MEDNAX, INC. – 10-Q – Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion highlights the principal factors that have affected our financial condition and results of operations, as well as our liquidity and capital resources, for the periods described. This discussion should be read in conjunction with the unaudited Condensed Consolidated Financial Statements and the notes thereto included in this Quarterly Report. In addition, reference is made to our audited consolidated financial statements and notes thereto and related Management's Discussion and Analysis of Financial Condition and Results of Operations included in our most recent Annual Report on Form 10-K. As used in this Quarterly Report, the terms "MEDNAX", the "Company", "we", "us" and "our" refer to MEDNAX, Inc. and its consolidated subsidiaries (collectively "MDX"), together with MDX's affiliated professional associations, corporations and partnerships ("affiliated professional contractors"). Certain subsidiaries of MDX have contracts with our affiliated professional contractors, which are separate legal entities that provide physician services in certain states and Puerto Rico.

Overview

MEDNAX is a leading provider of physician services including newborn, maternal-fetal, other pediatric subspecialties, and anesthesia care. Our national network is composed of affiliated physicians, including those who provide neonatal clinical care in 34 states and Puerto Rico, primarily within hospital-based neonatal intensive care units, to babies born prematurely or with medical complications. We also have affiliated physicians who provide maternal-fetal and obstetrical medical care to expectant mothers experiencing complicated pregnancies primarily in areas where our affiliated neonatal physicians practice. Our network includes other pediatric subspecialists, including those who provide pediatric cardiology care, pediatric intensive care, hospital-based pediatric care and pediatric surgical care. In addition, we have physicians who provide anesthesia care to patients in connection with surgical and other procedures as well as pain management.

During the six months ended June 30, 2013, we completed the acquisition of five physician group practices consisting of three anesthesiology practices and two neonatology practices. During the six months ended June 30, 2012, we completed the acquisition of seven physician group practices consisting of three anesthesiology practices, one neonatology practice, one maternal-fetal medicine practice, one pediatric cardiology practice and one other pediatric subspecialty practice. Based on past results, we expect that we can improve the results of these practices through improved managed care contracting, improved collections, identification of growth initiatives, as well as operating and cost savings, based upon the significant infrastructure we have developed.

Our results of operations for the six months ended June 30, 2013 and 2012 include the results of operations for these physician group practices from their respective dates of acquisition and therefore are not comparable in some respects.

The United States continues to be affected by unfavorable economic conditions and slow economic growth. The number of unemployed and under-employed workers remains significant. During the three months ended June 30, 2013, on a sequential basis, the percentage of patients being reimbursed under government-sponsored healthcare programs decreased as compared to the three months ended March 31, 2013. However, during the six months ended June 30, 2013 as compared to the six months ended June 30, 2012, there were shifts toward government-sponsored programs. If economic conditions do not improve or deteriorate further, there could be additional shifts toward government-sponsored programs and patient volumes could decline. Payments received from government-sponsored programs are substantially less for equivalent services than payments received from commercial insurance payors. In addition, many states continue to experience lower than anticipated revenue and are facing significant budget shortfalls. Although the shortfalls for the budget year that began in July 2012 were lower than in recent years, they are still significant by historical standards. These shortfalls could lead to reduced or delayed funding for state Medicaid programs and, in turn, reduced or delayed reimbursement for physician services.

In March 2010, the "Patient Protection and Affordable Care Act," (the "Affordable Care Act"), was enacted. The Affordable Care Act contains a number of provisions that could affect us over the next several years. These provisions include establishing health insurance exchanges to facilitate the purchase of qualified health plans, expanding Medicaid eligibility, subsidizing insurance premiums and creating requirements and incentives for businesses to provide healthcare benefits. Other provisions contain changes to healthcare fraud and abuse laws and expand the scope of the Federal False Claims Act. Additionally, in November 2012, the Centers for Medicare & Medicaid Services ("CMS") adopted a rule under the Affordable Care Act that would allow physicians who provide eligible primary care services to generally be paid at the Medicare reimbursement rates in effect in calendar years 2013 and 2014 instead of state-established Medicaid reimbursement rates. Generally, state Medicaid reimbursement rates are lower than federally-established Medicare rates. State agencies were required to submit their state plan amendments outlining how they will implement the rule, including frequency and timing of payments by March 31, 2013. Almost all states have submitted their state plan amendments. Upon submission, CMS has a period of time to approve, disapprove or request additional information about the plans, a process that is still taking place. During the three months ended June 30, 2013, we started to receive parity payments from a few states that are now paying at the Medicare rate for Medicaid services. Our second quarter results include approximately $2.5 million in revenue from parity payments, that contributed approximately $0.02 to our net income per diluted share, reflecting the impacts from incentive compensation and income taxes. However, because of the unanswered questions regarding timing and frequency of future payments, at this time we cannot predict with any assurance the ultimate impact of the rule on us.

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The Affordable Care Act contains numerous other measures that could also affect us. For example, payment modifiers are to be developed that will differentiate payments to physicians under federal healthcare programs based on quality of care. In addition, other provisions authorize voluntary demonstration projects relating to the bundling of payments for episodes of hospital care and the sharing of cost savings achieved under the Medicare program.

Many of the Affordable Care Act's most significant reforms, such as the establishment of state-based and federally facilitated insurance exchanges, do not take effect until 2014 and thereafter, and their details will be shaped significantly by implementing regulations that have yet to be finalized. In 2012, the U.S. Supreme Court heard challenges to the constitutionality of the Affordable Care Act's individual mandate to purchase health insurance and to the viability of certain other provisions of the law. The Supreme Court issued a decision upholding most of the Affordable Care Act and determined that requiring individuals to maintain "minimum essential" health insurance coverage or pay a penalty to the Internal Revenue Service was within Congress' constitutional taxing authority. However, the Supreme Court struck down a provision in the Affordable Care Act that penalized states that choose not to expand their Medicaid programs through an increase in the Medicaid eligibility income limit from a state's current eligibility levels to 133% of the federal poverty limit. As a result of the Supreme Court's ruling, it is unclear to what extent states will expand their Medicaid programs by raising the income limit to 133% of the federal poverty level and whether there will be more uninsured patients in 2014 than anticipated when the Affordable Care Act was enacted. All of the states in which we operate, however, already cover children in the first year of life and pregnant women if their household income is at or below 133% of the federal poverty level.

Federal and state agencies are expected to continue to implement provisions of the Affordable Care Act and to develop regulations following the Supreme Court's decision. However, given the complexity and the number of changes expected as a result of the Affordable Care Act, as well as the implementation timetable for many of them, we cannot predict the ultimate impacts of the Affordable Care Act as they may not be known for several years. The Affordable Care Act also remains subject to continuing legislative scrutiny, including efforts by Congress to amend or repeal a number of its provisions. As a result, we cannot predict with any assurance the ultimate effect of the Affordable Care Act on our Company, nor can we provide any assurance that its provisions will not have a material adverse effect on our business, financial condition, results of operations or cash flows.

In addition, the Budget Control Act of 2011 sets forth across-the-board cuts ("sequestrations") to Medicare reimbursement rates for the years 2013 through 2021. This 2% reduction in Medicare reimbursement rates commenced on April 1, 2013 and is not expected to have a material adverse effect on our business, financial condition, results of operations or cash flows.

On July 26, 2013, our board of directors authorized the repurchase of shares of our common stock up to an amount sufficient to offset the dilutive impact from the issuance of shares under our equity programs. The share repurchase program is effective immediately and permits us to make open market purchases from time-to-time based upon general economic and market conditions and trading restrictions.

The following discussion contains forward-looking statements. Please see the Company's most recent Annual Report on Form 10-K, including Item 1A, Risk Factors, for a discussion of the uncertainties, risks and assumptions associated with these forward-looking statements. In addition, please see "Caution Concerning Forward-Looking Statements" below.

Results of Operations

Three Months Ended June 30, 2013 as Compared to Three Months Ended June 30, 2012

Our net patient service revenue increased $79.7 million, or 17.7%, to $529.2 million for the three months ended June 30, 2013, as compared to $449.5 million for the same period in 2012. Of this $79.7 million increase, $72.0 million, or 90.4%, was attributable to revenue generated from acquisitions completed after March 31, 2012. Same-unit net patient service revenue increased $7.7 million, or 1.7%, for the three months ended June 30, 2013. The change in same-unit net patient service revenue was the result of an increase in revenue of $8.8 million, or 2.0%, related to net reimbursement-related factors and a decrease of approximately $1.1 million, or 0.3%, from lower overall patient service volumes. The increase in revenue of $8.8 million related to net reimbursement-related factors was primarily due to continued improvements in managed care contracting and the favorable impact from the parity payments received during the three months ended June 30, 2013. The decrease in revenue of $1.1 million from lower patient service volumes is related to declines in our hospital-based neonatal and anesthesia practices as well as our office-based pediatric cardiology practices, partially offset by increases in our office-based maternal-fetal medicine practices and our hospital-based other pediatric services, primarily newborn nursery services. Same units are those units at which we provided services for the entire current period and the entire comparable period.

Practice salaries and benefits increased $55.9 million, or 20.3%, to $331.9 million for the three months ended June 30, 2013, as compared to $276.0 million for the same period in 2012. This $55.9 million increase was primarily attributable to increased costs associated with new physicians and other staff to support acquisition-related growth and growth at existing units, of which $48.5 million was related to salaries and $7.4 million was related to benefits and incentive compensation.

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Practice supplies and other operating expenses increased $1.4 million, or 8.1%, to $19.4 million for the three months ended June 30, 2013, as compared to $18.0 million for the same period in 2012. The increase was attributable to practice supply, rent and other costs of $0.8 million related to our acquisitions and $0.6 million at our existing units.

General and administrative expenses include all billing and collection functions and all other salaries, benefits, supplies and operating expenses not specifically related to the day-to-day operations of our physician group practices. General and administrative expenses increased $6.4 million, or 13.3%, to $54.6 million for the three months ended June 30, 2013, as compared to $48.2 million for the same period in 2012, and grew at a rate slower than the rate of revenue growth. The increase of $6.4 million is attributable to the overall growth of the Company including acquisition-related growth. General and administrative expenses as a percentage of net patient service revenue was 10.3% for the three months ended June 30, 2013, as compared to 10.7% for the three months ended June 30, 2012.

Depreciation and amortization expense increased $2.2 million, or 28.4%, to $9.9 million for the three months ended June 30, 2013, as compared to $7.7 million for the same period in 2012. The increase was primarily attributable to the amortization of intangible assets related to acquisitions.

Income from operations increased $13.7 million, or 13.7%, to $113.4 million for the three months ended June 30, 2013, as compared to $99.7 million for the same period in 2012. Our operating margin was 21.4% for the three months ended June 30, 2013, as compared to 22.2% for the same period in 2012. This decrease of 77 basis points was primarily due to the variability in margins due to the mix of practices acquired after December 31, 2012.

We recorded net interest expense of $1.3 million for the three months ended June 30, 2013, as compared to $0.5 million for the same period in 2012. The increase in net interest expense was primarily due to higher average borrowings, an increase in accretion related to our contingent consideration liabilities and an increase in commitment fees related to our $800 million amended and restated revolving credit facility ("Line of Credit"). Interest expense for the three months ended June 30, 2013 and 2012, consisted primarily of interest charges, commitment fees and amortized debt costs related to our Line of Credit and accretion expense related to our contingent consideration liabilities.

Our effective income tax rate was 38.3% for the three months ended June 30, 2013, as compared to 39.0% for the three months ended June 30, 2012.

Net income increased by 14.3% to $69.2 million for the three months ended June 30, 2013, as compared to $60.5 million for the same period in 2012.

Diluted net income per common and common equivalent share was $1.37 on weighted average shares outstanding of 50.5 million for the three months ended June 30, 2013, as compared to $1.22 on weighted average shares outstanding of 49.5 million for the same period in 2012.

  Six Months Ended June 30, 2013 as Compared to Six Months Ended June 30, 2012

Our net patient service revenue increased $159.7 million, or 18.3%, to $1.03 billion for the six months ended June 30, 2013, as compared to $872.1 million for the same period in 2012. Of this $159.7 million increase, $142.4 million, or 89.1%, was attributable to revenue generated from acquisitions completed after December 31, 2011. Same-unit net patient service revenue increased $17.3 million, or 2.0%, for the six months ended June 30, 2013. The change in same-unit net patient service revenue was the result of an increase of approximately $18.2 million, or 2.1%, related to net reimbursement-related factors, partially offset by a decrease in revenue of $0.9 million, or 0.1%, from lower overall patient service volumes. The increase in revenue of $18.2 million related to net reimbursement-related factors was primarily due to continued modest improvements in managed care contracting and the flow through of revenue from moderate price increases, partially offset by a decrease in revenue caused by an increase in the percentage of our patients being enrolled in government-sponsored programs. The decrease in revenue of $0.9 million from lower patient service volumes is related to declines in our hospital-based neonatal and anesthesia practices as well as our office-based pediatric cardiology practices, partially offset by an increase in our hospital-based other pediatric physician services, primarily newborn nursery services, and our office-based maternal-fetal medicine practices. Same units are those units at which we provided services for the entire current period and the entire comparable period.

Practice salaries and benefits increased $112.9 million, or 20.6%, to $661.1 million for the six months ended June 30, 2013, as compared to $548.2 million for the same period in 2012. This $112.9 million increase was primarily attributable to increased costs associated with new physicians and other staff to support acquisition-related growth and growth at existing units, of which $95.1 million was related to salaries and $17.8 million was related to benefits and incentive compensation.

Practice supplies and other operating expenses increased $4.0 million, or 11.4%, to $38.9 million for the six months ended June 30, 2013, as compared to $34.9 million for the same period in 2012. The increase was attributable to practice supply, rent and other costs of $2.3 million related to our acquisitions and $1.7 million at our existing units.

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General and administrative expenses include all billing and collection functions and all other salaries, benefits, supplies and operating expenses not specifically related to the day-to-day operations of our physician group practices. General and administrative expenses increased $12.8 million, or 13.5%, to $107.9 million for the six months ended June 30, 2013, as compared to $95.1 million for the same period in 2012. This increase of $12.8 million is attributable to the overall growth of the Company, including acquisition-related growth. General and administrative expenses as a percentage of net patient service revenue was 10.5% for the six months ended June 30, 2013, as compared to 10.9% for the six months ended June 30, 2012, and grew at a rate slower than the rate of revenue growth.

Depreciation and amortization expense increased $4.2 million, or 28.5%, to $19.0 million for the six months ended June 30, 2013, as compared to $14.8 million for the same period in 2012. The increase was primarily attributable to the amortization of intangible assets related to acquisitions and the depreciation of fixed asset additions.

Income from operations increased $25.8 million, or 14.4%, to $204.9 million for the six months ended June 30, 2013, as compared to $179.1 million for the same period in 2012. Our operating margin decreased to 19.9% for the six months ended June 30, 2013, as compared to 20.5% for the same period in 2012. This decrease of 68 basis points was primarily due to the variability in margins due to the mix of practices acquired after December 31, 2011.

We recorded net interest expense of $2.1 million for the six months ended June 30, 2013, as compared to $0.6 million for the same period in 2012. The increase in net interest expense was primarily due to higher average borrowings, an increase in commitment fees related to our Line of Credit, and an increase in accretion related to our contingent consideration liabilities. Interest expense for the six months ended June 30, 2013 and 2012, consisted primarily of interest charges, commitment fees and amortized debt costs related to our Line of Credit and accretion expense.

Our effective income tax rate was 38.6% for the six months ended June 30, 2013, as compared to 39.0% for the same period in 2012.

Net income increased by 14.4% to $124.6 million for the six months ended June 30, 2013, as compared to $108.9 million for the same period in 2012.

Diluted net income per common and common equivalent share was $2.47 on weighted average shares outstanding of 50.5 million for the six months ended June 30, 2013, as compared to $2.20 on weighted average shares outstanding of 49.5 million for the same period in 2012.

Liquidity and Capital Resources

As of June 30, 2013, we had $13.2 million of cash and cash equivalents on hand as compared to $21.3 million at December 31, 2012. In addition, we had working capital of $154.9 million at June 30, 2013, an increase of $64.2 million from working capital of $90.7 million at December 31, 2012. This net increase in working capital is primarily due to year-to-date earnings, proceeds from the issuance of common stock under our stock incentive and stock purchase plans and net borrowings on our Line of Credit, partially offset by the use of funds for practice acquisitions and contingent purchase price payments as well as the purchase of investments.

Our net cash provided from operating activities was $108.8 million for the six months ended June 30, 2013, as compared to net cash provided from operating activities of $85.0 million for the same period in 2012. This net improvement of $23.8 million for the six months ended June 30, 2013 is primarily due to: (i) improved operating results and (ii) a net increase in cash flow related to changes in our income tax accounts, partially offset by (iii) a net decrease in cash flow related to higher accounts receivable balances, primarily due to recent acquisitions.

During the six months ended June 30, 2013, accounts receivable increased by $21.7 million, as compared to an increase of $10.5 million for the same period in 2012. The net change in the increase of accounts receivable is due to increases in accounts receivable related to recent acquisitions, partially offset by improvements in cash collections at existing units.

Our accounts receivable are principally due from managed care payors, government payors, and other third-party insurance payors. We track our collections from these sources, monitor the age of our accounts receivable, and make all reasonable efforts to collect outstanding accounts receivable through our systems, processes and personnel at our corporate and regional billing and collection offices. We use customary collection practices, including the use of outside collection agencies, for accounts receivable due from private pay patients when appropriate. Almost all of our accounts receivable adjustments consist of contractual adjustments due to the difference between gross amounts billed and the amounts allowed by our payors. Any amounts written off related to private pay patients are based on the specific facts and circumstances related to each individual patient account.

Days sales outstanding ("DSO") is one of the key factors that we use to evaluate the condition of our accounts receivable and the related allowances for contractual adjustments and uncollectibles. DSO reflects the timeliness of cash collections on billed revenue and the level of reserves on outstanding accounts receivable. Our DSO improved to 46.4 days at June 30, 2013 as compared to 48.4 days at December 31, 2012, primarily as a result of improvements in cash collections at existing units.

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During the six months ended June 30, 2013, our net cash used in investing activities of $139.0 million included physician practice acquisition payments and contingent purchase price payments of $116.9 million, net purchases of $12.7 million related to the purchase and maturity of investments and purchases of capital expenditures of $9.3 million. Our acquisition payments were primarily related to the purchase of three anesthesiology practices and two neonatology practices. Our capital expenditures were for medical equipment, leasehold and other improvements, computer and office equipment, software and furniture and fixtures at our office-based practices and our corporate and regional offices. Under the current accounting guidance for business combinations, payments of contingent consideration liabilities related to acquisitions completed prior to January 1, 2009 are presented as cash flows from investing activities. Payments of contingent consideration liabilities related to acquisitions completed after January 1, 2009 are presented as cash flows from financing activities.

During the six months ended June 30, 2013, our net cash provided from financing activities of $22.0 million consisted primarily of proceeds from the exercise of employee stock options and the issuance of common stock under our stock purchase plans of $10.2 million, net borrowings on our Line of Credit of $9.8 million, and excess tax benefits related to the vesting of restricted stock and deferred stock and the exercise of employee stock options of $7.8 million, partially offset by the payment of $5.7 million for contingent consideration liabilities.

Our Line of Credit, which is guaranteed by substantially all of our subsidiaries and affiliated professional contractors, includes (1) a $75 million sub-facility for the issuance of letters of credit and (2) a $37.5 million sub-facility for swingline loans. The Line of Credit may be increased from $800.0 million up to $1.0 billion, subject to the satisfaction of specified conditions. At our option, borrowings under the Line of Credit (other than swingline loans) bear interest at (1) the alternate base rate (defined as the highest of (i) the Wells Fargo Bank, National Association prime rate, (ii) the Federal Funds Rate plus 1/2 of 1.00% and (iii) one month LIBOR plus 1.00%) or (2) the LIBOR rate, as defined in the Line of Credit, plus an applicable margin rate ranging from 0.125% to 0.750% for alternate base rate borrowings and 1.125% to 1.750% for LIBOR rate borrowings, in each case based on our consolidated leverage ratio. Swingline loans bear interest at the alternate base rate plus the applicable margin rate. We are subject to certain covenants and restrictions specified in the Line of Credit, including covenants that require us to maintain a minimum fixed charge coverage ratio and not to exceed a specified consolidated leverage ratio, to comply with laws, and restrict us from paying dividends and making certain other distributions, as specified therein. Failure to comply with these covenants would constitute an event of default under the Line of Credit, notwithstanding our ability to meet our debt service obligations. The Line of Credit includes various customary remedies for the lenders following an event of default.

At June 30, 2013, we had an outstanding principal balance of $153.8 million on our Line of Credit. We had outstanding letters of credit associated with our professional liability insurance program of $5.3 million which reduced the amount available on our Line of Credit to $640.9 million at June 30, 2013. At June 30, 2013, we believe we were in compliance, in all material respects, with the financial covenants and other restrictions applicable to us under our Line of Credit. We believe we will be in compliance with these covenants throughout 2013.

We maintain professional liability insurance policies with third-party insurers, subject to self-insured retention, exclusions and other restrictions. We self-insure our liabilities to pay self-insured retention amounts under our professional liability insurance coverage through a wholly owned captive insurance subsidiary. We record liabilities for self-insured amounts and claims incurred but not reported based on an actuarial valuation using historical loss information, claim emergence patterns and various actuarial assumptions. Our total liability related to professional liability risks at June 30, 2013 was $150.3 million, of which $18.8 million is classified as a current liability within accounts payable and accrued expenses in the Condensed Consolidated Balance Sheet.

We anticipate that funds generated from operations, together with our current cash on hand and funds available under our Line of Credit, will be sufficient to finance our working capital requirements, fund anticipated acquisitions and capital expenditures, fund our share repurchase program and meet our contractual obligations for at least the next 12 months.

Caution Concerning Forward-Looking Statements

Certain information included or incorporated by reference in this Quarterly Report may be deemed to be "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements may include, but are not limited to, statements relating to our objectives, plans and strategies, and all statements (other than statements of historical facts) that address activities, events or developments that we intend, expect, project, believe or anticipate will or may occur in the future are forward-looking statements. These statements are often characterized by terminology such as "believe," "hope," "may," "anticipate," "should," "intend," "plan," "will," "expect," "estimate," "project," "positioned," "strategy" and similar expressions and are based on assumptions and assessments made by our management in light of their experience and their perception of historical trends, current conditions, expected future developments and other factors they believe to be appropriate. Any forward-looking statements in this Quarterly Report are made as of the date hereof, and we undertake no duty to update or revise any such statements, whether as a result of new information, future events

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or otherwise. Forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties. Important factors that could cause actual results, developments and business decisions to differ materially from forward-looking statements are described in the Company's most recent Annual Report on Form 10-K, including the section entitled "Risk Factors."

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