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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2014

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     .

COMMISSION FILE NUMBER: 333-117362

 

 

IASIS HEALTHCARE LLC

(Exact name of registrant as specified in its charter)

 

 

 

DELAWARE   20-1150104

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

DOVER CENTRE

117 SEABOARD LANE, BUILDING E

FRANKLIN, TENNESSEE

  37067
(Address of principal executive offices)   (Zip Code)

(615) 844-2747

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  ¨    NO  x

        (Note: As a voluntary filer not subject to the filing requirements of Sections 13 or 15(d) of the Exchange Act, the registrant has filed all reports pursuant to Section 13 or 15(d) of the Exchange Act during the preceding 12 months as if it were subject to such filing requirements.)

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES  x    NO  ¨

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

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES  ¨    NO  x

As of February 12, 2015, 100% of the registrant’s common interests outstanding (all of which are privately owned and are not traded on any public market) were owned by IASIS Healthcare Corporation, its sole member.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

PART I. FINANCIAL INFORMATION

  3   

Item 1. Financial Statements

  3   

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

  29   

Item 3. Quantitative and Qualitative Disclosures about Market Risk

  45   

Item 4. Controls and Procedures

  46   

PART II. OTHER INFORMATION

  46   

Item 1. Legal Proceedings

  46   

Item 1A. Risk Factors

  47   

Item 6. Exhibits

  71   

Signatures

  72   

 

2


Table of Contents

PART I.

FINANCIAL INFORMATION

Item 1. Financial Statements

IASIS HEALTHCARE LLC

CONDENSED CONSOLIDATED BALANCE SHEETS

(In Thousands)

 

     December 31,
2014
     September 30,
2014
 
     (Unaudited)         
ASSETS      

Current assets

     

Cash and cash equivalents

   $ 294,838       $ 341,180   

Accounts receivable, net

     317,137         305,654   

Inventories

     59,577         57,632   

Deferred income taxes

     —           2,523   

Prepaid expenses and other current assets

     228,616         235,155   

Assets held for sale

     48,354         50,151   
  

 

 

    

 

 

 

Total current assets

  948,522      992,295   

Property and equipment, net

  827,038      826,478   

Goodwill

  817,933      814,498   

Other intangible assets, net

  22,511      23,331   

Other assets, net

  63,002      62,362   
  

 

 

    

 

 

 

Total assets

$ 2,679,006    $ 2,718,964   
  

 

 

    

 

 

 
LIABILITIES AND EQUITY

Current liabilities

Accounts payable

$ 116,477    $ 127,953   

Salaries and benefits payable

  53,840      71,121   

Accrued interest payable

  9,849      28,820   

Deferred income taxes

  1,442      —     

Medical claims payable

  90,420      79,449   

Other accrued expenses and current liabilities

  62,390      73,497   

Current portion of long-term debt, capital leases and other obligations

  12,142      12,690   

Liabilities held for sale

  6,450      9,171   
  

 

 

    

 

 

 

Total current liabilities

  353,010      402,701   

Long-term debt, capital leases and other obligations

  1,838,474      1,841,110   

Deferred income taxes

  108,381      100,868   

Other long-term liabilities

  115,620      117,289   

Non-controlling interests with redemption rights

  108,195      108,156   

Equity

Member’s equity

  145,656      139,164   

Non-controlling interests

  9,670      9,676   
  

 

 

    

 

 

 

Total equity

  155,326      148,840   
  

 

 

    

 

 

 

Total liabilities and equity

$ 2,679,006    $ 2,718,964   
  

 

 

    

 

 

 

See accompanying notes.

 

 

3


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IASIS HEALTHCARE LLC

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(In Thousands)

 

     Quarter Ended
December 31,
 
     2014     2013  

Revenues

    

Acute care revenue before provision for bad debts

   $ 553,916      $ 537,874   

Less: Provision for bad debts

     (89,352     (93,703
  

 

 

   

 

 

 

Acute care revenue

  464,564      444,171   

Premium and service revenues

  222,101      151,719   
  

 

 

   

 

 

 

Total revenue

  686,665      595,890   

Costs and expenses

Salaries and benefits (includes stock-based compensation of $1,539 and $861, respectively)

  229,730      214,266   

Supplies

  80,051      76,792   

Medical claims

  175,972      125,820   

Rentals and leases

  18,709      18,453   

Other operating expenses

  113,221      100,557   

Medicare and Medicaid EHR incentives

  (3,415   (3,278

Interest expense, net

  32,363      33,144   

Depreciation and amortization

  22,631      25,722   

Management fees

  1,250      1,250   
  

 

 

   

 

 

 

Total costs and expenses

  670,512      592,726   

Earnings from continuing operations before gain (loss) on disposal of assets and income taxes

  16,153      3,164   

Gain (loss) on disposal of assets, net

  (848   1,242   
  

 

 

   

 

 

 

Earnings from continuing operations before income taxes

  15,305      4,406   

Income tax expense

  6,405      2,477   
  

 

 

   

 

 

 

Net earnings from continuing operations

  8,900      1,929   

Earnings (loss) from discontinued operations, net of income taxes

  (1,500   7,061   
  

 

 

   

 

 

 

Net earnings

  7,400      8,990   

Net earnings attributable to non-controlling interests

  (2,287   (3,788
  

 

 

   

 

 

 

Net earnings attributable to IASIS Healthcare LLC

$ 5,113    $ 5,202   
  

 

 

   

 

 

 

See accompanying notes.

 

4


Table of Contents

IASIS HEALTHCARE LLC

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

(In Thousands)

 

     Quarter Ended
December 31,
 
     2014     2013  

Net earnings

   $ 7,400      $ 8,990   

Other comprehensive income

    

Change in fair value of highly effective interest rate hedges

     407        424   
  

 

 

   

 

 

 

Other comprehensive income before income taxes

  407      424   

Change in income tax expense

  (148   (158
  

 

 

   

 

 

 

Other comprehensive income, net of income taxes

  259      266   
  

 

 

   

 

 

 

Comprehensive income

  7,659      9,256   

Net earnings attributable to non-controlling interests

  (2,287   (3,788
  

 

 

   

 

 

 

Comprehensive income attributable to IASIS Healthcare LLC

$ 5,372    $ 5,468   
  

 

 

   

 

 

 

See accompanying notes.

 

5


Table of Contents

IASIS HEALTHCARE LLC

CONDENSED CONSOLIDATED STATEMENT OF EQUITY (UNAUDITED)

(In Thousands)

 

     Non-controlling
Interests with
Redemption
Rights
    Member’s
Equity
    Non-
controlling
Interests
    Total Equity  

Balance at September 30, 2014

   $ 108,156      $ 139,164      $ 9,676      $ 148,840   

Net earnings

     2,293        5,113        (6     5,107   

Distributions to non-controlling interests

     (1,853     —          —          —     

Sale of non-controlling interests

     39        —          —          —     

Stock-based compensation

     —          1,539        —          1,539   

Other comprehensive income

     —          259        —          259   

Other

     (859     —          —          —     

Adjustment to redemption value of non-controlling interests with redemption rights

     419        (419     —          (419
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2014

$ 108,195    $ 145,656    $ 9,670    $ 155,326   
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes.

 

6


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IASIS HEALTHCARE LLC

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In Thousands)

 

     Quarter Ended
December 31,
 
     2014     2013  

Cash flows from operating activities

    

Net earnings

   $ 7,400      $ 8,990   

Adjustments to reconcile net earnings to net cash used in operating activities:

    

Depreciation and amortization

     22,631        25,722   

Amortization of loan costs

     1,971        1,853   

Amortization of deferred gain on sale-leaseback

     (624     —     

Change in physician minimum revenue guarantees

     827        599   

Stock-based compensation

     1,539        861   

Deferred income taxes

     10,273        171   

Loss (gain) on disposal of assets, net

     848        (1,242

Loss (earnings) from discontinued operations, net

     1,500        (7,061

Changes in operating assets and liabilities, net of the effect of acquisitions and dispositions:

    

Accounts receivable, net

     (11,810     (12,504

Inventories, prepaid expenses and other current assets

     3,167        (5,518

Accounts payable, other accrued expenses and other accrued liabilities

     (48,965     (50,818

Income taxes and other transaction costs payable related to sale-leaseback of real estate

     —          (22,270
  

 

 

   

 

 

 

Net cash used in operating activities — continuing operations

  (11,243   (61,217

Net cash used in operating activities — discontinued operations

  (234   (12,085
  

 

 

   

 

 

 

Net cash used in operating activities

  (11,477   (73,302
  

 

 

   

 

 

 

Cash flows from investing activities

Purchases of property and equipment

  (23,410   (10,883

Cash paid for acquisitions, net

  (3,900   (1,038

Cash paid in sale-leaseback of real estate

  —        (3,100

Proceeds from sale of assets

  265      425   

Change in other assets, net

  (2,100   (2,436
  

 

 

   

 

 

 

Net cash used in investing activities — continuing operations

  (29,145   (17,032

Net cash provided by (used in) investing activities — discontinued operations

  (340   691   
  

 

 

   

 

 

 

Net cash used in investing activities

  (29,485   (16,341
  

 

 

   

 

 

 

Cash flows from financing activities

Payment of long-term debt, capital leases and other obligations

  (3,560   (3,450

Distributions to non-controlling interests

  (1,853   (8,367

Cash received for the sale of non-controlling interests

  39      —     
  

 

 

   

 

 

 

Net cash used in financing activities — continuing operations

  (5,374   (11,817

Net cash used in financing activities — discontinued operations

  (6   (58
  

 

 

   

 

 

 

Net cash used in financing activities

  (5,380   (11,875
  

 

 

   

 

 

 

Change in cash and cash equivalents

  (46,342   (101,518

Cash and cash equivalents at beginning of period

  341,180      438,131   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

$ 294,838    $ 336,613   
  

 

 

   

 

 

 

Supplemental disclosure of cash flow information:

Cash paid for interest

$ 50,116    $ 48,787   
  

 

 

   

 

 

 

Cash paid (received) for income taxes, net

$ (162 $ 35,088   
  

 

 

   

 

 

 

See accompanying notes.

 

7


Table of Contents

IASIS HEALTHCARE LLC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. ORGANIZATION AND BASIS OF PRESENTATION

The unaudited condensed consolidated financial statements as of and for the quarters ended December 31, 2014 and 2013, reflect the financial position, results of operations and cash flows of IASIS Healthcare LLC (“IASIS” or the “Company”). The Company’s sole member and parent company is IASIS Healthcare Corporation (“Holdings” or “IAS”).

IASIS provides high quality affordable healthcare services primarily in higher growth markets. At December 31, 2014, the Company owned or leased 16 acute care hospital facilities and one behavioral health hospital facility, with a total of 3,781 licensed beds, several outpatient service facilities and 138 physician clinics. On September 26, 2014, the Company approved and committed to a plan to dispose of its Nevada operations, which includes one hospital in the Las Vegas area and related physician operations. Accordingly, the Company’s Nevada operations have been included in discontinued operations in these consolidated financial statements for all periods presented. On January 22, 2015, the Company closed the sale of its Nevada operations. As part of continuing operations, the Company owned or leased 15 acute care hospital facilities and one behavioral health hospital facility with a total of 3,604 licensed beds, several outpatient service facilities and 136 physician clinics as of December 31, 2014.

IASIS’ continuing operations are in various regions including:

 

    Salt Lake City, Utah;

 

    Phoenix, Arizona;

 

    five cities in Texas, including Houston and San Antonio; and

 

    West Monroe, Louisiana.

The Company also owns and operates Health Choice Arizona, Inc. and related entities (“Health Choice” or the “Plan”), a managed care organization and insurer that delivers healthcare services to more than 337,000 members through multiple health plans, accountable care networks and managed care solutions. The Plan is headquartered in Phoenix, Arizona, with offices in Tampa, Florida and Salt Lake City, Utah.

The unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial reporting and in accordance with Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. The condensed consolidated balance sheet of the Company at September 30, 2014, has been derived from the audited consolidated financial statements at that date, but does not include all of the information and notes required by GAAP for complete financial statements. For further information, refer to the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2014, which was filed with the U.S. Securities and Exchange Commission (the “SEC”) on December 8, 2014.

In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all material adjustments (consisting of normal recurring items) necessary for a fair presentation of results for the interim periods presented. The results of operations for any interim period are not necessarily indicative of results for the full year or any other future periods.

Principles of Consolidation

The unaudited condensed consolidated financial statements include all subsidiaries and entities under common control of the Company. Control is generally defined by the Company as ownership of a majority of the voting interest of an entity. In addition, control is demonstrated in most instances when the Company is the sole general partner in a limited partnership. Significant intercompany transactions have been eliminated.

Use of Estimates

The preparation of the financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the accompanying unaudited condensed consolidated financial statements and notes. Actual results could differ from those estimates.

 

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Table of Contents

Reclassifications

As a result of discontinued operations, certain prior year amounts have been reclassified to conform to the current year presentation. These reclassifications have no impact on the Company’s total assets or total liabilities and equity.

General and Administrative

The majority of the Company’s expenses are “cost of revenue” items. Costs that could be classified as “general and administrative” by the Company include the IASIS corporate office costs (excluding stock-based compensation costs), which were $14.4 million and $12.3 million for the quarters ended December 31, 2014 and 2013, respectively.

Cash and Cash Equivalents

The Company considers highly liquid investments with original maturities of three months or less to be cash equivalents. The Company maintains its cash and cash equivalents balances primarily with high credit quality financial institutions. The Company manages its credit exposure by placing its investments in U.S. Treasury securities or other high quality securities, and by periodically evaluating the relative credit standing of the financial institution.

As discussed in Note 3, cash generated from certain asset dispositions may be subject to prepayment requirements under our senior credit agreement and indenture.

Stock-Based Compensation

Although IASIS has no stock option plan or outstanding stock options, the Company, through its parent, IAS, grants stock options for a fixed number of common shares and restricted stock units (“RSUs”) to its employees. The Company accounts for these stock-based incentive awards under the measurement and recognition provisions of Accounting Standards Codification (“ASC”) 718, Compensation—Stock Compensation (“ASC 718”). Accordingly, the Company applies the fair value recognition provisions requiring all share-based payments to employees, including grants of employee stock options and RSUs, to be measured based on the grant-date fair value of the awards, with the resulting expense recognized in the income statement. In accordance with the provisions of ASC 718, the Company uses the Black-Scholes-Merton valuation model in determining the fair value of its share-based payments. Compensation cost for time-vested options and RSUs will generally be amortized on a straight-line basis over the requisite service periods of the awards, generally equal to the awards’ vesting periods, while compensation cost for options with market-based conditions are recognized on a graded schedule generally over the awards’ vesting periods.

Fair Value of Financial Instruments

The Company applies the provisions of ASC 820, Fair Value Measurements and Disclosures (“ASC 820”), which provides a single definition of fair value, establishes a framework for measuring fair value, and expands disclosures concerning fair value measurements. The Company applies these provisions to the valuation and disclosure of certain financial instruments. ASC 820 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: (i) Level 1, which is defined as quoted prices in active markets that can be accessed at the measurement date; (ii) Level 2, which is defined as inputs other than quoted prices in active markets that are observable, either directly or indirectly; and (iii) Level 3, which is defined as unobservable inputs resulting from the existence of little or no market data, therefore potentially requiring an entity to develop its own assumptions.

Cash and cash equivalents, accounts receivable, inventories, prepaid expenses and other current assets, accounts payable, salaries and benefits payable, accrued interest, medical claims payable, and other accrued expenses and current liabilities are reflected in the accompanying consolidated financial statements at amounts that approximate fair value because of the short-term nature of these instruments. The fair value of the Company’s capital leases and other long-term financing obligations also approximate their carrying value as they bear interest at current market rates.

 

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The carrying value and fair value of the Company’s senior secured term loan facility and its 8.375% senior notes due 2019 (the “Senior Notes”) as of December 31, 2014 and September 30, 2014, were as follows (in thousands):

 

     Carrying Amount      Fair Value  
     December 31,
2014
     September 30,
2014
     December 31,
2014
     September 30,
2014
 

Senior secured term loan facility

   $ 984,481       $ 986,815       $ 980,753       $ 987,589   

Senior Notes

     846,571         846,479         898,769         893,563   

The estimated fair value of the Company’s senior secured term loan facility and its Senior Notes were based upon quoted market prices at that date and are categorized as Level 2 within the fair value hierarchy.

The Company determines the fair value of its interest rate hedges in a manner consistent with that used by market participants in pricing hedging instruments, which includes using a discounted cash flow analysis based upon the terms of the agreements, the impact of the forward LIBOR curve and an evaluation of credit risk. Given the use of observable market assumptions and the consideration of credit risk, the Company has categorized the valuation of its interest rate hedges as Level 2.

Discontinued Operations

The following table provides the components of discontinued operations (in thousands):

 

     Quarter Ended
December 31,
 
     2014      2013  

Acute care revenue less provision for bad debts

   $ 23,172       $ 11,388   

Earnings (loss) before income taxes

     (2,157      11,300   

Income tax benefit (expense) from discontinued operations

     657         (4,239
  

 

 

    

 

 

 

Earnings (loss) from discontinued operations, net of income taxes

$ (1,500 $ 7,061   
  

 

 

    

 

 

 

Effective October 1, 2013, the Company completed the sale of its Florida operations which primarily included three hospitals in the Tampa-St. Petersburg area and all related physician operations. Accordingly, the operating results and cash flows of the Florida operations are reported as discontinued operations for all periods presented. The aggregate proceeds from the sale were $144.8 million, which resulted in a gain on the sale of assets totaling $22.2 million during the quarter ended December 31, 2013. This gain was included in discontinued operations for the quarter ended December 31, 2013.

On September 26, 2014, the Company approved and committed to a plan to dispose of its Nevada operations, which included one hospital in the Las Vegas area and all related physician operations. Accordingly, the operating results and cash flows of the Nevada operations are reported as discontinued operations for all periods presented. The sale of the Company’s Nevada operations closed January 22, 2015. A loss totaling $7.9 million related to the fair value of long-lived assets was recognized on the sale of the Company’s Nevada operations, of which $7.5 million was recognized in the fourth quarter of September 30, 2014. Proceeds received from the sale were $41.8 million, and are subject to a final working capital settlement at a future date. No additional gains or losses are anticipated in connection with the closing of the transaction.

The following table provides the components of assets and liabilities held for sale (in thousands):

 

     December 31,
2014
     September 30,
2014
 

Accounts receivable, net

   $ 20,244       $ 21,651   

Inventories

     2,418         2,737   

Prepaid expenses and other current assets

     692         763   

Property and equipment, net

     25,000         25,000   
  

 

 

    

 

 

 

Assets held for sale

$ 48,354    $ 50,151   
  

 

 

    

 

 

 

Accounts payable

$ 4,730    $ 5,736   

Salaries and benefits payable

  1,194      2,898   

Other accrued expenses and current liabilities

  296      300   

Current portion of long-term debt, capital leases and other obligations

  65      64   

Long-term debt, capital leases and other obligations

  165      173   
  

 

 

    

 

 

 

Liabilities held for sale

$ 6,450    $ 9,171   
  

 

 

    

 

 

 

 

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Recent Accounting Pronouncements

Recently Issued

In April 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-08, “Presentation of Financial Statements and Property, Plant, and Equipment—Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity” (“ASU 2014-08”). Among other provisions and in addition to expanded disclosures, ASU 2014-08 changes the definition of what components of an entity qualify for discontinued operations treatment and reporting from a reportable segment, operating segment, reporting unit, subsidiary or asset group to only those components of an entity that represent a strategic shift that has, or will have, a major effect on an entity’s operations and financial results. Additionally, ASU 2014-08 requires disclosure about a disposal of an individually significant component of an entity that does not qualify for discontinued operations presentation in the financial statements, including the pretax profit or loss attributable to the component of an entity for the period in which it is disposed of or is classified as held for sale. The disclosure of this information is required for all of the same periods that are presented in the entity’s results of operations for the period. The provisions of ASU 2014-08 are effective prospectively for all disposals or classifications as held for sale of components of an entity that occur within annual periods beginning on or after December 15, 2014, and interim periods within those years. Early adoption is permitted. The Company has not yet adopted ASU 2014-08.

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers” (“ASU 2014-09”), which outlines a single comprehensive model for recognizing revenue and supersedes most existing revenue recognition guidance, including guidance specific to the healthcare industry. In addition, ASU 2014-09 will require new and enhanced disclosures. Companies can adopt the new standard either using the full retrospective approach, a modified retrospective approach with practical expedients, or a cumulative effect upon adoption approach. ASU 2014-09 will become effective for annual and interim reporting periods beginning after December 15, 2016. Early adoption is not permitted. The Company is currently evaluating the effect of the new revenue recognition guidance.

2. REVENUE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS

Acute Care Revenue and Accounts Receivable

The Company’s healthcare facilities have entered into agreements with third-party payors, including government programs (Medicare, Medicaid and TRICARE), managed care health plans, including Medicare and Medicaid managed health plans, commercial insurance companies and employers under which the facilities are paid based upon established charges, the cost of providing services, predetermined rates per diagnosis, fixed per diem rates or discounts from established charges. Additionally, the Company offers discounts through its uninsured discount program to all uninsured patients receiving healthcare services who do not qualify for assistance under state Medicaid, other federal or state assistance plans, or charity care.

Acute care revenue is reported at the estimated net realizable amounts from third-party payors and others for services rendered, including estimated retroactive adjustments under reimbursement agreements with third-party payors. Retroactive adjustments are accrued on an estimated basis in the period the related services are rendered and are adjusted, if necessary, in future periods when final settlements are determined. The Company also records a provision for bad debts related to uninsured accounts, as well as co-insurance and deductible balances due from insured patients, to reflect its self-pay accounts receivable at the estimated amounts expected to be collected. The sources of the Company’s hospital net patient revenue by payor before its provision for bad debts are summarized as follows:

 

     Quarter Ended
December 31,
 
     2014     2013  

Medicare

     19.0     20.0

Managed Medicare

     9.8     10.5

Medicaid and managed Medicaid

     13.3     11.5

Managed care and other

     42.3     41.7

Self-pay

     15.6     16.3
  

 

 

   

 

 

 

Total

  100.0   100.0
  

 

 

   

 

 

 

 

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Allowance For Doubtful Accounts

The provision for bad debts and the associated allowance for doubtful accounts relate primarily to amounts due directly from patients. The Company does not pursue collection of amounts related to patients who qualify for charity care under the Company’s guidelines; therefore, charity care accounts are deducted from gross revenue and are not included in the provision for bad debts.

The Company’s estimation of its allowance for doubtful accounts is based primarily upon the type and age of the patient accounts receivable and the effectiveness of related collection efforts. The Company’s policy is to reserve a portion of all self-pay receivables, including amounts due from the uninsured and amounts related to co-payments and deductibles, as these charges are recorded. The Company monitors accounts receivable balances and the effectiveness of reserve policies on a regular basis and reviews various analytics to support the basis for its estimates. These efforts primarily consist of reviewing the following:

 

    Cash collections as a percentage of net patient revenue less bad debts;

 

    Changes in the aging and payor mix of accounts receivable, including increased focus on accounts due from the uninsured and accounts that represent co-payments and deductibles due from patients;

 

    Revenue and volume trends by payor, particularly the self-pay components;

 

    Trending of days revenue in accounts receivable;

 

    Various allowance coverage statistics; and

 

    Historical write-off and collection experience using a hindsight or look-back approach.

The Company performs hindsight procedures to evaluate historical write-off and collection experience throughout the year to assist in determining the reasonableness of the process for estimating the allowance for doubtful accounts. The Company does not pursue collection of amounts related to patients who qualify for charity care under the Company’s guidelines. Charity care accounts are deducted from gross revenue and do not affect the provision for bad debts.

At December 31, 2014 and September 30, 2014, the Company’s net self-pay receivables, including amounts due from uninsured patients and co-payment and deductible amounts due from insured patients, were $256.9 million and $264.6 million, respectively. At December 31, 2014 and September 30, 2014, the Company’s allowance for doubtful accounts was $212.9 million and $220.8 million, respectively.

Premium and Service Revenues

Health Choice is the Company’s managed care organization and insurer that serves health plan enrollees in Arizona and Utah. The Plan derives most of its revenue through a contract in Arizona with the Arizona Health Care Cost Containment System (“AHCCCS”) to provide specified health services to qualified Medicaid enrollees through contracted providers. AHCCCS is the state agency that administers Arizona’s Medicaid program.

Effective October 1, 2013, Health Choice entered into a contract with AHCCCS with an initial term of three years, and two one-year renewal options at the discretion of AHCCCS. The contract is terminable without cause on 90 days’ written notice or for cause upon written notice if the Company fails to comply with any term or condition of the contract or fails to take corrective action as required to comply with the terms of the contract. Additionally, AHCCCS can terminate the contract in the event of the unavailability of state or federal funding.

Health Choice also provides coverage as a Medicare Advantage Prescription Drug (“MAPD”) Special Needs Plan (“SNP”) provider pursuant to a contract with the Centers for Medicare and Medicaid Services (“CMS”). The SNP allows Health Choice to offer Medicare and Part D drug benefit coverage for new and existing dual-eligible members (i.e. those that are eligible for Medicare and Medicaid). The contract with CMS includes successive one-year renewal options at the discretion of CMS and is terminable without cause on 90 days’ written notice or for cause upon written notice if the Company fails to comply with any term or condition of the contract or fails to take corrective action as required to comply with the terms of the contract. Health Choice has received notification that CMS has exercised its option to extend its contract through December 31, 2015.

 

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In Arizona and surrounding states, the Plan subcontracts with hospitals, physicians and other medical providers to provide services to its Medicaid and Medicare enrollees in Apache, Coconino, Gila, Maricopa, Mohave, Navajo, Pima and Pinal counties, regardless of the actual costs incurred to provide these services.

The Plan’s contracts require the arrangement of healthcare services for enrolled patients in exchange for fixed monthly premiums, based upon negotiated per capita member rates. Capitation payments received by Health Choice are recognized as revenue in the month that members are entitled to healthcare services. The Plan receives reinsurance and other supplemental payments from AHCCCS for healthcare costs that exceed stated amounts at a rate ranging from 75% to 100% of qualified healthcare costs in excess of stated levels of up to $35,000 per claim, depending on the eligibility classification of the member. Qualified costs must be incurred during the contract year and are the lesser of the amount paid by the Plan or the AHCCCS fee schedule. Reinsurance recoveries are recognized under the contract with AHCCCS when healthcare costs exceed stated amounts as provided under the contract, including estimates of such costs at the end of each accounting period.

On March 10, 2014, Health Choice entered into a contract with a large national insurer to serve as a management services organization (“MSO”) to Medicaid enrollees in two separate geographic areas in the state of Florida. Under this contract, which covers 88,300 Medicaid enrollees, Health Choice receives an administrative fee based upon the number of members served.

The sources of Health Choice’s premium and service revenues by major product line are summarized as follow:

 

     Quarter Ended
December 31,
 
     2014     2013  

Medicaid and Medicaid MSO

     86.7     89.1

MAPD SNP

     13.0        10.9   

Other

     0.3        —    
  

 

 

   

 

 

 

Total

  100.0   100.0
  

 

 

   

 

 

 

3. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS

Long-term debt, capital leases and other obligations consists of the following (in thousands):

 

     December 31,
2014
     September 30,
2014
 

Senior secured term loan facility

   $ 984,481       $ 986,815   

Senior Notes

     846,571         846,479   

Capital leases and other obligations

     19,564         20,506   
  

 

 

    

 

 

 
  1,850,616      1,853,800   

Less current maturities

  12,142      12,690   
  

 

 

    

 

 

 
$ 1,838,474    $ 1,841,110   
  

 

 

    

 

 

 

As of December 31, 2014 and September 30, 2014, the senior secured term loan facility balance reflects an original issue discount (“OID”) of $2.4 million and $2.6 million, respectively, which is net of accumulated amortization of $2.7 million and $2.5 million, respectively. The Senior Notes balance reflects an OID of $3.3 million and $3.5 million, respectively, which is net of accumulated amortization of $2.8 million and $2.6 million, respectively.

As of December 31, 2014 and September 30, 2014, capital leases and other obligations includes a financing obligation totaling $10.2 million and $10.4 million, respectively, resulting from the Company’s sale-leaseback transactions.

$1.325 Billion Senior Secured Credit Facilities

The Company is party to a senior credit agreement (the “Amended and Restated Credit Agreement”) for which IAS and certain of the Company’s subsidiaries serve as guarantors. The Amended and Restated Credit Agreement provides for senior secured financing of up to $1.325 billion consisting of (1) a $1.025 billion senior secured term loan facility maturing in May 2018 and (2) a $300.0 million senior secured revolving credit facility maturing in May 2016, of which up to $150.0 million may be utilized for the issuance of letters of credit (together, the “Senior Secured Credit Facilities”). Principal under the senior secured term loan facility is due in consecutive equal quarterly installments in an aggregate annual amount equal to 1% of the principal amount of $1.007 billion outstanding as of the effective date, February 20, 2013, of a repricing amendment, with the remaining balance due upon maturity of the senior secured term loan facility. The senior secured revolving credit facility does not require installment payments prior to maturity.

 

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Borrowings under the senior secured term loan facility (giving effect to a repricing amendment) bear interest at a rate per annum equal to, at the Company’s option, either (1) a base rate (the “base rate”) determined by reference to the highest of (a) the federal funds rate plus 0.50%, (b) the prime rate of Bank of America, N.A. and (c) a one-month LIBOR rate, subject to a floor of 1.25%, plus 1.00%, in each case, plus a margin of 2.25% per annum or (2) the LIBOR rate for the interest period relevant to such borrowing, subject to a floor of 1.25%, plus a margin of 3.25% per annum. Borrowings under the senior secured revolving credit facility generally bear interest at a rate per annum equal to, at the Company’s option, either (1) the base rate plus a margin of 2.50% per annum, or (2) the LIBOR rate for the interest period relevant to such borrowing plus a margin of 3.50% per annum. In addition to paying interest on outstanding principal under the Senior Secured Credit Facilities, the Company is required to pay a commitment fee on the unutilized commitments under the senior secured revolving credit facility, as well as pay customary letter of credit fees and agency fees.

The Senior Secured Credit Facilities are unconditionally guaranteed by IAS and certain subsidiaries of the Company (collectively, the “Credit Facility Guarantors”) and are required to be guaranteed by all future material wholly-owned subsidiaries of the Company, subject to certain exceptions. All obligations under the Amended and Restated Credit Agreement are secured, subject to certain exceptions, by substantially all of the Company’s assets and the assets of the Credit Facility Guarantors, including (1) a pledge of 100% of the equity interests of the Company and the Credit Facility Guarantors, (2) mortgage liens on all of the Company’s material real property and that of the Credit Facility Guarantors, and (3) all proceeds of the foregoing.

The Amended and Restated Credit Agreement requires the Company to mandatorily prepay borrowings under the senior secured term loan facility with net cash proceeds of certain asset dispositions, following certain casualty events, following certain borrowings or debt issuances, and from a percentage of annual excess cash flow.

The Amended and Restated Credit Agreement contains certain restrictive covenants, including, among other things: (1) limitations on the incurrence of debt and liens; (2) limitations on investments other than, among other exceptions, certain acquisitions that meet certain conditions; (3) limitations on the sale of assets outside of the ordinary course of business; (4) limitations on dividends and distributions; and (5) limitations on transactions with affiliates, in each case, subject to certain exceptions. The Amended and Restated Credit Agreement also contains certain customary events of default, including, without limitation, a failure to make payments under the Senior Secured Credit Facilities, cross-defaults, certain bankruptcy events and certain change of control events.

8.375% Senior Notes due 2019

The Company, together with its wholly owned subsidiary IASIS Capital Corporation (together, the “Issuers”), issued $850.0 million aggregate principal amount of Senior Notes, which mature on May 15, 2019, pursuant to an indenture, dated as of May 3, 2011, among the Issuers and certain of the Issuers’ wholly owned domestic subsidiaries that guarantee the Senior Secured Credit Facilities (the “Notes Guarantors”) (the “Indenture”). The Indenture provides that the Senior Notes are general unsecured, senior obligations of the Issuers, and initially will be unconditionally guaranteed on a senior unsecured basis by certain of the Company’s subsidiaries.

On October 31, 2014, the Issuers completed an asset purchase offer for up to $210.0 million aggregate principal amount of the outstanding Senior Notes. The Issuers were required to make the offer to purchase under the terms of the Indenture governing the Senior Notes using excess proceeds from certain asset dispositions. The offer to purchase was made at 100% of the aggregate principal amount of the Senior Notes plus accrued and unpaid interest, to but excluding the redemption date. Holders validly tendered $0.1 million in aggregate principal amount of the Senior Notes, all of which were accepted by the Issuers. The Company made payment to settle all validly tendered Senior Notes on November 6, 2014. At December 31, 2014, the outstanding principal balance of the Senior Notes was $849.9 million.

The Senior Notes bear interest at a rate of 8.375% per annum, payable semi-annually, in cash in arrears, on May 15 and November 15 of each year.

The Issuers may redeem the Senior Notes, in whole or in part, at any time on or after May 15, 2014, at a price equal to 106.281% of the aggregate principal amount of the Senior Notes plus accrued and unpaid interest and special interest, if any, to but excluding the redemption date. Each subsequent year the redemption price declines 2.093 percentage points until 2017, and thereafter, at which point the redemption price is equal to 100% of the aggregate principal amount of the Senior Notes plus accrued and unpaid interest and special interest, if any, to but excluding the redemption date.

The Indenture contains covenants that limit the Company’s (and its restricted subsidiaries’) ability to, among other things: (1) incur additional indebtedness or liens or issue disqualified stock or preferred stock; (2) pay dividends or make other distributions on, redeem or repurchase the Company’s capital stock; (3) sell certain assets; (4) make certain loans and investments; (5) enter into certain transactions with affiliates; (6) impose restrictions on the ability of a subsidiary to pay dividends or make payments or distributions to the Company and its restricted subsidiaries; and (7) consolidate, merge or sell all or substantially all of the Company’s assets. These covenants are subject to a number of important limitations and exceptions.

 

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The Indenture also provides for events of default, which, if any of them occurs, may permit or, in certain circumstances, require the principal, premium, if any, interest and any other monetary obligations on all the then outstanding Senior Notes to be due and payable immediately. If the Company experiences certain kinds of changes of control, it must offer to purchase the Senior Notes at 101% of their principal amount, plus accrued and unpaid interest and special interest, if any, to but excluding the repurchase date. Under certain circumstances, the Company will have the ability to make certain payments to facilitate a change of control transaction and to provide for the assumption of the Senior Notes by a new parent company resulting from such change of control transaction. If such change of control transaction is facilitated, the Issuers will be released from all obligations under the Indenture and the Issuers and the trustee will execute a supplemental indenture effectuating such assumption and release.

4. INTEREST RATE SWAPS

In August 2011, the Company executed forward starting interest rate swaps with Citibank N.A. and Barclays Bank PLC, as counterparties, with notional amounts totaling $350.0 million, with each agreement effective March 28, 2013 and expiring between September 30, 2014 and September 30, 2016. On September 30, 2014, interest rate swaps with notional amounts totaling $50.0 million at a rate of 1.6% expired under the terms of the related agreement. Under the remaining agreements, the Company is required to make quarterly fixed rate payments at annual rates ranging from 1.9% to 2.2%. The counterparties are obligated to make quarterly floating rate payments to the Company based on the three-month LIBOR rate, each subject to a floor of 1.25%. The Company completed an assessment of these cash flow hedges during the quarters ended December 31, 2014 and 2013, and determined that these hedges were highly effective. Accordingly, no gain or loss related to these hedges has been reflected in the accompanying condensed consolidated statements of operations, and the change in fair value has been included in accumulated other comprehensive loss as a component of member’s equity. The outstanding interest rate swaps at December 31, 2014 are as follows:

 

     Total Notional
Amounts
 
Effective Dates    (in thousands)  

Effective from March 28, 2013 to September 30, 2015

   $ 100,000   

Effective from March 28, 2013 to September 30, 2016

     200,000   

The fair value of the Company’s interest rate hedges at December 31, 2014 and September 30, 2014, reflect liability balances of $3.5 million and $3.9 million, respectively, and are included in other long-term liabilities in the accompanying condensed consolidated balance sheets. The fair value of the Company’s interest rate hedges reflects a liability because the effect of the forward LIBOR curve on future interest payments results in less interest due to the Company under the variable rate component included in the interest rate hedging agreements, as compared to the amount due the Company’s counterparties under the fixed interest rate component.

5. GOODWILL

The following table presents the changes in the carrying amount of goodwill (in thousands):

 

     Acute
Care
     Health
Choice
     Total  

Balance at September 30, 2014

   $ 808,741       $ 5,757       $ 814,498   

Adjustments related to acquisitions

     3,435         —          3,435   
  

 

 

    

 

 

    

 

 

 

Balance at December 31, 2014

$ 812,176    $ 5,757    $ 817,933   
  

 

 

    

 

 

    

 

 

 

6. ACCUMULATED OTHER COMPREHENSIVE LOSS

The components of accumulated other comprehensive loss, net of income taxes, are as follows (in thousands):

 

     December 31,
2014
     September 30,
2014
 

Fair value of interest rate hedges

   $ (3,488    $ (3,895

Income tax benefit

     1,403         1,551   
  

 

 

    

 

 

 

Accumulated other comprehensive loss

$ (2,085 $ (2,344
  

 

 

    

 

 

 

 

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7. INCOME TAXES

For the quarter ended December 31, 2014, the Company recorded income tax expense of $6.4 million, for an effective tax rate of 41.8%, compared to income tax expense of $2.5 million, for an effective tax rate of 56.2%, in the prior year quarter. The decrease in the effective tax rate is primarily attributable to the following: (1) a decrease in compensation deduction limitations applicable to certain health insurers, which were recorded in the prior year quarter, but to which the Company is no longer subject in the current or prior year after final regulations issued during September 2014, and (2) the increase in net earnings from continuing operations, which reduced the rate impact of state income taxes including the Texas margins tax. These decreases were partially offset by the following increases to the effective tax rate: (1) the annual health insurer fee imposed by the health reform law beginning in 2014, which is treated as a nondeductible excise tax, and (2) the lower ratio of net earnings from non-controlling interests to net earnings from continuing operations, as compared to the prior year quarter.

8. COMMITMENTS AND CONTINGENCIES

Net Revenue

The calculation of appropriate payments from the Medicare and Medicaid programs, including supplemental Medicaid reimbursement, as well as terms governing agreements with other third-party payors are complex and subject to interpretation. Final determination of amounts earned under the Medicare and Medicaid programs often occurs subsequent to the year in which services are rendered because of audits by the programs, rights of appeal and the application of numerous technical provisions. In the opinion of management, adequate provision has been made for adjustments that may result from such routine audits and appeals.

Professional, General and Workers’ Compensation Liability Risks

The Company is subject to claims and legal actions in the ordinary course of business, including claims relating to patient treatment and personal injuries. To cover these types of claims, the Company maintains professional and general liability insurance in excess of self-insured retentions through a commercial insurance carrier in amounts that the Company believes to be sufficient for its operations, although, potentially, some claims may exceed the scope of coverage in effect. Plaintiffs in these matters may request punitive or other damages that may not be covered by insurance. The Company is currently not a party to any such proceedings that, in the Company’s opinion, would have a material adverse effect on the Company’s business, financial condition or results of operations. The Company expenses an estimate of the costs it expects to incur under the self-insured retention exposure for professional and general liability claims using historical claims data, demographic factors, severity factors, current incident logs and other actuarial analysis. At December 31, 2014 and September 30, 2014, the Company’s professional and general liability accrual for asserted and unasserted claims totaled $66.3 million and $66.5 million, respectively, with the current portion totaling $13.3 million during both respective periods.

The Company is subject to claims and legal actions in the ordinary course of business relative to workers’ compensation matters. To cover these types of claims, the Company maintains workers’ compensation insurance coverage with a self-insured retention. The Company accrues the costs of workers’ compensation claims based upon estimates derived from its claims experience.

Health Choice

Health Choice has entered into capitated contracts whereby the Plan provides healthcare services in exchange for fixed periodic and supplemental payments from AHCCCS and CMS. These services are provided regardless of the actual costs incurred to provide these services. The Plan receives reinsurance and other supplemental payments from AHCCCS to cover certain costs of healthcare services that exceed certain thresholds. The Company believes the capitated payments, together with reinsurance and other supplemental payments are sufficient to pay for the services Health Choice is obligated to deliver. As of December 31, 2014, the Company has provided performance guaranties in the form of a letter of credit totaling $52.5 million for the benefit of AHCCCS and a demand note totaling $12.0 million for the benefit of CMS to support its obligations under the Health Choice contracts to provide and pay for the healthcare services. The amount of these performance guaranties are generally based in part upon the membership in the Plan and the related capitation revenue paid to Health Choice. On January 12, 2015 the performance guarantee for the benefit of AHCCCS was increased to $57.5 million.

Acquisitions

The Company has acquired and in the future may choose to acquire businesses with prior operating histories. Such businesses may have unknown or contingent liabilities, including liabilities for failure to comply with healthcare laws and regulations, such as billing and reimbursement, fraud and abuse and similar anti-referral laws. Although the Company has procedures designed to conform business practices to its policies following the completion of any acquisition, there can be no assurance that the Company will not become liable for previous activities of prior owners that may later be asserted to be improper by private plaintiffs or government agencies. Although the Company generally seeks to obtain indemnification from prospective sellers covering such matters, there can be no assurance that any such matter will be covered by indemnification, or if covered, that such indemnification

 

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will be adequate to cover potential losses and fines.

Other

In November 2010, the U.S. Department of Justice (“DOJ”) sent a letter to IAS requesting a 12-month tolling agreement in connection with an investigation into Medicare claims submitted by the Company’s hospitals in connection with the implantation of implantable cardioverter defibrillators (“ICDs”) between January 1, 2003 and November 30, 2010. At that time, neither the precise number of procedures, number of claims, nor the hospitals involved were identified by the DOJ. The Company understands that the government is conducting a national initiative with respect to ICD procedures involving a number of healthcare providers and is seeking information in order to determine if ICD implantation procedures were performed in accordance with Medicare coverage requirements. On January 11, 2011, IAS entered into the tolling agreement with the DOJ and, subsequently, the DOJ has provided the Company with a list of 194 procedures involving ICDs at 14 hospitals which are the subject of further medical necessity review by the DOJ. The Company is cooperating fully with the government and, to date, the DOJ has not asserted any claim against its hospitals. Applying the resolution model proposed by the DOJ, the Company believes that at least 131 of these procedure claims were properly documented for medical necessity and billed appropriately. The Company’s outside counsel has submitted to the DOJ summary justifications and supporting evidence relating to the medical claims at six of the Company’s hospitals. The Company continues to provide support for the remaining 63 of these cases that could have some likelihood of enforcement by the DOJ. If the Company is unable to place these claims in a non-enforcement or lesser enforcement category, the government may require repayment, which could impose a multiplier. Given the case-specific nature of the claims and the DOJ’s discretion to compromise claims, the Company is unable at this time to estimate any potential repayment obligation related to this matter. The tolling agreement between IAS and the government, as recently extended, is currently set to expire April 30, 2015.

On September 25, 2013, the Company voluntarily self-disclosed for resolution through the Self-Referral Disclosure Protocol established by CMS non-compliance by ten of its affiliated hospitals with a certain element of an exception of the Stark Law. Provisions of the Health Reform Law that became effective on September 23, 2011 require, as an element of the Stark Law’s “whole-hospital” exception, that hospitals having physician ownership disclose such ownership on their public websites and in public advertising. The self-disclosure states that, on August 12, 2013, the Company discovered that the ten Company-affiliated hospitals partially owned by physicians did not consistently make such disclosures. The self-disclosure also states that, on August 13, 2013, the hospitals added the disclosures to those public websites that did not previously have them and began to include the disclosures in new public advertising. The self-disclosure explains that, as a result of the absence of the website and advertising disclosures, the referrals of direct and indirect physician owners (and physicians who are immediate family members of direct and indirect owners) to the physician-owned hospitals of Medicare beneficiaries did not consistently qualify for the Stark Law’s whole-hospital exception from September 23, 2011 through August 13, 2013. On October 21, 2013, the Company submitted a supplement to its self-disclosure, reporting Medicare payments to these hospitals for services resulting from referrals affected by the non-compliance and the hospitals’ profit distributions to physicians (and known immediate family members of physicians) with respect to their ownership interests in the hospitals during the same period. The Company has been in communication with CMS about resolving this matter but, at present, CMS has made no commitments, as a general matter or in this case, regarding the timing or substance of resolution of self-disclosed Stark Law noncompliance through the voluntary CMS Self-Referral Disclosure Protocol. As a result, the Company expresses no opinion as to its outcome and, at this time, any repayment obligation or other penalties to be determined by CMS are unknown and not currently estimable.

 

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9. SEGMENT INFORMATION

The Company’s reportable operating segments consist of (1) acute care hospitals and related healthcare businesses, collectively and (2) Health Choice. The following is a financial summary by business segment for the periods indicated (in thousands):

 

     For the Quarter Ended December 31, 2014  
     Acute Care      Health Choice      Eliminations      Consolidated  

Acute care revenue before provision for bad debts

   $ 553,916       $ —         $ —         $ 553,916   

Less: Provision for bad debts

     (89,352      —           —           (89,352
  

 

 

    

 

 

    

 

 

    

 

 

 

Acute care revenue

  464,564      —        —        464,564   

Premium and service revenues

  —        222,101      —        222,101   

Revenue between segments

  3,942      —        (3,942   —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenue

  468,506      222,101      (3,942   686,665   

Salaries and benefits (excludes stock-based compensation)

  215,534      12,657      —        228,191   

Supplies

  79,896      155      —        80,051   

Medical claims

  —        179,914      (3,942   175,972   

Rentals and leases

  17,966      743      —        18,709   

Other operating expenses

  100,258      12,963      —        113,221   

Medicare and Medicaid EHR incentives

  (3,415   —        —        (3,415
  

 

 

    

 

 

    

 

 

    

 

 

 

Adjusted EBITDA(1)

  58,267      15,669      —        73,936   

Interest expense, net

  32,363      —        —        32,363   

Depreciation and amortization

  21,603      1,028      —        22,631   

Stock-based compensation

  1,539      —        —        1,539   

Management fees

  1,250      —        —        1,250   
  

 

 

    

 

 

    

 

 

    

 

 

 

Earnings from continuing operations before loss on disposal of assets and income taxes

  1,512      14,641      —        16,153   

Loss on disposal of assets, net

  (848   —        —        (848
  

 

 

    

 

 

    

 

 

    

 

 

 

Earnings from continuing operations before income taxes

$ 664    $ 14,641    $ —      $ 15,305   
  

 

 

    

 

 

    

 

 

    

 

 

 

Segment assets

$ 2,300,077    $ 378,929    $ 2,679,006   
  

 

 

    

 

 

       

 

 

 

Capital expenditures

$ 22,587    $ 823    $ 23,410   
  

 

 

    

 

 

       

 

 

 

Goodwill

$ 812,176    $ 5,757    $ 817,933   
  

 

 

    

 

 

       

 

 

 

 

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     For the Quarter Ended December 31, 2013  
     Acute Care      Health Choice      Eliminations      Consolidated  

Acute care revenue before provision for bad debts

   $ 537,874       $ —         $ —         $ 537,874   

Less: Provision for bad debts

     (93,703      —           —           (93,703
  

 

 

    

 

 

    

 

 

    

 

 

 

Acute care revenue

  444,171      —        —        444,171   

Premium and service revenues

  —        151,719      —        151,719   

Revenue between segments

  2,208      —        (2,208   —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenue

  446,379      151,719      (2,208   595,890   

Salaries and benefits (excludes stock-based compensation)

  206,364      7,041      —        213,405   

Supplies

  76,733      59      —        76,792   

Medical claims

  —        128,028      (2,208   125,820   

Rentals and leases

  18,090      363      —        18,453   

Other operating expenses

  92,971      7,586      —        100,557   

Medicare and Medicaid EHR incentives

  (3,278   —        —        (3,278
  

 

 

    

 

 

    

 

 

    

 

 

 

Adjusted EBITDA(1)

  55,499      8,642      —        64,141   

Interest expense, net

  33,144      —        —        33,144   

Depreciation and amortization

  24,665      1,057      —        25,722   

Stock-based compensation

  861      —        —        861   

Management fees

  1,250      —        —        1,250   
  

 

 

    

 

 

    

 

 

    

 

 

 

Earnings (loss) from continuing operations before gain on disposal of assets and income taxes

  (4,421   7,585      —        3,164   

Gain on disposal of assets, net

  1,242      —        —        1,242   
  

 

 

    

 

 

    

 

 

    

 

 

 

Earnings (loss) from continuing operations before income taxes

$ (3,179 $ 7,585    $ —      $ 4,406   
  

 

 

    

 

 

    

 

 

    

 

 

 

Segment assets

$ 2,305,773    $ 319,154    $ 2,624,927   
  

 

 

    

 

 

       

 

 

 

Capital expenditures

$ 10,832    $ 51    $ 10,883   
  

 

 

    

 

 

       

 

 

 

Goodwill

$ 809,828    $ 5,757    $ 815,585   
  

 

 

    

 

 

       

 

 

 

 

(1) Adjusted EBITDA represents net earnings from continuing operations before net interest expense, income tax expense, depreciation and amortization, stock-based compensation, net gain (loss) on disposal of assets and management fees. Management fees represent monitoring and advisory fees paid to management companies affiliated with TPG and JLL. Management routinely calculates and communicates adjusted EBITDA and believes that it is useful to investors because it is commonly used as an analytical indicator within the healthcare industry to evaluate performance, allocate resources and measure leverage capacity and debt service ability. In addition, the Company uses adjusted EBITDA as a measure of performance for its business segments and for incentive compensation purposes. Adjusted EBITDA should not be considered as a measure of financial performance under GAAP, and the items excluded from adjusted EBITDA are significant components in understanding and assessing financial performance. Adjusted EBITDA should not be considered in isolation or as an alternative to net earnings, cash flows generated by operating, investing, or financing activities or other financial statement data presented in the condensed consolidated financial statements as an indicator of financial performance or liquidity. Adjusted EBITDA, as presented, differs from what is defined under the Company’s Senior Secured Credit Facilities and may not be comparable to similarly titled measures of other companies.

 

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Table of Contents

10. SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL INFORMATION

The Senior Notes described in Note 3 are fully and unconditionally guaranteed on a joint and several basis by all of the Company’s 100% owned existing domestic subsidiaries, other than non-guarantor subsidiaries, which include Health Choice and the Company’s non-wholly owned subsidiaries. The guarantees are subject to customary release provisions set forth in the Indenture for the Senior Notes.

Summarized condensed consolidating balance sheets at December 31, 2014 and September 30, 2014, condensed consolidating statements of operations for the quarters ended December 31, 2014 and 2013, condensed consolidating statements of comprehensive income (loss) for the quarters December 31, 2014 and 2013, and condensed consolidating statements of cash flows for the quarters ended December 31, 2014 and 2013, for the Company, segregating the parent company issuer, the subsidiary guarantors, the subsidiary non-guarantors and eliminations, are found below.

 

20


Table of Contents

IASIS HEALTHCARE LLC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

IASIS Healthcare LLC

Condensed Consolidating Balance Sheet (unaudited)

December 31, 2014

(in thousands)

 

     Parent Issuer      Subsidiary
Guarantors
    Subsidiary
Non-Guarantors
     Eliminations     Condensed
Consolidated
 

Assets

            

Current assets

            

Cash and cash equivalents

   $ —         $ 279,757      $ 15,081       $ —        $ 294,838   

Accounts receivable, net

     —           61,070        256,067         —          317,137   

Inventories

     —           14,738        44,839         —          59,577   

Prepaid expenses and other current assets

     —           53,363        175,253         —          228,616   

Assets held for sale

     —           48,354        —           —          48,354   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total current assets

  —        457,282      491,240      —        948,522   

Property and equipment, net

  —        236,914      590,124      —        827,038   

Intercompany

  —        (162,592   162,592      —        —     

Net investment in and advances to subsidiaries

  2,070,653      —        —        (2,070,653   —     

Goodwill

  7,407      62,946      747,580      —        817,933   

Other intangible assets, net

  —        8,261      14,250      —        22,511   

Other assets, net

  21,471      25,573      15,958      —        63,002   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total assets

$ 2,099,531    $ 628,384    $ 2,021,744    $ (2,070,653 $ 2,679,006   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Liabilities and Equity

Current liabilities

Accounts payable

$ —      $ 42,885    $ 73,592    $ —      $ 116,477   

Salaries and benefits payable

  —        26,338      27,502      —        53,840   

Accrued interest payable

  9,849      (3,219   3,219      —        9,849   

Deferred income taxes

  1,442      —        —        —        1,442   

Medical claims payable

  —        —        90,420      —        90,420   

Other accrued expenses and current liabilities

  —        51,073      11,317      —        62,390   

Current portion of long-term debt, capital leases and other obligations

  10,071      2,071      22,782      (22,782   12,142   

Liabilities held for sale

  —        6,450      —        —        6,450   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total current liabilities

  21,362      125,598      228,832      (22,782   353,010   

Long-term debt, capital leases and other obligations

  1,821,142      17,332      631,108      (631,108   1,838,474   

Deferred income taxes

  108,381      —        —        —        108,381   

Other long-term liabilities

  2,990      112,043      587      —        115,620   

Non-controlling interests with redemption rights

  —        108,195      —        —        108,195   

Equity

Member’s equity

  145,656      255,546      1,161,217      (1,416,763   145,656   

Non-controlling interests

  —        9,670      —        —        9,670   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total equity

  145,656      265,216      1,161,217      (1,416,763   155,326   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total liabilities and equity

$ 2,099,531    $ 628,384    $ 2,021,744    $ (2,070,653 $ 2,679,006   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

 

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Table of Contents

IASIS HEALTHCARE LLC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

IASIS Healthcare LLC

Condensed Consolidating Balance Sheet (unaudited)

September 30, 2014

(in thousands)

 

     Parent Issuer      Subsidiary
Guarantors
    Subsidiary
Non-Guarantors
     Eliminations     Condensed
Consolidated
 

Assets

            

Current assets

            

Cash and cash equivalents

   $ —         $ 325,555      $ 15,625       $ —        $ 341,180   

Accounts receivable, net

     —           66,165        239,489         —          305,654   

Inventories

     —           13,925        43,707         —          57,632   

Deferred income taxes

     2,523         —          —           —          2,523   

Prepaid expenses and other current assets

     —           40,828        194,327         —          235,155   

Assets held for sale

     —           50,151        —           —          50,151   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total current assets

  2,523      496,624      493,148      —        992,295   

Property and equipment, net

  —        232,421      594,057      —        826,478   

Intercompany

  —        (82,478   82,478      —        —     

Net investment in and advances to subsidiaries

  2,072,704      —        —        (2,072,704   —     

Goodwill

  7,407      62,947      744,144      —        814,498   

Other intangible assets, net

  —        8,331      15,000      —        23,331   

Other assets, net

  23,067      23,055      16,240      —        62,362   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total assets

$ 2,105,701    $ 740,900    $ 1,945,067    $ (2,072,704 $ 2,718,964   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Liabilities and Equity

Current liabilities

Accounts payable

$ —      $ 47,437    $ 80,516    $ —      $ 127,953   

Salaries and benefits payable

  —        32,164      38,957      —        71,121   

Accrued interest payable

  28,820      (3,223   3,223      —        28,820   

Medical claims payable

  —        —        79,449      —        79,449   

Other accrued expenses and current liabilities

  —        47,911      25,586      —        73,497   

Current portion of long-term debt, capital leases and other obligations

  10,071      2,619      23,176      (23,176   12,690   

Liabilities held for sale

  —        9,171      —        —        9,171   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total current liabilities

  38,891      136,079      250,907      (23,176   402,701   

Long-term debt, capital leases and other obligations

  1,823,545      17,565      521,216      (521,216   1,841,110   

Deferred income taxes

  100,868      —        —        —        100,868   

Other long-term liabilities

  3,233      113,466      590      —        117,289   

Non-controlling interests with redemption rights

  —        108,156      —        —        108,156   

Equity

Member’s equity

  139,164      355,958      1,172,354      (1,528,312   139,164   

Non-controlling interests

  —        9,676      —        —        9,676   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total equity

  139,164      365,634      1,172,354      (1,528,312   148,840   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total liabilities and equity

$ 2,105,701    $ 740,900    $ 1,945,067    $ (2,072,704 $ 2,718,964   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

 

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Table of Contents

IASIS HEALTHCARE LLC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

IASIS Healthcare LLC

Condensed Consolidating Statement of Operations (unaudited)

For the Quarter Ended December 31, 2014

(in thousands)

 

     Parent Issuer     Subsidiary
Guarantors
    Subsidiary
Non-Guarantors
    Eliminations     Condensed
Consolidated
 

Revenues

          

Acute care revenue before provision for bad debts

   $ —        $ 126,858      $ 431,000      $ (3,942   $ 553,916   

Less: Provision for bad debts

     —          (15,406     (73,946     —          (89,352
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Acute care revenue

  —        111,452      357,054      (3,942   464,564   

Premium and service revenues

  —        —        222,101      —        222,101   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

  —        111,452      579,155      (3,942   686,665   

Costs and expenses

Salaries and benefits

  1,539      78,061      150,130      —        229,730   

Supplies

  —        19,023      61,028      —        80,051   

Medical claims

  —        —        179,914      (3,942   175,972   

Rentals and leases

  —        6,173      12,536      —        18,709   

Other operating expenses

  —        17,587      95,634      —        113,221   

Medicare and Medicaid EHR incentives

  —        (180   (3,235   —        (3,415

Interest expense, net

  32,363      —        12,249      (12,249   32,363   

Depreciation and amortization

  —        7,891      14,740      —        22,631   

Management fees

  1,250      (8,966   8,966      —        1,250   

Equity in earnings of affiliates

  (33,764   —        —        33,764      —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total costs and expenses

  1,388      119,589      531,962      17,573      670,512   

Earnings (loss) from continuing operations before loss on disposal of assets and income taxes

  (1,388   (8,137   47,193      (21,515   16,153   

Loss on disposal of assets, net

  —        (773   (75   —        (848
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (loss) from continuing operations before income taxes

  (1,388   (8,910   47,118      (21,515   15,305   

Income tax expense

  6,405      —        —        —        6,405   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net earnings (loss) from continuing operations

  (7,793   (8,910   47,118      (21,515   8,900   

Loss from discontinued operations, net of income taxes

  657      (2,157   —        —        (1,500
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net earnings (loss)

  (7,136   (11,067   47,118      (21,515   7,400   

Net earnings attributable to non-controlling interests

  —        (2,287   —        —        (2,287
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net earnings (loss) attributable to IASIS Healthcare LLC

$ (7,136 $ (13,354 $ 47,118    $ (21,515 $ 5,113   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

IASIS HEALTHCARE LLC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

IASIS Healthcare LLC

Condensed Consolidating Statement of Operations (unaudited)

For the Quarter Ended December 31, 2013

(in thousands)

 

     Parent Issuer     Subsidiary
Guarantors
    Subsidiary
Non-Guarantors
    Eliminations     Condensed
Consolidated
 

Revenues

          

Acute care revenue before provision for bad debts

   $ —        $ 128,298      $ 411,784      $ (2,208   $ 537,874   

Less: Provision for bad debts

     —          (21,450     (72,253     —          (93,703
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Acute care revenue

  —        106,848      339,531      (2,208   444,171   

Premium and service revenues

  —        —        151,719      —        151,719   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

  —        106,848      491,250      (2,208   595,890   

Costs and expenses

Salaries and benefits

  861      75,525      137,880      —        214,266   

Supplies

  —        18,374      58,418      —        76,792   

Medical claims

  —        —        128,028      (2,208   125,820   

Rentals and leases

  —        6,159      12,294      —        18,453   

Other operating expenses

  —        20,021      80,536      —        100,557   

Medicare and Medicaid EHR incentives

  —        (17   (3,261   —        (3,278

Interest expense, net

  33,144      —        12,245      (12,245   33,144   

Depreciation and amortization

  —        11,588      14,134      —        25,722   

Management fees

  1,250      (8,438   8,438      —        1,250   

Equity in earnings of affiliates

  (34,928   —        —        34,928      —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total costs and expenses

  327      123,212      448,712      20,475      592,726   

Earnings (loss) from continuing operations before gain on disposal of assets and income taxes

  (327   (16,364   42,538      (22,683   3,164   

Gain on disposal of assets, net

  —        1,212      30      —        1,242   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (loss) from continuing operations before income taxes

  (327   (15,152   42,568      (22,683   4,406   

Income tax expense

  2,477      —        —        —        2,477   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net earnings (loss) from continuing operations

  (2,804   (15,152   42,568      (22,683   1,929   

Earnings (loss) from discontinued operations, net of income taxes

  (4,239   11,300      —        —        7,061   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net earnings (loss)

  (7,043   (3,852   42,568      (22,683   8,990   

Net earnings attributable to non-controlling interests

  —        (3,788   —        —        (3,788
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net earnings (loss) attributable to IASIS Healthcare LLC

$ (7,043 $ (7,640 $ 42,568    $ (22,683 $ 5,202   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

24


Table of Contents

IASIS HEALTHCARE LLC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

IASIS Healthcare LLC

Condensed Consolidating Statement of Comprehensive Income (Loss)

For the Quarter Ended December 31, 2014 (unaudited)

(In thousands)

 

     Parent Issuer     Subsidiary
Guarantors
    Subsidiary
Non-Guarantors
     Eliminations     Condensed
Consolidated
 

Net earnings (loss)

   $ (7,136   $ (11,067   $ 47,118       $ (21,515   $ 7,400   

Other comprehensive income

           

Change in fair value of highly effective interest rate hedges

     407        —          —           —          407   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Other comprehensive income before income taxes

     407        —          —           —          407   

Change in income tax expense

     (148     —          —           —          (148
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Other comprehensive income, net of income taxes

     259        —          —           —          259   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Comprehensive income (loss)

     (6,877     (11,067     47,118         (21,515     7,659   

Net earnings attributable to non-controlling interests

     —          (2,287     —           —          (2,287
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Comprehensive income (loss) attributable to IASIS Healthcare LLC

   $ (6,877   $ (13,354   $ 47,118       $ (21,515   $ 5,372   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

 

25


Table of Contents

IASIS HEALTHCARE LLC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

IASIS Healthcare LLC

Condensed Consolidating Statement of Comprehensive Income (Loss)

For the Quarter Ended December 31, 2013 (unaudited)

(In thousands)

 

     Parent Issuer     Subsidiary
Guarantors
    Subsidiary
Non-Guarantors
     Eliminations     Condensed
Consolidated
 

Net earnings (loss)

   $ (7,043   $ (3,852   $ 42,568       $ (22,683   $ 8,990   

Other comprehensive income

           

Change in fair value of highly effective interest rate hedges

     424        —          —           —          424   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Other comprehensive income before income taxes

  424      —        —        —        424   

Change in income tax expense

  (158   —        —        —        (158
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Other comprehensive income, net of income taxes

  266      —        —        —        266   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Comprehensive income (loss)

  (6,777   (3,852   42,568      (22,683   9,256   

Net earnings attributable to non-controlling interests

  —        (3,788   —        —        (3,788
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Comprehensive income (loss) attributable to IASIS Healthcare LLC

$ (6,777 $ (7,640 $ 42,568    $ (22,683 $ 5,468   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

 

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Table of Contents

IASIS HEALTHCARE LLC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

IASIS Healthcare LLC

Condensed Consolidating Statement of Cash Flows

For the Quarter Ended December 31, 2014 (unaudited)

(In thousands)

 

     Parent Issuer     Subsidiary
Guarantors
    Subsidiary
Non-Guarantors
    Eliminations     Condensed
Consolidated
 

Cash flows from operating activities

          

Net earnings (loss)

   $ (7,136   $ (11,067   $ 47,118      $ (21,515   $ 7,400   

Adjustments to reconcile net earnings (loss) to net cash provided by (used in) operating activities:

          

Depreciation and amortization

     —          7,891        14,740        —          22,631   

Amortization of loan costs

     1,971        —          —          —          1,971   

Amortization of deferred gain on sale-leaseback transaction

     (624     —          —          —          (624

Change in physician minimum revenue guarantees

     —          58        769        —          827   

Stock-based compensation

     1,539        —          —          —          1,539   

Deferred income taxes

     10,273        —          —          —          10,273   

Loss on disposal of assets, net

     —          773        75        —          848   

Loss (earnings) from discontinued operations, net

     (657     2,157        —          —          1,500   

Equity in earnings of affiliates

     (33,764     —          —          33,764        —     

Changes in operating assets and liabilities, net of the effect of acquisitions and dispositions:

          

Accounts receivable, net

     —          4,379        (16,189     —          (11,810

Inventories, prepaid expenses and other current assets

     —          (14,888     18,055        —          3,167   

Accounts payable, other accrued expenses and other accrued liabilities

     (19,876     (2,227     (26,862     —          (48,965
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) operating activities — continuing operations

  (48,274   (12,924   37,706      12,249      (11,243

Net cash provided by operating activities — discontinued operations

  —        (234   —        —        (234
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) operating activities

  (48,274   (13,158   37,706      12,249      (11,477

Cash flows from investing activities

Purchases of property and equipment

  —        (13,713   (9,697   —        (23,410

Cash paid for acquisitions, net

  —        —        (3,900   —        (3,900

Proceeds from sale of assets

  —        253      12      —        265   

Change in other assets, net

  —        (2,309   209      —        (2,100
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in investing activities — continuing operations

  —        (15,769   (13,376   —        (29,145

Net cash used in investing activities — discontinued operations

  —        (340   —        —        (340
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

  —        (16,109   (13,376   —        (29,485
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from financing activities

Payment of long-term debt, capital leases and other obligations

  (2,618   (156   (786   —        (3,560

Distributions to non-controlling interests

  —        (1,853   —        —        (1,853

Cash received for the sale of non-controlling interests

  —        39      —        —        39   

Change in intercompany balances with affiliates, net

  50,892      (14,555   (24,088   (12,249   —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) financing activities — continuing operations

  48,274      (16,525   (24,874   (12,249   (5,374

Net cash used in financing activities — discontinued operations

  —        (6   —        —        (6
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) financing activities

  48,274      (16,531   (24,874   (12,249   (5,380
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Change in cash and cash equivalents

  —        (45,798   (544   —        (46,342

Cash and cash equivalents at beginning of period

  —        325,555      15,625      —        341,180   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at end of period

$ —      $ 279,757    $ 15,081    $ —      $ 294,838   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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IASIS HEALTHCARE LLC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

IASIS Healthcare LLC

Condensed Consolidating Statement of Cash Flows

For the Quarter Ended December 31, 2013 (unaudited)

(In thousands)

 

     Parent Issuer     Subsidiary
Guarantors
    Subsidiary
Non-Guarantors
    Eliminations     Condensed
Consolidated
 

Cash flows from operating activities

          

Net earnings (loss)

   $ (7,043   $ (3,852   $ 42,568      $ (22,683   $ 8,990   

Adjustments to reconcile net earnings (loss) to net cash provided by (used in) operating activities:

          

Depreciation and amortization

     —          11,588        14,134        —          25,722   

Amortization of loan costs

     1,853        —          —          —          1,853   

Change in physician minimum revenue guarantees

     —          46        553        —          599   

Stock-based compensation

     861        —          —          —          861   

Deferred income taxes

     171        —          —          —          171   

Gain on disposal of assets, net

     —          (1,212     (30     —          (1,242

Loss (earnings) from discontinued operations, net

     4,239        (11,300     —          —          (7,061

Equity in earnings of affiliates

     (34,928     —          —          34,928        —     

Changes in operating assets and liabilities, net of the effect of acquisitions and dispositions:

          

Accounts receivable, net

     —          (9,268     (3,236     —          (12,504

Inventories, prepaid expenses and other current assets

     —          (5,399     (119     —          (5,518

Accounts payable, other accrued expenses and other accrued liabilities

     (17,920     (6,614     (26,284     —          (50,818

Income taxes and other transaction costs payable related to sale-leaseback of real estate

     (18,901     (1,048     (2,321     —          (22,270
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) operating activities — continuing operations

  (71,668   (27,059   25,265      12,245      (61,217

Net cash used in operating activities — discontinued operations

  —        (12,085   —        —        (12,085
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) operating activities

  (71,668   (39,144   25,265      12,245      (73,302
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from investing activities

Purchases of property and equipment

  —        (6,253   (4,630   —        (10,883

Cash paid for acquisitions, net

  —        (1,038   —        —        (1,038

Cash paid in sale-leaseback of real estate

  —        (2,799   (301   —        (3,100

Proceeds from sale of assets

  —        425      —        —        425   

Change in other assets, net

  —        (2,857   421      —        (2,436
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in investing activities — continuing operations

  —        (12,522   (4,510   —        (17,032

Net cash provided by investing activities — discontinued operations

  —        691      —        —        691   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

  —        (11,831   (4,510   —        (16,341
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from financing activities

Payment of long-term debt, capital leases and other obligations

  (2,518   (151   (781   —        (3,450

Distributions to non-controlling interests

  —        (8,367   —        —        (8,367

Change in intercompany balances with affiliates, net

  74,186      (41,308   (20,633   (12,245   —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) financing activities — continuing operations

  71,668      (49,826   (21,414   (12,245   (11,817
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in financing activities — discontinued operations

  —        (58   —        —        (58

Net cash provided by (used in) financing activities

  71,668      (49,884   (21,414   (12,245   (11,875
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Change in cash and cash equivalents

  —        (100,859   (659   —        (101,518

Cash and cash equivalents at beginning of period

  —        430,047      8,084      —        438,131   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at end of period

$ —      $ 329,188    $ 7,425    $ —      $ 336,613   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements, the notes to our unaudited condensed consolidated financial statements and the other financial information appearing elsewhere in this report. Data for the quarters ended December 31, 2014 and 2013, have been derived from our unaudited condensed consolidated financial statements. References herein to “we,” “our” and “us” are to IASIS Healthcare LLC and its subsidiaries. References herein to “IAS” are to IASIS Healthcare Corporation, our parent company.

FORWARD-LOOKING STATEMENTS

Some of the statements we make in this report are forward-looking within the meaning of the federal securities laws, which are intended to be covered by the safe harbors created thereby. Those forward-looking statements include all statements that are not historical statements of fact and those regarding our intent, belief or expectations including, but not limited to, the discussions of our operating and growth strategy (including possible acquisitions and dispositions), financing needs, projections of revenue, income or loss, capital expenditures and future operations. Forward-looking statements involve known and unknown risks and uncertainties that may cause actual results in future periods to differ materially from those anticipated in the forward-looking statements. Those risks and uncertainties, among others discussed in this report, are detailed in our Annual Report on Form 10-K for the fiscal year ended September 30, 2014, filed with the Securities and Exchange Commission (the “SEC”), as amended and restated in Item 1A. “Risk Factors.”

While we believe our assumptions are reasonable, it is very difficult to predict the impact of known factors, and, of course, it is impossible to anticipate all factors that could affect our actual results. These factors include, but are not limited to:

 

  the effects of changes in governmental healthcare programs, principally Medicare, Medicaid and other federal healthcare programs, including limitations or reductions of levels of payments that our hospitals receive under such programs;

 

  the effects related to implementation of the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010 (collectively, the “Health Reform Law”), the possible enactment of additional federal or state healthcare reforms and possible amendments, changes or court challenges to such laws and other federal, state or local laws or regulations affecting the healthcare industry;

 

  our Health Choice managed care business’ ability to effectively manage costs of care, maintain its governmental contracts and achieve its service line expansion strategies;

 

  the effects of a shift in volume or payor mix from commercial managed-care payors to self-pay and Medicaid;

 

  increases in the amount and risk of collectability of uninsured accounts and deductibles and copayment amounts for insured accounts;

 

  a reduction in or withholding of government-sponsored supplemental payments to our hospitals;

 

  the effects of any inability to retain and negotiate reasonable contracts with managed care plans or if insured patients switch from traditional commercial insurance plans to exchange plans;

 

  industry trends towards value-based purchasing and narrow networks and related competitive challenges to our hospitals;

 

  possible changes in the Medicare, Medicaid and other state programs, including Medicaid supplemental reimbursement programs or waiver programs, that may impact reimbursement to healthcare providers and insurers;

 

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  controls imposed by Medicare and third-party payors to reduce admissions and length of stay;

 

  competition to attract and retain quality physicians, nurses, technicians and other personnel;

 

  the generally competitive nature of the healthcare industry;

 

  the possibility of health pandemics and the related impacts on our operations and financial results;

 

  a failure of our information systems or breach of our cyber-security protections;

 

  the costs and operational challenges associated with information technology and medical equipment upgrades;

 

  challenges associated with the implementation of electronic health records and coding systems;

 

  compliance with extensive healthcare industry laws, regulations and investigations, including those with respect to patient privacy and physician-owned hospitals;

 

  reliance upon services provided by third-party vendors;

 

  the effects of local or national economic downturns on our business lines;

 

  risks associated with our acquisition and development strategy, including liabilities assumed in acquisitions of facilities and physician practices and our need to effectively integrate acquired companies into our existing operations;

 

  increased lease rates and amended lease terms at certain of our facilities in connection with sale-leaseback transactions;

 

  the effectiveness of our reinvestment of proceeds from sale-leaseback transactions and asset dispositions;

 

  timely completion of under-construction facilities;

 

  risks associated with environmental, health and safety laws;

 

  risks associated with labor laws;

 

  potential adverse accounting impacts associated with goodwill carrying value;

 

  our dependence upon the services of key executive management personnel;

 

  risks related to our indebtedness and capital structure; and

 

  other risk factors described in Item 1A. “Risk Factors”.

Given these risks and uncertainties, you are cautioned not to place undue reliance on these forward-looking statements. Any forward-looking statement that we make in this Form 10-Q speaks only as of the date of such statement, and we undertake no obligation to update any forward-looking statements or to publicly announce the results of any revisions to any of those statements to reflect future events or developments. Comparisons of results for current and any prior periods are not intended to express any future trends or indications of future performance, unless specifically expressed as such, and should only be viewed as historical data.

EXECUTIVE OVERVIEW

We are a healthcare services company delivering high-quality, cost-effective healthcare through a broad and differentiated set of capabilities and assets that includes acute care hospitals with related patient access points, and a diversified and growing managed care risk platform (“risk platform”). Our business model is centered on deploying our acute care expertise and risk platform, either separately or on an integrated basis, in attractive markets to manage population health, integrate the delivery and payment of healthcare services and ultimately expand our total market opportunities within our existing and new geographic markets. Our company is comprised of our acute care operations, which, as of December 31, 2014, included 16 acute care hospitals, one behavioral hospital and multiple other access points, including 138 physician clinics, multiple outpatient surgical units, imaging centers, and investments in urgent care centers and on-site employer-based clinics, and our diversified and growing risk platform, Health Choice.

Acute Care Operations

As of December 31, 2014, as part of continuing operations, we owned or leased 15 acute care hospital facilities and one behavioral health hospital facility with a total of 3,604 licensed beds, several outpatient service facilities and 136 physician clinics. On September 26, 2014, we approved and committed to a plan to dispose of our Nevada operations, which included one hospital in the Las Vegas area and related physician operations. Accordingly, our Nevada operations have been included in discontinued operations for all periods presented. In January 2015, we closed on the sale of our Nevada operations.

 

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We operate our hospitals with a strong community focus by offering and developing healthcare services targeted to the needs of the markets we serve, promoting strong relationships with physicians and working with local managed care plans to develop quality and outcome driven, cost-efficient and innovative reimbursement models. Our major acute care geographic markets include Salt Lake City, Utah; Phoenix, Arizona; five cities in Texas, including Houston, San Antonio and Odessa; and West Monroe, Louisiana.

Since our company was founded in 1998, we believe we have developed a reputation for operating hospitals that deliver high quality care in our markets at rates that are often more affordable than many other hospitals in our markets with larger local market share than us. Our corporate and divisional infrastructure allows us to leverage savings in information technology services, revenue cycle, hospital supplies, and labor force costs.

Managed Care Operations

Health Choice, headquartered in Phoenix, Arizona, began providing managed Medicaid services under contract with the Arizona Health Care Cost Containment System (“AHCCCS”) in 1990, making it one of the nation’s first Medicaid managed care plans. Under our ownership beginning in 1999, Health Choice has evolved into a managed care organization and insurer that, while growing its core managed Medicaid business, has expanded to serve certain Medicare Advantage and Exchange members and is utilizing its population health management expertise to offer management and administrative services to other payors through its management services organization (“MSO”). In collaboration with our hospitals and affiliated physicians in certain of our markets, Health Choice also manages accountable care networks.

Health Choice represents one of our company’s key strategic assets, which we believe provides the Company with the ability to engage in innovative value-based purchasing initiatives and opportunities. Its leadership team has considerable experience in population health management, physician relations and network development. We believe Health Choice also deploys state of the art disease management and claims processing technology. In light of the current healthcare industry trends toward integrated delivery and clinical integration, we are seeking to bring Health Choice’s expertise and technology to bear as part of the accountable care networks we offer to other health plans.

As of December 31, 2014, Health Choice’s related entities delivered healthcare services to 337,000 members through multiple health plans, accountable care networks, MSO-related services and other managed care solutions. These members include 214,000 managed Medicaid members served primarily through Health Choice’s core health plan business in Arizona, 9,000 members participating in Health Choice’s Medicare Advantage Prescription Drug (“MAPD”) Special Needs Plan (“SNP”), 88,000 members of a large national insurer’s Florida managed Medicaid plan for whom Health Choice serves as a MSO, and 26,000 member lives managed through Health Choice’s accountable care networks and members of Health Choice’s Utah Managed Medicaid and Arizona health insurance exchange plans.

Our business consists of the two operating segments previously discussed: (1) our acute care segment comprised of our hospitals, outpatient service facilities and physician clinics and (2) our managed care operations, consisting of Health Choice and its various related service lines. The financial information for our reportable operating segments is presented in Footnote 9 (Segment Information) to our unaudited, consolidated financial statements included under “Item 1.—Financial Statements” of this Report.

Recent Developments

Health Choice integrated behavioral health joint venture. On December 18, 2014, Health Choice and its joint venture partner, the Northern Arizona Regional Behavioral Health Authority (“NARBHA”) won a competitive bid to begin operating an integrated acute and behavioral health plan in Northern Arizona in our 2016 fiscal year. The joint venture, Health Choice Integrated Care LLC, is expected to provide standalone behavioral health benefit for approximately 225,000 plan members in Northern Arizona, and acute and behavioral care on an integrated basis for approximately 6,000 members who are seriously mentally ill. Health Choice owns 52% of the joint venture and NARBHA owns 48% of the joint venture.

New hospital construction in Lehi, Utah. We are building a new expandable inpatient and outpatient health campus in fast-growing Lehi, Utah, called Mountain Point Medical Center, as a provider-based campus of Jordan Valley Medical Center. The hospital will provide a full range of services including inpatient intensive care, obstetrics and surgical services. The hospital also will provide cardiology

 

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services, which includes a cardiac catheterization lab. Additional outpatient services will include emergency, imaging, lab and outpatient surgery. The hospital has been designed to serve the growing transition to outpatient-related services and is being constructed with the capability to expand depending on community need and demand for services in the Lehi area. A medical office building is being constructed immediately adjacent to, and connected with, the hospital to be occupied by primary care and multi-specialty physician groups practicing in the area. This new hospital, anticipated to cost in excess of $80.0 million, will serve eight cities in Northern Utah County and is in the fastest growing area within the state of Utah. This project is anticipated to be completed and open for business in the summer of 2015.

Sale of North Vista Hospital. Effective January 22, 2015, we closed a transaction for the sale of our Nevada operations, which primarily included North Vista Hospital, a 177-bed general acute care facility located in Las Vegas, Nevada. We intend to use proceeds from the sale in a variety of strategic initiatives aimed at growth in existing markets and expansion into new markets.

Revenue and Volume Trends

Total revenue for the quarter ended December 31, 2014, increased 15.2% to $686.7 million, compared to $595.9 million in the same prior year quarter. Total revenue is comprised of acute care revenue, which is recorded net of the provision for bad debts, and premium and service revenues. Acute care revenue contributed $20.4 million to the increase in total revenue for the quarter ended December 31, 2014, compared to the same prior year quarter, while premium and service revenues at Health Choice contributed $69.4 million to the increase in total revenue over the same prior year period.

Acute Care Revenue

Acute care revenue is comprised of net patient revenue and other revenue. A large percentage of our hospitals’ net patient revenue consists of fixed payment, discounted sources, including Medicare, Medicaid and managed care organizations. Reimbursement for Medicare and Medicaid services are often fixed regardless of the cost incurred or the level of services provided. Similarly, a greater percentage of the managed care companies we contract with reimburse providers on a fixed payment basis regardless of the costs incurred or the level of services provided. Net patient revenue is reported net of discounts and contractual adjustments. The contractual adjustments principally result from differences between the hospitals’ established charges and payment rates under Medicare, Medicaid and various managed care plans. Additionally, discounts and contractual adjustments result from our uninsured discount and charity care programs. Acute care revenue is reported net of the provision for doubtful accounts. Other revenue includes medical office building rental income and other miscellaneous revenue.

Admissions and adjusted admissions increased 3.1% and 4.0%, respectively for the quarter ended December 31, 2014, compared to the same prior year quarter. We believe our volume benefited from improving economic and employment trends in our markets and from the impact of health reform. For the quarter ended December 31, 2014, our volumes also were positively impacted by an increase in emergency room visits of 7.4% compared to the same prior year quarter.

The following table provides the sources of our hospitals’ gross patient revenue by payor before discounts, contractual adjustments and the provision for bad debt:

 

     Quarter Ended
December 31,
 
     2014     2013  

Medicare

     25.9     26.9

Managed Medicare

     14.7     14.9

Medicaid and managed Medicaid

     22.1     20.3

Managed care and other

     31.8     31.2

Self-pay

     5.5     6.7
  

 

 

   

 

 

 

Total

  100.0   100.0
  

 

 

   

 

 

 

 

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The following table provides the sources of our hospitals’ net patient revenue by payor before the provision for bad debts:

 

     Quarter Ended
December 31,
 
     2014     2013  

Medicare

     19.0     20.0

Managed Medicare

     9.8     10.5

Medicaid and managed Medicaid

     13.3     11.5

Managed care and other

     42.3     41.7

Self-pay

     15.6     16.3
  

 

 

   

 

 

 

Total

  100.0   100.0
  

 

 

   

 

 

 

As noted in the above tables, our gross and net patient revenue by payor is experiencing a shift from self-pay to Medicaid and managed Medicaid and managed care payors. The shift to Medicaid and managed Medicaid is primarily a result of Arizona’s expansion of its Medicaid program under the Health Reform Law, which became effective January 1, 2014. Additionally, we have benefited from individuals enrolling in health insurance exchanges (“Exchanges”) in our markets, as well improvements in employment and other economic factors in the markets we serve.

Net patient revenue per adjusted admission, which includes the impact of the provision for bad debts, increased 1.2% for the quarter ended December 31, 2014, compared to the same prior year quarter.

See “Item 1 — Business — Sources of Acute Care Revenue” and “Item 1 — Business — Government Regulation and Other Factors” included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2014, filed with the SEC on December 8, 2014, for a description of the types of payments we receive for services provided to patients enrolled in the traditional Medicare plan, managed Medicare plans, Medicaid plans, managed Medicaid plans and managed care plans. In those sections, we also discussed the unique reimbursement features of the traditional Medicare plan, including the annual Medicare regulatory updates published by CMS that impact reimbursement rates for services provided under the plan. The future potential impact to reimbursement for certain of these payors under the Health Reform Law is also discussed in such Annual Report on Form 10-K.

Premium and Service Revenues

Premium and service revenues generated by Health Choice, our managed care operations, represented 32.3% of our total revenue for the quarter ended December 31, 2014, respectively, compared to 25.5% in the same prior year quarter.

Health Choice contracts with state Medicaid programs in Arizona and Utah to provide specified health services to qualified Medicaid enrollees through contracted healthcare providers. Most of its premium revenue is derived through a contract with AHCCCS, the state agency that administers Arizona’s Medicaid program. The contract requires Health Choice to arrange for healthcare services for enrolled Medicaid patients in exchange for fixed monthly premiums, based upon negotiated per capita member rates, and supplemental payments from AHCCCS. Health Choice also contracts with the Centers for Medicare and Medicaid Services (“CMS”) to provide coverage as a MAPD SNP. This contract allows Health Choice to offer Medicare and Part D drug benefit coverage to new and existing dual-eligible members (i.e., those that are eligible for Medicare and Medicaid). In accordance with CMS regulations, SNPs are now expected to meet additional requirements, including requirements relating to model of care, cost-sharing, disclosure of information and reporting of quality measures.

One notable provision of the Health Reform Law is the annual health insurer fee (“HIF”) that applies to most health plans, including commercial health plans and Medicaid managed care plans like Health Choice. While characterized as a “fee” in the text of the Health Reform Law, the intent of Congress was to impose a broad based health insurance industry excise tax, with the understanding that the tax could be passed on to consumers, most likely through higher commercial insurance premiums. However, because Medicaid is a government-funded program, Medicaid health plans have no alternative but to look to their respective state partners for payment to offset the impact of this tax. Arizona has agreed to reimburse all of the managed Medicaid plans, for the economic impact of this fee. In addition to the reimbursement of the fee, the state of Arizona has agreed to reimburse insurers for the impact resulting from these fees being treated as non-deductible for income tax purposes. For the quarter ended December 31, 2014, we recognized expense for the HIF totaling $2.0 million, which was offset by expected reimbursement from the state of Arizona of $2.9 million, which includes $0.9 million related to the reimbursement of the impact of tax related issues.

Other Industry Items Impacting Our Company

The following section discusses updates to recent trends included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2014, that we believe are significant factors in our current and/or future operating results and cash flows. Certain of these trends apply to the

 

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entire acute care hospital industry, while others may apply to us more specifically. These trends could be short-term in nature or could require long-term attention and resources. While these trends may involve certain factors that are outside of our control, the extent to which these trends affect our hospitals and health plan operations and our ability to manage the impact of these trends play vital roles in our current and future success. In many cases, we are unable to predict what impact, if any, these trends will have on us.

The Impact of Health Reform

We believe that the Health Reform Law, which expands healthcare coverage through the growth of Exchanges, private sector coverage and expanded Medicaid coverage will, over time, reduce the level of uncompensated care we provide to uninsured individuals. The reductions in the growth in Medicare payments and the decreases in disproportionate share hospital (“DSH”) payments, however, will adversely affect our government reimbursement, which is offset by the benefits realized from expanded healthcare coverage under the Health Reform Law. Because of the many variables, including the law’s complexity, continued delays or exceptions to employer mandates, possible amendments or changes, court challenges to the law, uncertainty regarding the success of Exchanges in enrolling uninsured individuals and possible reductions in funding by Congress and future reductions in Medicare and Medicaid reimbursement, the long-term effect of the Health Reform Law on our company, including how individuals and businesses will respond to the new choices and obligations, is not yet fully known. For example, the Supreme Court of the United States (“SCOTUS”) has agreed to hear a case known as King v. Burwell during its 2015 judicial session. The plaintiffs are challenging the extension of premium subsidies to health insurance policies purchased through federally operated Exchanges, arguing that subsidies must be limited to state-operated Exchanges. If decided in favor of the plaintiffs, this case could make it more difficult for uninsured individuals in states that do not operate an Exchange to purchase coverage and otherwise significantly affect implementation of the Health Reform law, in a manner that may result in less than projected numbers of newly insured individuals. We cannot predict the impact on our Company of these continuing developments with respect to the Health Reform Law.

State Medicaid Budgets

Over recent years, the states in which we operate experienced budget constraints as a result of increased costs and lower than expected tax collections. Health and human services programs, including Medicaid and similar programs, represent a significant portion of state budgets. In previous years, the states in which we operate responded to these budget concerns by decreasing funding for Medicaid and other healthcare programs, or by making structural changes that resulted in a reduction in hospital reimbursement and by imposing more restrictive Medicaid eligibility requirements. In addition, many states have received waivers from CMS in order to implement or expand managed Medicaid programs.

Texas

The Texas legislature and the Texas Health and Human Services Commission (“THHSC”) recommended expanding Medicaid managed care enrollment in the state, and in December 2011, CMS approved a five-year Medicaid waiver that: (1) allows Texas to expand its Medicaid managed care program while preserving hospital funding; (2) provides incentive payments for improvements in healthcare delivery; and (3) directs more funding to hospitals that serve large numbers of uninsured patients. All of our acute care hospitals in Texas currently receive supplemental Medicaid reimbursement, including reimbursement from programs for participating private hospitals that enter into indigent care affiliation agreements with public hospitals or county governments in the state of Texas. Under the CMS-approved programs, affiliated hospitals, including our Texas hospitals, have expanded the community healthcare safety net by providing indigent healthcare services. Revenue recognized under these Texas private supplemental Medicaid reimbursement programs, including amounts recognized under the Texas Medicaid DSH program (“Texas Medicaid DSH”) for the quarter ended December 31, 2014, was $24.0 million compared to $25.5 million in the same prior year quarter. Under the Medicaid waiver, funds are distributed to participating hospitals based upon both the costs associated with providing care to individuals without third party coverage and the investment made to support coordinating care and quality improvements that transform the local communities’ care delivery systems. The responsibility to coordinate and develop plans that address the concerns of the local delivery care systems, including improved access, quality, cost effectiveness and coordination will be controlled primarily by government-owned public hospitals that serve the surrounding geographic areas. Complexities of the underlying methodologies in determining the funding for the state’s Medicaid supplemental reimbursement programs, along with a lack of sufficient resources at THHSC to administer the programs, has resulted in a delay in related reimbursements. As of December 31, 2014 and September 30, 2014, we had $72.3 million and $90.2 million, respectively, in receivables due to our Texas hospitals in connection with these supplemental reimbursement programs, which includes $25.7 million and $34.9 million, respectively, of amounts due under Texas Medicaid DSH.

On October 1, 2014, the THHSC issued a notice to certain hospitals participating in the Texas waiver program. These hospitals operate in the surrounding areas of Dallas, Tarrant, Nueces and Travis counties (including the cities of Dallas/Fort Worth, Corpus Christi and Austin). According to the notice, a review conducted by CMS identified some of these affiliation agreements it believed may be inconsistent with the waiver. As a result of these findings, CMS temporarily deferred the federal portion of the Medicaid payments associated with these affiliations. CMS lifted the deferral on January 7, 2015, but has not yet made a final determination regarding the acceptability of the affiliations. None of our hospitals were included in the programs reviewed by CMS. We cannot assure you that CMS, THHSC and other similar agencies will not in the future audit or delay our programs in a manner that reduces the amount or slows the timing of our receipt of such funding.

The THHSC has adopted rules to change the Texas Medicaid DSH methodology for the state’s fiscal year 2014 and 2015. Texas has appropriated $160.0 million for fiscal year 2014 and $140.0 million for fiscal year 2015 to stabilize and improve the Texas Medicaid DSH program, including providing rate adjustments to recognize improvements in quality of patient care, the most appropriate use of care, and patient outcomes. During the quarter ended December 31, 2014, we recognized $8.6 million in Texas Medicaid DSH revenue, compared to $7.5 million in the same prior year quarter.

Arizona

Beginning in July 2011, in an effort to control its budgeted expenditures and balance its budget, the state of Arizona implemented a plan to reduce its eligible Medicaid beneficiaries, particularly childless adults. Following implementation of this plan by the state of Arizona, Health Choice experienced a significant decline through the end of our fiscal year 2013 in its enrollees, premium revenue and related earnings.

 

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Effective January 1, 2014, Arizona expanded its Medicaid program under the Health Reform Law, which includes increased eligibility for adults, children and pregnant women, and the restoration of eligibility to childless adults that had previously eliminated. The expansion of the state’s Medicaid program under the Health Reform Law could potentially result in the addition of approximately 350,000 people to its Medicaid rolls. Primarily as a result of the Medicaid expansion, enrollment under Health Choice’s Medicaid product line increased 16.6% for the quarter ended December 31, 2014, compared to the same prior year quarter. In addition, in connection with the expanded Medicaid coverage, the state implemented a provider assessment effective January 1, 2014, to fund a portion of the expanded eligibility related to the childless adult population. During the quarter ended December 31, 2014, we incurred $2.0 million in provider assessments.

Further, while the Arizona legislature approved an expansion of Medicaid in 2013 which became effective on January 1, 2014, a lawsuit filed by several state lawmakers has challenged the legality of a provider fee assessed to all providers and used to help pay for Arizona’s Medicaid expansion. The suit was dismissed by the trial court, based on a finding that the plaintiffs did not have standing to sue; however, on December 31, 2014, the Arizona Supreme Court ruled that the plaintiffs in the case had standing to sue, and the case is now moving forward in the trial court. If the legality of the provider fee used to help fund Arizona’s Medicaid expansion is successfully challenged in court, this may result in the loss of certain funding for the state’s Medicaid program, which could potentially result in changes that restrict eligibility and increase the number of uninsured individuals and adversely affecting our operations in Arizona.

Arizona’s Medicaid expansion in 2014, and Health Choice’s related increase in enrolled members and premium revenue, followed a period of several years during which AHCCCS tightened Medicaid eligibility standards in Arizona and decreased capitation rates paid to managed Medicaid contractors, reflecting state government budgetary pressures and a struggling state economy. If additional Medicaid program changes are implemented in the future in Arizona or other states in which we operate, our premium revenue and earnings could be significantly impacted.

Uncompensated Care

While the amount of uncompensated care, including discounts to the uninsured, bad debts and charity care, we deliver to the communities we serve continues to remain high in comparison to historical levels, we have experienced a decrease during the quarter ended December 31, 2014. During the quarter ended December 31, 2014, our uncompensated care as a percentage of acute care revenue was 21.4%, compared to 23.5% in the same prior year quarter. During the quarter ended December 31, 2014, our self-pay admissions represented 6.2% of our total admissions, compared to 8.1% in the same prior year quarter. We believe the improvement in our uncompensated care as a percentage of acute care revenue and our self-pay admissions mix can be attributed primarily to the impact of Medicaid expansion in the state of Arizona, as well as improvements in employment and other economic factors in our markets, which has resulted in lower self-pay volume and revenue for the quarter ended December 31, 2014, compared to the same prior year quarter.

We anticipate uninsured volumes to continue to decline in the near future as the impact of the Health Reform Law is fully realized. However, if we were to experience growth in uninsured volume and revenue, our uncompensated care may increase and our results of operations would be adversely affected.

The percentages of our insured and uninsured net hospital receivables are summarized as follows (1):

 

     December 31,
2014
    September 30,
2014
 

Insured receivables

     85.1     84.4

Uninsured receivables

     14.9     15.6
  

 

 

   

 

 

 

Total

  100.0   100.0
  

 

 

   

 

 

 

The percentages of hospital net receivables in summarized aging categories are as follows (1):

 

     December 31,
2014
    September 30,
2014
 

0 to 90 days

     65.9     63.2

91 to 180 days

     18.0     18.0

Over 180 days

     16.1     18.8
  

 

 

   

 

 

 

Total

  100.0   100.0
  

 

 

   

 

 

 

 

(1)  Excludes hospital receivables related to our discontinued Florida and Nevada operations.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

A summary of significant accounting policies is disclosed in Note 2 to the consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2014. Our critical accounting policies are further described under the caption “Critical Accounting Policies and Estimates” in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended September 30, 2014. Other than disclosed below, there have been no changes in the nature of our critical accounting policies or the application of those policies since September 30, 2014.

 

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Stock-based compensation. We account for stock-based compensation awards in accordance with Accounting Standards Codification (“ASC”) 718—Compensation, which requires a fair-value based method for measuring the value of stock-based compensation. Fair value is measured once at the date of grant and is not adjusted for subsequent changes. Our stock-based compensation plans include programs for stock options and RSU awards.

We estimate the grant date fair value, and the resulting stock-based compensation expense, using the Black-Scholes option-pricing model. The Black-Scholes option-pricing model requires the use of highly subjective assumptions which determine the fair value of stock-based awards. These assumptions include:

Expected term—The expected term represents the period that stock-based awards are expected to be outstanding. We used the simplified method to determine the expected term, which is calculated as the average of the time-to-vesting and the contractual life of the awards.

Expected volatility—Since we are currently privately held and do not have any trading history for our common stock, the expected volatility was estimated based on the average volatility for comparable publicly traded peer companies over a period equal to the expected term of the awards. When selecting comparable publicly traded peer companies on which we based our expected stock price volatility, we selected companies with comparable characteristics to us, including enterprise value, risk profiles, and with historical share price information sufficient to meet the expected life of the stock-based awards. The historical volatility data was computed using the daily closing prices for the selected companies’ shares during the equivalent period of the calculated expected term of the stock-based awards.

Risk-free interest rate—The risk-free interest rate is based on the U.S. Treasury zero coupon issues in effect at the time of grant for periods corresponding with the expected term of the award.

Expected dividend—No recurring dividends have been authorized and we do not expect to pay cash dividends in the foreseeable future. Therefore, we used an expected dividend yield of zero.

In addition to the Black-Scholes assumptions, we estimate our forfeiture rate based on an analysis of our actual forfeitures and will continue to evaluate the adequacy of the forfeiture rate based on actual forfeiture experience, analysis of employee turnover behavior, and other factors. The impact from any forfeiture rate adjustment would be recognized in full in the period of adjustment and if the actual number of future forfeitures differs from our estimates, we might be required to record adjustments to stock-based compensation in future periods. These assumptions represent our best estimates, but these estimates involve inherent uncertainties and the application of management’s judgment. As a result, if factors change and we use different assumptions, our equity-based compensation expense could be materially different in the future.

 

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SELECTED OPERATING DATA

The following table sets forth certain unaudited operating data from continuing operations for each of the periods presented.

 

     Quarter Ended December 31,  
     2014     2013  

Acute care operations (1)

    

Number of acute care hospital facilities at end of period

     15        15   

Licensed beds at end of period (2)

     3,604        3,600   

Average length of stay (days) (3)

     5.0        5.0   

Occupancy rates (4)

     49.6     47.4

Admissions (5)

     25,868        25,096   

Adjusted admissions (6)

     47,910        46,058   

Patient days (7)

     129,843        124,275   

Adjusted patient days (6)

     240,483        228,078   

Surgeries

     16,811        17,003   

Emergency room visits

     106,340        99,039   

Net patient revenue per adjusted admission (8)

   $ 9,608      $ 9,495   

Outpatient revenue as a % of gross patient revenue

     46.0     45.5

Managed care operations

    

Health plan lives (9)

     229,600        191,800   

MSO lives (10)

     88,300        —     

Accountable care network lives (11)

     19,800        700   
  

 

 

   

 

 

 

Total lives

  337,700      192,500   

Medical loss ratio (12)

  84.5   84.4

 

(1) Excludes the impact of our Nevada and Florida operations, which are reflected in discontinued operations.
(2) Includes St. Luke’s Behavioral Hospital in Phoenix, Arizona.
(3) Represents the average number of days that a patient stayed in our hospitals.
(4) Calculated by dividing the average daily number of inpatients by the weighted-average number of beds in service.
(5) Represents the total number of patients admitted to our hospitals that qualify for inpatient status. Management and investors use this number as a general measure of inpatient volume.
(6) Adjusted admissions and adjusted patient days are general measures of combined inpatient and outpatient volume. We compute adjusted admissions (or adjusted patient days) by multiplying admissions (or patient days) by gross patient revenue and then dividing that number by gross inpatient revenue.
(7) Represents the number of days our beds were occupied by inpatients over the period.
(8) Includes the impact of the provision for bad debts as a component of revenue.
(9) Represents total lives enrolled across all health plan product lines. Includes dual-eligible lives, which are members eligible for Medicare and Medicaid benefits, under Health Choice’s contract with CMS to provide coverage as a MAPD SNP totaling 9,300 and 5,300 as of December 31, 2014 and 2013, respectively.
(10) Represents lives enrolled in Health Choice’s MSO that provides management and administrative services to a large national insurer’s Medicaid plan members in the Tampa and “Panhandle” regions of Florida.
(11) Represents attributed health plan member lives from other third-party payors for which Health Choice Preferred accountable care networks manage medical care and participating providers and Health Choice share associated financial risks.
(12) Represents medical claims expense as a percentage of premium revenue, including claims paid to our hospitals.

 

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RESULTS OF OPERATIONS SUMMARY

Consolidated

The following table sets forth, for the periods presented, the results of our consolidated operations expressed in dollar terms and as a percentage of total revenue. Such information has been derived from our unaudited condensed consolidated statements of operations.

 

     Quarter Ended
December 31, 2014
    Quarter Ended
December 31, 2013
 

($ in thousands ):

   Amount      Percentage     Amount      Percentage  

Revenues

          

Acute care revenue before provision for bad debts

   $ 553,916         $ 537,874      

Less: Provision for bad debts

     (89,352        (93,703   
  

 

 

    

 

 

   

 

 

    

 

 

 

Acute care revenue

  464,564      67.7   444,171      74.5

Premium and service revenues

  222,101      32.3   151,719      25.5
  

 

 

    

 

 

   

 

 

    

 

 

 

Total revenue

  686,665      100.0   595,890      100.0

Costs and expenses

Salaries and benefits

  229,730      33.5   214,266      36.0

Supplies

  80,051      11.7   76,792      12.9

Medical claims

  175,972      25.6   125,820      21.1

Rentals and leases

  18,709      2.7   18,453      3.1

Other operating expenses

  113,221      16.5   100,557      16.9

Medicare and Medicaid EHR incentives

  (3,415   (0.5 %)    (3,278   (0.6 %) 

Interest expense, net

  32,363      4.6   33,144      5.6

Depreciation and amortization

  22,631      3.3   25,722      4.3

Management fees

  1,250      0.2   1,250      0.2
  

 

 

    

 

 

   

 

 

    

 

 

 

Total costs and expenses

  670,512      97.6   592,726      99.5

Earnings from continuing operations before gain (loss) on disposal of assets and income taxes

  16,153      2.4   3,164      0.5

Gain (loss) on disposal of assets, net

  (848   (0.1 %)    1,242      0.2
  

 

 

    

 

 

   

 

 

    

 

 

 

Earnings from continuing operations before income taxes

  15,305      2.3   4,406      0.7

Income tax expense

  6,405      0.9   2,477      0.4
  

 

 

    

 

 

   

 

 

    

 

 

 

Net earnings from continuing operations

  8,900      1.4   1,929      0.3

Earnings (loss) from discontinued operations, net of income taxes

  (1,500   (0.2 %)    7,061      1.2
  

 

 

    

 

 

   

 

 

    

 

 

 

Net earnings

  7,400      1.2   8,990      1.5

Net earnings attributable to non-controlling interests

  (2,287   (0.3 %)    (3,788   (0.6 %) 
  

 

 

    

 

 

   

 

 

    

 

 

 

Net earnings attributable to IASIS Healthcare LLC

$ 5,113      0.9 $ 5,202      0.9
  

 

 

    

 

 

   

 

 

    

 

 

 

 

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Acute Care Operations

The following table and discussion sets forth, for the periods presented, the results of our acute care operations expressed in dollar terms and as a percentage of total acute care revenue. Such information has been derived from our unaudited condensed consolidated statements of operations.

 

     Quarter Ended
December 31, 2014
    Quarter Ended
December 31, 2013
 

($ in thousands ):

   Amount      Percentage     Amount      Percentage  

Acute care revenue

          

Acute care revenue before provision for bad debts

   $ 553,916         $ 537,874      

Less: Provision for bad debts

     (89,352        (93,703   
  

 

 

    

 

 

   

 

 

    

 

 

 

Acute care revenue

  464,564      99.2   444,171      99.5

Revenue between segments (1)

  3,942      0.8   2,208      0.5
  

 

 

    

 

 

   

 

 

    

 

 

 

Total acute care revenue

  468,506      100.0   446,379      100.0

Costs and expenses

Salaries and benefits

  217,073      46.3   207,225      46.4

Supplies

  79,896      17.1   76,733      17.2

Rentals and leases

  17,966      3.8   18,090      4.1

Other operating expenses

  100,258      21.4   92,971      20.8

Medicare and Medicaid EHR incentives

  (3,415   (0.7 %)    (3,278   (0.7 %) 

Interest expense, net

  32,363      6.9   33,144      7.4

Depreciation and amortization

  21,603      4.6   24,665      5.5

Management fees

  1,250      0.3   1,250      0.3
  

 

 

    

 

 

   

 

 

    

 

 

 

Total costs and expenses

  466,994      99.7   450,800      101.0

Earnings (loss) from continuing operations before gain (loss) on disposal of assets and income taxes

  1,512      0.3   (4,421   (1.0 %) 

Gain (loss) on disposal of assets, net

  (848   (0.2 %)    1,242      0.3
  

 

 

    

 

 

   

 

 

    

 

 

 

Earnings (loss) from continuing operations before income taxes

$ 664      0.1 $ (3,179   (0.7 %) 
  

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) Revenue between segments is eliminated in our consolidated results.

 

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Quarters Ended December 31, 2014 and 2013

Total acute care revenue — Total acute care revenue for the quarter ended December 31, 2014, was $468.5 million, an increase of $22.1 million or 5.0% compared to $446.4 million in the same prior year quarter. The increase in total acute care revenue during the quarter ended December 31, 2014, is comprised primarily of an increase in adjusted admissions of 4.0% and an increase in net patient revenue per adjusted admission of 1.2%, both compared to the same prior year quarter.

Net adjustments to estimated third-party payor settlements, also known as prior year contractuals, resulted in an increase in total acute care revenue for the quarters ended December 31, 2014 and 2013, of $1.3 million and $2.0 million, respectively.

Salaries and benefits — Salaries and benefits expense for the quarter ended December 31, 2014, was $217.1 million, or 46.3% of total acute care revenue, compared to $207.2 million, or 46.4% of total acute care revenue in the same prior year quarter.

Supplies — Supplies expense for the quarter ended December 31, 2014, was $79.9 million, or 17.1% of total acute care revenue, compared to $76.7 million, or 17.2% of total acute care revenue in the same prior year quarter.

Other operating expenses — Other operating expenses for the quarter ended December 31, 2014, were $100.3 million, or 21.4% of total acute care revenue, compared to $93.0 million, or 20.8% of total acute care revenue in the same prior year quarter. The increase in other operating expenses as a percentage of total acute care revenue is primarily attributable to the Arizona provider fee incurred to help fund the state’s expansion of its Medicaid program.

Managed Care Operations

The following table and discussion sets forth, for the periods presented, the results of our managed care operations expressed in dollar terms and as a percentage of premium and service revenues. Such information has been derived from our unaudited condensed consolidated statements of operations.

 

     Quarter Ended
December 31, 2014
    Quarter Ended
December 31, 2013
 

($ in thousands ):

   Amount      Percentage     Amount      Percentage  

Premium and service revenues

          

Premium revenue

   $ 215,925         $ 151,719      

Service revenue

     6,176           —        
  

 

 

      

 

 

    

Premium and service revenues

  222,101      100   151,719      100

Costs and expenses

Salaries and benefits

  12,657      5.7   7,041      4.6

Supplies

  155      0.1   59      0.1

Medical claims (1)

  179,914      81.0   128,028      84.4

Other operating expenses

  12,963      5.8   7,586      5.0

Rentals and leases

  743      0.3   363      0.2

Depreciation and amortization

  1,028      0.5   1,057      0.7
  

 

 

    

 

 

   

 

 

    

 

 

 

Total costs and expenses

  207,460      93.4   144,134      95.0
  

 

 

    

 

 

   

 

 

    

 

 

 

Earnings before income taxes

$ 14,641      6.6 $ 7,585      5.0
  

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) Medical claims paid to our hospitals of $3.9 million and $2.2 million for the quarters ended December 31, 2014 and 2013, respectively, are eliminated in our consolidated results.

 

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Quarters Ended December 31, 2014 and 2013

Premium and service revenues — Premium and service revenues were $222.1 million for the quarter ended December 31, 2014, an increase of $70.4 million or 46.4%, compared to $151.7 million in the same prior year quarter. The increase in premium and service revenues is driven by growth in all of our managed care product lines, including our MSO subsidiary. For the quarter ended December 31, 2014, enrollment in our Medicare and Medicaid product lines increased 73.1% and 17.9%, respectively, compared to the same prior year quarter. Our managed Medicaid product line has been impacted favorably by the state of Arizona’s expansion of the Medicaid program in connection with the Health Reform Law. Premium revenue on a per member per month basis for our health plan products increased 15.6% compared to the same prior year quarter, as a result of a shift in the membership mix primarily attributable to the reinstatement of eligibility for the childless adult population. We also recognized $2.9 million of revenue related to the HIF assessed in connection with the Health Reform Law.

Medical claims — Prior to eliminations, medical claims expense was $179.9 million for the quarter ended December 31, 2014, compared to $128.0 million in the same prior year quarter. Medical claims expense as a percentage of premium revenue related to our health plan products, excluding the impact of HIF revenue, was 84.5% for the quarter ended December 31, 2014, compared to 84.4% in the same prior year quarter.

Other operating expenses — Other operating expenses for the quarter ended December 31, 2014, were $13.0 million, or 5.8% of premium and service revenues, compared to $7.6 million, or 5.0% of premium and service revenue in the same prior year quarter. Other operating expenses as a percentage of premium and service revenue increased primarily as a result of $2.0 million in HIF expense.

 

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LIQUIDITY AND CAPITAL RESOURCES

Overview of Cash Flow Activities for the Quarter Ended December 31, 2014 and 2013

Our cash flows are summarized as follows (in thousands):

 

     Quarter Ended
December 31,
 
     2014      2013  

Cash flows from operating activities

   $ (11,477    $ (73,302

Cash flows from investing activities

   $ (29,485    $ (16,341

Cash flows from financing activities

   $ (5,380    $ (11,875

Operating Activities

Cash flows used in operating activities were $11.5 million for the quarter ended December 31, 2014, compared to $73.2 million in the same prior year quarter. The prior year cash flows from operating activities were impacted by the payment of $22.3 million in income taxes, transaction fees and other costs associated with the sale-leaseback of certain real estate, along with delays in certain Texas and Arizona supplemental reimbursement.

At December 31, 2014, we had $553.6 million in net working capital, compared to $548.6 million at September 30, 2014, both excluding assets and liabilities held for sale. Net accounts receivable increased $11.5 million to $317.1 million at December 31, 2014, from $305.7 million at September 30, 2014. Our days revenue in accounts receivable at December 31, 2014, were 54, compared to 55 at September 30, 2014 and 58 at December 31, 2013.

Investing Activities

Cash flows used in investing activities were $29.5 million for the quarter ended December 31, 2014, compared to $16.3 million in the same prior year quarter. Purchases of property and equipment were $23.4 million, including $9.0 million related to the construction of a new greenfield hospital in Lehi, Utah, for the quarter ended December 31, 2014, compared to $10.9 million in the prior year quarter.

Financing Activities

Cash flows used in financing activities were $5.4 million for the quarter ended December 31, 2014, compared to $11.9 million in the same prior year quarter. The quarter ended December 31, 2013, included distributions to non-controlling interests of $5.2 million associated with the sale-leaseback of certain hospital real estate.

Capital Resources

As of December 31, 2014, we had the following debt arrangements:

 

    up to $1.325 billion senior secured credit facilities; and

 

    $849.9 million in 8.375% senior notes due 2019.

At December 31, 2014, amounts outstanding under our senior secured credit facilities consisted of $986.9 million in term loans. In addition, we had $77.7 million in letters of credit outstanding under the revolving credit facility. The weighted average interest rate of outstanding borrowings under the senior secured credit facilities was 4.6% for both the quarters ended December 31, 2014 and 2013.

$1.325 Billion Senior Secured Credit Facilities

We are a party to a senior credit agreement (the “Amended and Restated Credit Agreement”). The Amended and Restated Credit Agreement provides for senior secured financing of up to $1.325 billion consisting of (1) a $1.025 billion senior secured term loan facility maturing in May 2018 and (2) a $300.0 million senior secured revolving credit facility maturing in May 2016, of which up to $150.0 million may be utilized for the issuance of letters of credit (together, the “Senior Secured Credit Facilities”). Principal under the senior secured term loan facility is due in consecutive equal quarterly installments in an aggregate annual amount equal to 1% of the principal amount of $1.007 billion outstanding as of the effective date, February 20, 2013, of a repricing amendment, with the remaining balance due upon maturity of the senior secured term loan facility. The senior secured revolving credit facility does not require principal installment payments prior to maturity. On September 12, 2014, the Amended and Restated Credit Agreement was amended to, among other things, extend the deadline by which we must reinvest the proceeds of certain assets sales from 12 months to 24 months.

 

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Borrowings under the senior secured term loan facility (giving effect to the repricing amendment) bear interest at a rate per annum equal to, at our option, either (1) a base rate (the “base rate”) determined by reference to the highest of (a) the federal funds rate plus 0.50%, (b) the prime rate of Bank of America, N.A. and (c) a one-month LIBOR rate, subject to a floor of 1.25%, plus 1.00%, in each case, plus a margin of 2.25% per annum or (2) the LIBOR rate for the interest period relevant to such borrowing, subject to a floor of 1.25%, plus a margin of 3.25% per annum. Borrowings under the senior secured revolving credit facility generally bear interest at a rate per annum equal to, at our option, either (1) the base rate plus a margin of 2.50% per annum, or (2) the LIBOR rate for the interest period relevant to such borrowing plus a margin of 3.50% per annum. In addition to paying interest on outstanding principal under the Senior Secured Credit Facilities, we are required to pay a commitment fee on the unutilized commitments under the senior secured revolving credit facility, as well as pay customary letter of credit fees and agency fees.

The Senior Secured Credit Facilities are unconditionally guaranteed by IAS and certain of our subsidiaries (collectively, the “Credit Facility Guarantors”) and are required to be guaranteed by all of our future material wholly owned subsidiaries, subject to certain exceptions. All obligations under the Amended and Restated Credit Agreement are secured, subject to certain exceptions, by substantially all of our assets and the assets of the Credit Facility Guarantors, including (1) a pledge of 100% of our equity interests and that of the Credit Facility Guarantors, (2) mortgage liens on all of our material real property and that of the Credit Facility Guarantors, and (3) all proceeds of the foregoing.

The Amended and Restated Credit Agreement requires us to mandatorily prepay borrowings under the senior secured term loan facility with net cash proceeds of certain asset dispositions, following certain casualty events, certain borrowings or debt issuances, and from a percentage of annual excess cash flow.

The Amended and Restated Credit Agreement contains certain restrictive covenants, including, among other things: (1) limitations on the incurrence of debt and liens; (2) limitations on investments other than, among other exceptions, certain acquisitions that meet certain conditions; (3) limitations on the sale of assets outside of the ordinary course of business; (4) limitations on dividends and distributions; and (5) limitations on transactions with affiliates, in each case, subject to certain exceptions. The Amended and Restated Credit Agreement also contains certain customary events of default, including, without limitation, a failure to make payments under the Senior Secured Credit Facilities, cross-defaults, certain bankruptcy events and certain change of control events.

8.375% Senior Notes due 2019

We and IASIS Capital Corporation (together, the “Issuers”) issued an $850.0 million aggregate principal amount of Senior Notes, which mature on May 15, 2019, pursuant to an indenture, dated as of May 3, 2011, among the Issuers and certain of the Issuers’ wholly owned domestic subsidiaries that guarantee the Senior Secured Credit Facilities (the “Notes Guarantors”) (the “Indenture”). The Indenture provides that the Senior Notes are general unsecured, senior obligations of the Issuers, and initially will be unconditionally guaranteed on a senior unsecured basis by certain of our subsidiaries.

On October 31, 2014, the Issuers completed an offer to purchase up to $210.0 million aggregate principal amount of its outstanding Senior Notes. The Issuers were required to make the offer to purchase under the terms of the Indenture governing the Senior Notes using excess proceeds from certain asset dispositions. The offer to purchase was made at a price equal to 100% of the aggregate principal amount of the Senior Notes plus accrued and unpaid interest, to but excluding the redemption date. Holders validly tendered $0.1 million in aggregate principal amount of the Senior Notes, all of which were accepted by the Issuers. We made payment to settle all validly tendered Senior Notes on November 6, 2014.

The Senior Notes bear interest at a rate of 8.375% per annum, payable semi-annually, in cash in arrears, on May 15 and November 15 of each year.

We may redeem the Senior Notes in whole or in part, at anytime on or after May 15, 2014, the redemption prices set forth below, plus accrued and unpaid interest and special interest, if any, to but excluding the redemption date, subject to compliance with certain conditions. Each subsequent year the redemption price declines 2.093 percentage points until 2017, and thereafter, at which point the redemption price is equal to 100% of the aggregate principal amount of the Senior Notes plus accrued and unpaid interest and special interest, if any, to but excluding the redemption date.

 

Date

   Percentage  

May 15, 2014

     106.281

May 15, 2015

     104.188

May 15, 2016

     102.094

May 15, 2017 and thereafter

     100.000

        The Indenture contains covenants that limit our (and our restricted subsidiaries’) ability to, among other things: (1) incur additional indebtedness or liens or issue disqualified stock or preferred stock; (2) pay dividends or make other distributions on, redeem or repurchase our capital stock; (3) sell certain assets; (4) make certain loans and investments; (5) enter into certain transactions with affiliates; (6) impose restrictions on the ability of a subsidiary to pay dividends or make payments or distributions to us and our restricted subsidiaries; and (7) consolidate, merge or sell all or substantially all of our assets. These covenants are subject to a number of important limitations and exceptions.

 

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The Indenture also provides for events of default, which, if any of them occurs, may permit or, in certain circumstances, require the principal, premium, if any, interest and any other monetary obligations on all the then outstanding Senior Notes to be due and payable immediately. If we experience certain kinds of changes of control, we must offer to purchase the Senior Notes at 101% of their principal amount, plus accrued and unpaid interest and special interest, if any, to but excluding the repurchase date. Under certain circumstances, we will have the ability to make certain payments to facilitate a change of control transaction and to provide for the assumption of the Senior Notes by a new parent company resulting from such change of control transaction. If such change of control transaction is facilitated, the Issuers will be released from all obligations under the Indenture and the Issuers and the trustee will execute a supplemental indenture effectuating such assumption and release.

Credit Ratings

The table below summarizes our corporate rating, as well as our credit ratings for the Senior Secured Credit Facilities and Senior Notes as of the date of this filing:

 

     Moody’s    Standard & Poor’s
Corporate credit    B2    B
Senior secured term loan facility    Ba3    B
Senior secured revolving credit facility    Ba3    BB-
Senior Notes    Caa1    CCC+
Outlook    Stable    Stable

Other

We executed interest rate swaps with Citibank, N.A. (“Citibank”) and Barclays Bank PLC (“Barclays”), as counterparties, with notional amounts totaling $350.0 million, of which $50.0 million expired on September 30, 2014. The remaining agreements were effective March 28, 2013 and expire September 30, 2015 and September 30, 2016. Under these remaining agreements, we are required to make quarterly fixed rate payments to the counterparties at annual rates ranging from 1.9% to 2.2%. The counterparties are obligated to make quarterly floating rate payments to us based on the three-month LIBOR rate, each subject to a floor of 1.25%. The interest rate swaps outstanding at December 31, 2014 are as follows:

 

     Total Notional
Amounts
 

Effective Dates

   (in thousands)  
Effective from March 28, 2013 to September 30, 2015    $ 100,000   
Effective from March 28, 2013 to September 30, 2016      200,000   

Capital Expenditures

We plan to finance our proposed capital expenditures with cash generated from operations, borrowings under our Senior Secured Credit Facilities and other capital sources that may become available. We expect our capital expenditures for fiscal 2015 to be $130 million to $140 million, including the following significant expenditures:

 

    $65 million to $70 million for growth and new business projects, including approximately $30 million related to our new greenfield hospital in Lehi, Utah;

 

    $45 million to $50 million in replacement or maintenance related projects at our hospitals; and

 

    $20 million in hardware and software costs related to information systems projects, including healthcare IT stimulus initiatives.

Liquidity

We rely on cash generated from our operations as our primary source of liquidity, as well as available credit facilities, project and bank financings and the issuance of long-term debt. From time to time, we have also utilized operating lease transactions that are sometimes referred to as off-balance sheet arrangements. We expect that our future funding for working capital needs, capital expenditures, long-term debt repayments and other financing activities will continue to be provided from some or all of these sources. Each of our existing and projected sources of cash is impacted by operational and financial risks that influence the overall amount of cash generated and the capital available to us. For example, cash generated by our business operations may be impacted by, among other things, economic downturns, federal and state budget initiatives, weather-related catastrophes and adverse industry conditions. Our future liquidity will be impacted by our ability to access capital markets, which may be restricted due to our credit ratings, general market conditions, leverage capacity and by existing or future debt agreements. For a further discussion of risks that can impact our liquidity, see Item 1A, “Risk Factors”.

 

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Including available cash at December 31, 2014, we have available liquidity as follows (in millions):

 

Cash and cash equivalents $  294.8   
Available capacity under our senior secured revolving credit facility   222.3   
  

 

 

 

Net available liquidity at December 31, 2014

$ 517.1   
  

 

 

 

Net available liquidity assumes 100% participation from all lenders currently committed under our senior secured revolving credit facility. In addition to our available liquidity, we expect to generate sufficient operating cash flows in fiscal 2014. We will also utilize proceeds from our financing activities as needed.

Based upon our current level of operations and anticipated growth, we believe we have sufficient liquidity to meet our cash requirements over the short-term (next 12 months) and over the next three years. In evaluating the sufficiency of our liquidity for both the short-term and long-term, we considered the expected cash flow to be generated by our operations, cash on hand and the available borrowings under our Senior Secured Credit Facilities, compared to our anticipated cash requirements for debt service, working capital, capital expenditures and the payment of taxes, as well as funding requirements for long-term liabilities.

We are unable at this time to extend our evaluation of the sufficiency of our liquidity beyond three years. We cannot assure you, however, that our operating performance will generate sufficient cash flow from operations or that future borrowings will be available under our Senior Secured Credit Facilities, or otherwise, to enable us to grow our business, service our indebtedness, or make anticipated capital expenditures and tax payments. For more information, see our risk factors in our Annual Report on Form 10-K for the fiscal year ended September 30, 2014, as amended and restated in Item 1A. “Risk Factors”.

One element of our business strategy is to selectively pursue acquisitions and strategic alliances in existing and new markets. Any acquisitions or strategic alliances may result in the incurrence, or assumption by us, of additional indebtedness. We continually assess our capital needs and may seek additional financing, including debt or equity as considered necessary to fund capital expenditures and potential acquisitions or for other corporate purposes. Our future operating performance and our ability to service or refinance our debt will be subject to future economic conditions and to financial, business and other factors, many of which are beyond our control. For more information, see Item 1A. “Risk Factors.”

SEASONALITY

The patient volumes and total revenue of our healthcare operations are subject to seasonal variations and generally are greater during the quarter ended March 31 than other quarters. These seasonal variations are caused by a number of factors, including seasonal cycles of illness, climate and weather conditions in our markets, vacation patterns of both patients and physicians and other factors relating to the timing of elective procedures.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

We are subject to market risk from exposure to changes in interest rates based on our financing, investing and cash management activities. We do not, however, hold or issue financial instruments or derivatives for trading or speculative purposes. At December 31, 2014, the following components of our Senior Secured Credit Facilities bear interest at variable rates at specified margins above either the agent bank’s alternate base rate or the LIBOR rate: (i) a $1.025 billion, seven-year term loan; and (ii) a $300.0 million,
five-year revolving credit facility. As of December 31, 2014, we had outstanding variable rate debt of $986.9 million.

We have managed our market exposure to changes in interest rates by implementing a comprehensive interest rate hedging strategy that includes converting variable rate debt to fixed rate debt. We have executed interest rate swaps for non-trading and non-speculative purposes with Citibank and Barclays, as counterparties, with notional amounts totaling $350.0 million, of which $50.0 million expired on September 30, 2014. The remaining agreements were effective March 28, 2013 and expire between September 30, 2015 and September 30, 2016, and have annual rates ranging from 1.9% to 2.2%. Our interest rate hedging agreements expose us to credit risk in the event of non-performance by our counterparties, Citibank and Barclays. However, we do not anticipate non-performance by either of our counterparties.

Although changes in the alternate base rate or the LIBOR rate would affect the cost of funds borrowed in the future, we believe the effect, if any, of reasonably possible near-term changes in interest rates on our remaining variable rate debt or our consolidated financial position, results of operations or cash flows would not be material. Holding other variables constant, including levels of indebtedness, a 0.125% increase in current interest rates would have no estimated impact on pre-tax earnings and cash flows for the next twelve month period given the 1.25% LIBOR floor that exists in our Senior Secured Credit Facilities.

 

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We currently believe we have adequate liquidity to fund operations during the near term through the generation of operating cash flows, cash on hand and access to our senior secured revolving credit facility. Our ability to borrow funds under our senior secured revolving credit facility is subject to, among other things, the financial viability of the participating financial institutions. While we do not anticipate any of our current lenders defaulting on their obligations, we are unable to provide assurance that any particular lender will not default at a future date.

Item 4. Controls and Procedures

Evaluations of Disclosure Controls and Procedures

Under the supervision and with the participation of our management team, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended, as of December 31, 2014. Based on this evaluation, the principal executive officer and principal accounting officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic reports.

Changes in Internal Control Over Financial Reporting

During the period covered by this report, there has been no change in our internal control over financial reporting that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

In November 2010, the U.S. Department of Justice (“DOJ”) sent a letter to IAS requesting a 12-month tolling agreement in connection with an investigation into Medicare claims submitted by our hospitals in connection with the implantation of implantable cardioverter defibrillators (“ICDs”) between January 1, 2003 and November 30, 2010. At that time, neither the precise number of procedures, number of claims, nor the hospitals involved were identified by the DOJ. We understand that the government is conducting a national initiative with respect to ICD procedures involving a number of healthcare providers and is seeking information in order to determine if ICD implantation procedures were performed in accordance with Medicare coverage requirements. On January 11, 2011, IAS entered into the tolling agreement with the DOJ and, subsequently, the DOJ provided us with a list of 194 procedures involving ICDs at 14 hospitals which are the subject of further medical necessity review by the DOJ. We are cooperating fully with the government and, to date, the DOJ has not asserted any claim against our hospitals. Applying the resolution model proposed by the DOJ, we believe that at least 131 of these procedure claims were properly documented for medical necessity and billed appropriately. Our outside counsel has submitted to the DOJ summary justifications and supporting evidence relating to the medical claims at six of our hospitals. We continue to provide support for the remaining 63 of these cases that could have some likelihood of enforcement by the DOJ. If we are unable to place these claims in a non-enforcement or lesser enforcement category, the government may require repayment, which could impose a multiplier. Given the case-specific nature of the claims and the DOJ’s discretion to compromise claims, we are unable at this time to estimate any potential repayment obligation related to this matter. The tolling agreement between IAS and the government, as recently extended, is currently set to expire April 30, 2015.

On September 25, 2013, we voluntarily self-disclosed for resolution through the Self-Referral Disclosure Protocol established by CMS non-compliance by ten of our affiliated hospitals with a certain element of an exception of the Stark Law. Provisions of the Health Reform Law that became effective on September 23, 2011 require, as an element of the Stark Law’s “whole-hospital” exception, that hospitals having physician ownership disclose such ownership on their public websites and in public advertising. The self-disclosure states that, on August 12, 2013, we discovered that our ten affiliated hospitals partially owned by physicians did not consistently make such disclosures. The self-disclosure also states that, on August 13, 2013, the hospitals added the disclosures to those public websites that did not previously have them and began to include the disclosures in new public advertising. The self-disclosure explains that, as a result of the absence of the website and advertising disclosures, the referrals of direct and indirect physician owners (and physicians who are immediate family members of direct and indirect owners) to the physician-owned hospitals of Medicare beneficiaries did not consistently qualify for the Stark Law’s whole-hospital exception from September 23, 2011 through August 13, 2013. On October 21, 2013, we submitted a supplement to our self-disclosure, reporting Medicare payments to these hospitals for services resulting from referrals affected by the non-compliance and the hospitals’ profit distributions to physicians (and known immediate family members of physicians) with respect to their ownership interests in the hospitals during the same period. We have been in communication with CMS about resolving this matter but, at present, CMS has made no commitments, as a general matter or in this case, regarding the timing or substance of resolution of self-disclosed Stark Law noncompliance through the voluntary CMS Self-Referral Disclosure Protocol. As a result, we express no opinion as to its outcome and, at this time, any repayment obligation or other penalties to be determined by CMS are unknown and not currently estimable.

 

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Item 1A. Risk Factors

Reference is made to the factors set forth under the caption “Forward-Looking Statements” in Part I, Item 2 of this Form 10-Q and other risk factors previously disclosed in our Annual Report on Form 10-K for the fiscal year ended September 30, 2014, which are amended and restated below.

Risks related to our acute care operations

Changes in governmental healthcare programs may reduce our revenues.

Governmental healthcare programs, principally Medicare and Medicaid, including managed Medicare and managed Medicaid, accounted for 44.0%, 43.5% and 44.4% of our hospitals’ net patient revenue before the provision for bad debts for the years ended September 30, 2014, 2013 and 2012, respectively. However, in recent years legislative and regulatory changes have limited, and sometimes reduced, the levels of payments that our hospitals receive for various services under Medicare, Medicaid and other federal healthcare programs. The Budget Control Act of 2011 (“BCA”) provides for spending on program integrity initiatives intended to reduce fraud and abuse under the Medicare program. The BCA requires automatic spending reductions of $1.2 trillion for federal fiscal years 2013 through 2021, minus any deficit reductions enacted by Congress and debt service costs. However, the percentage reduction for Medicare may not be more than 2% for a fiscal year, with a uniform percentage reduction across all Medicare programs. These automatic spending reductions are commonly referred to as “sequestration.” Sequestration began on March 1, 2013, with CMS imposing a 2% reduction on Medicare claims beginning April 1, 2013. These spending reductions have been extended through 2024. We cannot predict what other deficit reduction initiatives may be proposed by the President or the Congress or whether the President and the Congress will restructure or suspend sequestration. Changes in the law to end or restructure sequestration may cause greater spending reductions than required by the BCA.

The Health Reform Law also provides for material reductions in the growth of Medicare program spending, including reductions in Medicare market basket updates and Medicare DSH funding. Further, from time to time, CMS revises the reimbursement systems used to reimburse healthcare providers and the requirements for coverage of services, including changes to the MS-DRG system and national and local coverage decisions, which may result in reduced Medicare payments. Sometimes, commercial third-party payors and other payors, such as some state Medicaid programs, rely on all or portions of the Medicare MS-DRG system to determine payment rates, and therefore, adjustments that negatively affect Medicare payments also may negatively affect payments from Medicaid programs or commercial third-party payors and other payors.

In addition, from time to time, state legislatures consider measures to reform healthcare programs and coverage within their respective states. Because of economic conditions and other factors, several states are experiencing budget problems and have adopted or are considering legislation designed to reduce their Medicaid expenditures, including enrolling Medicaid recipients in managed care programs, reducing the number of Medicaid beneficiaries by implementing more stringent eligibility requirements and imposing additional taxes or assessments on hospitals to help finance or expand states’ Medicaid systems. The states in which we operate have decreased funding for healthcare programs or made other structural changes resulting in a reduction in Medicaid hospital rates in recent years. Additional Medicaid spending cuts may be implemented in the states in which we operate, including reductions in supplemental Medicaid reimbursement programs.

Our Texas hospitals participate in private supplemental Medicaid reimbursement programs that are structured to expand the community safety net by providing indigent healthcare services and result in additional revenues for participating hospitals. Although CMS approved a five-year Medicaid waiver in December 2011 that allows Texas to continue receiving supplemental Medicaid reimbursement while expanding its managed Medicaid program, we cannot predict whether the Texas private supplemental Medicaid reimbursement programs will continue or guarantee that revenues recognized from the programs will not decrease. Beginning in 2014, the Health Reform Law provides for significant expansion of the Medicaid program, but the Department of Health and Human Services (the “Department”) may not penalize states that do not implement the Medicaid expansion provisions by withholding existing federal Medicaid funding. As a result, a number of states have opted not to implement the expansion, including Texas and Louisiana.

We believe that hospital operating margins across the country, including ours, have been and may continue to be under pressure because of limited pricing flexibility and growth in operating expenses in excess of the increase in payments under Medicare and other governmental programs. Current or future healthcare reform efforts, additional changes in laws or regulations regarding government health programs, changes to structure and reimbursement rates of governmental health programs or other changes in the administration of government health programs could have a material adverse effect on our financial position and results of operations.

 

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We cannot predict with certainty the long-term impact of the Health Reform Law, which represents significant change to the healthcare industry.

The Health Reform Law represents a significant change across the healthcare industry. The Health Reform Law is decreasing the number of uninsured individuals by expanding coverage to additional individuals through public program expansion and private sector health insurance reforms. The Health Reform Law expands eligibility under existing Medicaid programs and subsidizes states that create non-Medicaid plans for certain residents that do not qualify for Medicaid. States have opted, and may continue to opt, not to implement the expansion. Several state governors and legislatures, including Texas and Louisiana, have chosen not to participate in the expanded Medicaid program; however these states could implement the expansion at a later date. Further, the Health Reform Law requires states to establish or participate in health insurance exchanges or default to a federally operated Exchange to facilitate the purchase of health insurance by individuals and small businesses. Through the “individual mandate,” the Health Reform Law imposes financial penalties on individuals who fail to carry insurance coverage. However, there were significant problems during the initial implementation of the federal online Exchange and certain state Exchanges which negatively impacted the ability of individuals to enroll in Medicaid and to purchase health insurance. Further implementation issues, especially if not corrected in a timely manner, could lead to the federal government suspending the individual mandate tax penalties, further delays in uninsured individuals obtaining health insurance and an increase in the number of individuals who choose to pay the tax mandates rather than to purchase health insurance. In addition, the employer mandate requires companies with 50 or more employees to provide health insurance or pay fines, as well as insurer reporting requirements, but will not be fully implemented until January 1, 2016. The Health Reform Law also establishes a number of health insurance market reforms, including a ban on lifetime limits and pre-existing condition exclusions, new benefit mandates, and increased dependent coverage.

Although the expansion of health insurance coverage should increase revenues from providing care to certain previously uninsured individuals, we believe that the Health Reform Law could adversely affect our business and results of operations due to provisions of the Health Reform Law that are intended to reduce Medicare and Medicaid healthcare costs. Among other things, in order to fund the expansion of coverage to the uninsured population, the Health Reform Law reduces market basket updates, reduces Medicare and Medicaid DSH funding, and expands efforts to tie payments to quality and clinical integration. Any decrease in payment rates or an increase in rates that is below our increase in costs may adversely affect our results of operations. The Health Reform Law also provides additional resources to combat fraud, waste, and abuse, including expansion of the Recovery Audit Contractors (“RAC”) program to identify and recoup improper Medicare payments, which may result in increased costs for us to appeal or refund any alleged overpayments.

The Health Reform Law contains additional provisions intended to promote value-based purchasing. The Department has established a value-based purchasing system for hospitals that provides incentive payments to hospitals that meet or exceed certain quality performance standards, and such system is funded through decreases in the inpatient prospective payment system market basket updates to all hospitals. Further, hospitals with excess readmissions for conditions designated by the Department receive reduced payments for all inpatient discharges, not just discharges relating to the conditions subject to the excess readmissions standard. The Health Reform Law also prohibits the use of federal funds under the Medicaid program to reimburse providers for medical assistance provided to treat certain hospital-acquired conditions (“HACs”) and other provider-preventable conditions. In addition, beginning in federal fiscal year 2015, hospitals that fall into the worst 25% of national risk-adjusted HAC rates for all hospitals in the previous year will receive a 1% reduction in their total Medicare payments.

The Health Reform Law changes how healthcare services are covered, delivered, and reimbursed. However, many variables continue to impact the effect of the Health Reform Law, including the law’s complexity, continued delays or exceptions to employer mandates, possible amendment or repeal, changes or court challenges to the law, further technical issues with operating the federal and state Exchanges, uncertainty regarding the success of Exchanges enrolling uninsured individuals, possible reductions in funding by Congress and future reductions in Medicare and Medicaid reimbursement, how individuals and businesses will respond to the new choices and obligations under the law as well as the uncertainty as to the extent to which states will choose to participate in the expanded Medicaid program. For example, the SCOTUS has agreed to hear a case known as King v. Burwell during its 2015 judicial session. The plaintiffs are challenging the extension of premium subsidies to health insurance policies purchased through federally operated Exchanges, arguing that subsidies must be limited to state-operated Exchanges. If decided in favor of the plaintiffs, this case could make it more difficult for uninsured individuals in states that do not operate an Exchange to purchase coverage and otherwise significantly affect implementation of the Health Reform Law, in a manner that may result in less than projected numbers of newly insured individuals. Because of these many variables, we are unable to predict with certainty the net effect on our operations of the expected increases in insured individuals using our facilities, the reductions in government healthcare spending, and numerous other provisions in the Health Reform Law that may affect us. We are unable to predict with certainty how providers, payors, employers and other market participants will respond to the various reform provisions because many provisions will not be implemented for several years under the Health Reform Law’s implementation schedule.

 

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If we experience a shift in payor mix from commercial managed care payors to self-pay and Medicaid, our revenue and results of operations could be adversely affected.

Reimbursement from self-pay and Medicaid programs is generally lower than traditional commercial managed care products. In the several years prior to fiscal 2014, we experienced a shift in our patient volumes and revenue from commercial and managed care payors to self-pay and Medicaid, including managed Medicaid. This shift resulted in pressure on pricing and operating margins from expending the same resources to provide patient care, but for less reimbursement. This shift also reflected elevated unemployment levels and the resulting increases in states’ Medicaid rolls and the uninsured population. In addition, certain states have implemented measures to reduce enrollment in Medicaid which increased the number of uninsured patients seeking care at our hospitals. More recently, we have seen a reduction in the levels of our self-pay payor mix, which reflects improvement in the U.S. economy and decline in unemployment rate, and adoption of Medicaid expansion under the Health Reform Law in certain of our markets, including Arizona. However, we can provide no assurance that our payor mix will continue to improve. Despite an overall anticipated expansion in the number of insured individuals, implementation of the Health Reform Law could cause some patients to terminate their current insurance plans in favor of lower cost Medicaid plans or other insurance coverage with lower reimbursement. Increased enrollment in Exchange plans may cause lower reimbursement rates relative to traditional employer-sponsored health insurance plans for the healthcare services provided by our hospitals and employed physicians, and those Exchange-insured persons may pay higher deductibles, which may cause them to delay their medical treatment. Certain Exchange plans may also include limits on an enrollee’s overall benefit coverage as well as higher deductibles and other out-of-pocket costs that are the responsibility of such Exchange insured-persons, which, if unpaid, would result in higher levels of bad debt.

Utilization behavior of the insured population has changed because of the increasing prevalence of higher deductible and co-insurance plans implemented by employers, which has resulted in the deferral of elective and non-emergent procedures by individuals with high co-payments. We may be adversely affected by the growth in patient responsibility accounts because of increased adoption of plan structures, including health savings accounts, which shift greater responsibility for care to individuals through greater exclusions and higher co-payment and deductible amounts. Patient responsibility accounts may continue to increase even with expanded health plan coverage because of increases in plan exclusions and co-payment and deductible amounts. If we experience certain shifts in our patient volumes, our revenue and results of operations may be adversely affected.

If government-sponsored reimbursement and supplemental payment programs withhold payments due to our hospitals for services rendered, our cash flows, revenues and profitability of our operations could be adversely affected.

Our Texas hospitals participate in private supplemental Medicaid reimbursement programs structured to expand the community safety net by providing indigent healthcare services and result in additional revenues for participating hospitals. Although CMS approved a Medicaid waiver allowing Texas to continue receiving supplemental Medicaid reimbursement while expanding its managed Medicaid program, we cannot predict whether the Texas private supplemental Medicaid reimbursement programs will continue or guarantee that revenues recognized from the programs will not decrease, which may negatively affect our cash flows and profitability.

On October 1, 2014, the THHSC issued a notice to certain hospitals participating in a Texas Medicaid waiver program. The waiver, from CMS, allows the state to receive federal matching Medicaid funds for certain local government/hospital affiliations. According to the notice, a review conducted by CMS identified certain of these affiliations it believed may be inconsistent with the waiver. Because of these findings, CMS temporarily deferred the federal portion of the Medicaid payments associated with these affiliations. CMS lifted the deferral on January 7, 2015, but has not yet made a final determination regarding the acceptability of the affiliations. The CMS review referenced in the notice did not target any of our hospitals and we do not operate in the Texas geographic regions mentioned in the notice. However, the review reflects the nature of challenges that we may face with receiving governmental matching funds and supplemental payments. We cannot assure you that in the future that CMS, THHSC and other similar agencies will not audit or delay our operations in a manner that reduces the amount or slows the timing of our receipt of such funding.

If we are unable to retain and negotiate reasonable contracts with managed care plans or if insured patients switch from traditional commercial insurance plans to Exchange plans, then our net revenue may be reduced.

Our ability to obtain reasonable contracts with health maintenance organizations, preferred provider organizations and other managed care plans significantly affects the revenue and operating results of our hospitals. Net patient revenue, before the provision for bad debts, derived from health maintenance organizations, preferred provider organizations and other managed care plans accounted for 40.9%, 39.2% and 39.8% of our hospitals’ net patient revenue for the years ended September 30, 2014, 2013 and 2012, respectively. Our hospitals have more than 250 managed care contracts with no one payor contract representing more than 10.0% of our net patient revenue. Typically, we negotiate our managed care contracts annually as they come up for renewal at various times

 

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during the year. Further, many are terminable by either party on relatively short notice. Our future success will depend, in part, on our ability to retain and renew our managed care contracts and enter into new managed care contracts on terms favorable to us. Other healthcare providers, including some with larger and more integrated health systems, provider networks, greater geographic coverage or a wider range of services, may affect our ability to enter into managed care contracts or negotiate increases in our reimbursement and other favorable terms and conditions. Some of our competitors may negotiate exclusivity provisions with managed care plans or otherwise restrict the ability of managed care companies to contract with us. In one region in which we operate, the largest healthcare provider organization controls one of the largest payor organizations and operates it primarily as a closed network. The patients enrolled in this integrated health system are largely unavailable to us. In addition, continued consolidation among managed care companies may reduce our ability to negotiate favorable contracts with such payors.

Also, some employed individuals may move from commercial insurance coverage with higher reimbursement rates for our services and lower co-pays and deductibles for the insured employee to Exchange insurance plans that may provide lower reimbursement for our services, higher co-pays and deductibles for the insured employee or even exclusion of our hospitals and employed-physicians from coverage under certain Exchange plans. It is not clear what impact the increased obligations on managed care and other payors imposed by the Health Reform Law will have on our ability to negotiate reimbursement increases or other terms favorable to us. If we cannot retain and negotiate favorable contracts with managed care plans or experience reductions in payment increases or amounts received from non-governmental payors or a shift in business from commercial insurance payors to Exchange plans, then our revenues may be reduced.

If we experience growth in volume and revenue related to uncompensated care, our financial condition or results of operations could be adversely affected.

Like others in the hospital industry, from time to time we have experienced high levels of uncompensated care, including charity care and bad debts. These levels are driven by the number of uninsured and under-insured patients seeking care at our hospitals, the acuity levels at which these patients present for treatment, primarily resulting from economic pressures and their related decisions to defer care, increasing healthcare costs and other factors beyond our control, such as increases for co-payments and deductibles as employers continue to pass more of these costs on to their employees. In addition, in periods of high unemployment, we believe that our hospitals may continue to experience high levels of or possibly growth in bad debts and charity care.

While, over time, the Health Reform Law is expected to continue to decrease the number of uninsured individuals through expanding Medicaid and incentivizing employers to offer, and requiring individuals to carry health insurance or be subject to penalties, these provisions generally did not become effective until January 1, 2014 and some are still in the implementation stage. The federal Exchange experienced significant technical issues that negatively affected the ability of individuals to enroll in Medicaid and to purchase health insurance during 2014. Further, the extent to which additional states, including Texas and Louisiana, will participate in the Health Reform Law’s expanded Medicaid program is unclear since the federal government cannot eliminate or reduce existing federal Medicaid funding if states opt out of the law’s Medicaid expansion. Several state governors and legislatures, including Texas and Louisiana, have chosen not to participate in the expanded Medicaid program, the results of which have adversely affected our operations in those markets compared to states that have elected to expand their Medicaid programs; however, these states could implement some form of Medicaid expansion at a later date.

It is difficult to predict with certainty the full impact of the Health Reform Law due to the law’s complexity, continued delays or exceptions to employer mandates, possible amendment, or changes, court challenges to the law including the outcome of the SCOTUS’ decision regarding premium subsidies for eligible enrollees under federally operated health insurance exchanges, further technical issues with the federal government’s or any state’s website, uncertainty regarding the long-term success of Exchanges enrolling uninsured individuals, possible reductions in funding by Congress, future reductions in Medicare and Medicaid reimbursement and uncertainty surrounding state participation in the law’s expanded Medicaid program, as well as our inability to foresee how individuals and businesses will respond to choices afforded them under the law. We may continue to provide charity care to those who choose not to comply with the insurance requirements and undocumented aliens not permitted to enroll in a health insurance exchange or government healthcare program.

Although we continue to seek ways of improving point of service collection efforts and implementing payment plans with our patients, if we experience growth in self-pay volume and revenue, including increased acuity levels for uninsured patients and continued increases in co-payments and deductibles for insured patients, our results of operations could be adversely affected. Further, our ability to improve collections from self-pay patients may be limited by regulatory and investigatory initiatives, including private lawsuits directed at hospital charges and collection practices for uninsured and underinsured patients.

 

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Industry trends towards value-based purchasing, care coordination and “narrow networks” of healthcare providers may present our Company with operational, financial and competitive challenges.

There is a trend in the healthcare industry towards value-based purchasing of healthcare services. These value-based purchasing programs include both public reporting of quality data and preventable adverse events tied to the quality and efficiency of care provided by facilities. Governmental programs, including Medicare and Medicaid, require hospitals to report certain quality data to receive full reimbursement updates. In addition, Medicare does not reimburse for care related to certain preventable adverse events (called “never events”). Many large commercial payors require hospitals to report quality data, and several commercial payors do not reimburse hospitals for certain preventable adverse events. The Health Reform Law contains several provisions intended to promote value-based purchasing under Medicare and Medicaid. We expect value-based purchasing programs, including programs that condition reimbursement on patient outcome measures, to become more common and to involve a higher percentage of reimbursement amounts. While we believe we are adapting our business strategies to compete in a value-based reimbursement environment, we cannot predict how this trend will affect our results of operations, and it could negatively affect our revenues.

Integrated accountable care organizations and other kinds of “narrow” provider networks or organizations may exclude our hospitals, employed-physicians and other affiliated providers from their plans’ networks of healthcare providers. These contracting networks often organize hospitals, physicians and ancillary healthcare providers into narrow networks involving a smaller number of healthcare providers than does a network that allows all providers to participate, a so-called “open panel” network of providers, in exchange for which the “narrow network” may, if appropriately structured, achieve lower cost and/or higher quality in a way that benefits patients, employers, providers and payors. For instance, in some of the regions in which our hospitals operate, we face competition from large, not-for-profit healthcare systems with vertically integrated healthcare providers including health plans, physician groups and facilities, which affect our ability to obtain managed care contracts with their affiliated health insurance plans. Similarly, accountable care organizations commonly require physicians and other providers to participate exclusively in their organization. If our affiliated providers are excluded from such networks, or we are unable to recruit sufficient providers to our own networks, our business will face competitive disadvantages.

If controls imposed by Medicare, Medicaid and other third-party payors to reduce admissions and length of stay affect our inpatient volumes, our financial condition or results of operations could be adversely affected.

Controls imposed by Medicare, Medicaid and commercial third-party payors designed to reduce admissions and lengths of stay, commonly referred to as “utilization reviews,” have affected and are expected to continue to affect our facilities. Utilization review entails the review of the admission and course of treatment of a patient by managed care plans. Inpatient utilization, average lengths of stay and occupancy rates continue to be negatively affected by payor-required preadmission authorization and utilization review and by payor pressures to maximize outpatient and alternative healthcare delivery services for less acutely ill patients. Efforts to impose more stringent cost controls and reductions are expected to continue. For example, the Health Reform Law potentially expands the use of prepayment review by Medicare Administrative Contractors (“MACs”) by eliminating statutory restrictions on their use. Furthermore, the modified CMS policy on how MACs review inpatient hospital admissions for payment purposes could potentially reduce inpatient volume for patient stays spanning fewer than two midnights.

There has been increased scrutiny of a hospital’s “Medicare Observation Rate” from government enforcement agencies and industry observers. A low rate may raise suspicions that a hospital is inappropriately admitting patients that could be cared for in an observation setting. The industry may be subject to increased scrutiny and litigation risk, including government investigations and qui tam suits, related to inpatient admission decisions and the Medicare Observation Rate. In addition, CMS has established what is referred to as the “two midnight rule” (“TMR”) to guide practitioners admitting patients and contractors conducting payment reviews on when it is appropriate to admit individuals as hospital inpatients. Under the TMR, Medicare beneficiaries are to be admitted as inpatients only when there is a reasonable expectation that the care is medically necessary and expectation that the care will cross two midnights absent unusual circumstances. Compliance with TMR becomes subject to audits beginning October 1, 2015, but CMS began conducting reviews for admissions beginning October 1, 2013 at selected facilities to provide educational outreach on the TMR.

If we are unable to attract and retain quality medical professionals, our financial condition or results of operations could be adversely affected.

The success of our hospitals depends on the following factors, among others:

 

    the number and quality of the physicians on the medical staffs of our hospitals;

 

    the competency of those physicians and our facilities to meet their communities’ needs for healthcare services in a convenient, high quality and high value manner;

 

    the referral patterns of those physicians; and

 

    our maintenance of good relations with those physicians.

Our efforts to attract and retain physicians are affected by our managed care contracting relationships, national shortages in some specialties, the adequacy of our support personnel, the condition of our facilities and medical equipment, the availability of suitable medical office space and federal and state laws and regulations prohibiting financial relationships that may have the effect of inducing patient referrals.

 

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To meet varying community needs for healthcare services in certain markets in which we operate, and to better coordinate patient care, we have implemented a strategy to employ physicians, which has expanded our employed physician base. The execution of a physician employment strategy includes an increased cost at our company for salaries, wages and benefits; increases in malpractice insurance coverage costs; risks of unsuccessful physician integration and difficulties associated with physician practice management. While we believe this strategy follows industry trends, we cannot be assured of the long-term success of our physician employment strategy.

We also compete with other healthcare providers in recruiting and retaining qualified management and staff to run the
day-to-day operations of our hospitals, including administrators, nurses, technicians and non-physician healthcare professionals. Some of our markets are more difficult to recruit physicians and nurses to locate there compared to other of our markets or other competing markets, depending on the community need, area of practice and the recruited physician’s or nurse’s personal considerations. Our failure to recruit and retain such management personnel and skilled professionals could adversely affect our financial condition and results of operations.

Our hospitals face competition for staffing, especially because of the shortage of nurses, which has in the past and may in the future increase our labor costs and materially reduce our profitability.

We compete with other healthcare providers in recruiting and retaining qualified management and staff personnel responsible for the day-to-day operations of each of our hospitals, physician practices and our managed care operations, including most significantly nurses and other non-physician healthcare professionals. While the national nursing shortage has abated somewhat, certain portions of our markets have limited nursing resources. In the healthcare industry, including in our markets, the shortage of nurses and other medical support personnel is a significant operating issue. This shortage has caused us in the past and may require us in the future to increase wages and benefits to recruit and retain nurses and other medical support personnel or to hire more expensive temporary personnel. Frequently in the past, we voluntarily raised, and expect to raise, wages for our nurses and other medical support personnel.

If our labor costs continue to increase, we may not be able to achieve higher payor reimbursement levels or reduce other operating expenses in a manner sufficient to offset these increased labor costs. Because substantially all of our net patient revenues are based on reimbursement rates fixed or negotiated no less frequently than annually, our ability to pass along periodic increased labor costs is materially constrained. Our failure to recruit and retain qualified management, nurses and other medical support personnel, or to control our labor costs, could have a material adverse effect on our profitability.

Our hospitals face competition from other hospitals and healthcare providers that could negatively affect patient volume.

The hospital industry is highly competitive. Our hospitals face competition for patients from other hospitals in our markets, large vertically integrated providers, large tertiary care centers and outpatient service providers that provide similar services to those provided by our hospitals. While our small 15-bed critical access hospital in Woodland Park, Colorado is an exception, none of our other hospitals are sole community providers and all of them are in geographic areas in which at least one other hospital provides services comparable to those offered by our hospitals. Some of the hospitals that compete with ours are owned by governmental agencies or not-for-profit corporations supported by endowments and charitable contributions and can finance capital expenditures and operations on a tax-exempt basis. In addition, the number of freestanding specialty hospitals, outpatient surgery centers, emergency departments, urgent care centers and outpatient diagnostic centers has increased significantly in the areas in which we operate. We also face competition from competitors implementing physician alignment strategies, such as employing physicians, acquiring physician practice groups and participating in accountable care organizations or other clinical integration models. Some of our competitors also have greater geographic coverage, offer a wider range of services or invest more capital or other resources than we do. In addition, competitors that operate non-hospital facilities or hospitals not owned by physicians are not subject to the same federal restrictions on expansion as our physician-owned hospitals. If our competitors can achieve greater geographic coverage, improve access and convenience to physicians and patients, recruit physicians to provide competing services at their facilities, expand or improve their services or obtain more favorable managed care contracts, we may experience a decline in patient volume.

CMS publicizes performance data relating to quality measures and data on patient satisfaction surveys that hospitals are required to submit to CMS. Federal law provides for the expansion of the number of quality measures that we are required to make publicly available. Further, the Health Reform Law requires all hospitals annually to establish, update and make public a list of their standard charges for items and services. If any of our hospitals should achieve poor results (or results that are lower than our competitors) on these quality criteria, or if our standard charges are higher than those published by our competitors, our patient volumes could decline.

 

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The required reporting of additional quality measures and other trends toward clinical transparency and value-based purchasing of healthcare services may have an adverse impact on our competitive position and patient volume.

A health pandemic could negatively affect our business.

If a pandemic or other widespread health crisis, such as the spread of the Ebola virus, were to occur in our markets, our business could be adversely affected. Such a crisis could diminish the public trust in healthcare facilities, especially hospitals treating (or that have treated) patients affected by the pandemic. If any of our facilities treated patients from such a health crisis, patients might cancel elective procedures or fail to seek needed care at our facilities. Further, a health pandemic might adversely affect our business by disrupting or delaying production and delivery of materials and products in the supply chain or by causing staffing shortages in our facilities. Although we have infection control and disaster plans in place, and we manage our hospital facilities pursuant to infectious disease protocols, the impact of a pandemic on our business could be materially adverse.

A failure of our information systems, or increased costs associated with upgrading and operating such systems, could adversely affect our ability to properly manage our operations.

We rely on our advanced information systems and our ability to successfully use these systems in our operations. These systems are essential to the following areas of our business operations, among others:

 

    patient accounting, including billing and collection of net patient revenue;

 

    financial, accounting, reporting and payroll;

 

    coding and compliance;

 

    laboratory, radiology and pharmacy systems;

 

    materials and asset management;

 

    negotiating, pricing and administering managed care contracts; and

 

    monitoring quality of care and collecting data on quality measures for full Medicare payment updates.

If we fail to operate these systems effectively, we may experience delays in collection of net patient revenue and may not properly manage our operations or oversee compliance with laws or regulations. Moreover, if we fail to continue to demonstrate meaningful use of certified electronic health record (“EHR”) technology, we will be subject to reduced payments from Medicare (in addition to any ongoing statutory reductions). Furthermore, because the information technology landscape changes frequently, our systems require upgrades and replacement as new technologies are introduced, old technologies are no longer supported and physician and patient needs evolve requiring greater emphasis on integration of clinical, revenue and patient accounting systems. In this context, we may face significant financial costs, cash flow disruptions and operational difficulties as we from time to time change our information technology platforms, as well as operational difficulties in installing such new technology into our hospitals and operating it effectively. Such difficulties could affect our ability to properly manage our operations and adversely affect our cash flows.

Our inability to effectively replace information technology systems used by our hospitals, or the costs associated with such replacements and upgrades, could adversely affect our operations and financial results.

Healthcare information technology continues to evolve at a rapid pace. In order to remain competitive and to provide high quality clinical care, our company invests heavily in numerous information technology systems used by our hospitals and other lines of business. These information technology systems relate to clinical care, quality review, communications among providers, the storage of health records and many other business functions.

We incur substantial costs to maintain and upgrade our information technology systems. Such costs can occur not only in connection with maintenance and upgrades, but also when our third-party information technology vendors discontinue systems upon which we rely. For instance, we are party to a services contract with McKesson Information Solutions LLC (“McKesson”), through which we operate an advanced clinical information technology platform called Horizon Clinicals (“Horizon Clinicals”). Horizon Clinicals provides patient care information solutions, including computerized provider order entry solutions, medication management solutions, shared communications for providers meant to enhance patient safety, management reporting capabilities, compliance tools and advanced clinical analytics to simplify data collection and reporting. Horizon Clinicals has been the primary advanced clinical information technology platform used by our hospitals for an number of years. In December 2011, McKesson announced its plan to stop development of Horizon Clinicals. McKesson has stated that it plans to support Horizon Clinicals through March 2018. In response to this announcement, we are evaluating the capabilities of, and costs associated with transitioning to, alternate healthcare information technology platforms that could replace the capabilities currently provided by Horizon Clinicals. Moreover, if we fail to demonstrate meaningful use of certified EHR technology either through Horizon Clinicals or a replacement platform, we will be subject to reduced payments from Medicare (in addition to any ongoing statutory reductions).

 

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The replacement of any information technology system upon which we rely may be financially and administratively burdensome to us. Such replacements, upgrades and similar projects require modifications to our capital expenditure plans and constrain our ability to pursue other opportunities requiring significant capital and management resources. Additionally, such upgrades may be time consuming and complex from an administrative standpoint. If our implementation of a replacement technology system is inefficient, delayed or ineffective, we may experience disruptions or delays in our cash flows and day-to-day caregiver processes, experience errors related to sharing of patient care information and declines in patient and/or hospital employee satisfaction. Because the healthcare information technology business and our business’ and patients’ needs continuously evolve, we cannot assure you that we will not incur such financial and administrative difficulties.

We are required to comply with laws governing the transmission, security and privacy of health information.

The Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) administrative simplification provisions require the use of uniform electronic data transmission standards for healthcare claims and payment transactions submitted or received electronically. In addition, the Health Reform Law requires the Department to adopt standards for additional electronic transactions and to establish operating rules to promote uniformity in the implementation of each standardized electronic transaction. On August 10, 2012, the Department issued an interim final rule to establish operating rules for healthcare electronic funds transfers and remittance advice transactions. Compliance with the interim final rule was required by January 1, 2014. Further, CMS has published final rule making changes to the formats used for certain electronic transactions and requiring the use of updated standard code sets for certain diagnoses and procedures known as ICD-10 code sets. Use of the ICD-10 code sets is required by October 1, 2015, and will require significant changes; however, we believe that the cost of compliance with these regulations has not had and is not expected to have a material adverse effect on our business, financial position or results of operations.

As required by HIPAA, the Department has issued privacy and security regulations that extensively regulate the use and disclosure of individually identifiable health information (known as protected health information or “PHI”) and require covered entities, including healthcare providers, to implement administrative, physical and technical safeguards to protect the security of PHI. As a result of changes made as part of the American Recovery and Reinvestment Act of 2009 (“ARRA”) and implementing regulations, entities that handle PHI on behalf of covered entities (known as “business associates”) or of other business associates must comply with most provisions of the HIPAA privacy and security regulations and are subject to civil and criminal penalties for violations to these regulations. A covered entity may be subject to penalties as a result of a business associate violating HIPAA, if the business associate is found to be an agent of the covered entity. Covered entities and business associates were generally required to comply with regulations implementing the ARRA changes by September 23, 2013. Covered entities must report breaches of unsecured PHI to affected individuals without unreasonable delay, but not to exceed 60 days, of discovery of the breach by the covered entity or its agents. Agreements with certain of our business associates may also subject us contractually to breach notification periods of fewer than 60 days. Notification must also be made to the Department and, in certain situations involving large breaches, to the media. All non-permitted uses or disclosures of unsecured PHI are presumed to be breaches unless the covered entity or business associate establishes that there is a low probability the information has been compromised.

The privacy and security regulations have and will continue to impose significant costs on our facilities in order to comply with these standards. Violations of the HIPAA privacy and security regulations may result in civil and criminal penalties, which have been significantly increased by ARRA. Further, the Department is required to perform compliance audits, which may result in increased enforcement activity. In addition, state attorneys general may bring civil actions seeking either injunctive relief or damages in response to violations of HIPAA privacy and security regulations that threaten the privacy of state residents. The Department is required to impose penalties for violations resulting from willful neglect. There are numerous other laws and legislative and regulatory initiatives at the federal and state levels addressing privacy and security concerns. Our facilities remain subject to any federal or state privacy-related laws that are more restrictive than the privacy regulations issued under HIPAA. These laws vary, may impose additional obligations and could impose additional penalties. For example, various state laws and regulations may require us to notify affected individuals in the event of a data breach involving individually identifiable information (even if no health-related information is involved). In addition, the Federal Trade Commission (“FTC”) uses its consumer protection authority to initiate enforcement actions in response to data breaches. To the extent we fail to comply with one or more federal and/or state privacy and security requirements, we could be subject to substantial fines, penalties as well as third-party claims which could have a material adverse effect on our financial position, results of our operations and cash flows.

A breach of our information system’s cyber-security precautions may cause loss of protected health information, adversely affect our ability to properly manage our operations, cause us to incur remediation costs, increase our operating expenses and result in litigation and negative publicity.

Aspects of our business operations give rise to material cybersecurity risks and the potential costs and consequences. Additionally, we outsource functions that may also have material cybersecurity risks. Certain risks related to cyber incidents may

 

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remain undetected for an extended period. We maintain a cyber and privacy risk commercial insurance policy with a $20 million limit of liability. If we incur a security breach, the policy provides coverage for information security and privacy liability, regulatory defense and penalties, website media content liability, notification services and privacy breach response services.

The objectives of cyber attacks vary widely and may include theft of PHI, financial assets, intellectual property, or other sensitive information belonging to us, our customers or our business partners. Cyber attacks also may be directed at disrupting our operations or the operations of our business partners. If we fall victim to cyber attacks, we may incur substantial costs and suffer other negative consequences, which may include, but are not limited to, remediation costs that may include liability for stolen assets or information and repairing system damage that may have been caused, including incentives offered to customers or other business partners in an effort to maintain the business relationships after an attack; increased cyber-security protection costs that may include organizational changes, deploying additional personnel and protection technologies, training employees, and engaging third party experts and consultants; lost revenues resulting from unauthorized use of proprietary information or the failure to retain or attract customers following an attack; litigation; and reputational damage adversely affecting customer or investor confidence. Furthermore, breaches of unsecured PHI caused by cyber-attacks will trigger notification requirements under HIPAA as well as additional procedures, which if not followed properly, could result in civil and criminal penalties and could have a material adverse effect on our business.

If we fail to continually enhance our hospitals with the most recent technological advances in diagnostic and surgical equipment, our ability to maintain and expand our markets may be adversely affected.

Technological advances regarding CTs, MRIs and PET equipment, and other equipment used in our facilities, are continually evolving. To compete with other healthcare providers, we must constantly evaluate our equipment needs and upgrade equipment because of technological improvements. If we fail to remain current with the technological advancements of the medical community, our volumes and revenue may be negatively affected. Further, technological advances, including regarding both medical equipment and pharmaceuticals, may cure disease or alter the processes used for the diagnosis or treatment of certain illnesses or diseases which could increase competition for our healthcare services, reduce our patient volumes, reduce our revenues and have a material adverse effect on our profitability.

If we fail to effectively and timely implement EHR systems and transition to the ICD-10 coding system, our operations could be adversely affected.

As required by the ARRA, the Department has adopted an incentive payment program for eligible hospitals and healthcare professionals that implement certified EHR technology and use it consistently with “meaningful use” requirements. If our hospitals and employed or contracted professionals do not meet the Medicare or Medicaid EHR incentive program requirements, we will not receive Medicare or Medicaid incentive payments to offset some of the costs of implementing the EHR systems. Further, beginning in federal fiscal year 2015, eligible hospitals and physicians that fail to demonstrate meaningful use of certified EHR technology are subject to reduced payments from Medicare. Failure to implement EHR systems effectively and in a timely manner could have a material adverse effect on our financial position and results of operations.

Health plans and providers, including our hospitals, must transition to the new ICD-10 coding system, which greatly expands the number and detail of billing codes used for inpatient claims. Use of the ICD-10 system will be required on October 1, 2015. Although we anticipate meeting such requirements, transitioning to the new ICD-10 system requires significant investment in coding technology and software and the training of staff involved in the coding and billing process. Besides these upfront costs of transition to ICD-10, our hospitals might experience disruption or delays in payment due to technical or coding errors or other implementation issues involving our systems or the systems and implementation efforts of health plans and their business partners. Further, the transition to the more detailed ICD-10 coding system could cause decreased reimbursement if using ICD-10 codes result in conditions being reclassified to MS-DRGs or commercial payor or payment groupings with lower levels of reimbursement than assigned under the previous system.

If we fail to comply with extensive laws and governmental regulations, we could suffer penalties, be required to alter financial arrangements with our referral sources, including referral source investors in some of our hospitals, or be required to significantly change our operations.

The healthcare industry, including our company, must comply with extensive and complex statutes and regulations at the federal, state and local government levels relating to:

 

    billing and coding for services and proper handling of overpayments;

 

    classification of level of care provided, including proper classification of emergency treatment, inpatient admissions, observation status and outpatient care;

 

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    relationships with physicians and other referral sources, including financial arrangements and ownership interests involving physicians and other referral sources, such as physicians holding ownership interests in hospitals;

 

    necessity and adequacy of medical care;

 

    quality of medical equipment and services;

 

    qualifications of medical and support personnel;

 

    confidentiality, maintenance, data breach, identity theft and security issues associated with health related and personal information and medical records;

 

    screening, stabilization and transfer of individuals who have emergency medical conditions;

 

    licensure and certification;

 

    hospital rate or budget review;

 

    preparation and filing of cost reports;

 

    activities regarding competitors;

 

    operating policies and procedures;

 

    addition of facilities and services;

 

    provider-based reimbursement, including complying with requirements allowing multiple locations of a hospital to be billed under the hospital’s Medicare provider number;

 

    incentive payments for the adoption and meaningful use of certified EHR technology; and

 

    disclosures to patients, including disclosure of any physician ownership in a hospital.

Because some of these statutes and regulations are relatively new and subject to ongoing interpretation by regulatory agencies, we do not always have the benefit of significant regulatory or judicial interpretation of these laws and regulations. Because these laws and regulations are so complex, hospital companies face a risk of inadvertent violations. Different interpretations or enforcement of these laws and regulations could subject our current or past practices to allegations of impropriety or illegality or could require us to change our facilities, equipment, personnel, services, capital expenditure programs and operating expenses.

If we fail to comply with applicable laws and regulations, we could be subjected to liabilities, including:

 

    criminal penalties;

 

    civil penalties, including the loss of our licenses to operate one or more of our facilities; and

 

    exclusion of one or more of our facilities from participation in the Medicare, Medicaid and other federal and state healthcare programs.

The Health Reform Law imposes significant restrictions on hospitals that have physician owners.

Some of our hospitals have physician ownership pursuant to an exception to the Stark Law known as the “whole-hospital” exception. The Health Reform Law significantly narrows this exception to apply only to hospitals that had physician ownership in place as of March 23, 2010, and a Medicare provider agreement effective as of December 31, 2010. While the amended whole-hospital exception grandfathers certain existing physician-owned hospitals, including nine of ours, it prohibits a grandfathered hospital from increasing its percentage of physician ownership beyond the aggregate level that was in place as of March 23, 2010. Subject to limited exceptions, a grandfathered physician-owned hospital may not increase its aggregate number of operating rooms, procedure rooms, and beds for which it is licensed beyond the number in place as of March 23, 2010. A grandfathered physician-owned hospital must comply with a number of additional requirements, including not conditioning any physician ownership directly or indirectly on the owner making or influencing referrals, not offering any ownership interests to physician owners on more favorable terms than those offered to non-physicians and not providing any guarantee to physician owners to purchase other business interests related to the hospital. Further, a grandfathered hospital cannot have been converted from an ambulatory surgery center to a hospital.

        The whole-hospital exception, as amended, also contains additional disclosure requirements. For example, a grandfathered physician-owned hospital is required to submit an annual report to the Department listing each investor in the hospital, including all physician owners. In addition, grandfathered physician-owned hospitals must have procedures in place that require each referring physician owner to disclose to patients, with enough notice for the patient to make a meaningful decision regarding receipt of care, the physician’s ownership interest and, if applicable, any ownership interest held by the treating physician. A grandfathered physician-owned hospital also must disclose on its website and in any public advertising the fact that it has physician ownership. The Health Reform Law requires the Department to audit grandfathered physician-owned hospitals’ compliance with these requirements.

On September 25, 2013, we voluntarily self-disclosed for resolution through the Self-Referral Disclosure Protocol established by CMS, non-compliance by ten of our affiliated hospitals with the whole-hospital exception provision that requires disclosure of physician ownership on hospital websites and in public advertising. Provisions of the Health Reform Law that became effective on September 23, 2011 require, as an element of the Stark Law’s whole-hospital exception, that hospitals having physician ownership disclose such ownership on their public websites and in public advertising. Our self-disclosure states that, on August 12, 2013, we

 

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discovered that the ten of our affiliated hospitals partially owned by physicians did not consistently make such disclosures. The self-disclosure also states that, on August 13, 2013, the hospitals added the disclosures to those public websites that did not previously have them and began to include the disclosures in new public advertising. The self-disclosure explains that, as a result of the absence of the website and advertising disclosures, the referrals of direct and indirect physician owners (and physicians who are immediate family members of direct and indirect owners) to the physician-owned hospitals of Medicare beneficiaries did not consistently qualify for the whole-hospital exception from September 23, 2011 through August 13, 2013. On October 21, 2013, we submitted a supplement to our self-disclosure, reporting Medicare payments to these hospitals for services resulting from referrals affected by the non-compliance and the hospitals’ profit distributions to physicians (and known immediate family members of physicians) with respect to their ownership interests in the hospitals during the same period. We have been in communication with CMS about resolving this matter but, at present, CMS has made no commitments, as a general matter or in this case, regarding the timing or substance of resolution of self-disclosed Stark Law noncompliance through the voluntary CMS Self-Referral Disclosure Protocol. As a result, we express no opinion as to its outcome and, at this time, any repayment obligation or other penalties to be determined by CMS are unknown and not currently estimable.

In light of the Health Reform Law’s restrictions on the whole-hospital exception and limited interpretive guidance, it may be difficult for us to determine how the exception will apply to specific situations, including the ones discussed above, that may arise with our hospitals. If any of our hospitals, including the ones discussed above, fail to comply with the amended whole-hospital exception, those hospitals could be found to be in violation of the Stark Law, and we could incur significant financial or other penalties.

Providers in the healthcare industry have been the subject of federal and state investigations, and we may become subject to additional investigations that could cause significant liabilities or penalties to us.

Both federal and state government agencies have increased their focus on and coordination of civil and criminal enforcement efforts in the healthcare area. There are numerous ongoing investigations of hospital companies, and their executives and managers. The Office of Inspector General of the U.S. Department of Health and Human Services (“OIG”) and the DOJ have, from time to time, established national enforcement initiatives that focus on specific billing practices or other suspected areas of abuse. Further, under the False Claims Act (“FCA”), private parties may bring “qui tam” whistleblower lawsuits against companies that submit false claims for payments to, or improperly retain overpayments from, the government. Some states have adopted similar state whistleblower and false claims provisions.

Federal and state investigations relate to a wide variety of routine healthcare operations including:

 

    cost reporting and billing practices;

 

    financial arrangements with referral sources;

 

    physician recruitment activities;

 

    physician joint ventures; and

 

    hospital charges and collection practices for self-pay patients.

We engage in many of these and other activities that could be the subject of governmental investigations or inquiries from time to time. We have significant Medicare and Medicaid billings, we have numerous financial arrangements with physicians who are referral sources to our hospitals and we have nine hospitals as of September 30, 2014, that have physician investors. In addition, our executives and managers, many of whom have worked at other healthcare companies that are or may become the subject of federal and state investigations and private litigation, may be included in governmental investigations or named as defendants in private litigation. Any additional investigations of us, our executives or our managers could cause significant liabilities or penalties to us, and adverse publicity.

In addition, governmental agencies and their agents, such as MACs, fiscal intermediaries and carriers, and the OIG, CMS and state Medicaid programs, conduct audits of our healthcare operations. Private payors may conduct similar audits, and we also perform internal audits and monitoring. Depending on the conduct found in such audits and whether the underlying conduct could be considered systemic, resolving these audits could have a material adverse effect on our financial position, results of operations and cash flows.

CMS has implemented a nationwide RAC program under which it engages private contractors to conduct post-payment reviews to detect and correct improper payments in the Medicare program. The contractors receive a contingency fee based on corrected, improper payments. The Health Reform Law expanded the RAC program’s scope to include other Medicare programs, including managed Medicare, effective December 31, 2010. In addition, CMS has implemented a pre-payment demonstration project that allows RACs to review claims before they are paid to ensure that the provider complied with all Medicare payment rules. Under the demonstration project, RACs conduct prepayment reviews on certain types of claims that historically result in high rates of improper

 

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payments, beginning with those involving short stay inpatient hospital services. These reviews focus on seven states (Florida, California, Michigan, Texas, New York, Louisiana and Illinois) with high populations of fraud and error-prone providers and four states (Pennsylvania, Ohio, North Carolina and Missouri) with high claims volumes of short inpatient hospital stays. The demonstration project began on August 27, 2012 and runs for a three year period.

In addition, through the Deficit Reduction Act of 2005 (“DEFRA”), Congress has expanded the federal government’s involvement in fighting fraud, waste and abuse in the Medicaid program by creating the Medicaid Integrity Program. Under this program, CMS engages private contractors, referred to as Medicaid Integrity Contractors (“MICs”), to perform post-payment audits of Medicaid claims and identify overpayments. In addition, the Health Reform Law expanded the RAC program’s scope to include Medicaid claims. In addition to MICs and RACs, several other contractors and state Medicaid agencies have increased their review activities.

In November 2010, the DOJ sent a letter to us requesting a 12-month tolling agreement in connection with an investigation into Medicare claims submitted by our hospitals in connection with the implantation of ICDs between January 1, 2003 and November 30, 2010. In January 2011, we entered into the tolling agreement with the DOJ which is currently set to expire in April 2015. Although we believe these procedure claims were properly documented for medical necessity and billed appropriately, to the extent the government disagrees with our determinations, we would be required to repay any improper payments as well any additional penalties imposed, which could adversely affect our business. For additional information, refer to Note 8, Commitments and contingencies, to our consolidated financial statements included elsewhere in this Form 10-Q.

Any such audit or investigation could have a material adverse effect on our financial position, results of our operations and cash flows.

We face risks associated with federal and state antitrust laws applicable to the management and operation of our provider-sponsored networks.

Federal and state antitrust laws prohibit unreasonable restraints of trade, including price fixing and market allocations among competitors. Joint contracting among competitors may constitute price fixing, and may therefore be illegal, unless the contracting parties are under common governance, the contracting parties are involved in a legitimate joint venture to which joint contracting is ancillary, joint contracting is obtained through a “messenger” or there is sufficient clinical integration or substantial financial risk sharing. Violation of antitrust laws can result in civil penalties and/or criminal prosecution. The FTC has issued certain guidance regarding joint contracting among healthcare providers, including examples of financial arrangements that constitute sufficient risk sharing, and clinical integration that is sufficient, to permit joint provider contracting.

Our acute care hospitals have collaborated with Health Choice, through its Health Choice and accountable care networking business, to build networks consisting of our hospitals, some of our hospitals’ medical staffs and our employed physicians and independent physicians and facilities. These so-called “narrow networks” can provide managed services to patients in contract with select payors, with the goal of achieving clinical integration and associated efficiencies among such providers, to improve population health, improve patients’ experience of care and control healthcare costs.

Our aggregation of providers into single networks, our joint contracting policies and procedure and our financial arrangements with third party payors through these networks are structured to comply with all federal and state antitrust laws. However, we can provide no assurance we will meet all the requirements under applicable antitrust law regarding operation of our provider networks. Failure to comply with various federal and state antitrust laws and regulations, could result in investigations or litigation, with potential penalties or damages, and limitations on our ability to expand that could adversely affect our business, cash flows, financial condition and results of operations.

We are subject to risks associated with outsourcing functions to third parties.

To improve operating margins, productivity and efficiency, we outsource selected nonclinical business functions to third parties. We take steps to monitor and regulate the performance of independent third parties to whom we have delegated selected functions which may include revenue cycle management, patient access, billing, cash collections, payment compliance and other support services. Arrangements with third party service providers may make our operations vulnerable if vendors fail to satisfy their obligations to us because of their performance, changes in their own operations, financial condition, or other matters outside of our control. Our use of third party providers also may require changes to our existing operations and the adoption of new procedures and processes for retaining and managing these providers, and redistributing responsibilities to realize the potential productivity and operational efficiencies. Effective management, development and implementation of our outsourcing strategies are important to our business and strategy. If there are delays or difficulties in enhancing business processes or our third party providers do not perform as

 

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anticipated, we may not fully realize on a timely basis the anticipated economic and other benefits of the outsourcing projects or other relationships we enter into with key vendors, which could cause substantial costs, divert management’s attention from other strategic activities, negatively affect employee morale or create other operational or financial problems for us. Terminating or transitioning arrangements with key vendors could cause additional costs and a risk of operational delays, potential errors and possible control issues because of the termination or during the transition phase.

Regional economic downturns or other material changes in the economic condition in the markets in which we operate could cause our overall business results to suffer.

During times of economic volatility, which includes unstable consumer spending and high levels of unemployment, governmental entities often experience budgetary constraints because of increased costs and lower than expected tax collections. These budgetary constraints have resulted in decreased spending for health and human service programs, including Medicare, Medicaid and similar programs, which represent significant payor sources for our hospitals. Many states, including states in which we operate, have decreased funding for state healthcare programs or made other structural changes resulting in a reduction in Medicaid spending. Additional Medicaid spending cuts may be implemented in the states in which we operate. Other risks we face from general economic volatility include patient decisions to postpone or cancel elective and non-emergent healthcare procedures, increases in the uninsured population and further difficulties in our collection of patient co-payment and deductible receivables.

Our acute care and managed care business segments operate in various regions across the country. For the fiscal year ended September 30, 2014, our total revenue was generated in the following geographic areas:

 

Phoenix, Arizona

     41.9

Five cities in Texas, including Houston and San Antonio

     30.1

Salt Lake City, Utah

     20.8

Other

     7.2

Our business is not as geographically diversified as some competing multi-facility healthcare companies and, therefore, is subject to greater market risks. Any material change in the current demographic, economic, competitive or regulatory conditions in any of the regions in which we operate could materially adversely affect our overall business results because of the significance of our operations in each of these regions to our overall operating performance.

We may not achieve our acute care acquisition and growth strategies and we may have difficulty acquiring non-profit hospitals due to regulatory barriers and scrutiny.

Part of our business strategy has been expansion by acquiring hospitals and ambulatory care and other facilities in our existing markets and in markets and by entering into partnerships or affiliations with other healthcare service providers. The competition to acquire these facilities is significant, including competition from healthcare companies with financial resources greater than us. There is no guarantee we can successfully integrate acquired hospitals and ambulatory care facilities, which limits our ability to complete future acquisitions.

In addition, we may not acquire additional hospitals on satisfactory terms and future acquisitions may be on less than favorable terms. We may have difficulty obtaining financing for future acquisitions on satisfactory terms. We invest capital in our existing facilities to develop new services or expand or renovate our facilities to generate new, or sustain existing, revenues from our operations. We may finance these capital commitments or development programs through operating cash flows or additional debt proceeds. Many states, including some where we have hospitals and others where we may attempt to acquire hospitals, have adopted legislation regarding the sale or other disposition of hospitals operated by non-profit entities. In other states that do not have such legislation, the attorneys general have demonstrated an interest in these transactions under their general obligations to protect charitable assets from waste. These legislative and administrative efforts focus primarily on the valuation of the assets divested and the use of the sale proceeds by the non-profit seller. These review and approval processes can add time to the consummation of an acquisition of a non-profit hospital, and future actions on the state level could seriously delay or even prevent future acquisitions of non-profit hospitals. As a condition to approving an acquisition, the attorney general of the state in which the hospital is located may require us to maintain services, such as emergency departments, or to continue to provide certain levels of charity care, which may affect our decision to acquire, or the terms upon which we acquire, these hospitals.

Difficulties in integrating acquired businesses may disrupt our ongoing operations.

We may, from time to time, evaluate strategic opportunities such as joint ventures and acquisitions that may be material, including the acquisition of healthcare systems, individual hospitals, outpatient clinics, physician groups and other ancillary healthcare

 

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businesses. Integrating acquired hospitals, physician practices or other business operations may require a disproportionate amount of management’s time and attention, potentially distracting management from its other day-to-day responsibilities. In addition, poor integration of acquired businesses could cause interruptions to our business activities, including those of the acquired facilities, and could cause potential loss of key employees or customers of acquired companies. We may not realize all or any of the anticipated benefits of an acquisition and we may incur significant costs related to the acquisitions or integration of these facilities. In addition, we may acquire hospitals and other businesses that have unknown or contingent liabilities, including liabilities for failure to comply with healthcare laws and regulations. Although we seek indemnification from prospective sellers covering these matters, we may have material liabilities for past activities of acquired hospitals.

We may be subject to liabilities because of claims brought against our hospitals, physician practices, outpatient facilities or other business operations.

Plaintiffs frequently sue hospitals and other healthcare providers, alleging malpractice, product liability or other legal theories. Many involve large claims and significant defense costs. Certain other hospital companies have been subject to class-action claims with respect to their billing practices for uninsured patients or lawsuits alleging inappropriate classification of claims, for billing, between observation and inpatient status.

We maintain professional malpractice liability insurance and general liability insurance in amounts we believe covers claims arising out of the operations of our facilities. Some of the claims could exceed the coverage in effect, and coverage of particular claims or damages could be denied.

The volatility of professional liability insurance and, sometimes, the lack of availability of such insurance coverage for physicians with privileges at our hospitals increase our risk of vicarious liability where both our hospital and the uninsured or underinsured physician are named as co-defendants. We are subject to self-insured risk and may be required to fund claims out of our operating cash flow. We cannot assure you that we can continue to obtain insurance coverage or that such insurance coverage, if it is available, will be available on acceptable terms.

As of September 30, 2014, our self-insured retention for professional and general liability coverage is $7.0 million for the first claim and $5.0 million per claim for each additional claim, with an excess aggregate limit of $55.0 million, and maximum coverage under our insurance policies is $75.0 million.

In addition, physicians’ professional liability insurance costs in certain markets have dramatically increased to where some physicians are choosing to retire early or leave those markets. If physician professional liability insurance costs continue to escalate in markets in which we operate, some physicians may choose not to practice at our facilities, which could reduce our patient volumes and revenues. Our hospitals also may incur a greater percentage of the amounts paid to claimants if physicians cannot obtain adequate malpractice coverage since we are often sued in the same malpractice suits brought against physicians on our medical staffs who are not employed by us.

As part of our broader physician alignment strategies, we expect to continue to employ additional physicians, which could result in a significant increase in our professional and general liability risks and related costs in future periods.

We have entered into sale-leaseback arrangements with a real estate investment trust for certain of our hospitals’ real estate and the related lease terms and obligations expose us to increased risk of loss of property or other unfavorable leasing implications, which could materially and adversely affect our business, financial condition and results of operations.

From time to time, we may enter into lease-related transactions with real estate investment trusts (“REITs”). On September 26, 2013, we entered into a sale-leaseback transaction involving the land and buildings associated with Glenwood Regional Medical Center in West Monroe, Louisiana; Mountain Vista Medical Center in Mesa, Arizona; and The Medical Center of Southeast Texas in Port Arthur, Texas. We continue to own and operate the business of these three hospitals but now lease the land and the buildings associated with these facilities for an initial period of 15 years at what we believe are attractive long-term lease rates, with renewal options. At the same time we entered into the sale-leaseback transaction, we amended an existing lease agreement with the same REIT with respect to Pioneer Valley Hospital, which extended the lease term and reduced the annual rent payment. Additionally, we lease from another landlord the land and buildings associated with Wadley Regional Medical Center in Texarkana, Texas. Our leases provide for renewal or extension options. These options are based upon prescribed formulas but, in certain cases, may be at fair market value. We expect to renew or extend our leases in the normal course of business; however, there can be no assurance these rights will be exercised or that we can satisfy the conditions precedent to exercising any such renewal or extension. The terms of any such options based upon fair market value are inherently uncertain and could be unacceptable or unfavorable to us depending upon the circumstances at the time of exercise.

 

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In addition, our leases can be subject to early termination if we violate certain provisions or covenants in the leases. Some of our hospital leases are with the same landlord and contain cross-default provisions that would allow that landlord to terminate all leases with us if we violate certain defined provisions related to a single lease with them.

If we cannot renew or extend our existing leases, or purchase the hospitals subject to such leases, at or prior to the end of the existing lease terms, if the terms of such options are unfavorable or unacceptable to us, or if any landlord terminates a lease because of our breach of the lease, our business, financial condition and results of operations could be materially and adversely affected.

Our use of the proceeds we received from the sale-leaseback or other dispositions of assets is subject to restrictions, and although we have some discretion over how we apply such proceeds, we cannot guarantee that we will invest such proceeds promptly, effectively, or in compliance with our debt instruments.

We received certain proceeds for the sale-leaseback of three of our hospital properties on September 26, 2013, the disposition of our Florida operations on September 30, 2013, and the sale of our Nevada hospital operations on January 22, 2015. Our use of these net proceeds (gross proceeds less applicable taxes and other related transaction costs) is restricted by the terms of our senior credit agreement and the indenture under which we issued our senior notes.

Pursuant to the terms of our senior credit agreement, these net proceeds must be directed toward prepayment of borrowings under the senior credit agreement unless they are reinvested within 12 months in existing facilities or in 24 months in a greenfield construction project (36 months if there is a binding commitment for such investment within such 12 or 24 month periods). In September 2014, pursuant to an amendment to our senior credit agreement, our lenders extended for one year the deadlines related to the reinvestment of the net proceeds received from both the disposition of our Florida operations and the sale-leaseback of our three hospital properties. Similarly, the indenture requires us to use the proceeds to offer to repurchase the senior notes or make prepayments under the senior credit agreement unless they are reinvested in qualifying investments within 365 days. This deadline may also be extended by 180 days if we make a binding commitment to enter into a qualifying investment within such 365 day period. In October 2014, we satisfied these obligations under the indenture with respect to our September 2013 transactions by conducting such an offer to repurchase the senior notes. We are also required to comply with these obligations with respect to the proceeds from the sale of our Nevada facilities in January 2015. See “Management’s discussion and analysis—Liquidity and capital resources—Capital resources.”

While we currently expect to reinvest all of the net proceeds noted above, we are unable to make assurances that our plans to invest such proceeds will be achieved or that they will be on acceptable terms to our debt investors, within the prepayment grace period or at all. Any failure by us to invest these proceeds in compliance with our debt instruments could result in a default thereunder and harm our financial condition and operating results. Even if our investments fully comply with the terms of the senior credit agreement and indenture, we cannot assure you that they will generate positive value for us.

Delays in investing proceeds that have not been committed, besides requiring prepayments, may delay and/or impair our growth, revenues and cash flows. We cannot assure you we can identify any acquisition or development opportunities or other investments that meet our investment objectives or that any investment we make will produce a positive return. If we do not invest or apply such proceeds in ways that enhance our value, we may fail to achieve expected financial results and our business, financial condition and result from operations could be materially and adversely affected.

To the extent we engage in other similar capital-raising measures in the future, we may not invest the proceeds we receive from capital-raising measures promptly, effectively or on acceptable terms to our creditors. Subject to the types of restrictions described above, we have discretion over how to use such proceeds, and we may not do so effectively.

We may not complete construction of the Jordan Valley expansion project in Lehi, Utah in a timely manner and, even if we do, the start-up costs may exceed our current estimates.

We are building a new 40-bed hospital in Lehi, Utah as a campus of Jordan Valley Medical Center. The hospital has been designed to provide a full range of services including inpatient intensive care, obstetrics and surgical services, heart services, cardiac catheterization, emergency medical services, imaging, lab and outpatient surgery. A medical office building is being constructed immediately adjacent to, and connected with, the hospital to be occupied by primary care and multi-specialty physician groups practicing in the area. This project is anticipated to cost in excess of $80.0 million, a significant portion of which has been expended, and is anticipated to be completed and open for business by the summer of 2015. There is no guarantee we can successfully complete this construction project on time or within budget or that its operating performance, once open for business, will perform as anticipated.

 

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We depend on key personnel and losing one or more of our senior management team or local management personnel could have a material adverse effect on our business.

Our business strongly depends upon the services and management experience of our senior management team and local management personnel. We depend on the ability of these senior management team members and key employees to manage growth successfully and on our ability to attract and retain skilled employees. We manage our staffing carefully to enhance efficiency and control our salaries, wages and benefits. Historically our hospitals have not overstaffed or had deep ranks of employees for succession planning but, rather, have maintained an efficient, small group of experienced personnel to manage our day-to-day business operations. If any of our executive officers resign or otherwise cannot serve, our management expertise and ability to deliver healthcare services efficiently and to execute our business strategy could be diminished. If we fail to attract and retain managers at our hospitals and related facilities, our operations could be adversely affected. We do not maintain key man life insurance policies on any of our officers, including our senior corporate executives.

We may be subject to unionization, work stoppages, slowdowns or increased labor costs.

None of our employees are represented by a union. However, our employees have the right under the National Labor Relations Act to form or affiliate with a union. If some or all of our workforce were to become unionized and the terms of the collective bargaining agreement differed significantly from our current compensation agreements, it could increase our costs and adversely affect our profitability. Participation by our workforce in labor unions could put us at increased risk of labor strikes and disruption of our services.

Our hospitals are subject to compliance and other responsibilities and costs under environmental laws that could lead to material expenditures or liability.

We are subject to various federal, state and local environmental laws and regulations, including those relating to the protection of human health and the environment. We could incur substantial costs to maintain compliance with, and/or address liabilities arising under, these laws and regulations. We could become the subject of future enforcement or other legal proceedings, which could lead to damage claims, fines or criminal penalties if we are found to have liability under these laws and regulations. We also may be subject to requirements related to the investigation or remediation of substances or wastes released into the environment at properties owned or operated by us or our predecessors or at other properties where substances or wastes were sent for off-site treatment or disposal. These remediation requirements may be imposed without regard to fault, and liability for environmental remediation can be substantial.

To our knowledge, we have not been and are not the subject of any investigations relating to noncompliance with or liability under environmental laws and regulations. We maintain insurance coverage for third-party liability related to the storage tanks at our facilities, which consists of several separate insurance policies, each providing for at least $2.0 million per claim and $5.0 million in the aggregate.

If the fair value of our reporting units declines, a material non-cash charge to earnings from an impairment of our goodwill may result.

At September 30, 2014, we had $814.5 million of goodwill recorded in our consolidated financial statements. We expect to recover the carrying value of this goodwill through our future cash flows. On an ongoing basis, we evaluate, based on the fair value of our reporting units, whether the carrying value of our goodwill is impaired. If the carrying value of our goodwill is impaired, we may incur a material non-cash charge to earnings.

Risks related to our managed care operations

Our revenue and profitability could be adversely affected by the loss of, or changes in, Health Choice’s contract with AHCCCS, a failure to control medical costs at Health Choice and other factors related to Health Choice.

Effective October 1, 2013, Health Choice entered into a contract with AHCCCS, Arizona’s Medicaid agency. The contract has an initial term of three years and includes two additional one-year renewal options that can be exercised at the discretion of AHCCCS. The contract is terminable without cause on 90 days written notice or for cause upon written notice if Health Choice fails to comply with any term or condition or fail to take corrective action as required to comply with the terms of the contract. AHCCCS can also terminate our contract upon unavailability of state or federal funding. If our existing contract with AHCCCS is terminated, our financial condition, cash flows and results of operations would be materially adversely affected. The contract allows Health Choice to serve Medicaid members in the following Arizona counties:

Apache, Coconino, Gila, Maricopa, Mohave, Navajo, Pima and Pinal. For the years ended September 30, 2014, 2013 and 2012, Health Choice’s contract with AHCCCS contributed 24.5%, 22.0% and 22.9%, respectively, to our consolidated total revenue.

 

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In response to state budgetary issues in Arizona during recent years, AHCCCS worked to control its costs, through cuts in provider reimbursement and capitation premiums, targeted reductions in Medicaid eligible beneficiaries, the imposition of a tiered profit sharing plan and implementing a risk-based or severity-adjusted payment methodology for all health plans. Capitation rates for each health plan and geographic service area are adjusted annually based on the severity of treatment episodes experienced by each plan’s membership compared to the average over a specified 12-month period. Adjustments are calculated using diagnosis codes and procedural information from medical and pharmacy claims data, in addition to member demographic information. Each year, capitation rates are risk adjusted prospectively approximately six months into the contract year and then retroactively back to the start of the contract year. AHCCCS has implemented a tiered profit sharing plan, which is administered through an annual reconciliation process with all participating managed Medicaid health plans and will limit our net profit margins. If AHCCCS continues to reduce capitation premium rates, implements further eligibility restrictions or makes further alterations to the payment structure of its contracts, our results of operations and cash flows may be materially adversely affected.

Although Health Choice’s enrollment declined during recent years, in fiscal 2014, it experienced significant enrollment growth following the governor of Arizona’s 2013 signing into law the state’s expansion of its Medicaid program under the Health Reform Law, which includes increased eligibility for adults, children and pregnant women, and the restoration of eligibility to childless adults previously frozen. The expansion of the state’s Medicaid program under the Health Reform Law may result in the addition of approximately 350,000 people to its Medicaid rolls over the next few years. As described above, the Health Reform Law, which became effective on January 1, 2014, faced and may continue to face opposition from groups considering lawsuits to challenge the passage of the law. The law was also implemented with a roll back provision if the federally matched portion is reduced by 80% from its current levels. If additional changes to the Arizona Medicaid program are implemented, our revenue and earnings could be significantly impacted.

Further, while the Arizona legislature approved an expansion of Medicaid in 2013 which became effective on January 1, 2014, a lawsuit filed by several state lawmakers has challenged the legality of a provider fee assessed to all providers and used to help pay for Arizona’s Medicaid expansion. The suit was dismissed by the trial court, based on a finding that the plaintiffs did not have standing to sue; however, on December 31, 2014, the Arizona Supreme Court ruled that the plaintiffs in the case had standing to sue, and the case is now moving forward in the trial court. If the legality of the provider fee used to help fund Arizona’s Medicaid expansion is successfully challenged in court, this may result in the loss of certain funding for the state’s Medicaid program, which could potentially result in changes that restrict eligibility and increase the number of uninsured individuals and adversely affecting our operations in Arizona. In addition, if similar challenges are successful in other states, we may be similarly adversely affected by such challenges.

AHCCCS and the Medicaid agency in Utah, with the required approval of CMS, set the capitated rates received at Health Choice which subcontracts with physicians, hospitals and other healthcare providers to provide services to its enrollees. If Health Choice fails to manage healthcare costs effectively, these costs may exceed the payments it receives. Our medical loss ratio (medical claims expense as a percentage of premium revenue) for the years ended September 30, 2014, 2013 and 2012, was 84.2%, 84.1% and 83.1%, respectively. Relatively small changes in these medical loss ratios can create significant changes in the profitability of Health Choice. Many factors can cause actual healthcare costs to exceed the capitated rates Health Choice receives, including:

 

    an inability to contract with cost-effective healthcare providers;

 

    the increased cost of individual healthcare services and new drug therapies;

 

    the type and number of individual healthcare services delivered; and

 

    catastrophes, epidemics or other unforeseen occurrences.

Although Health Choice has been able to manage medical claims expense through a variety of initiatives, it may not continue to manage medical claims expense effectively. Any future growth in members increases the risk associated with managing health claims expense. If our medical claims expense increases, our financial condition or results of operations may be materially adversely affected.

Effective October 1, 2013, Health Choice began offering insurance plans on the Arizona state insurance exchange (“AZ Exchange”). The profitability of our insurance plans offered on the AZ Exchange is directly linked with the ability of the AZ Exchange to attract a sufficient cross-section of risk membership to balance high and low cost membership. If the AZ Exchange is not perceived as attractive to healthier low cost consumers, the AZ Exchange could become susceptible to enrollment of a disproportionate amount of older members and/or members requiring higher utilization of medical services, a phenomenon known as “adverse selection.” The Health Reform Law includes provisions to mitigate the risk of adverse selection; however, there can be no assurance these provisions will be effective. The effectiveness of these provisions will not be known until certain provisions of the Health Reform Law are fully implemented. If our profitability decreases because of adverse selection, our financial condition or results of operations may be adversely affected.

 

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Health Choice’s failure to successfully execute its growth strategy and expand its product lines, including its MSO services, may result in reduction or elimination of anticipated revenue or profitability and could have materially adverse consequences on our financial condition and results of operations.

We have sought to grow Health Choice’s business lines both in Arizona and beyond its core Arizona managed Medicaid operations. These growth initiatives include expansion of our service lines, expansion of our managed Medicaid business into other states, delivery of MSO services to third-party insurers and operation of accountable care networks in a manner that allows participating providers to engage in value- and risk-based contracts with such insurers.

Each of these growth strategies and expansion opportunities involves risks and there can be no assurance that we will successfully execute them. While Health Choice intends to pursue an expansion of its MSO and managed care solutions businesses, there can be no assurance that Health Choice will be successful in its efforts to diversify its client base, service offerings and geographic reach and compete successfully against other more established MSOs. For instance, in 2014, Health Choice Florida commenced operating as a MSO in the state of Florida, and employs approximately 90 employees located primarily in the Tampa area, providing managed care and administrative services for a large national insurer’s managed Medicaid plan members. Such service relationships, including Health Choice Florida’s existing arrangement with a large national insurer, customarily include rigorous performance standards applicable to the third party service provider and significant penalties associated with nonperformance, including termination rights of the service provider. If Health Choice does not meet these performance obligations and contractual penalties are imposed or termination rights are exercised as a result, this may result in an elimination or reduction in our anticipated revenue and profitability.

When we expand our core managed Medicaid business into new markets or service lines, we face competition with other managed Medicaid providers, many of whom may have incumbent relationships with state Medicaid agencies or who may be part of larger, more established regional or national insurance companies. Additionally, where Health Choice contracts with government agencies with respect to new business opportunities, there can be no assurance that such government programs will not be materially changed or that our contracts will be renewed and not be terminated, and as a result, we may not realize the benefits of these contracts. Furthermore, our development of accountable care networks involves significant challenges. These include efforts of other provider-based health systems to establish competing networks, recruit sufficient numbers of physicians into these networks, develop arrangements with sufficient payors, and effectively coordinate care and manage the health of various populations through these networks in a profitable manner. If we fail to execute successfully on any of these strategies, it will result in reduction or loss of anticipated revenue or profitability.

Our inability to effectively maintain and upgrade information technology systems used in our managed care operations, or the costs associated with such replacements and upgrades, could adversely affect our operations and financial results.

As with the healthcare information technology systems we use in our acute care operations, we invest heavily in our managed care information systems, and these systems evolve rapidly and are subject to extensive regulatory requirements. The replacement of any information technology system upon which we rely may be financially and administratively burdensome to us. Such replacements, upgrades and similar projects require modifications to our capital expenditure plans and constrain our ability to pursue other opportunities requiring significant capital and management resources. Additionally, such upgrades may be time consuming and complex from an administrative standpoint. If our implementation of a replacement technology system is inefficient, delayed or ineffective, we may experience disruptions or delays in our day-to-day administrative and care management processes, experience errors related to sharing of patient care information and declines in member, provider and/or employee satisfaction. Because the healthcare information technology business, regulatory requirements and the needs of our healthcare providers and health plan members continuously evolve, we cannot assure you that we will not incur such financial and administrative difficulties, which may have an adverse effect on our business, financial condition and results of operations.

Material risks are associated with participating in government-sponsored programs such as Medicaid, Medicare and the Exchanges, including dependence upon government funding, changes occurring because of the Health Reform Law, compliance with government contracts and increased regulatory oversight.

Health Choice contracts with state departments of health, Medicaid agencies and CMS to provide managed healthcare services. Revenues from the Medicaid and Medicare programs are dependent, in whole or in part, upon annual funding from the federal government through CMS and/or applicable state or local governments. Funding for these programs depends on many factors outside our control, including general economic conditions, tax revenues, continuing government efforts to contain healthcare costs, budgetary

 

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constraints at the federal or applicable state or local level, and general political issues and priorities. These governmental agencies have the right not to renew or cancel their contracts with Health Choice on short notice without cause or if funds are not available. Unanticipated changes in funding by the federal or state governments could substantially reduce our revenues and profitability.

State governments have experienced tight budgetary conditions within their Medicaid programs due to difficult macroeconomic conditions and increases in the Medicaid eligible population. We anticipate this will require government agencies with which we contract to find funding alternatives, which may cause reductions in funding. If any state in which Health Choice operates were to decrease premiums paid to Health Choice, or pay Health Choice less than the amount to keep pace with its cost trends, it could have a material adverse effect on Health Choice’s revenues and results of operations. Economic conditions affecting state governments and agencies could also result in delays in receiving premium payments. If there is a significant delay in Health Choice’s receipt of premiums to pay health benefit costs, it could have a material adverse effect on our results of operations, cash flows and liquidity.

At both the federal and state government levels, legislative and regulatory proposals have been made related to, or potentially affecting, the health care industry, including but not limited to limitations on managed care organizations, including benefit mandates, and reform of the Medicaid and Medicare programs. Any such legislative or regulatory action, including benefit mandates or reform of the Medicaid and Medicare programs, could have the effect of reducing the premiums paid to us by governmental programs, increasing our medical and administrative costs or requiring us to materially alter the manner in which we operate. We are unable to predict the specific content of any future legislation, action or regulation that may be enacted or when any such future legislation or regulation will be adopted. Therefore, we cannot predict accurately the effect or ramifications of such future legislation, action or regulation on our managed care business.

The Medicare program has been the subject of recent regulatory reform initiatives, including the Health Reform Law. Effective in 2012, the Health Reform Law tied a portion of each Medicare Advantage plan’s reimbursement to the plan’s “star rating” by CMS, with those plans receiving a rating of three or more stars eligible for quality-based bonus payments. The star rating system considers various measures adopted by CMS, including quality of care, preventative services, chronic illness management and customer satisfaction. Beginning in 2015, plans must have a minimum of a “three star” rating to retain its contract with CMS and must have a star rating of four or higher to qualify for bonus payments. While Health Choice currently has a “three star” rating, if it does not maintain its star rating, its plan may be terminated, and if it does not continue to improve its star rating, it may not be eligible for full-level quality bonuses, which could adversely affect the benefits its plans offer, reduce our customer base, reduce profit margins or eliminate one or more of its plans all together.

Medicare has implemented a Hierarchical Condition Categories model to adjust capitation payments to private Medicare Advantage healthcare plans for the health expenditure risk of their beneficiaries. The CMS Risk Adjustment Model measures the disease burden which is correlated to diagnosis codes dependent upon clinical documentation and claims files. Each year CMS re-calibrates its model, pressuring acuity adjustment payments. If Health Choice does not maintain or continue to improve the effectiveness with which its provider delivery system codes the acuity of its patients, its financial performance could be adversely affected.

Contracts with CMS and the state governmental agencies contain certain provisions regarding data submission, provider network maintenance, quality measures, claims payment, continuity of care, call center performance and other requirements. If Health Choice fails to comply with these requirements, it may be subject to fines or penalties that could adversely affect its profitability.

In addition, Health Choice’s Exchange plan subsidiary in the State of Arizona and its Utah managed Medicaid plan subsidiary are subject to regulations by the respective state’s department of insurance oversight and health maintenance organization rules. These require those business lines to operate under requirements governing minimum amounts of permissible capital, adequacy of provider networks and other complex rules. We cannot assure that future action taken by state insurance or health maintenance organization authorities, or federal authorities regarding our Exchange plan products, will not have a material adverse effect on Health Choice’s health plan products or its business, financial condition or results of operations.

Failure to comply with various state and federal healthcare laws and regulations, including those directed at preventing fraud and abuse in government funded programs, could cause investigations or litigation, with imposing fines, limitations on Health Choice’s ability to expand, restrictions or exclusions from program participation or other agreements with a federal or state governmental agency that could adversely affect its business, cash flows, financial condition and results of operations.

 

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Managed care organizations have been the subject of federal and state investigations, and we may become subject to additional investigations that could cause significant liabilities or penalties to us.

Our managed care business is extensively regulated by the federal government and the states in which we operate. The laws and regulations governing our managed care operations are generally intended to benefit and protect health plan members and providers rather than stockholders and creditors. The government agencies administering these laws and regulations have broad latitude to enforce them. These laws and regulations, along with the terms of our government contracts, regulate how we do business, what services we offer, and how we interact with our members, providers and the public. Any violation by us of applicable laws or regulations could reduce our revenues and profitability, thereby having a material adverse effect on our financial condition and results of operations.

We face a significant risk of litigation and regulatory investigations and actions in the ordinary course of operating our managed care business. The following are examples of types of potential litigation and regulatory investigations we face:

 

    claims by government agencies relating to compliance with laws and regulations;

 

    claims relating to sales practices;

 

    claims relating to the methodologies for calculating premiums;

 

    claims relating to the denial or delay of health care benefit payments;

 

    claims relating to claims payments and procedures;

 

    claims relating to provider marketing;

 

    claims by providers for network termination or exclusion;

 

    anti-kickback claims;

 

    medical malpractice or negligence actions based on our medical necessity decisions or brought against us on the theory that we are liable for our providers’ malpractice or negligence;

 

    allegations of anti-competitive and unfair business activities;

 

    provider disputes over compensation and termination of provider contracts;

 

    allegations of discrimination;

 

    allegations of breaches of duties;

 

    claims relating to inadequate or incorrect disclosure or accounting in our public filings;

 

    allegations of agent misconduct;

 

    claims related to deceptive trade practices; and

 

    claims relating to audits and contract performance.

As we contract with various governmental agencies to provide managed health care services, we are subject to various reviews, audits and investigations to verify our compliance with the contracts and applicable laws and regulations. Any adverse review, audit, investigation or result from litigation could result in:

 

    loss of our right to participate in government-sponsored programs, including Medicaid and Medicare;

 

    forfeiture or recoupment of amounts we have been paid pursuant to our government contracts;

 

    imposition of significant civil or criminal penalties, fines or other sanctions on us and/or our key associates;

 

    reduction or limitation of our membership;

 

    damage to our reputation in various markets;

 

    increased difficulty in marketing our products and services;

 

    restrictions on acquisitions or dispositions;

 

    suspension or loss of one or more of our licenses to act as an insurer, health maintenance organization (“HMO”) or third-party administrator or to otherwise provide a service; and

 

    an event of default under our debt agreements.

        In particular, because we receive payments from federal and state governmental agencies, we are subject to various laws commonly referred to as “fraud and abuse” laws, including the FCA, which permit agencies and enforcement authorities to institute suit against us for violations and, in some cases, to seek treble damages, penalties and assessments. Many states, including states where we currently operate, have enacted parallel legislation. Liability under such federal and state statutes and regulations may arise if we know, or it is found that we should have known, that information we provide to form the basis for a claim for government payment is false or fraudulent.

Some courts have permitted FCA suits to proceed if the claimant was out of compliance with program requirements. Liability for such matters could have a material adverse effect on our financial position, results of operations and cash flows. Qui tam actions under federal and state law can be brought by any individual on behalf of the government. Qui tam actions have increased significantly in recent years, causing greater numbers of health care companies to defend false claim actions, pay fines or be excluded from Medicare, Medicaid or other state or federal health care programs as a result of investigations arising out of such actions. Qui tam actions may have been filed against of us of which we are presently unaware, or qui tam actions may be filed against us in the future.

 

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Health Choice’s medical membership remains concentrated in certain geographic areas and governmental health plan offerings, exposing us to unfavorable changes in local economic and governmental conditions.

Despite its recent expansion into new service lines and geographic markets, including management and administrative services, the formation of a Utah managed Medicaid plan, the launch of an Arizona Exchange plan, and provider networking on behalf of our acute care operations in certain markets, Health Choice’s core business remains its Arizona managed Medicaid plan, which as of January 1, 2015 served 209,700 members. Health Choice maintains this business subject to its contract with AHCCCS, the current version of which became effective October 1, 2013, and has a term of three years, subject to two one-year renewal terms at the option of AHCCCS. Health Choice’s continued maintenance of its managed Medicaid business in Arizona depends upon its ability to meet its contractual obligations under its governmental contracts, and win awards for new such contracts during the state’s periodic procurement or request for proposal (“RFP”) process. These RFP processes typically involve intense competition with local and national managed care payors, many of whom have varying operational and greater financial resources than Health Choice. There can be no assurance that Health Choice’s managed Medicaid business will continue to perform effectively in this competitive landscape or continue to be awarded Arizona state contracts during future RFP cycles.

Unfavorable changes in healthcare or other benefit costs or reimbursement rates or increased competition in those geographic areas where Health Choice’s membership is concentrated could have a disproportionately adverse effect on our operating results. Health Choice’s membership has been and may continue to be affected by unfavorable general economic and state budgetary conditions, which in recent years have involved challenges such as capitation rate cuts by the state of Arizona and a tightening of eligibility requirements for Medicaid coverage, including past reductions in Medicaid coverage for childless adults.

If Medicaid programs, including the state of Arizona through its AHCCCS program, fail to provide supplemental payments to Health Choice for new or experimental drugs that physicians and consumers deem medically necessary, then Health Choice’s pharmaceutical costs and medical loss ratio may increase, and Health Choice’s profitability may decrease.

New or experimental drugs for which AHCCCS or other governmental agencies do not provide supplemental payments or other subsidies may affect Health Choice’s financial performance. For instance, during our 2014 fiscal year, Gilead Sciences, Inc. began marketing its pharmaceutical Sofosbuvir, commonly called Sovaldi, as a cure for patients diagnosed with Hepatitis C, a virus that spreads from person to person through blood and infects the liver. Medical costs involved with a single health plan member’s treatment through new or experimental drugs such as Sovaldi can exceed Health Choice’s annual capitation payment attributable to such plan member by many multiples. When rates are established during routine contracting cycles for Health Choice in its bids with state Medicaid agencies in Arizona and Utah, the availability and related costs of new and experimental drugs such as Sovaldi are often not fully taken into account, which can result in unexpected medical costs in the treatment of patients whose needs for such treatments are determined to be a medically necessary treatment.

In response to development of new pharmaceuticals and treatments, such as Sovaldi, there can be no assurance that state Medicaid programs, including AHCCCS and other governmental agencies, will retroactively or timely adjust their capitation payments to us under our contracts with them, in which case Health Choice may be forced to bear the financial cost of those new pharmaceuticals and treatments for covered patients it manages, either temporarily or permanently. These unanticipated medical costs, if not partially or fully reimbursed by governmental agencies, may increase our medical loss ratio and reduce the profitability of our managed care operations.

Health Choice’s profitability depends upon its ability to accurately predict and control healthcare costs.

A substantial majority of the revenue Health Choice receives is used to pay the costs of healthcare services or supplies delivered to our members. The total healthcare costs it incurs are affected by the number and type of individual services provided and the cost of each service. Our future profitability will depend, in part, on Health Choice’s ability to accurately predict healthcare costs and to control future healthcare utilization and costs through, utilization management, product design and negotiation of favorable physician provider, hospital and pharmacy contracts. Periodic renegotiations of healthcare provider contracts, coupled with continued consolidation of physician, hospital and other provider groups, may cause increased healthcare costs or limit our ability to negotiate favorable rates. Changes in utilization rates, demographic characteristics, the regulatory environment, healthcare practices, inflation, new technologies, new high cost drug therapies, clusters of high-cost cases, continued consolidation of physician, hospital and other provider groups and numerous other factors affecting healthcare costs may negatively impact our ability to predict and control healthcare costs and, thereby materially adversely affecting our financial condition, results of operations and cash flows. In addition, a large scale public health epidemic, such as the avian flu or Ebola, could affect our ability to control healthcare costs.

For several years, one of the fastest increasing categories of our healthcare costs has been the cost of hospital-based products and services. Factors underlying the increase in hospital costs include, but are not limited to, the underfunding of public programs,

 

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such as Medicaid and Medicare, growing rates of uninsured individuals, new technology, state initiated mandates, alleged abuse of hospital chargemasters, an aging population and, under certain circumstances, relatively low levels of hospital competition. In addition to hospital costs, pharmacy costs for specialty medication and compounds trended higher than any other medical expense category of service in 2014 and included such medications as Sovaldi. New specialty drugs are being fast tracked through FDA trials. In connection with these new treatments Health Choice must meet certain medical necessity requirements for its Medicaid and Medicare program contracts with regard to the provision of medication therapy. Due to this paradigm, pharmacy costs likely may outpace capitation reimbursement rates, adversely affecting our financial condition.

Changes in the prescription drug industry pricing benchmarks may adversely affect our financial performance.

Pharmaceutical products and services constitute a significant portion of Health Choice’s medical costs. Contracts in the prescription drug industry use certain published benchmarks to establish pricing for prescription drugs. These benchmarks include average wholesale price, referred to as “AWP,” average selling price, referred to as “ASP,” and wholesale acquisition cost. It is uncertain whether pharmacy providers, pharmacy benefit managers, or PBMs, and others in the prescription drug industry will continue to utilize AWP as it has been calculated, or whether other pricing benchmarks will be adopted for establishing prices within the industry. Legislation may lead to changes in the pricing for Medicare and Medicaid programs. Regulators have investigated the use of AWP for federal program payment, and whether using AWP has inflated drug expenditures by the Medicare and Medicaid programs.

Federal and state proposals have sought to change the basis for calculating payment of certain drugs by the Medicare and Medicaid programs. Adoption of ASP in lieu of AWP as the measure for determining payment by Medicare or Medicaid programs for the drugs sold in our mail-order pharmacy business may reduce the revenues and gross margins of this business, which may cause a material adverse effect on our results of operations, financial position and cash flows.

If Health Choice fails to develop and maintain satisfactory relationships with physicians, hospitals and ancillary healthcare providers, our business and results of operations may be adversely affected.

Health Choice contracts with physicians, hospitals and other healthcare providers to provide healthcare services rendered to our health plan members. Its results of operations depend on our ability to contract for these services at competitive rates. In any market, physicians, hospitals and healthcare providers could refuse to contract with any of our health plans, demand higher payments or take other actions that could cause higher medical costs or less desirable products for our customers. In some markets, certain providers, particularly hospitals, physician/hospital organizations and multi-specialty physician groups, may have significant or controlling market positions that could cause a diminished bargaining position for us. If providers refuse to contract with Health Choice, use their market position to negotiate favorable contracts or place us at a competitive disadvantage, our ability to market products or to be profitable in those areas could be materially and adversely affected.

Our ability to develop and maintain satisfactory relationships with healthcare providers also may be negatively affected by other factors not associated with us, such as changes in Medicare and/or Medicaid reimbursement levels, increasing revenue and other pressures on healthcare providers and consolidation activity among hospitals, physician groups and healthcare providers. Ongoing reductions by CMS and state governments in amounts payable to providers for services provided to Medicare and Medicaid enrollees may pressure the financial condition of certain providers and adversely affect our ability to maintain or develop new cost-effective healthcare provider contracts or result in a loss of revenues or customers.

Recent and continuing consolidation among physicians, hospitals and other healthcare providers, development of accountable care organizations and other changes in the organizational structures that physicians, hospitals and healthcare providers choose may change the way these providers interact with us and may change the competitive landscape in which we operate. Sometimes, these organizations may compete directly with us, potentially affecting how we price our products or causing us to incur increased costs if we change our operations to be more competitive.

Out-of-network providers have no pre-established understanding with us about the compensation due for their services. Some states define by law or regulation the amounts due, but usually it is not defined or is established by a standard not clearly translatable into dollar terms. In such instances, providers may believe that they were underpaid and may litigate or arbitrate their dispute with us or try to recover from our customers the difference between what we have paid them and the amount they charged us. The outcome of disputes where we have no provider contract may cause us to pay higher medical or other benefit costs than we projected, which may adversely affect our cash flows and profitability.

 

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Health Choice depends on the success of its relationships with third parties for various services and functions, including pharmacy benefit and radiation management services.

As part of its operations, Health Choice contracts with third parties for selected services and functions, including pharmacy benefit management services, radiology benefit management services, and various other service providers in areas such as information technology and disease management services. Health Choice’ operations may be vulnerable if these third parties fail to perform their obligations to it or if the arrangement is terminated. If there are delays or difficulties that cause our third party vendors to not perform as expected, Health Choice may not realize, or realize on a timely basis, the anticipated operating efficiencies and financial benefits of these relationships. Violation of or noncompliance with laws by our third party vendors could increase Health Choice’s exposure of liability to its members and government regulators. Noncompliance with any privacy or security laws and regulations or any security breach involving one of its third-party vendors could have a material adverse effect on Health Choice’s business, results of operations, financial condition, liquidity and reputation.

Risks related to capital structure

Servicing our indebtedness requires a significant amount of cash. Our ability to generate sufficient cash depends on numerous factors beyond our control, and we may not generate sufficient cash flow to service our debt obligations, including making payments on our 8.375% Senior Notes and Senior Secured Credit Facilities.

As of September 30, 2014, we have outstanding $850.0 million in aggregate principal amount of 8.375% senior notes due 2019 (“Senior Notes”), which mature on May 15, 2019. We also have entered into our senior secured credit facilities, which include (1) amounts outstanding under our senior secured term loan of $989.4 million, maturing May 2018 and (2) a senior secured revolving credit facility of $300.0 million maturing in 2016, of which up to $150.0 million may be utilized for issuing letters of credit (together, the “Senior Secured Credit Facilities”). Our ability to borrow funds under our revolving credit facility is subject to the financial viability of the participating financial institutions. If any of our creditors were to suffer financial difficulties, or if the credit markets deteriorated, our ability to access funds under our revolving credit facility could be limited.

We cannot assure you that our business will generate sufficient cash flow from operations or that future borrowing will be available to us under our Senior Secured Credit Facilities in an amount sufficient to enable us to pay the principal and interest on our indebtedness, including the Senior Notes and term loan, or to fund our other liquidity needs. Our ability to fund these payments is subject to general economic, financial, competitive, legislative, regulatory and other factors beyond our control. We may need to refinance all or a portion of our indebtedness, including the Senior Notes and term loan, by maturity. We cannot assure you we can refinance any of our indebtedness, on commercially reasonable terms or otherwise. In addition, the terms of existing or future debt agreements, including the amended and restated credit agreement governing the Senior Secured Credit Facilities and the indenture governing the Senior Notes, may restrict us from affecting any of these alternatives.

During the next twelve months, along with interest on our Senior Secured Credit Facilities, we must repay $10.1 million in principal under our Senior Secured Credit Facilities and $71.2 million in interest under the Senior Notes. If we cannot make scheduled payments on our debt, we will be in default and, as a result:

 

    our debt holders could declare all outstanding principal and interest to be due;

 

    our secured debt lenders could terminate their commitments and commence foreclosure proceedings against our assets; and

 

    we could be forced into bankruptcy or liquidation.

Our substantial indebtedness could adversely affect our financial flexibility and our competitive position.

We have significant indebtedness. As of September 30, 2014, we had $1.85 billion of indebtedness outstanding, besides availability under the revolving credit portion of our Senior Secured Credit Facilities. Our substantial amount of indebtedness could have significant consequences on our financial condition and results of operations. It could:

 

    make it more difficult for us to satisfy our obligations regarding our outstanding debt;

 

    increase our vulnerability to adverse economic and industry conditions;

 

    expose us to fluctuations in the interest rate environment because the interest rates under our Senior Secured Credit Facilities are variable;

 

    require us to dedicate a substantial portion of our cash flow from operations to make payments on our indebtedness, reducing the availability of our cash flow to fund working capital, capital expenditures and other general corporate purposes;

 

    limit our flexibility in planning for, or reacting to, changes in the business and industry in which we operate;

 

    restrict us from exploiting business opportunities;

 

    place us at a disadvantage compared to our competitors that have less debt; and

 

    limit our ability to borrow additional funds for working capital, capital expenditures, acquisitions, debt service requirements, execution of our business strategy and other general corporate purposes or to refinance our existing debt.

 

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We, including our subsidiaries, can incur substantially more indebtedness, including senior secured indebtedness.

Subject to the restrictions in our Senior Secured Credit Facilities and the indenture governing the Senior Notes, we, including our subsidiaries, may incur significant additional indebtedness. As of September 30, 2014:

 

    we had $850.0 million of senior unsecured indebtedness under the Senior Notes;

 

    we had $989.4 million of senior secured debt outstanding under our Senior Secured Credit Facilities; and

 

    subject to compliance with customary conditions, we had available to us $219.0 million (after consideration of outstanding letters of credit totaling $81.0 million under our revolving credit facility) under the revolving credit portion of our Senior Secured Credit Facilities, which, if borrowed, would be senior secured indebtedness.

Although our Senior Secured Credit Facilities and the indenture governing the Senior Notes, contain restrictions on the incurrence of additional indebtedness, these restrictions are subject to several important exceptions, and indebtedness incurred in compliance with these restrictions could be substantial. If we and our subsidiaries incur significant additional indebtedness, the related risks we face could increase.

Our indebtedness may restrict our current and future operations, which could adversely affect our ability to respond to changes in our business and to manage our operations.

Agreements governing our indebtedness and the indenture governing the Senior Notes contain, and any future indebtedness may contain, several restrictive covenants that impose significant operating and financial restrictions on us and our subsidiaries, including restrictions on our or our subsidiaries’ ability to:

 

    incur additional indebtedness or issue disqualified stock or preferred stock;

 

    pay dividends or make other distributions on, redeem or repurchase our capital stock;

 

    sell certain assets;

 

    make certain loans and investments;

 

    enter into certain transactions with affiliates;

 

    incur liens on certain assets to secure debt;

 

    pay dividends or make payments or distributions to us and our subsidiaries; or

 

    consolidate, merge or sell all or substantially all of our assets.

Our ability to comply with these agreements may be affected by events beyond our control, including prevailing economic, financial and industry conditions. These covenants could have an adverse effect on our business by limiting our ability to take advantage of financing, mergers and acquisitions or other corporate opportunities. The breach of any of these restrictions could cause a default under the indenture governing the Senior Notes or under our Senior Secured Credit Facilities.

An increase in interest rates would increase the cost of servicing our debt and could reduce our profitability.

Borrowings under our Senior Secured Credit Facilities bear interest at variable rates. Interest rate changes could affect our interest payments, and our future earnings and cash flows, assuming other factors are held constant. We have, and may, enter into interest rate hedging instruments to reduce our exposure to interest rate volatility; however, any hedging instruments we enter into may not fully mitigate our interest rate risk. An increase in interest rates, whether because of an increase in market interest rates or an increase in our own cost of borrowing, would increase the cost of servicing our debt and could materially reduce our profitability.

Our failure by us or our subsidiaries to comply with the agreements relating to our outstanding indebtedness, including because of events beyond our control, could cause an event of default that could materially and adversely affect our results of operations and our financial condition.

If we or our subsidiaries defaulted under any of the agreements relating to our outstanding indebtedness, the holders of the defaulted debt could cause all amounts outstanding regarding that debt to be due immediately. Upon acceleration of certain of our other indebtedness, holders of the Senior Notes could declare all amounts outstanding under the Senior Notes immediately due and payable. We cannot assure you that our assets or cash flow would be sufficient to fully repay borrowings under our outstanding debt instruments if accelerated upon an event of default. Further, if we cannot repay, refinance or restructure our secured debt, the holders of such debt could proceed against the collateral securing that indebtedness. In addition, any event of default or declaration of acceleration under one debt instrument could also result in an event of default under one or more of our other debt instruments. In addition, counterparties to some of our contracts material to our business may amend or terminate those contracts if we have an event of default or a declaration of acceleration under certain of our indebtedness, which could adversely affect our business, financial condition or results of operations.

 

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We are controlled by our principal equity sponsors.

We are controlled by our principal equity sponsors who can control our financial related policies and decisions. Our principal equity sponsors could cause us to enter into transactions that, in their judgment, could enhance their equity investment, even though such transactions might reduce our cash flows or capital reserves. So long as our principal equity sponsors continue to own a significant amount of our equity interests, they will continue to strongly influence and control the decisions related to our company. Our principal equity sponsors may from time to time acquire and hold interests in businesses that compete directly or indirectly with us and, therefore, have interests that may conflict with the interests of our company.

Item 6. Exhibits

 

(a) List of Exhibits:

Exhibits: See the Index to Exhibits at the end of this report, which is incorporated herein by reference.

 

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SIGNATURES

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