will continue to
negatively affect our net revenues on an ongoing basis, as each month additional
customers reach the 36-month capped service period, resulting in up to two or
more years without rental income from these customers. During 2011, we estimate
that our sequential net revenues were reduced as a result of additional
customers reaching the payment cap by approximately $20.2 million when compared
to the prior year period. During the first half of 2012, we estimate that our
net revenues were reduced by approximately $19.7 million compared to the first
half of 2011, attributed to the oxygen rental payment cap.
On July 15, 2008, Congress enacted the MIPPA legislation which reduced Medicare
payment rates nationwide for certain DME items, including oxygen equipment, by
9.5% beginning in 2009. In addition to the 9.5% reduction, CMS subjected the
monthly payment amount for stationary oxygen equipment to additional cuts of
2.3% in 2009, thereby reducing the monthly payment rate from $199.28 in 2008 to
$175.79 in 2009. The monthly payment amount was reduced by 1.5% in 2010, to
$173.17. We estimate that this reduction negatively impacted our annual net
revenues in 2010 by approximately $8.4 million when compared to the prior year
period. The stationary oxygen payment rate for 2011 was increased to $173.31 per
month, an increase of 0.1%, and was not material to the Company's operating
results in 2011. The stationary oxygen payment rate for 2012 has been
established by CMS at $176.06 per month, an increase of 1.6%. We estimate that
this increase will favorably impact our revenues in 2012 by approximately $10.0
million.
A SIGNIFICANT PERCENTAGE OF OUR BUSINESS IS DERIVED FROM THE SALE OF
MEDICARE-COVERED RESPIRATORY MEDICATIONS, AND RECENT LEGISLATION AND MEDICARE
POLICY REVISIONS IMPOSED SIGNIFICANT REDUCTIONS IN MEDICARE REIMBURSEMENT FOR
SUCH INHALATION DRUGS.
Recently enacted legislation negatively affected Medicare reimbursement amounts
for covered Part B drugs, including inhalation drugs that we provide, beginning
April 1, 2008 (See "MEDICARE REIMBURSEMENT"). The SCHIP Extension Act required
CMS to adjust the average sales price ("ASP") calculation methodology used to
determine Medicare payment amounts for inhalation drugs by using volume-weighted
ASPs based on actual sales volume rather than average sales price. CMS publishes
payment rates for inhalation drugs each calendar quarter, representing the unit
reimbursement rates in effect for inhalation drugs dispensed within that
quarter. These payment rates may be subject to volatility as a result of the
underlying ASP data used to determine the rates in effect each quarter. The
quarterly ASP data published by CMS for inhalation drugs provided in 2010 and
2011 resulted in reductions in the Medicare payment rates for inhalation drugs
that negatively impacted the Company's annual net revenues by approximately $5.0
million and $14.8 million, respectively. Based upon the ASP payment rates
published by CMS for the first three quarters of 2012, and assuming no changes
in the volume or mix of drugs that we currently dispense, we estimate that our
annual net revenues will be favorably impacted by approximately $11.7 million in
2012 when compared with 2011. We can not determine whether quarterly updates in
ASP pricing data will result in future reductions in payment rates for
inhalation drugs, or what impact such payment reductions could have on our
business in the future.
Additionally, since 2011, CMS is using 103% of Average Manufacturer Price
("AMP") rather than 106% of ASP for a drug when ASP exceeds AMP by 5% for either
two straight quarters or three of the past four quarters. The policy limits
substitution of the price formula in a given quarter to only those drugs where
ASP and AMP can be compared using the same set of national drug codes. We can
not determine at this time which, if any, inhalation drugs might meet the
criteria established for substitution in a particular future quarter, nor the
impact on payment rates for such drugs in the event that the AMP formula is
utilized.
FEDERAL REGULATORY CHANGES SUBJECT THE MEDICARE REIMBURSEMENT RATES FOR OUR
EQUIPMENT AND SERVICES TO ADDITIONAL REDUCTIONS AND TO POTENTIAL DISCRETIONARY
ADJUSTMENT BY CMS, WHICH COULD REDUCE OUR REVENUES, NET INCOME AND CASH FLOWS.
In February 2006, a final rule governing CMS' Inherent Reasonableness, or IR,
authority became effective. The IR rule establishes a process for adjusting fee
schedule amounts for Medicare Part B services when existing payment amounts are
determined to be either grossly excessive or deficient. The rule describes the
factors that CMS or its contractors will consider in making such determinations
and the procedures that will be followed in establishing new payment amounts. To
date, no payment adjustments have occurred or have been proposed as a result of
the IR rule.
37
--------------------------------------------------------------------------------
Table of Contents
The effectiveness of the IR rule itself did not trigger payment adjustments for
any items or services. Nevertheless, the IR rule puts in place a process that
could eventually have a significant impact on Medicare payments for our
equipment and services. We can not predict whether or when CMS will exercise its
IR authority with respect to payment for our equipment and services, or the
effect that such payment adjustments would have on our financial position or
operating results.
FUTURE IMPLEMENTATION OF A COMPETITIVE BIDDING PROCESS UNDER MEDICARE COULD
REDUCE OUR REVENUES, NET INCOME AND CASH FLOWS.
CMS is required by law to establish and implement programs under which
competitive acquisition areas will be established throughout the United States
for purposes of awarding contracts for the furnishing of competitively priced
items of DME, including oxygen equipment (See "MEDICARE REIMBURSEMENT"). The
program was initially intended to be implemented in phases such that competition
under the program would occur in nine of the largest MSAs in the first year, and
an additional 70 of the largest MSAs in a second, subsequent round of bidding.
The PPACA legislation expands the DME competitive bidding program from 79
markets under prior law to 100 markets. PPACA also adds a requirement to
competitively bid all areas or use competitive bid information to set prices in
all areas by 2016, effectively expanding the program to all geographic markets.
For each competitive acquisition area, CMS is required to conduct a competition
under which providers submit bids to supply certain covered items of DME.
Successful bidders are expected to meet certain program quality standards in
order to be awarded a contract and only successful bidders can supply the
covered items to Medicare beneficiaries in the acquisition area (there are,
however, regulations in place that allow non-contracted providers to continue to
provide equipment and services to their existing customers at the new prices
determined through the bidding process). The contracts are expected to be re-bid
at least every three years. CMS is required to award contracts to multiple
entities submitting bids in each area for an item or service, but has the
authority to limit the number of contractors in a competitive acquisition area
to the number it determines to be necessary to meet projected demand.
CMS concluded the bidding process for the first round of MSAs in September 2007,
however, in July 2008, Congress enacted the MIPPA legislation which
retroactively delayed the implementation of competitive bidding and reduced
Medicare prices nationwide by 9.5% beginning in 2009 for the product categories,
including oxygen, that were initially included in competitive bidding.
In 2009, CMS reinstituted the bidding process in the nine largest MSA markets.
Reimbursement rates from the re-bidding process were publicly released by CMS on
June 30, 2010. CMS announced average savings of approximately 32% off the
current payment rates in effect for the product categories included in
competitive bidding. As of January 1, 2011, these payment rates were in effect
in the nine markets only. We were offered contracts to provide oxygen equipment
in just two of the nine markets, Charlotte and Miami, and we accepted and signed
those contracts. The Company's annual Medicare revenues from the product
categories in the nine markets affected by competitive bidding were
approximately $48.0 million at the time the program commenced. During 2011, we
completed acquisitions of companies that were contracted to provide home oxygen
equipment and positive airway pressure devices in all nine competitive bidding
markets.
CMS is currently undertaking a second round of competitive bidding in up to 91
additional markets, with contracts expected to be effective in July 2013. The
bid submission period closed on March 30, 2012, and CMS is expected to announce
final pricing results in November 2012. The Company's Medicare revenues from the
product categories in the 91 additional markets to be included in the second
round of competitive bidding were approximately $267.0 million in 2011. The
PPACA legislation requires CMS to expand competitive bidding further to
additional geographic markets (certain markets may be excluded at the discretion
of CMS) or to use competitive bid pricing information to adjust the payment
amounts otherwise in effect for areas that are not competitive acquisition areas
by January 1, 2016.
We will continue to monitor developments regarding the implementation of the
competitive bidding program. While we can not predict the outcome of the
competitive bidding program on our business when fully implemented nor the
Medicare payment rates that will be in effect in future years for the items
subjected to competitive bidding it is likely that the program will materially
adversely effect our future financial position and operating results.
FUTURE REDUCTIONS IN REIMBURSEMENT RATES UNDER MEDICAID COULD REDUCE OUR
REVENUES, NET INCOME AND CASH FLOWS.
Due to budgetary shortfalls, many states are considering, or have enacted, cuts
to their Medicaid programs, including funding for our equipment and services.
These cuts have included, or may include, elimination or reduction of
38
--------------------------------------------------------------------------------
Table of Contents
coverage for some or all of our equipment and services, amounts eligible for
payment under co-insurance arrangements, or payment rates for covered items.
Approximately 7% of our customers are eligible for primary Medicaid benefits,
and State Medicaid programs fund approximately 12% of our payments from primary
and secondary insurance benefits. Continued state budgetary pressures could lead
to further reductions in funding for the reimbursement for our equipment and
services which, in turn, could have a material adverse effect on our financial
position and operating results.
FUTURE REDUCTIONS IN REIMBURSEMENT RATES FROM PRIVATE PAYORS COULD HAVE A
MATERIAL ADVERSE EFFECT ON OUR FINANCIAL CONDITION AND OPERATING RESULTS.
Payors such as private insurance companies and employers are under pressure to
increase profitability and reduce costs. In response, certain payors are
limiting coverage or reducing reimbursement rates for the equipment and services
we provide. Approximately 28% of our customers and approximately 32% of our
primary and secondary payments are derived from private payors. Continued
financial pressures on these entities could lead to further reimbursement
reductions for our equipment and services that could have a material adverse
effect on our financial condition and operating results.
WE DEPEND UPON REIMBURSEMENT FROM THIRD-PARTY PAYORS FOR A SIGNIFICANT MAJORITY
OF OUR REVENUES, AND IF WE FAIL TO MANAGE THE COMPLEX AND LENGTHY REIMBURSEMENT
PROCESS, OUR BUSINESS AND OPERATING RESULTS COULD SUFFER.
We derive a significant majority of our revenues from reimbursement by
third-party payors. We accept assignment of insurance benefits from customers
and, in most instances, invoice and collect payments directly from Medicare,
Medicaid and private insurance carriers, as well as from customers under
co-payment provisions. Approximately 49% of our revenues are derived from
Medicare, 32% from private insurance carriers, 12% from Medicaid and the balance
directly from individual customers and commercial entities.
Our financial condition and results of operations may be affected by the
reimbursement process, which in the health care industry is complex and can
involve lengthy delays between the time that services are rendered and the time
that the reimbursement amounts are settled. Depending on the payor, we may be
required to obtain certain payor-specific documentation from physicians and
other health care providers before submitting claims for reimbursement. Certain
payors have filing deadlines and they will not pay claims submitted after such
time. We are also subject to extensive pre-payment and post-payment audits by
governmental and private payors that could result in material refunds of monies
received or denials of claims submitted for payment under such third-party payor
programs and contracts. We can not ensure that we will be able to continue to
effectively manage the reimbursement process and collect payments for our
equipment and services promptly.
WE ARE SUBJECT TO EXTENSIVE FEDERAL, STATE AND CANADIAN REGULATION, AND IF WE
FAIL TO COMPLY WITH APPLICABLE REGULATIONS, WE COULD SUFFER SEVERE CRIMINAL OR
CIVIL SANCTIONS OR BE REQUIRED TO MAKE SIGNIFICANT CHANGES TO OUR OPERATIONS
THAT COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS AND RESULTS OF
OPERATIONS.
The federal governments of the United States and Canada and all states and
provinces in which we currently operate regulate various aspects of our
business. In particular, our operating centers are subject to federal laws that
regulate the repackaging of drugs (including oxygen) and interstate
motor-carrier transportation. Our operations also are subject to state and
provincial laws, where applicable, governing, among other things, pharmacies,
nursing services, distribution of medical equipment and certain types of home
health activities. Certain of our employees are subject to state laws and
regulations governing the ethics and professional practices of respiratory
therapy, pharmacy and nursing.
As a health care provider in the United States, we are subject to extensive
government regulation, including numerous laws directed at preventing fraud and
abuse and laws regulating reimbursement under various government programs. In
Canada, we are subject to numerous similar and other laws and regulations
including anti-corruption laws and regulations. The marketing, billing,
documenting and other practices of health care companies are all subject to
government scrutiny. To ensure compliance with Medicare, Medicaid and other
regulations, regional health insurance carriers and state agencies often conduct
audits and request customer records and other documents to support our claims
submitted for payment of services rendered to customers. Similarly, government
agencies periodically open investigations and obtain information from health
care providers pursuant to the legal process. Violations of federal and state
regulations can result in severe criminal, civil and administrative penalties
and sanctions, including disqualification from Medicare and other reimbursement
programs, which could have a material adverse effect on our business.
Health care is an area of rapid regulatory change. Changes in the laws and
regulations and new interpretations of existing laws and regulations may affect
permissible activities, the relative costs associated with doing business, and
39
--------------------------------------------------------------------------------
Table of Contents
reimbursement amounts paid by federal, state, provincial and other third-party
payors. We can not predict the future of federal, state and local regulation or
legislation, including Medicare and Medicaid statutes and regulations, or
possible changes in national health care policies. Future legislation and
regulatory changes could have a material adverse effect on our business.
WE ARE SUBJECT TO BURDENSOME AND COMPLEX BILLING AND RECORD-KEEPING REQUIREMENTS
IN ORDER TO SUBSTANTIATE OUR CLAIMS FOR PAYMENT UNDER FEDERAL, STATE AND
COMMERCIAL HEALTH CARE REIMBURSEMENT PROGRAMS, AND OUR FAILURE TO COMPLY WITH
EXISTING REQUIREMENTS, OR CHANGES IN THOSE REQUIREMENTS OR INTERPRETATIONS
THEREOF, COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS AND RESULTS OF
OPERATIONS.
We are subject to many comprehensive and frequently changing laws and
regulations, and interpretations thereof, at both the federal and state levels,
requiring compliance with burdensome and complex billing and record-keeping
requirements in order to substantiate our claims for payment under federal,
state and commercial health care reimbursement programs. On an ongoing basis, we
have implemented policies and procedures designed to meet the various
documentation requirements of government payors as they have been interpreted
and applied. Examples of such documentation requirements are contained in the
Durable Medical Equipment Medicare Administrative Contractor ("DME MAC")
Supplier Manuals which provide that clinical information from the "patient's
medical record" is required to justify the medical necessity for the provision
of DME. Auditors working on behalf of the DME MACs have recently taken the
position, among other things, that the "patient's medical record" refers not to
documentation maintained by the DME supplier but instead to documentation
maintained by the patient's physician, health care facility, or other clinician,
and that clinical information created by the DME supplier's personnel and
confirmed by the patient's physician is not sufficient to establish medical
necessity. Other government auditors have recently taken the same or a similar
position. It may be difficult, and sometimes impossible, for us to obtain such
documentation from other health care providers. If these or other burdensome
positions continue to be adopted by auditors, DME MACs, other contractors or CMS
in administering the Medicare program, we have the right to challenge these
positions as being contrary to law. If these interpretations of the
documentation requirements are ultimately upheld, however, it could result in
our making significant refunds and other payments to Medicare and our future
revenues from Medicare would likely be substantially reduced. We have also
experienced a significant increase in pre-payment reviews of our claims by the
DME MACs, which has caused substantial delays in the collection of our Medicare
accounts receivable as well as related amounts due under supplemental insurance
plans. We estimate that accounts receivable subject to Medicare pre-payment
review were approximately $59.9 million as of June 30, 2012. We can not
currently predict the adverse impact that these new, more burdensome
interpretations of the Medicare documentation requirements might have on our
financial position or operating results, but such impact could be material.
EXPANDED GOVERNMENT AUDITING AND OVERSIGHT OF MEDICARE AND MEDICAID SUPPLIERS
AND MORE STRINGENT INTERPRETATIONS BY THOSE AUDITORS OF REGULATIONS AND RULES
CONCERNING BILLING FOR OUR PRODUCTS AND SERVICES COULD HAVE A MATERIAL ADVERSE
EFFECT ON OUR BUSINESS AND RESULTS OF OPERATIONS.
Current law provides for a significant expansion of the government's auditing
and oversight of suppliers who care for patients covered by various government
health care programs. Examples of this expansion include audit programs being
implemented by the DME MAC contractors, the Zone Program Integrity Contractors
("ZPICs"), the Recovery Audit Contractors ("RACs") and the Comprehensive Error
Rate Testing contractors ("CERTs") operating under the direction of CMS. We work
cooperatively with these auditors and have long maintained a process for
centrally tracking and managing our responses to their audit requests. However,
unlike other government programs that are subject to a formal rulemaking
process, there are only limited publicly-available guidelines and methodologies
for determining errors or for providing clear and timely communications to DME
suppliers in connection with these new types of audits. As a result, there is
significant lack of clarity regarding the authority of the auditors, their
expectations for document production requested during audits and the
methodologies for issuing claim denials, determining billing errors and
calculating billing error rates.
Along with other health care providers and suppliers, we have recently been
subject to a significant increase in the number of pre-payment audits conducted
under these new programs. Many of these audits have resulted in claim denial
rates at our audited locations that are significantly higher than we, and others
in the industry, have experienced in the past. In some cases, these high claim
denial rates appear to be based on the auditors' incomplete or erroneous review
of our submitted documentation or unclear scoring methodologies used by the
auditors. In other instances, high claim denial rates have resulted from the
auditors' use of inconsistent interpretations of the types of medical necessity
documentation required for CMS to pay for the services we provide. We are
appealing the results of these recent audits and making
40
--------------------------------------------------------------------------------
Table of Contents
changes to our operating policies and procedures. We can not predict the adverse
impact that the government's expanded auditing activities may have on our
business, financial condition or results of operations, but such impact could be
material.
We have been informed by these auditors that health care providers and suppliers
of certain DME product categories are expected to experience further increased
scrutiny from these audit programs. When a government auditor ascribes a high
billing error rate to one or more of our locations, it generally results in
protracted pre-payment claims review, payment delays, refunds and other payments
to the government and/or our need to request more documentation from referral
sources than has historically been required. It may also result in additional
audit activity in other company locations in that state or DME MAC jurisdiction.
We can not currently predict the adverse impact that these new audits,
methodologies and interpretations might have on our operations, cash flow and
capital resources, but such impact could be material.
COMPLIANCE WITH REGULATIONS UNDER THE FEDERAL HEALTH INSURANCE PORTABILITY AND
ACCOUNTABILITY ACT OF 1996 ("HIPAA"), THE HEALTH INFORMATION TECHNOLOGY FOR
ECONOMIC AND CLINICAL HEALTH ACT ("HITECH ACT"), RELATED RULES, RELATING TO THE
TRANSMISSION, SECURITY AND PRIVACY OF HEALTH INFORMATION AND SIMILAR CANADIAN
REGULATIONS COULD IMPOSE ADDITIONAL SIGNIFICANT COSTS ON OUR OPERATIONS.
Numerous federal, state and provincial laws and regulations, including HIPAA and
the HITECH Act, govern the collection, dissemination, security, use and
confidentiality of patient-identifiable health information. HIPAA and the HITECH
Act require us to comply with standards for the use and disclosure of health
information within our company and with third parties. HIPAA and the HITECH Act
also include standards for common health care electronic transactions and code
sets, such as claims information, plan eligibility, payment information and the
use of electronic signatures, and privacy and electronic security of
individually identifiable health information. HIPAA requires health care
providers, including us, in addition to health plans and clearinghouses, to
develop and maintain policies and procedures with respect to protected health
information that is used or disclosed. The HITECH Act expands the notification
requirement for breaches of patient-identifiable health information, restricts
certain disclosures and sales of patient-identifiable health information and
provides a tiered system for civil monetary penalties for HIPAA violations.
If we do not comply with existing or new laws and regulations related to patient
health information in the United States and Canada, we could be subject to
criminal or civil sanctions. New health information standards, whether
implemented pursuant to HIPAA, the HITECH Act, congressional action or
otherwise, could have a significant effect on the manner in which we handle
health care related data and communicate with payors, and the cost of complying
with these standards could be significant.
WE MAY UNDERTAKE ACQUISITIONS THAT COULD SUBJECT US TO UNANTICIPATED LIABILITIES
AND THAT COULD FAIL TO ACHIEVE EXPECTED BENEFITS.
Our strategy is to increase our market share through internal growth and
strategic acquisitions. Consideration for the acquisitions has generally
consisted of cash, unsecured non-interest bearing obligations and the assumption
of certain liabilities.
The implementation of an acquisition strategy entails certain risks, including
inaccurate assessment of disclosed liabilities, the existence of undisclosed
liabilities, regulatory compliance issues associated with the acquired business,
entry into markets in which we may have limited or no experience, diversion of
management's attention and human resources from our underlying business,
difficulties in integrating the operations of an acquired business or in
realizing anticipated efficiencies and cost savings, failure to retain key
management or operating personnel of the acquired business, and an increase in
indebtedness and a limitation in the ability to access additional capital on
favorable terms. The successful integration of an acquired business may be
dependent on the size of the acquired business, condition of the customer
billing records, and complexity of system conversions and execution of the
integration plan by local management. If we do not successfully integrate the
acquired business, the acquisition could fail to achieve its expected revenue
contribution or there could be delays in the billing and collection of claims
for services rendered to customers, which may have a material adverse effect on
our financial position and operating results.
WE FACE INTENSE NATIONAL, REGIONAL AND LOCAL COMPETITION AND IF WE ARE UNABLE TO
COMPETE SUCCESSFULLY, WE WILL LOSE REVENUES AND OUR BUSINESS WILL SUFFER.
The home respiratory market is a fragmented and highly competitive industry. We
compete against other national providers and, by our estimate, more than 2,000
local and regional providers. Home respiratory companies compete primarily on
the basis of service rather than price since reimbursement levels are
established by Medicare and Medicaid or by the individual determinations of
private health plans.
41
--------------------------------------------------------------------------------
Table of Contents
Our ability to compete successfully and to increase our referrals of new
customers is highly dependent upon our reputation within each local health care
market for providing responsive, professional and high-quality service and
achieving strong customer satisfaction. Given the relatively low barriers to
entry in the home respiratory market, we expect that the industry will become
increasingly competitive in the future. Increased competition in the future
could limit our ability to attract and retain key operating personnel and
achieve continued growth in our core business.
INCREASES IN OUR COSTS COULD ERODE OUR PROFIT MARGINS AND SUBSTANTIALLY REDUCE
OUR NET INCOME AND CASH FLOWS.
Cost containment in the health care industry, fueled, in part, by federal and
state government budgetary shortfalls, is likely to result in constant or
decreasing reimbursement amounts for our equipment and services. As a result, we
must control our operating cost levels, particularly labor and related costs,
which account for a significant component of our operating costs and
expenditures. We compete with other health care providers to attract and retain
qualified or skilled personnel. We also compete with various industries for
administrative and service employees. Since reimbursement rates are established
by fee schedules mandated by Medicare, Medicaid and private payors, we are not
able to offset the effects of general inflation in labor and related cost
components, if any, through increases in prices for our equipment and services.
Consequently, such cost increases could erode our profit margins and reduce our
net income.
IF THE COVERAGE LIMITS ON OUR INSURANCE POLICIES ARE INADEQUATE TO COVER OUR
LIABILITIES OR OUR INSURANCE COSTS CONTINUE TO INCREASE, THEN OUR FINANCIAL
CONDITION AND RESULTS OF OPERATIONS WOULD LIKELY DECLINE.
Participants in the health care industry, including the Company, are subject to
substantial claims and litigation in the ordinary course, often involving large
claims and significant defense costs. As a result of the liability risks
inherent in our lines of business we maintain liability insurance intended to
cover such claims. Our insurance policies are subject to annual renewal. The
coverage limits of our insurance policies may not be adequate, and we may not be
able to obtain liability insurance in the future on acceptable terms or at all.
In addition, our insurance premiums could be subject to increases in the future,
which increases may be material. If the coverage limits are inadequate to cover
our liabilities or our insurance costs continue to increase, then our financial
condition and results of operations would likely decline.
