THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH OUR ANNUAL REPORT ON
FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2011, INCLUDING THE FINANCIAL
STATEMENTS AND NOTES THERETO, AS WELL AS THE FINANCIAL STATEMENTS AND NOTES THAT
APPEAR ELSEWHERE IN THIS REPORT.
GENERAL
Unless otherwise indicated or the context otherwise requires, all references in
this Form 10-Q to "we," "us," "our," "Metropolitan" or the "Company" refer to
Metropolitan Health Networks, Inc. and its consolidated subsidiaries.
CAUTIONARY NOTE REGARDING FORWARD LOOKING STATEMENTS
Sections of this Quarterly Report contain statements that are "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended,
including, without limitation, statements with respect to anticipated future
operations and financial performance, growth and acquisition opportunities and
other similar forecasts and statements of expectation. We intend such statements
to be covered by the safe harbor provisions for forward-looking statements
created thereby. These statements involve known and unknown risks and
uncertainties, such as our plans, objectives, expectations and intentions, and
other factors that may cause our or our industry's actual results, levels of
activity, performance or achievements to be materially different from any future
results, levels of activity, performance or achievements expressed or implied by
the forward-looking statements. In some cases, you can identify forward-looking
statements by statements that include the words "estimate," "project,"
"anticipate," "expect," "intend," "may," "should," "believe," "seek" or other
similar expressions.
Specifically, this report contains forward-looking statements, including
statements regarding the following topics:
? the ability of our provider services network ("PSN"), acting through our
contracting subsidiaries, to renew its agreements with the health plans
operated by Humana, Inc. and its subsidiaries ("Humana"), United Healthcare
of Florida, Inc. ("United"), Vista Healthplan of South Florida, Inc. and
its affiliated companies, a subsidiary of Coventry Health Care, Inc.
("Coventry"), and Wellcare Health Plans, Inc. and its affiliated companies
("Wellcare," and, together with Humana, United and Coventry, the
"Contracting HMOs") that have renewable one-year terms, and to maintain all
of its agreements with Contracting HMOs on favorable terms;
? our ability to increase the number of customers assigned to us by the
Contracting HMOs ("Participating Customers") using our PSN, either within
our current geographic markets or in additional markets, and our ability to
realize the benefits of any such increases, including the anticipated
benefits of economies of scale;
? our ability to amend one of our existing agreements with a Contracting HMO
in order to reduce the likelihood that we will incur additional losses
under such agreement in the future;
? the anticipated benefits of our acquisition of Continucare Corporation
("Continucare");
? our intention to sell the sleep diagnostic business that we acquired in the
Continucare acquisition, and the expected timing and proceeds of such sale;
? the factors that we believe may mitigate the impact of anticipated premium
reductions;
? our ability to make, and the expected timing of, payments on our senior
secured first lien credit agreement (the "First Lien Credit Agreement") and
our senior secured second lien credit agreement (the "Second Lien Credit
Agreement" and, together with the First Lien Credit Agreement, the "Credit
Facilities");
? our ability to adequately predict and control medical expense and to make
reasonable estimates and maintain adequate accruals for estimated medical
claims expense payable; and
? our ability to make reasonable estimates of Medicare retroactive capitation
fee adjustments.
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The forward-looking statements reflect our current view about future events and
are subject to risks, uncertainties and assumptions. We wish to caution readers
that certain important factors may have affected and could in the future affect
our actual results and could cause actual results to differ significantly from
those expressed in any forward-looking statement. The following important
factors could prevent us from achieving our goals and cause the assumptions
underlying the forward-looking statements and the actual results to differ
materially from those expressed in or implied by those forward-looking
statements:
? our ability to integrate the operations of Continucare or other entities,
if any, that we may acquire in the future, and to realize any anticipated
revenues, economies of scale, cost synergies or productivity gains in
connection with our acquisition of Continucare and any other entity, if
any, that we may acquire in the future, including the potential for
unanticipated issues, expenses and liabilities associated with those acquisitions and the risk that Continucare or such other acquired entity,
if any, fails to meet its expected financial and operating targets;
? the potential for diversion of management time and resources in seeking to
integrate Continucare's operations;
? our potential failure to retain key employees of Continucare;
? the impact of our significantly increased levels of indebtedness entered
into in connection with the acquisition of Continucare on our funding
costs, operating flexibility and ability to fund ongoing operations with
additional borrowings, particularly in light of ongoing volatility in the
credit and capital markets;
? the potential for dilution to our shareholders as a result of our
acquisition of Continucare;
? our ability to operate pursuant to the terms of our Credit Facilities and
to meet all financial covenants;
? reductions in premium payments to Medicare Advantage plans;
? the loss of, or a material negative amendment, to any of our significant
contracts;
? disruptions in the PSN's or any Contracting HMO's healthcare provider
network;
? failure to receive accurate and timely revenue, claim, membership and other
information from the Contracting HMOs;
? our ability to sell the sleep diagnostic business;
? future legislation and changes in governmental regulations;
? increased operating costs;
? reductions in government funding of the Medicare program and changes in the
political environment that may affect public policy and have an adverse
impact on the demand for our services;
? the impact of Medicare Risk Adjustments on payments we receive from
Contracting HMOs;
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? the impact of the Medicare prescription drug plan on our operations;
? general economic and business conditions;
? increased competition;
? the relative health of our Participating Customers;
? changes in estimates and judgments associated with our critical accounting
policies;
? federal and state investigations;
? our ability to successfully recruit and retain key management personnel and
qualified medical professionals; and
? impairment charges that could be required in future periods.
Additional information concerning these and other risks and uncertainties is
contained in our filings with the United States Securities and Exchange
Commission (the "Commission"), including the section entitled "Risk Factors" in
our Annual Report on Form 10-K for the year ended December 31, 2011 and in our
Quarterly Report on Form 10-Q for the quarter ended March 31, 2012.
Forward-looking statements should not be relied upon as a prediction of actual
results. Subject to any continuing obligations under applicable law or any
relevant listing rules, we expressly disclaim any obligation to disseminate,
after the date of this Quarterly Report on Form 10-Q, any updates or revisions
to any such forward-looking statements to reflect any change in expectations or
events, conditions or circumstances on which any such statements are based.
We undertake no obligation to publicly update or revise any forward-looking
statements to reflect events or circumstances that may arise after the date of
this report unless otherwise required by law.
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BACKGROUND
Our primary business is the operation of a PSN through our wholly owned
subsidiaries, Metcare of Florida, Inc. and Continucare, the latter of which we
acquired on October 4, 2011. The PSN provides and arranges for the provision of
healthcare services to Medicare Advantage, Medicaid and commercially insured
customers in the State of Florida. At June 30, 2012, we operated the PSN through
our 33 wholly-owned primary care practices, a wholly-owned oncology practice,
and contracts with independent physician affiliates (each an "IPA"). As of June
30, 2012, the PSN operated in 20 Florida counties, including the counties in
which the cities of Miami, Ft. Lauderdale, West Palm Beach, Tampa, Daytona and
Pensacola are located.
Humana Agreements
Pursuant to our agreements with Humana (the "Humana Agreements"), at June 30,
2012, the PSN provided or arranged for the provision of healthcare services to
Medicare Advantage, Medicaid and commercial customers in 20 Florida counties and
has contract rights to expand its service offerings to an additional 12 Florida
counties. Our PSN assumes full financial responsibility for the provision or
management of all necessary medical care for each Participating Customer covered
by the Humana Agreements (each a "Humana Participating Customer"), even for
services we do not provide directly. For approximately 25,000 Humana
Participating Customers, our PSN and Humana share in the cost of inpatient
hospital services and the PSN is responsible for the full cost of all other
medical care provided to the Humana Participating Customers. For the remaining
Humana Participating Customers, our PSN is responsible for the cost of all
medical care provided, including the cost of inpatient hospital services. In
return for the provision of these medical services, our PSN receives from Humana
a capitation fee for each Humana Participating Customer established pursuant to
the Humana Agreements. The amount we receive from Humana represents a
substantial percentage of the monthly premiums received by Humana from the
Centers for Medicare and Medicaid Services ("CMS") or the State of Florida with
respect to Humana Participating Customers.
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The Humana Agreements covering a majority of the Humana Participating Customers
have one-year terms, subject to automatic renewal unless either party provides
the other party notice of non-renewal 90, 120 or 180 days prior to the end of
the subject agreement's term (as applicable). The remaining Humana Agreements
have terms that extend to between August 31, 2013 and July 31, 2014, subject to
automatic renewal for additional terms of one to three years, unless either
party provides the other party notice of non-renewal 90 or 120 days prior to the
end of the subject agreement's term (as applicable).
Under several of our PSN's Humana Agreements, Humana may amend the benefit and
risk obligations and compensation rights from time to time by providing the PSN
30 days' prior written notice of the proposed amendment. Thereafter, the PSN
will generally have 30 days to object to or be deemed to have accepted the
proposed amendment. Upon receipt of such an objection, Humana may terminate the
subject agreement upon 90 days' notice. In the 13 years that we have been
working with Humana, after Humana and we have agreed upon the terms pursuant to
which we will provide services for an upcoming year, Humana has only
occasionally requested contract amendments and has never requested a contract
amendment that has materially, negatively impacted our benefit obligations, risk
obligations or compensation rights.
Humana may immediately terminate a Humana Agreement and/or the services of any
individual physician in our primary care physician network if: (i) the PSN's or
such physician's continued participation may adversely affect the health, safety
or welfare of any Humana customer or bring Humana into disrepute; (ii) Humana
loses its authority to do business in total or as to any limited segment or
business provided that, in the event of a loss of authority with respect to a
limited segment, Humana may only terminate a Humana Agreement as to that
segment; (iii) the PSN or such physician violates certain provisions of Humana's
policies and procedures manual; and (iv) under certain of the Humana Agreements,
the PSN or any of its physicians fails to meet Humana's credentialing or
re-credentialing criteria or is excluded from participation in any federal
healthcare program.
In addition to the foregoing termination provisions, each of the Humana
Agreements permits the PSN or Humana to terminate any such agreement upon 60 to
90 days prior written notice (subject to certain cure periods) in the event the
other party breaches other provisions of the agreement.
Under most of the Humana Agreements, our subsidiary that is party to such
agreement and its affiliated providers are generally prohibited, during the term
of the applicable agreement plus one year, from: (i) engaging in any activities
that are in competition with Humana's health insurance, HMO or benefit plans
business; (ii) having a direct or indirect interest in any provider sponsored
organization or network that administers, develops, implements or sells
government sponsored health insurance or benefit plans; (iii) contracting or
affiliating with another licensed managed care organization for the purpose of
offering and sponsoring HMO, preferred provider organization ("PPO") or point of
service ("POS") products where such subsidiary and/or its affiliated providers
obtain an ownership interest in the HMO, PPO or POS products to be marketed; and
(iv) under certain provisions of the Humana Agreements, entering into agreements
with managed care entities, insurance companies, or provider sponsored networks
for the provision of healthcare services to Medicare HMO, POS and/or replacement
Participating Customers at the same office sites or within five miles of the
office sites where services are provided to the Humana Plan Customers.
In addition, under the Humana Agreements covering a majority of the areas we
serve, or are eligible to serve, our subsidiary that is party to any such
agreement and/or its participating physicians and affiliated entities (including
us) are prohibited from entering into a risk contract with any non-Humana
Medicare Advantage HMO or provider sponsored organization in the counties
subject to the agreement. These restrictions lapse between January 1, 2013 and
January 1, 2015, as applicable, and are not applicable to certain previously
established contracts our subsidiaries have with non-Humana HMOs with respect to
a number of designated counties.
In addition, under each of our Humana Agreements, our subsidiary that is party
to any such agreement and/or its participating physicians and affiliated
entities (including us) are prohibited from causing groups of Medicare
Participating Customers assigned to an individual physician to disenroll from a
Humana plan and to enroll in a competing HMO plan.
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Agreements With Other HMOs
As of June 30, 2012, the PSN also had agreements to provide or arrange for the
provision of medical services to Participating Customers of other Medicare
Advantage plans including those offered by United, Coventry and Wellcare. The
majority of such services are provided on a risk basis pursuant to which our PSN
receives a capitated fee with respect to each of these Participating Customers.
Our agreements with United, Coventry and Wellcare have one-year terms expiring
between December 31, 2012 and June 30, 2013, subject to automatic renewal for an
additional one-year term each unless either party provides the other with 60, 90
or 120 days' notice of its intent to terminate such agreement, as
applicable. These agreements are generally subject to the same type of
amendment, termination, non-solicitation and/or non-competition provisions as
those included in the Humana Agreements.
Our Physician Network
At June 30, 2012, the 33 primary care practices owned and operated by the PSN
were responsible for providing and arranging for medical care to 51.8% of the
PSN's Participating Customers under risk agreements.
The PSN contracts with IPAs to provide and manage care for our remaining
Participating Customers. Some of these contracts provide for payment to the
provider of a fixed per customer per month ("PCPM") amount and require the
provider to provide all the necessary primary care medical services to
Participating Customers. The monthly amount is negotiated and is subject to
change based on certain quality of service metrics. Other contracts provide for
payments on a fee-for-service basis, pursuant to which the provider is paid only
for the services provided.
Appropriate Risk Coding
We strive to ensure that our Participating Customers are assigned the proper
risk scores. Our processes include ongoing training of medical staff responsible
for coding and routine auditing of Participating Customers' charts to assure
risk-coding compliance. Participating Customers with higher risk codes generally
require more healthcare resources than those with lower risk codes. Proper
coding helps to ensure that we receive capitation fees consistent with the cost
of treating these Participating Customers. Our efforts related to coding
compliance are ongoing and we continue to dedicate considerable resources to
this important discipline.
Insurance Arrangements
To mitigate our exposure to high cost medical claims under our risk agreements,
we have reinsurance arrangements that provide for the reimbursement of certain
customer medical expenses. At June 30, 2012, for 58.2% of our Participating
Customers under risk agreements, we purchase reinsurance through the HMOs with
which we contract. The HMOs charge us a per customer per month fee that limits
our healthcare costs for any individual Participating Customer. Healthcare costs
in excess of an annual deductible, which generally ranges from $30,000 to
$40,000 per Participating Customer, are paid directly by the HMOs and we are not
entitled to and do not receive any related insurance recoveries.
The remaining Participating Customers are covered under one policy with an
annual per customer deductible of $250,000 in 2012 and $225,000 in
2011. Reinsurance recoveries under these policies are remitted to us and are
recorded as a reduction to medical claims expense.
All policies have a maximum annual benefit per customer of $1.0
million. Although we maintain insurance of the types and in the amounts that we
believe are reasonable, there can be no assurances that the insurance policies
maintained by us will insulate us from material expenses and/or losses in the
future.
Healthcare Reform Legislation
The healthcare reform legislation described below is not directly applicable to
us since we are not a Medicare Advantage plan. However, this legislation will
directly impact Medicare Advantage plans such as those offered by the Contacting
HMOs, and, therefore, are expected to indirectly affect PSNs such as ours.
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The United States' healthcare system, including the Medicare Advantage program,
is subject to a broad array of laws and regulations as a result of the Patient
Protection and Affordable Care Act, which became law on March 23, 2010 as
amended by the Health Care and Education Reconciliation Act of 2010, which
became law on March 30, 2010 (collectively, the "Reform Acts"). The Reform Acts
are considered by some to be the most dramatic change to the country's
healthcare system in decades. This legislation made significant changes to the
Medicare program and to the health insurance market overall. Among other
things, the Reform Acts limit Medicare Advantage payment rates, stipulate a
prescribed minimum ratio for the amount of premium revenues to be expended on
medical costs, give the Secretary of Health and Human Services the ability to
deny Medicare Advantage plan bids that propose significant increases in cost
sharing or decreases in benefits, and make certain changes to Medicare Part D.
Because substantially all of our revenue is directly or indirectly derived from
reimbursements generated by Medicare Advantage health plans, any changes that
limit or reduce Medicare reimbursement levels, such as reductions in or
limitations of reimbursement amounts or rates under programs, reductions in
funding of programs, expansion of benefits without adequate funding, elimination
of coverage for certain benefits, or elimination of coverage for certain
individuals or treatments under programs, could have a material adverse effect
on our business.
There are numerous steps required to implement the Reform Acts, and Congress may
seek to alter or eliminate some of their provisions. In June 2012, the United
States Supreme Court upheld most of the provisions of the Affordable Care Act,
including the health insurance mandate. While Federal regulatory agencies are
moving forward with implementation of the provisions of the Reform Act, Congress
is attempting to pass legislation which would reverse the Reform
Acts. Furthermore, various health insurance reform proposals are also emerging
at the state level. Due to the unsettled nature of these reforms and the
numerous steps required to implement them, we cannot predict to what extent (if
at all) Congress will succeed in limiting or reversing the Reform Acts, whether
(and if so, what) additional health insurance reforms will be implemented at the
Federal or state level and/or the effect that any future legislation or
regulation will have on our business.
For additional information on the Reform Acts see "Business - Healthcare Reform
Legislation in 2011 and 2010" included in our Annual Report on Form 10-K for the
fiscal year ended December 31, 2011 and the Risk Factor captioned "Risk Factors
- Reductions in Funding for Medicare Programs and Other Provisions Under the
Recent Healthcare Reform Legislation…" included in Part II, Item 1A of this
Quarterly Report on Form 10-Q.
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CRITICAL ACCOUNTING POLICIES
A description of our critical accounting policies is contained in our Annual
Report on Form 10-K for the year ended December 31, 2011. Included within these
policies are certain policies that contain critical accounting estimates and,
therefore, have been deemed to be "critical accounting policies." Critical
accounting estimates are those which require management to make assumptions
about matters that were uncertain at the time the estimate was made and for
which the use of different estimates, which reasonably could have been used, or
changes in the accounting estimates that are reasonably likely to occur from
period to period, could have a material impact on the presentation of our
financial condition, changes in financial condition or results of operations.
COMPARISON OF RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2012 AND
JUNE 30, 2011
Summary
Net income for the second quarter of 2012 was $2.9 million compared to $5.9
million in the second quarter of 2011. Although we experienced significant
growth in both revenue and gross profitability, our quarterly net income
declined primarily due to the $3.6 million pre-tax loss in the second quarter of
2012 under an agreement with a Contracting HMO other than Humana (the
"Contracting HMO Agreement") and an increase in professional fees of $0.9
million in the second quarter of 2012 compared to the second quarter of 2011.
In the second quarter of 2012, we realized a pre-tax loss of $3.6 million on
approximately 6,600 new Participating Customers added in 2012 under the
Contracting HMO Agreement. The second quarter loss for this agreement includes
unfavorable claims development from the first quarter of 2012 of $1.6 million.
The loss represents the excess of medical costs over revenue earned from the
agreement and is the result of a number of factors including utilization that
was higher than anticipated by both the Contracting HMO and us. We are currently
in discussions with the Contracting HMO to modify the contract terms to reduce
the loss being incurred under this agreement. While no amendment to this
agreement is in place, the Contracting HMO has indicated a willingness to amend
the agreement. Therefore, we anticipate that the revenue we realize under this
agreement in the second half of 2012 will be sufficient to offset the projected
medical costs under this agreement during the same period. If we are unable to
amend the agreement, we anticipate that our losses under this agreement incurred
in the second half of 2012 would be similar to or greater than the pre-tax loss
of $4.4 million under this agreement in the first half of 2012. The contract can
be terminated with 120 days' notice.
Basic and diluted earnings per share were $0.07 for the second quarter of 2012
as compared to $0.15, basic, and $0.14, diluted, for the same period in
2011. The after tax loss on the Contracting HMO Agreement reduced both basic and
diluted earnings per share by $0.05. Basic and diluted earnings per share from
income from continuing operations was $0.06 for the second quarter of 2012 as
compared to $0.15, basic, and $0.14, diluted, for the same period in 2011. Basic
and diluted earnings from discontinued operations for the second quarter of 2012
were $0.01 per share.
Revenue for the second quarter of 2012 was $193.4 million compared to $97.3
million for the second quarter of 2011, an increase of $96.1 million or
98.8%. The increase in revenue was primarily attributable to Participating
Customers added with the acquisition of Continucare, the net addition of new
Participating Customers under risk arrangements since December 31, 2011 and
increased risk scores for our Participating Customers. Revenue for the second
quarter of 2012 included $1.6 million from the mid-year retroactive adjustment
that was earned in the first quarter of 2012. Revenue for the second quarter of
2011 included $2.0 million from the mid-year retroactive adjustment that was
earned in the first quarter of 2011.
Total medical expense for the second quarter of 2012 was $165.0 million compared
to $80.7 million for the second quarter of 2011, an increase of $84.3 million or
104.5%. This increase is primarily attributable to the additional medical claims
expense associated with the Contracting HMO Agreement, the addition of the
Continucare Participating Customers, the medical costs associated with the net
addition of new Participating Customers under risk arrangements in 2012, the
addition of the 19 Continucare medical practices, the addition of three
practices we purchased in the first half of 2011, and an increase in benefits,
utilization and medical cost inflation.
Gross profit was $28.4 million for the second quarter of 2012 as compared to
$16.6 million for the same quarter in 2011, an increase of $11.8 million or
71.1%.
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The medical expense ratio ("MER"), which is computed by dividing total medical
expense by revenue, represents a statistic used to measure gross profit. In the
second quarter of 2012 our MER was 85.3%, compared to 83.0% for the second
quarter of 2011. The increase in MER is primarily attributable to the higher
than expected medical claims expense incurred under the Contracting HMO
Agreement. Excluding the revenue and medical costs associated with the
Contracting HMO Agreement, our MER for the second quarter would have been 82.1%.
Operating expenses increased to $16.0 million for the second quarter of 2012 as
compared to $6.2 million for the same period in 2011, an increase of $9.8
million or 158.1%. The increase in operating expenses is primarily due to the
additional expenses of Continucare and an increase in amortization expense of
$3.1 million, related to the amortizable intangible assets recorded in the
Continucare acquisition.
Other expense increased by $7.4 million due primarily to an increase in interest
expense of $8.1 million for the second quarter of 2012 related to the debt used
to finance the Continucare acquisition.
Income before income taxes from continuing operations for the second quarter of
2012 was $4.2 million as compared to income before income taxes for the second
quarter of 2011 of $9.6 million. The primary reasons for the decrease were the
$3.6 million operating loss associated with the Contracting HMO Agreement and an
increase in professional fees of $0.9 million in the second quarter of 2012
compared to the second quarter of 2011.
Income from discontinued operations for the second quarter of 2012 was $0.3
million. This amount represents the income realized by the sleep diagnostic
business, net of income tax expense.
Customer Information
The table set forth below provides (i) the total number of customers to whom we
were providing healthcare services as of June 30, 2012 and 2011 and (ii) the
aggregate customer months for the second quarter of both 2012 and 2011. Customer
months are the aggregate number of months of healthcare services we have
provided to customers during a period of time.
Percentage
Participating Customer Increase In
Participating Customers at Months In The Quarter Participating
June 30, Ended June 30, Customer Months
2012 2011 2012 2011
Risk arrangements 69,400 34,000 208,700 102,200 104.2 %
Non-risk arrangements 8,200 - 25,200 - N/A
77,600 34,000 233,900 102,200 128.9 %
The following table sets forth the number of Participating Customers by program
at June 30, 2012 and June 30, 2011:
Participating Customers Percentage Increase
June 30, In Participating
2012 2011 Customers
Medicare Advantage 61,400 34,000 80.6 %
Medicaid 12,800 - N/A
Commercial 3,400 - N/A
77,600 34,000 128.2 %
The increase in total customer months under risk arrangements for the second
quarter of 2012 as compared to the same period in 2011 is primarily a result of
the Participating Customers added with the Continucare acquisition and the net
addition of new Participating Customers under risk arrangements in 2012. Changes
in our customer base are also a result of new enrollments and/or transfers from
other physician's practices and individuals aging into Medicare and becoming a
Participating Customer, reduced by disenrollments, deaths, Participating
Customers moving from the covered areas, Participating Customers transferring to
another physician practice or Participating Customers making other insurance
selections.
The increase in customer months under non-risk arrangements is a result of the
Continucare acquisition.
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The most significant component of our revenue is generated from Medicare
Advantage risk arrangements with the Contracting HMOs. Risk revenue increased by
$87.4 million, or 90.4%, during the second quarter of 2012 as compared to the
same period in 2011. The increase in revenue is primarily attributable to
Participating Customers added with the acquisition of Continucare, the net
addition of new Participating Customers under risk arrangements in 2012 and
increased risk scores for our Participating Customers.
Our PCPM Medicare risk revenue increased by $60 for the second quarter of 2012
compared to the same period in 2011. The increase in our PCPM revenue was
primarily generated by the acquisition of Continucare, which realizes higher
rates in Miami-Dade County than we realize in our other service areas, and
increases in our capitation payments as a result of changes in the Medicare risk
adjustment scores of our Participating Customers.
In July 2012, we were notified by the Contracting HMOs of the amount of the
retroactive mid-year MRA revenue increase from CMS for the first six months of
2012. This increase is effective July 1 and is retroactively applied to all
premiums paid in the first half of 2012. The retroactive mid-year adjustment
totaled $11.4 million of which $6.0 million relates to capitation fees earned in
the first quarter of 2012 with the balance relating to capitation fees earned in
the second quarter of 2012. At March 31, 2012, we had recorded a receivable for
the estimated retroactive revenue earned during the first quarter of 2012 of
$4.4 million. As a result, our revenue for the second quarter of 2012 was
increased by $1.6 million, the difference between the originally estimated $4.4
million of retroactive revenue adjustment recorded during the first quarter of
2012 and the $6.0 million of retroactive revenue received for that period.
In July 2011, we were notified by Humana of the amount of the retroactive
mid-year MRA revenue increase from CMS for the first six months of 2011. This
increase is effective July 1 and was retroactively applied to all premiums paid
in the first half of 2011. The retroactive mid-year adjustment totaled $9.5
million of which $4.9 million relates to capitation fees earned in the first
quarter of 2011 with the balance relating to capitation fees earned in the
second quarter of 2011. At March 31, 2011, we had recorded a receivable for the
estimated retroactive revenue earned during the first quarter of 2011 of $2.9
million. As a result, our revenue for the second quarter of 2011 was increased
by $2.0 million, the difference between the originally estimated $2.9 million of
retroactive revenue adjustment recorded during the first quarter of 2011 and the
$4.9 million of retroactive revenue received for that period.
Fee-for-service revenue represents amounts earned from medical services provided
to non-Participating Customers in our owned medical practices. Fee-for-service
revenue represents less than 0.5% of our total revenue for the three months
ended June 30, 2012 and June 30, 2011.
Total Medical Expense
Total medical expense represents the estimated total cost of providing medical
care and is comprised of two components, medical claims expense and medical
practice costs. Medical claims expense is recognized in the period in which
services are provided and includes an estimate of our obligations for medical
services that have been provided to our Participating Customers but for which we
have neither received nor processed claims. Medical claims expense includes such
costs as inpatient and outpatient services, pharmacy benefits and physician
services by providers other than the IPAs and physician practices owned by the
PSN (collectively "Non-Affiliated Providers"). Medical practice costs represent
the operating costs of the physician practices owned by the PSN.
We develop our estimated medical expense payable using an actuarial process that
is consistently applied. The actuarial process develops a range of estimated
medical claims expense payable and we record the amount in the range that is our
best estimate of the ultimate liability. Each period, we re-examine previously
recorded medical claims expense payable estimates based on actual claim
submissions and other changes in facts and circumstances. As medical claims
expense payable recorded in prior periods becomes more exact, we adjust the
amount of the estimate and include the change in medical claims expense in the
period in which the change is identified. In each reporting period, our
operating results include a change in medical expense from the effects of more
completely developed medical claims expense payable estimates associated with
previously reported periods. While we believe our estimated medical claims
expense payable is adequate to cover future claims payments required, such
estimates are based on our claims experience to date and various management
assumptions. Therefore, the actual liability could differ materially from the
amount recorded.
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Total medical expense and the MER are as follows (in thousands):
Three Months Ended March 31,
2012 2011
Estimated medical expense for the period,
excluding prior period claims development $ 162,085 $
79,659
(Favorable) unfavorable prior period medical
claims development in current period based on
actual claims submitted 2,933
1,070
Total medical expense for period $ 165,018 $
80,729
Medical Expense Ratio for period 85.3 %
83.0 %
Unfavorable claims development is a result of actual medical claim cost for
prior periods exceeding the original estimated cost which increases the total
reported medical expense and the MER in the reporting period.
The reported MER is impacted by both revenue and expense. Periodically we
receive retroactive adjustments of the capitation fees paid to us. Retroactive
adjustments of prior periods' capitation fees that are recorded in the current
period impact the MER of that period. If the retroactive adjustment increases
revenue then the impact reduces the MER for the period. Conversely, if the
retroactive adjustment reduces revenue, then the MER for the period is
higher. These retroactive adjustments include, among other things, the mid-year
and annual retroactive MRA capitation fee adjustments and settlement of Part D
program capitation fees. Actual medical claims expense usually develops
differently than originally estimated.
Because the risk agreements provide that the PSN is financially responsible for
all medical services provided to the Participating Customers, medical claims
expense includes the cost of medical services provided to Participating
Customers by providers other than the physician practices owned by the PSN.
Total medical expense for the second quarter of 2012 increased by $84.3 million,
or 104.4%, to $165.0 million from $80.7 million for the second quarter of
2011. Medical claims expense, which is the largest component of medical services
expense, increased by $74.6 million, or 98.0%, to $150.7 million for the second
quarter of 2012 from $76.1 million for the same period in 2011, primarily due to
the acquisition of Continucare, the net addition of new Participating Customers
under risk arrangements in 2012 and higher than expected medical claims
expense under the Contracting HMO Agreement.
Our PCPM Medicare risk expense increased by $45 for the second quarter of 2012
compared to the same period in 2011. The increase in our PCPM expense was
primarily generated by the acquisition of Continucare. The counties in which
Continucare operates, particularly Miami-Dade County, have higher costs than
those in most of the counties in which we had operated. The increase was also a
result of the higher than average medical claims expense associated with the
Contracting HMO Agreement.
The MER for the second quarter of 2012 was 85.3%, compared to 83.0% for the
second quarter of 2011. The increase in MER is primarily attributable to the
higher than expected medical claims expense incurred under the Contracting HMO
Agreement. Excluding the revenue and medical costs associated with the
Contracting HMO Agreement our MER in the second quarter of 2012 would have been
82.1%. As discussed above, we are currently seeking to negotiate an amendment to
the Contracting HMO Agreement.
Medical practice costs include the salaries, taxes and benefits of the PSN's
employed health professionals and staff providing primary care services and the
costs associated with the operations of our wholly-owned medical
practices. Medical practice costs increased by $9.7 million, or 210.9%, to $14.3
million for the second quarter of 2012 from $4.6 million for the second quarter
of 2011. The increase in medical practice costs was primarily a result of our
acquisition of Continucare, with its 19 wholly-owned centers, and the three
medical practices we purchased in the first half of 2011.
26
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At June 30, 2012, we determined that the range for estimated medical claims
payable was between $42.2 million and $47.1 million and we recorded a liability
of $44.5 million. Based on historical results, we believe that the actuarial
mid-point of the range continues to be the best estimate within the range of the
PSN's ultimate liability.
Operating Expenses
The following table provides information regarding the various items which
comprise operating expenses (dollar amounts in thousands).
Three Months Ended June 30, %
2012 2011 Increase Change
Payroll, payroll taxes and benefits $ 7,871 $ 3,858 $ 4,013 104.0 %
Percentage of total revenue 4.1 % 4.0 %
General and administrative 4,731 2,201 2,530 114.9 %
Percentage of total revenue 2.4 % 2.3 %
Marketing and advertising 222 52 170 326.9 %
Percentage of total revenue 0.1 % 0.1 %
Amortization of intangible assets 3,187 100 3,087 3087.0 %
Percentage of total revenue 1.6 % 0.1 %
Total operating expenses $ 16,011 $ 6,211 $ 9,800 157.8 %
Payroll, Payroll Taxes and Benefits
Payroll, payroll taxes and benefits include salary and related costs associated
with our corporate level executives, administrative, transportation and call
center personnel. The increase in 2012 is primarily a result of the inclusion of
Continucare's executive, administrative, transportation and call center payroll,
payroll taxes and benefits of $3.3 million. We also realized an increase in
stock-based compensation of $0.5 million for the second quarter of 2012 compared
to the same period in 2011 primarily due to the addition of certain Continucare
employees to the plan.
General and Administrative
This increase in general and administrative expenses for the second quarter of
2012 is primarily a result of the inclusion of $1.6 million of Continucare's
general and administrative costs. Legal and accounting fees increased by $0.9
million for the second period of 2012 compared to the second quarter of 2011
primarily as a result of the preparation and filing of a "shelf" registration
statement and related materials and non-recurring projects.
Marketing and Advertising
Marketing and advertising costs increased for the second quarter of 2012
compared to the second quarter of 2011 due primarily to the inclusion of
Continucare's marketing and advertising costs.
Amortization of Intangibles
The increase in amortization is a result of the intangible assets acquired in
connection with the acquisition of Continucare.
Other Expense
We recognized other expense of $8.1 million for the second quarter of 2012
compared to other expense of $0.7 million for the same period in 2011. For the
second quarter of 2012, we incurred $8.1 million of interest expense related to
the debt incurred in connection with the Continucare acquisition. For the second
quarter of 2011, we recorded transaction costs associated with the Continucare
transaction of $1.0 million.
27
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Income taxes
Our estimated effective income tax rate was 38.9% and 38.5% for the second
quarter of 2012 and 2011, respectively.
COMPARISON OF RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2012 AND
JUNE 30, 2011
Summary
Net income for the first six months of 2012 was $10.8 million compared to $13.9
million for the first six months of 2011. Although we experienced significant
growth in both revenue and gross profitability, net income for the first six
months of 2012 declined primarily due to the $4.4 million pre-tax loss from the
Contracting HMO Agreement for the six months ended June 30, 2012, the $0.8
million decrease in the favorable claims variance in the first six months of
2012 compared to 2011, and an increase in professional fees of $1.4 million in
the first six months of 2012 compared to the same period in 2011.
Basic and diluted earnings per share were $0.26 and $0.24, respectively, for the
first six months of 2012 as compared to $0.35 and $0.33, respectively, for the
same period in 2011. The after tax loss on the Contracting HMO Agreement reduced
both basic and diluted earnings per share by $0.06. Basic and diluted earnings
from continuing operations for the first six months of 2012 were $0.25 and $0.23
a share, respectively. Basic and diluted earnings from discontinued operations
for the first six months of 2012 were $0.01 per share.
Revenue for the first six months of 2012 was $388.7 million compared to $192.0
million for the first six months of 2011, an increase of $196.7 million or
102.4%. The increase in revenue was primarily attributable to Participating
Customers added with the acquisition of Continucare, the net addition of new
Participating Customers under risk arrangements in 2012 and increased risk
scores for our Participating Customers.
Total medical expense for the first six months of 2012 was $322.3 million
compared to $156.2 million for the first six months of 2011, an increase of
$166.1 million or 106.3%. This increase is primarily attributable to the
additional medical claims expense associated with the Contracting HMO Agreement,
the addition of the Continucare Participating Customers, the medical costs
associated with the net addition of new Participating Customers under risk
arrangements in 2012, the addition of the 19 Continucare medical practices, the
addition of three medical practices we purchased in the first half of 2011, and
an increase in benefits, utilization and medical cost inflation.
Gross profit was $66.3 million for the first six months of 2012 as compared to
$35.8 million for the same period in 2011, an increase of $30.5 million or
85.2%.
Our MER was 82.9% for the first six months of 2012, as compared to MER of 81.4%
for the first six months of 2011. The increase in MER is primarily attributable
to the higher than expected expenses incurred under the Contracting HMO
Agreement during the first six months of 2012. Excluding the revenue and medical
costs associated with the Contracting HMO Agreement, our MER for the first six
months of 2012 would have been 80.3%. As discussed above, we are currently
seeking to negotiate an amendment to the Contracting HMO Agreement.
Operating expenses increased to $32.7 million for the first six months of 2012
as compared to $12.6 million for the same period in 2011, an increase of $20.1
million or 159.5%. The increase in operating expenses is primarily due to the
additional expenses of Continucare and an increase in amortization expense of
$6.2 million, related to the amortizable intangible assets recorded in the
Continucare acquisition.
Other expense increased by $15.8 million due primarily to an increase in
interest expense of $16.4 million for the first six months of 2012 related to
the debt used to finance the Continucare acquisition.
Income before income taxes from continuing operations for the first six months
of 2012 and 2011 was $17.3 million and $22.6 million, respectively. The primary
reasons for the decrease were the $4.4 million operating loss associated with
the Contracting HMO Agreement, the $0.8 million decrease in the favorable claims
variance in the first six months of 2012 compared to 2011, and an increase in
professional fees of $1.4 million in the first six months of 2012 compared to
the same period in 2011.
Income from discontinued operations was $0.2 million for the first six months of
2012. This amount represents income realized by the sleep diagnostic business
during the first six months of 2012, net of income tax expense.
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Customer Information
The table set forth below provides (i) the total number of customers to whom we
were providing healthcare services as of June 30, 2012 and 2011 and (ii) the
aggregate customer months for the first six months of both 2012 and
2011. Customer months are the aggregate number of months of healthcare services
we have provided to customers during a period of time.
Percentage
Increase In
Participating Customer Participating
Participating Customers at Months For The Six Months Customer
June 30, Ended June 30, Months
2012 2011 2012 2011
Risk arrangements 69,400 34,000 419,200 205,100 104.4 %
Non-risk arrangements 8,200 - 50,900 - N/A
77,600 34,000 470,100 205,100 129.2 %
The increase in total customer months under risk arrangements for the first six
months of 2012 as compared to the same period in 2011 is primarily a result of
the Participating Customers added with the Continucare acquisition and the net
addition of new Participating Customers under risk arrangements in 2012. Changes
in our customer base are also a result of new enrollments and/or transfers from
other physician's practices, and individuals aging into Medicare and becoming a
Participating Customer, reduced by disenrollments, deaths, Participating
Customers moving from the covered areas, Participating Customers transferring to
another physician practice or Participating Customers making other insurance
selections.
The increase in customer months under non-risk arrangements is a result of the
Continucare acquisition.
Revenue
The most significant component of our revenue is the revenue generated from
Medicare Advantage risk arrangements with the Contracting HMOs. Risk revenue
increased by $178.5 million, or 93.3%, during the first six months of 2012 as
compared to the same period in 2011. The increase in revenue is primarily
attributable to Participating Customers added with the acquisition of
Continucare, the net addition of new Participating Customers under risk
arrangements in 2012 and increased risk scores for our Participating Customers.
Our PCPM Medicare risk revenue increased by $77 for the first six months of 2012
compared to the same period in 2011. The increase in our PCPM revenue is
primarily generated by the acquisition of Continucare, which realizes higher
rates in Miami-Dade County than we realize in our other service areas, and
increases in our capitation payments as a result of changes in the Medicare risk
adjustment scores of our Participating Customers.
Fee-for-service revenue represents amounts earned from medical services provided
to non-Participating Customers in our owned medical practices. Fee-for-service
revenue represented less than 0.5% of our total revenue for the six months ended
June 30, 2012 and June 30, 2011.
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Total Medical Expense
Total medical expense and the MER are as follows (in thousands):
Six Months Ended June 30,
2012 2011
Estimated medical expense for the period,
excluding prior period claims development $ 324,770$ 159,433
Unfavorable (favorable) prior period medical
claims development in current period based on
actual claims submitted (2,443 )
(3,219 )
Total medical expense for period $ 322,327 $ 156,214
Medical Expense Ratio for period 82.9 % 81.4 %
Favorable claims development is a result of actual medical claim cost for prior
periods developing lower than the original estimated cost which reduces the
reported medical expense and the MER in the reporting period.
Total medical expense for the first six months of 2012 increased by $166.1
million, or 106.3%, to $322.3 million from $156.2 million for the first six
months of 2011. Medical claims expense, which is the largest component of
medical services expense, increased by $146.2 million, or 99.3%, to $293.4
million for the first six months of 2012 from $147.2 million for the same period
in 2011, primarily due to the acquisition of Continucare, the net addition of
new Participating Customers under risk arrangements added in 2012 and the higher
than expected medical claims expense under the Contracting HMO Agreement.
Our PCPM Medicare risk expense increased by $48 for the first six months of 2012
compared to the same period in 2011. The increase in our PCPM expense was
primarily generated by the acquisition of Continucare. The counties in which
Continucare operates, particularly Miami-Dade County, have higher costs than
those in most of the counties in which we had operated. The increase was also a
result of the higher than average medical claims expense associated with the
Contracting HMO Agreement.
The MER for the first six months of 2012 was 82.9%, compared to MER of 81.4% for
the first six months of 2011. The increase in MER is primarily attributable to
the higher than expected expenses incurred under the Contracting HMO Agreement
during the first six months of 2012. Excluding the revenue and medical costs
associated with the Contracting HMO Agreement our MER for the first six months
of 2012 would have been 80.3%.
Medical practice costs include the salaries, taxes and benefits of the PSN's
employed health professionals and staff providing primary care services, and the
costs associated with the operations of our wholly-owned medical
practices. Medical practice costs increased by $20.0 million, or 222.2%, to
$29.0 million for the first six months of 2012 from $9.0 million for the first
six months of 2011. The increase in medical practice costs was primarily a
result of our acquisition of Continucare, with its 19 wholly-owned centers, and
the three medical practices we purchased in the first half of 2011.
30
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Operating Expenses
The following table provides information regarding the various items which
comprise operating expenses (dollar amounts in thousands).
2012 2011 Increase Change
Payroll, payroll taxes and benefits $ 16,860$ 7,960$ 8,900
111.8 %
Percentage of total revenue 4.3 % 4.1 %
General and administrative 9,077 4,343 4,734 109.0 %
Percentage of total revenue 2.3 % 2.3 %
Marketing and advertising 387 120 267 222.5 %
Percentage of total revenue 0.1 % 0.1 %
Amortization of intangible assets 6,374 194 6,180
3185.6 %
Percentage of total revenue 1.6 % 0.1 %
Total operating expenses $ 32,698 $ 12,617 $ 20,081 159.2 %
Payroll, Payroll Taxes and Benefits
Payroll, payroll taxes and benefits include salary and related costs associated
with our corporate level executives, administrative, transportation and call
center personnel. The increase in 2012 is primarily a result of the inclusion of
Continucare's executive, administrative, transportation and call center payroll,
payroll taxes and benefits of $7.4 million. We also realized an increase in
stock-based compensation of $0.6 million, primarily due to the addition of
certain Continucare employees to the plan and an increase in payroll expense of
$0.7 million for the first half of 2012 compared to the same period in 2011.
General and Administrative
This increase in general and administrative expenses for the first six months of
2012 is primarily a result of the inclusion of $3.1 million of Continucare's
general and administrative costs. Legal and accounting fees increased by $1.4
million for the first half of 2012 when compared to the same period in 2011
primarily as a result of the preparation and filing of a "shelf" registration
statement and related materials and non-recurring projects.
Marketing and Advertising
Marketing and advertising costs increased in the first six months of 2012
compared to the first six months of 2011 due primarily to the inclusion of
Continucare's marketing and advertising costs.
Amortization of Intangibles
The increase in amortization is a result of the intangible assets acquired in
connection with the acquisition of Continucare.
Other Expense
We recognized other expense of $16.4 million and $0.6 million for the first six
months of 2012 and 2011, respectively. The increase in other expense is
primarily due to $16.4 million of interest expense related to the debt incurred
in connection with the Continucare acquisition. For the first six months of
2011, we recorded transaction costs associated with the Continucare transaction
of $1.0 million.
Income taxes
Our estimated effective income tax rate was 38.7% for the first six months of
2012 and 38.5% for the first six months of 2011.
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LIQUIDITY AND CAPITAL RESOURCES
Cash and Cash Equivalents
Cash, cash equivalents and short-term investments at June 30, 2012 totaled $44.4
million as compared to $18.3 million at December 31, 2011, an increase of $26.1
million. As of June 30, 2012, we had working capital of $51.8 million as
compared to working capital of $43.2 million at December 31, 2011, an increase
of $8.6 million or 19.9%. Our total stockholders' equity was $118.2 million at
June 30, 2012 and $104.6 million at December 31, 2011.
Net cash provided by operating activities during the first six months of 2012
was $37.4 million. The most significant sources of cash from operating
activities were:
· net income, excluding non-cash items, of $23.5 million;
· a decrease in due from HMOs, net, of $7.0 million;
· an increase in due to HMO, net, of $6.4 million; and
· a decrease in prepaid income taxes of $4.9 million.
These sources of cash were partially offset by a decrease in accrued payroll and
payroll taxes of $2.8 million as a result of the payment for the first six
months of 2012 of the employee bonuses which were accrued at December 31, 2011.
Net cash used in investing activities for the six months ended June 30, 2012 was
$2.2 million which primarily related to capital expenditures.
Net cash used by financing activities for the six months ended June 30, 2012 was
$9.1 million. This was primarily a result of the repayment of the $5.0 million
of borrowings under the revolving loan facility and payments made of $4.8
million under our First Lien Term Loan Facility (see below). These uses were
partially offset by the excess tax benefits from stock based compensation of
$1.3 million.
We expect to collect the retroactive 2012 mid-year MRA receivable of $11.4
million in August 2012 and the $2.7 million retroactive 2011 year-end receivable
in September of 2012.
Adjusted EBITDA From Continuing Operations
The following table presents our Adjusted EBITDA from continuing operations
(Non-GAAP measure) for the six months ended June 30, 2012 and 2011, as well as a
reconciliation of Adjusted EBITDA from continuing operations to the reported
income from continuing operations for such periods (in thousands):
Three Months Ended June 30, Six Months Ended June 30,
2012 2011 2012 2011
Income from continuing operations $ 2,597 $ 5,926 $ 10,595 $ 13,892
Income tax expense 1,651 3,710 6,679 8,697
Net interest expense (income) 8,131 (281 ) 16,356 (464 )
Depreciation and amortization 4,104 311 8,168 742
Stock-based compensation 1,135 629 1,899 1,329
Adjusted EBITDA From Continuing Operations $ 17,618 $ 10,295 $ 43,697 $ 24,196
Adjusted EBITDA from continuing operations is not defined under U.S. GAAP and it
may not be comparable to similarly titled measures reported by other companies.
We use Adjusted EBITDA from continuing operations, along with other U.S. GAAP
measures, as a measure of profitability because Adjusted EBITDA from continuing
operations helps us to compare our performance on a consistent basis by removing
from our operating results from continuing operations the impact of our capital
structure, the accounting methods used to compute depreciation and amortization
and the effect of non-cash stock-based compensation expense. We believe Adjusted
EBITDA from continuing operations is useful to investors as it is a widely used
measure of performance and the adjustments we make to Adjusted EBITDA from
continuing operations provide further clarity on our profitability. We remove
the effect of non-cash stock-based compensation from our income which can vary
based on share price, share price volatility and expected life of the equity
instruments we grant. In addition, this stock-based compensation expense does
not result in cash payments by us. Adjusted EBITDA from continuing operations
has limitations as a profitability measure in that it does not include the
interest expense on our debt, our provisions for income taxes, the effect of our
expenditures for capital assets, and the effect of non-cash stock-based
compensation expense.
32
--------------------------------------------------------------------------------Credit Facilities
We entered into a senior secured First Lien Credit Agreement and a secured
Second Lien Credit Agreement on October 4, 2011. These facilities are
guaranteed jointly and severally by substantially all of our existing and future
subsidiaries (the "Guarantors") and are secured by a first-priority and
second-priority security interest, respectively, in substantially all of our and
the Guarantors' existing and future assets
First Lien Credit Agreement
The First Lien Credit Agreement provides for a $240.0 million first lien term
loan facility and a $40.0 million revolving loan facility (including
subfacilities for up to $15.0 million for letters of credit and $5.0 million for
same day, "swingline," borrowings). These loans bear interest at a variable rate
that is currently equal to 7.0% for term loan borrowings and 6.5% for revolving
loan borrowings. As of June 30, 2012, we had $235.2 million outstanding under
our first lien term loan facility. While no amount was outstanding under our
revolving loan facility, letters of credit against the revolving loan
facility. As of June 30, 2012, we had $33.4 million available for borrowing
under our revolving loan facility.
Borrowings under the First Lien Term Loan Facility are subject to quarterly
principal amortization at the following rates: 5.0% of the $240.0 million
principal amount the first year, 7.5% the second year, 10.0% the third year, and
12.5% for each of the fourth and fifth years. The balance of all borrowings
under the first lien term loan facility is due and payable on the maturity date
of October 4, 2016.
We may prepay the term loans or permanently reduce the revolver commitment under
the First Lien Facilities at any time without penalty. Commencing for the year
ended December 31, 2012, we will also be required to make prepayments on an
annual basis (subject to certain basket amounts and exceptions), in an amount
equal to 75.0% of our excess cash flow (defined as cash flow less scheduled
principal and interest payments, cash taxes, and any increase in working
capital, plus any decrease in working capital) less any voluntary prepayments
made during the applicable year, with a reduction to 50.0% based on achievement
of a total leverage ratio (defined as the ratio of our aggregate outstanding
indebtedness to our adjusted income before stock-based compensation, interest,
taxes, depreciation and amortization) not exceeding 2.00x as of the last day of
each year. We also must make prepayments of 25-50% of the net proceeds from
publicly offered equity issuances as well as 100% of the net proceeds from asset
sales, debt issuances (other than to the extent permitted under the First Lien
Credit Agreement) and extraordinary receipts, as defined.
The First Lien Credit Agreement includes customary restrictive covenants,
subject to certain basket amounts and exceptions, including covenants limiting
our ability to incur or amend certain types of indebtedness and liens; merge
with, make an investment in or acquire any property or assets of another
company; make capital expenditures; pay cash dividends; repurchase shares of our
outstanding stock; make loans; dispose of assets (including the equity
securities of our subsidiaries); or prepay the principal on any subordinate
indebtedness. Subject to certain terms and conditions, we have the right to make
up to $15.0 million of stock repurchases during the term of the credit
facilities, generally not to exceed $5.0 million in any year, and make up to
$100.0 million of acquisitions, generally not to exceed $50.0 million in any one
year. The First Lien Credit Agreement also requires us to maintain certain total
leverage ratios (defined above), senior leverage ratios (defined above) and
fixed charge coverage ratios (defined as the ratio of our free cash flow to our
fixed charges (interest, scheduled principal payments, earnout, stock
repurchases from officers, directors and employees) during the term of the
agreement, tested quarterly.
Second Lien Credit Agreement
The Second Lien Credit Agreement provides for a $75.0 million second lien term
loan facility. This loan bears interest at a variable rate that is currently
equal to 13.5%. As of June 30, 2012, we had $75.0 million outstanding under our
second lien term loan facility. Borrowings under the Second Lien Credit
Agreement are generally due and payable on the maturity date, October 4, 2017.
33
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Prior to the repayment of all borrowings under the First Lien Credit Agreement,
we may not prepay any borrowings under the Second Lien Credit Agreement without
the prior consent of the First Lien Lenders. To the extent a prepayment of
borrowings under the Second Lien Credit Agreement is permitted, we will be
required to pay prepayment penalties of 2-5% and, if the prepayment is made
prior to May 4, 2013, we will be required to pay a make-whole payment equal to
the estimated, discounted net present value of any interest payments that would
have been made on or prior to such date but are avoided as a result of the
prepayment.
After May 4, 2013, and provided all borrowings under the First Lien Credit
Agreement have been repaid and the facility has been terminated, we will,
subject to certain basket amounts and exceptions, be required to make mandatory
prepayments to the Second Lien Lenders on substantially the same terms and
conditions as mandatory prepayments are required under the First Lien Credit
Agreement. Mandatory prepayments as a result of asset sales or debt or equity
issuances will be subject to the prepayment charges described in the preceding
paragraph.
The Second Lien Credit Agreement contains substantially the same negative
covenants and financial covenants (other than the senior leverage ratio) as the
First Lien Credit Agreement, except that the permitted basket amounts in the
Second Lien Credit Agreement are generally higher than under the First Lien
Credit Agreement and the financial covenants ratios are 10-15% less restrictive
than under the First Lien Credit Agreement.
Interest Rate Cap
Effective December 4, 2011, we entered into an interest rate cap agreement
pursuant to which we will be entitled to receive certain payments in the event
the LIBOR rate on the First and Second Lien Credit Agreements exceeds 1.5%. The
notional amount of the interest rate cap, which expires on September 30, 2014,
is $155.1 million at June 30, 2012 and will decrease to $134.1 million over the
life of the agreement. The effect of this interest rate cap is to hedge our risk
of a rise in the LIBOR rate above 1.5% with respect to a portion of the
outstanding indebtedness under the First Lien Credit Agreement and the Second
Lien Credit Agreement equal to the notional amount of the cap.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any off-balance sheet arrangements that have or are reasonably
likely to have a current or future effect on our financial condition, changes in
financial condition, revenues or expenses, results of operations, liquidity,
capital expenditures or capital resources that are material to investors.
