UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

Form 10-Q

 

(Mark One)

For the quarterly period ended March 31, 2017

OR

For the transition period from                   to                 

Commission File Number: 333-176790

 

Aurora Diagnostics Holdings, LLC

(Exact Name of Registrant as Specified in Its Charter)

 

 

11025 RCA Center Drive, Suite 300

Palm Beach Gardens, Florida 33410

(Address of Principal Executive Offices) (Zip Code)

(866) 420-5512

(Registrant’s Telephone Number, Including Area Code)

None

(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  ☒ (Note: The registrant is a voluntary filer and for the preceding 12 months has filed all reports pursuant to the Securities Exchange Act of 1934 that would have been required to have been filed by it had it been subject to such sections.)

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  ☒    No  ☐

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

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act .   Yes  ☐    No   ☒

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No   ☒

 

 

 

 

 

 

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TABLE OF CONTENTS

 

 

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PART I – FINANCIAL INFORMATION

 

Aurora Diagnostics Holdings, LLC

Condensed Consolidated Balance Sheets

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

See Notes to Condensed Consolidated Financial Statements.

 

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Aurora Diagnostics Holdings, LLC

Condensed Consolidated Statements of Operations

Three Months Ended March 31, 2017 and 2016

Unaudited

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See Notes to Condensed Consolidated Financial Statements.

 

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Aurora Diagnostics Holdings, LLC

Condensed Consolidated Statements of Cash Flows

Three Months Ended March 31, 2017 and 2016

Unaudited

(in thousands)

 

 

(Continued)

 

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Aurora Diagnostics Holdings, LLC

Condensed Consolidated Statements of Cash Flows - (Continued)

Three Months Ended March 31, 2017 and 2016

Unaudited

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See Notes to Condensed Consolidated Financial Statements.

 

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Aurora Diagnostics Holdings, LLC

Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

Nature of Business

Aurora Diagnostics Holdings, LLC (together with its subsidiaries, the “Company”) was organized in the State of Delaware as a limited liability company on June 2, 2006 to operate as a diagnostic services company. The Company provides integrated diagnostic consultations, information services and personalized medicine services tailored to the patients of its referring physicians, hospitals and hospital systems. The Company also provides research services to pharmaceutical companies and other research entities. The Company’s operations consist of one reportable segment.

The Company operates in a highly regulated industry. The manner in which licensed physicians can organize to perform and bill for medical services is governed by state laws and regulations. Businesses like the Company often are not permitted to employ physicians or to own corporations that employ physicians or to otherwise exercise control over the medical judgments or decisions of physicians.

In states where the Company is not permitted to directly own a medical services provider or for other commercial reasons, it performs only non-medical administrative and support services, does not represent to the public or its clients that it offers medical services and does not exercise influence or control over the practice of medicine. In those states, the Company conducts business through entities that it controls, and it is these affiliated entities that employ the physicians who practice medicine. In such states, the Company generally enters into a contract that restricts the owners of the affiliated entity from transferring their ownership interests in the affiliated entity and otherwise provides the Company or its designee with a controlling voting or financial interest in the affiliated entity and its laboratory operations. This controlling financial interest generally is obtained pursuant to a long-term management services agreement between the Company and the affiliated entity. Under the management services agreement, the Company exclusively manages all aspects of the operation other than the provision of medical services. Generally, the affiliated entity has no operating assets because the Company acquired all of its operating assets at the time it acquired the related laboratory operations. In accordance with the relevant accounting guidance, these affiliated entities are included in the condensed consolidated financial statements of Aurora Diagnostics Holdings, LLC.

The accompanying condensed consolidated balance sheet as of December 31, 2016, which was derived from the audited consolidated financial statements as of December 31, 2016 of Aurora Diagnostics Holdings, LLC, and the accompanying unaudited condensed consolidated financial statements as of and for the three months ended March 31, 2017 and 2016 have been prepared by the Company in accordance with accounting principles generally accepted in the United States of America for interim financial reporting. Accordingly, they do not include all of the information and related footnotes that would normally be required by accounting principles generally accepted in the United States of America for complete financial reporting. These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements for the year ended December 31, 2016.

The accompanying unaudited condensed consolidated financial statements include all adjustments (consisting of a normal and recurring nature) that management considers necessary for a fair statement of financial information for the interim periods. Interim results are not necessarily indicative of the results that may be expected for the remainder of the year ending December 31, 2017.

Exchange of Senior Notes

These financial statements have been prepared in conformity with generally accepted accounting principles in the United States, which contemplate continuation of the Company as a going concern.  As further described in Note 6, as of March 31, 2017, the Company had outstanding $200.0 million of senior notes maturing on January 15, 2018 (the “Existing Senior Notes”) and owed $212.1 million under its senior secured credit facility.  The Company’s senior secured credit facility matures on July 14, 2019, but is subject to an accelerated maturity date of October 14, 2017, and will become due on such date, if the Company’s Existing Senior Notes, other than an aggregate principal amount not in excess of $2.6 million, are not refinanced or their maturity is not extended prior to October 14, 2017. As discussed below, the Company has commenced an Exchange Offer (as defined below) to refinance the Existing Senior Notes by May 30, 2017 to avoid the acceleration of the maturity of its senior secured credit facility.

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On April 20, 2017, the Company entered into a seventh amendment to the credit facility with Cerberus Business Finance, LLC, to modify the provision that accelerated the maturity date of the credit facility to October 14, 2017 to provide that the maturity of the credit facility will be accelerated to October 14, 2017 only in the event that the maturity of more than $2.6 million in aggregate principal amount of Existing Senior Notes has not been extended to October 31, 2019 or a later date on or before October 14, 2017. In addition, pursuant to the seventh amendment, following the consummation of the Company’s Exchange Offer referred to below, the Company may redeem, repurchase or pay at maturity up to $2.6 million of Existing Senior Notes at any time and from time to time within eight months of such consummation, but only to the extent that such Existing Senior Notes remain outstanding following the consummation of the Exchange Offer.

On April 24, 2017, the Company commenced a private offer to exchange any and all of the Existing Senior Notes (the “Exchange Offer”) for a combination of 12.250% Increasing Rate Senior Notes due 2020 (the “New Notes”) and warrants to purchase units of the common equity of the Company (the “Warrants”), and the solicitation of consents from registered holders of Existing Senior Notes to certain proposed amendments to the indenture governing the Existing Senior Notes to remove substantially all of the restrictive covenants and certain events of default from the indenture governing the Existing Senior Notes. Concurrently with the commencement of the Exchange Offer, the Company entered into a support agreement with holders of Existing Senior Notes owning approximately 98.7% of the aggregate outstanding principal amount of Existing Senior Notes. Pursuant to the support agreement, the holders party thereto agreed to validly tender all of their Existing Senior Notes in the Exchange Offer and provide consents to the proposed amendments to the indenture governing the Existing Senior Notes. The Exchange Offer expires at 5:00 p.m., New York City time, on May 22, 2017.

For every $1,000 principal amount of Existing Senior Notes tendered and not withdrawn prior to 5:00 p.m., New York City time, on May 5, 2017, the Company will issue $1,000 principal of New Notes and Warrants to purchase 15.366 of the Company’s common units. For every $1,000 principal amount of Existing Senior Notes tendered after 5:00 p.m., New York City time, on May 5, 2017, up to 5:00 p.m., New York City time, on May 22, 2017, the Company will issue $970 principal amount of New Notes and Warrants to purchase 15.366 of the Company’s common units. The Warrants will initially represent 12.5% of the outstanding common units of the Company on a fully diluted basis prior to the issuance of the Warrants, assuming 100% participation in the Exchange Offer, and will expire on the tenth anniversary of their issuance date.  

As of 5:00 p.m., New York City time, on May 5, 2017, $198.0 million aggregate principal amount of Existing Senior Notes, representing 99.0% of the outstanding Existing Senior Notes, had been validly tendered and not withdrawn. At that time, withdrawal rights expired and holders who tendered Existing Senior Notes prior to such time, including holders party to the support agreement, may no longer withdraw their tenders or revoke their consents. Accordingly, on May 5, 2017, the Company, the co-issuer, the guarantors of the Existing Senior Notes and the trustee entered into a supplemental indenture containing the proposed amendments to the indenture governing the Existing Senior Notes, which became effectively immediately, but will not become operative until the consummation of the Exchange Offer.

The Company intends to close the Exchange Offer no later than May 30, 2017 and at closing issue New Notes and Warrants in exchange for tendered Existing Senior Notes, with respect to at least $198.0 million of Existing Senior Notes thereby alleviating the accelerated maturity of the credit facility.  Furthermore, the Company has the intent and believes it has the ability to refinance, on a long-term basis up to $2.0 million of remaining outstanding after closing of Existing Senior Notes maturing January 15, 2018.

As of March 31, 2017, the amounts due under the Company’s senior secured credit facility have been classified as long-term debt.  Furthermore, $200.0 million of Existing Senior Notes maturing January 15, 2018, are expected to be refinanced and have been classified as long-term debt.

In light of the preceding plan to exchange the Existing Senior Notes, the Company’s management believes its current cash and cash equivalents, cash from operations and the amount available under its revolving credit facility will be sufficient to fund working capital requirements for the next 12 months. This belief assumes, among other things, that the Company will will continue to be successful in implementing its business strategy and that there will be no material adverse developments in its business, liquidity or capital requirements. There is no assurance that the Company will be able to achieve its forecasted cash from operations. If one or more of these factors do not occur as expected, it could cause a default under one or more of the agreements governing the Company’s indebtedness. If the Company’s cash from operations and refinancing sources are insufficient to service its debt or to fund its other liquidity needs, the Company may be forced to reduce or delay its business activities, sell material assets, seek additional capital or be forced into insolvency or liquidation.

In addition, in order to access the funds available under its revolving credit facility, the Company must meet the financial tests and ratios contained in its senior secured credit facility. If the Company fails to meet these financial tests and ratios, its ability to access the amounts otherwise available under its revolving credit facility could be limited.

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Supplemental Indenture to Senior Notes Indenture

In connection with the Exchange Offer, on May 5, 2017, the Company entered into a supplemental indenture governing the Company’s Senior Notes, (the “Tenth Supplemental Indenture”), which was included as Exhibit 4.1 to the Form 8-K filed on May 8, 2017 with the Securities and Exchange Commission.  Among other things, the Tenth Supplemental Indenture eliminated the requirement for the Company to file future quarterly or annual reports with the Securities and Exchange Commission and removed certain limitations on the Company’s ability to issue additional debt.    

Revenue Recognition and Accounts Receivable

The Company recognizes revenue at the time services are performed. Unbilled receivables are recorded for services rendered during, but billed subsequent to, the reporting period. Revenue is reported at the estimated realizable amounts from patients, third-party payors and others for services rendered. Revenue under certain third-party payor agreements is subject to audit and retroactive adjustments. Provisions for estimated third-party payor settlements and adjustments are estimated in the period the related services are rendered and adjusted in future periods as final settlements are determined. The provision for doubtful accounts and the related allowance are adjusted periodically based upon an evaluation of historical collection experience with specific payors for particular services, anticipated collection levels with specific payors for new services, industry reimbursement trends, and other relevant factors. Changes in these factors in future periods could result in increases or decreases in the Company’s provision for doubtful accounts and impact its results of operations, financial position and cash flows.

Recent Accounting Standards Updates

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers (Topic 606),” which will replace numerous requirements in U.S. GAAP and provide companies with a single revenue recognition model for recognizing revenue from contracts with customers. The core principle of the new standard is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. ASU 2014-09 will be effective for interim and annual reporting periods beginning after December 15, 2017. The two permitted transition methods under the new standard are the full retrospective method, in which case the standard would be applied to each prior reporting period presented, or the modified retrospective method, in which case the cumulative effect of applying the standard would be recognized at the date of initial application. The Company expects to adopt the full retrospective method under ASU 2014-09 for its first quarter of 2018 and is currently evaluating the effect of its adoption on its financial position, results of operations and cash flows.

In March 2016, the FASB issued ASU No. 2016-08, “Principal versus Agent Considerations (Reporting Revenue Gross versus Net).” The amendments in ASU 2016-08 affect ASU 2014-09 and are related to the principal versus agent considerations implementation guidance in ASU 2014-09. In April 2016, the FASB issued ASU No. 2016-10, “Identifying Performance Obligations and Licensing.” The amendments in ASU 2016-10 clarify the following two aspects in ASU 2014-09: identifying performance obligations and the licensing implementation guidance, while retaining the related principles for those areas. In May 2016, the FASB issued ASU No. 2016-11, “Rescission of SEC Guidance Because of Accounting Standards Updates 2014-09 and 2014-16 Pursuant to Staff Announcements at the March 3, 2016 EITF Meeting.” The amendments in ASU 2016-11 rescinded certain SEC Staff Observer comments that are codified, effective upon the adoption of ASU 2014-09. In May 2016, the FASB issued ASU No. 2016-12, “Narrow-Scope Improvements and Practical Expedients.” The amendments in ASU 2016-12 address certain issues identified in ASU 2014-09 in the guidance on assessing collectability, presentation of sales taxes, non-cash consideration, and completed contracts and contract modifications at transition. These ASU’s are effective concurrently with the adoption of ASU 2014-09. The Company is evaluating the impact of the adoption of these updates on its consolidated financial statements and related disclosures.

In February 2016, the FASB issued ASU 2016-02, “Leases” (topic 842). The FASB issued this update to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The updated guidance is effective for annual periods beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption of the update is permitted. The Company is evaluating the impact of the adoption of this update on its consolidated financial statements and related disclosures.

In March 2016, the FASB issued ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting,” which amends Accounting Standards Codification Topic 718, Compensation – Stock Compensation.  ASU 2016-09 simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. ASU 2016-09 is effective for the Company’s fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. The adoption of ASU 2016-09 did not have a material effect on the Company’s financial position, results of operations or cash flows.

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In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments”. ASU 2016-13 introduces a new forward-looking approach, based on expected losses, to estimate credit losses on certain types of financial instruments, including trade receivables and held-to-maturity debt securities, which will require entities to incorporate considerations of historical information, current information and reasonable and supportable forecasts. This ASU also expands disclosure requirements. ASU 2016-13 is effective for the Company beginning the first quarter of 2020 with early adoption permitted. The guidance will be applied using the modified-retrospective approach. The Company is currently evaluating the impact of adoption of ASU 2016-13 on its consolidated financial statements and related disclosures.

In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments,” which clarifies how certain cash receipts and cash payments are presented and classified in the statement of cash flows. ASU No. 2016-15 is effective for the Company in the first quarter of 2018 with early adoption permitted and must be applied retrospectively to all periods presented. As a result of adopting this guidance, the Company has classified acquisition related contingent note payments as $0.3 million cash used in operating activities and $0.1 million cash used in financing activities for the three months ended March 31, 2017 and $0.3 million cash used in operating activities and $0.3 million cash used in financing activities for the three months ended March 31, 2016.  Prior to adoption of this guidance, the Company had reported the $0.6 million of contingent note payments as cash flows used in investing activities for the three months ended March 31, 2016.

In October 2016, the FASB issued ASU 2016-16, “Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory.” This ASU requires entities to recognize the income tax consequences of any intercompany asset transfers at the transaction date. The seller and buyer will immediately recognize the current and deferred income tax consequences of an intercompany transfer of an asset other than inventory. The tax consequences were previously deferred until the asset is sold to a third party or recovered through use. ASU 2016-16 is effective for the Company for its annual reporting period beginning after December 15, 2017, including interim reporting periods within that annual reporting period. The Company is currently evaluating the impact of adoption of ASU 2016-16 on its consolidated financial statements and related disclosures.

In January 2017, the FASB issued ASU 2017-01, “Business Combinations (Topic 805): Clarifying the Definition of a Business.” This ASU is intended to clarify the definition of a business to help companies and other organizations evaluate whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. ASU 2017-01 is effective for public companies for annual and interim periods beginning after December 15, 2017, and early adoption is permitted under certain circumstances. ASU 2017-01 should be applied prospectively as of the beginning of the period of adoption. The Company is currently evaluating the impact of adoption of ASU 2017-01 on its consolidated financial statements and related disclosures.

In January 2017, the FASB issued ASU 2017-04, “Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment,” to simplify the subsequent measurement of goodwill. The amendment reduces the cost and complexity of evaluating goodwill for impairment by eliminating the second step in the goodwill impairment test. This update is effective for annual and interim periods beginning after December 15, 2019, and early adoption is permitted. The Company is currently evaluating the impact of adoption of ASU 2017-04 on its consolidated financial statements and related disclosures.

 

 

The Company has made strategic acquisitions of local practices to achieve greater economies of scale and expand or augment its geographic presence.

2016 Acquisitions

On March 31, 2016, the Company acquired 100% of the equity of a hospital-based pathology practice located in Oregon. On April 8, 2016, the Company acquired 100% of the equity of a second hospital-based pathology practice in Florida. In connection with these 2016 acquisitions, the Company paid total net cash of $7.2 million and issued contingent notes payable over three years. Payments under the contingent notes will be paid annually, up to a maximum of $1.5 million over the term of the notes, subject to the future financial performance of the acquired practice and the retention of a key facility contract. The Company used cash available under its $40.0 million delayed draw term loan B to pay the $7.2 million cash portion of the purchase price for the acquisition.

2017 Acquisition

On March 31, 2017, the Company acquired 100% of the equity of a hospital-based pathology practice located in Rhode Island and Massachusetts (the “2017 Acquisition”).  The Company paid net cash of $11.2 million at closing primarily with funds borrowed under its revolving credit facility and issued contingent notes payable annually over three years up to a total of $2.0 million.  As of March 31, 2017, the Company is still analyzing the acquisition and the allocation of the purchase price to the net assets acquired is preliminary and is expected to be finalized by December 31, 2017.

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The following table summarizes the preliminary estimated aggregate fair value of the assets acquired and liabilities assumed in connection with the 2017 Acquisition described above (in thousands):

 

 

Intangible assets acquired as the result of a business combination are recognized at fair value as an asset apart from goodwill if the asset arises from contractual or other legal rights or if it is separable. The Company’s intangible assets, which principally consist of the fair value of customer relationships, health care facility agreements and key physician agreements acquired in connection with the acquisition of diagnostic companies, are capitalized and amortized on the straight-line method over their useful life, which generally ranges from 3 to 15 years.  The 2017 Acquisition is a limited liability company for income tax purposes.  Accordingly, none of the goodwill recognized in the 2017 Acquisition will be deductible for federal income tax purposes.

The accompanying historical condensed consolidated financial statements include the results of operations of the 2016 acquisitions from the date acquired through March 31, 2017. The 2016 acquisitions contributed no revenue or net income for the three months ended March 31, 2016 and contributed revenue of $2.0 million and net income of $0.4 million for the three months ended March 31, 2017. The 2017 Acquisition contributed no revenue or net income for the three months ended March 31, 2017.  

Pro-forma information (unaudited)

The following unaudited pro forma information presents the consolidated results of the Company’s operations and the results of the 2016 acquisitions and 2017 Acquisition for the three months ended March 31, 2017 and 2016, after giving effect to amortization, depreciation, income tax, and the reduced level of certain specific operating expenses (primarily compensation and related expenses attributable to former owners) as if the 2016 acquisitions had been consummated on January 1, 2015 and the 2017 Acquisition had been consummated on January 1, 2016. Such unaudited pro forma information is based on historical unaudited financial information with respect to the 2016 acquisitions and 2017 Acquisition and does not include operational or other changes which might have been effected by the Company. The unaudited pro forma information for the three months ended March 31, 2017 and 2016 presented below is for illustrative purposes only and is not necessarily indicative of results which would have been achieved or results which may be achieved in the future (in thousands):

 

 

On April 17, 2017, the Company acquired 100% of the equity of a hospital-based pathology practice located in New Jersey.  The Company paid cash of $4.5 million at closing primarily with funds borrowed under its revolving credit facility and issued contingent notes payable annually over three years up to a total of $0.5 million. The Company has not completed its initial purchase price allocation and the pro forma information provided above does not give effect to this acquisition.

 

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Accounts receivable consist of the following as of March 31, 2017 and December 31, 2016 (in thousands):

 

 

 

The following table presents adjustments to goodwill during the three months ended March 31, 2017 and the year ended December 31, 2016 (in thousands):

 

 

The Company’s balances for intangible assets as of March 31, 2017 and December 31, 2016 and the related accumulated amortization are set forth in the table below (in thousands):

 

 

The Company recorded amortization expense related to its intangible assets of $4.2 million and $4.9 million for the three months ended March 31, 2017 and 2016, respectively. As of March 31, 2017, estimated future amortization expense is as follows (in thousands):

 

 

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Impairment of Goodwill and Other Intangible Assets

In March 2017, the Company received a notice from one of its customers that their hospital contract would not be renewed effective May 1, 2017. The Company expects the loss of the hospital contract effective May 1, 2017 will negatively impact the net revenue and profitability of one of its reporting units to such an extent as to indicate potential impairment of the reporting unit’s recorded hospital contracts intangible assets and goodwill. Accordingly, as of March 31, 2017, the Company tested hospital contracts intangible assets and goodwill for impairment at the affected reporting unit and recorded non-cash impairment charges of $4.2 million to write down the carrying value of its hospital contracts intangible assets and $5.3 million to write down the carrying value of goodwill. As of March 31, 2017 and December 31, 2016, the Company had accumulated impairment charges related to goodwill of $316.6 million and $311.3 million, respectively.

To estimate the fair value of the reporting unit at March 31, 2017, the Company utilized a discounted cash flow model as the primary approach to value, supported by a market approach guideline public company method (the “GPC Method”) which was used as a reasonableness test. The discounted cash flows approach provided a reasonable estimate of the fair value of the reporting unit because it utilized the unit’s actual results and reasonable estimates of future performance.  Furthermore, it takes into consideration a number of other factors deemed relevant by management, including but not limited to, expected future market revenue growth and operating profit margins. The Company has consistently used these approaches in determining the value of goodwill. The Company considers the GPC Method as an adequate reasonableness test which utilizes market multiples of industry participants to corroborate the discounted cash flow analysis. The Company believes this methodology is consistent with the approach that any strategic market participant would utilize if they were to value one of the Company’s reporting units.  

The following assumptions were made by management in determining the fair value of the reporting unit and related intangibles as of March 31, 2017: (a) the discount rate was 15.6 percent, based on relative size and perceived risk of the reporting unit; and (b) an average compound annual growth rate (CAGR) of 1.0 percent during the five year forecast period, after adjusting for the termination of the hospital contract effective May 1, 2017. These assumptions are based on both the actual historical performance and management’s estimates of future performance of the reporting unit.

As noted above, assumptions were made regarding the revenue, operating expense, and anticipated economic and market conditions related to the reporting unit as part of the impairment analysis. Assumptions made regarding future operations involve significant uncertainty, particularly with regard to anticipated economic and market conditions that are beyond the control of the Company’s management. Potential events or circumstances that could negatively impact future performance include, but are not limited to, losses of customers, changes in regulations or reimbursement rates and increased internalization of diagnostic testing by clients.

 

 

Accounts payable, accrued expenses and other current liabilities as of March 31, 2017 and December 31, 2016 consist of the following (in thousands):

 

 

 

On December 20, 2010, the Company issued $200.0 million in unsecured senior notes that mature on January 15, 2018, which are referred to as the Existing Senior Notes. The Existing Senior Notes bear interest at an annual rate of 10.75%, which is payable each January 15th and July 15th. In accordance with the indenture governing our Existing Senior Notes, the Company is subject to certain limitations on issuing additional debt and is required to submit quarterly and annual financial reports. The Existing Senior Notes are currently redeemable at the Company’s option at 100% of par, plus accrued interest. The Existing Senior Notes rank equally in right of repayment with all of the Company’s other senior indebtedness, but are subordinated to the Company’s secured indebtedness to the extent of the value of the assets securing that indebtedness.

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On July 31, 2014, the Company entered into a $220.0 million senior secured credit facility with Cerberus Business Finance, LLC. The credit facility consists of a $165.0 million initial term loan, $30.0 million revolving credit line and $25.0 million delayed draw term loan. Prior to the amendments discussed below, the delayed draw term loan facility was available through July 31, 2015 to pay the consideration for acquisitions, as permitted under the credit facility, including acquisition related fees and expenses. The Company used $145.6 million of the $165.0 million proceeds to retire a previous revolving credit facility due May 2015 and term loan facility due May 2016, including accrued interest and fees.  

Each of the term loan, revolving credit line and delayed draw term loan under the credit facility has a maturity of five years but is subject to a maturity date of October 14, 2017 if the Existing Senior Notes are not refinanced or their maturity is not extended prior to such date. Under the initial term loan, quarterly principal repayments of $0.9 million are due through June 30, 2018. Quarterly principal repayments increase to $1.3 million on September 30, 2018 through maturity. As of March 31, 2017, the balance outstanding under the initial term loan was $161.1 million and the balance outstanding under the delayed draw term loans was $35.0 million. As of March 31, 2017, $16.0 million was outstanding and the Company had $14.0 million available under its revolving credit facility.  

The proceeds under the credit facility were reduced by discounts of $5.1 million. Additionally, the Company used $3.9 million of the proceeds to pay issuance costs in connection with the credit facility. The remaining $10.4 million balance of the proceeds under the credit facility initial term loan and the funds available under the $30.0 million revolving credit line were intended to be used to execute future acquisitions and for the Company’s general working capital and operational needs.  

 

On April 10, 2015, the Company entered into a second amendment to the credit facility. The second amendment to the credit facility added a $40 million delayed draw term loan B facility which was available through April 10, 2016, which was subsequently extended to April 25, 2016 pursuant to a fifth amendment to the credit facility, to pay consideration for acquisitions, as permitted under the credit facility, including acquisition related fees and expenses.  The Company borrowed $10.0 million in March 2016 and the $30.0 million of unused availability under the delayed draw term loan B facility expired on April 25, 2016. The second amendment also increased the interest rate under the credit facility to LIBOR, with a 1.25% floor, plus 7.125%, or to the base rate, with a 2.25% floor, plus 6.125%. The senior secured credit facility is subject to a 2.25% per annum fee on the undrawn amount thereof, payable quarterly in arrears.

 

In connection with the acquisitions consummated by the Company on July 15, 2015, the Company borrowed the remaining $15.3 million available under the delayed draw term loan. The amount borrowed exceeded the total paid by the Company for eligible acquisitions, inclusive of related expenses, by $5.4 million. The Company entered into third and fourth amendments to its credit facility that extended the period in which the Company was able to use the remaining $5.4 million availability under the $25.0 million delayed draw term loan from July 31, 2015, to October 31, 2015. The Company used the remaining $5.4 million for an acquisition completed on October 29, 2015.

 

On April 20, 2017, the Company entered into a seventh amendment to the credit facility with Cerberus Business Finance, LLC, to modify the provision that accelerated the maturity date of the credit facility to October 14, 2017 to provide that the maturity of the credit facility will be accelerated to October 14, 2017 only in the event that the maturity of more than $2.6 million in aggregate principal amount of Existing Senior Notes has not been extended to October 31, 2019 or a later date on or before October 14, 2017. In addition, pursuant to the seventh amendment, following the consummation of the Company’s Exchange Offer referred to in Note 1, the Company may redeem, repurchase or pay at maturity up to $2.6 million of Existing Senior Notes at any time and from time to time within eight months of the consummation of the Company’s Exchange Offer, but only to the extent that such Existing Senior Notes remain outstanding following the consummation of the Exchange Offer.

The credit facility is secured by essentially all of the Company’s assets and unconditionally guaranteed by the Company and certain of the Company’s existing and subsequently acquired or organized domestic subsidiaries and is subject to certain financial covenants.The credit facility requires the Company to maintain certain levels of liquidity and comply on a quarterly basis with certain financial covenants, including a leverage ratio calculation, which generally becomes more restrictive over time, and an interest coverage ratio. Also, on an annual basis the Company must not exceed a specified maximum amount of consolidated capital expenditures. In addition, the credit facility includes negative covenants restricting or limiting the Company’s ability to, among other things, incur, assume or permit to exist additional indebtedness or guarantees; incur liens and engage in sale leaseback transactions; make loans and investments; declare dividends, make payments or redeem or repurchase capital stock; engage in mergers, acquisitions and other business combinations; prepay, redeem or purchase certain indebtedness; amend or otherwise alter terms of its indebtedness; sell assets; enter into transactions with affiliates and alter the business it conducts without prior approval of the lenders.

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Long-term debt consists of the following as of March 31, 2017 and December 31, 2016 (in thousands):

 

 

As of March 31, 2017, estimated future debt principal payments are as follows (in thousands):

 

 

At closing of the Exchange Offer, the Company intends to issue an aggregate amount of New Notes equal to the consideration offered in the Exchange Offer. The New Notes will be unsecured senior obligations of the Company and its wholly-owned subsidiary, Aurora Diagnostics Financing, Inc., which is acting as co-issuer of the New Notes. The New Notes will mature on January 15, 2020. The New Notes will accrue interest beginning on the issuance date at a rate of 10.75% per annum in cash plus payment-in-kind interest (“PIK Interest”) at a rate of 1.50% per annum, which PIK Interest rate shall increase to 3.00% from and after January 15, 2019. PIK Interest will be paid by increasing the principal amount of New Notes in an amount equal to the PIK Interest payable on the applicable interest payment date. The New Notes will bear interest on such increased principal amount from and after the applicable interest payment date of such PIK Interest. The issuers will pay interest on the New Notes on January 15 and July 15 of each year. The first interest payment date on the New Notes will be July 15, 2017 and will include the accrued and unpaid interest on any Existing Senior Notes exchanged in the Exchange Offer from January 15, 2017, the last interest payment date on the Existing Senior Notes, through, but not including, the settlement date of the Exchange Offer. The New Senior Notes will be immediately redeemable at the Company’s option at 100% of par, plus accrued interest.

The New Notes will be guaranteed on an unsecured senior basis by the Company’s current and future domestic subsidiaries that guarantee the Company’s credit facility indebtedness or capital markets indebtedness. The New Notes will rank equally in right of repayment with all of the Company’s other senior indebtedness, but will be subordinated to the Company’s secured indebtedness to the extent of the value of the assets securing that indebtedness.

The indenture governing the New Notes will not require the Company to continue its reporting obligations with the SEC; therefore, at closing of the Exchange Offer, we intend to cease filing any such reports and will only provide the reports required, under the method required, by the indenture governing the New Notes.

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In connection with certain of its acquisitions, the Company agreed to pay additional consideration in future periods based upon the attainment of stipulated levels of operating results by each of the acquired entities, as defined in their respective agreements. The Company records liabilities for contingent consideration issued in acquisitions at fair value as of the acquisition date. Payments under contingent notes issued in acquisitions are reflected in the change in fair value of contingent consideration.

 

As described in Note 2, in connection with the 2016 acquisitions and 2017 Acquisition the Company issued contingent notes payable annually over three years, up to a maximum of $3.5 million, subject to the future financial performance of the acquired practice and the retention of key facility contracts. The aggregate fair value of the contingent notes issued in the 2016 acquisitions and 2017 Acquisition was estimated at $2.6 million as of the acquisition dates.

During the three months ended March 31, 2017 and 2016, the Company made payments under contingent notes of $0.3 million and $0.6 million, respectively. The total fair value of the contingent consideration reflected in the accompanying condensed consolidated balance sheets as of March 31, 2017 and December 31, 2016 is $12.4 million and $10.7 million, respectively.

 

 

Acquisition Target Consulting Agreement

The Company has a professional services agreement with an entity owned by two of the Company’s members. Under this agreement, the entity provides certain acquisition target identification consulting services to the Company. In exchange for these services the Company pays to the entity a monthly retainer of $12,000, plus reimbursable expenses. The entity also earns a success fee of $65,000 for each identified acquisition consummated by the Company. The entity also will be paid a fee of 8% of revenue for certain new business development efforts as outlined in the professional services agreement. During the three months ended March 31, 2017 and 2016, the Company paid the entity $40,000 and $94,000, respectively. As of both March 31, 2017 and December 31, 2016, the Company owed to the entity $13,000 under this arrangement.  

Management and Financial Advisory Agreement

On June 2, 2006, the Company, through its wholly-owned subsidiary, and two members of the Company entered into a management services agreement. On June 12, 2009, the management agreement was amended to substitute a new member for one of the original members. The agreement calls for the members and their affiliates to provide certain financial and management advisory services in connection with the general business planning and forecasting and acquisition and divestiture strategies of the Company. In exchange for the services, the Company is required to pay fees equal to 1.0% of revenues plus expenses to the members.

In connection with an amendment to the Company’s previous credit facility in April 2013, the Company agreed to not make any payments of management or similar fees until payment in full of all loans under the credit facility, provided that such management fees continue to accrue. Management fees to the Company’s members up to 1% of net revenue are permitted under the current credit facility but may not be paid until payment in full of all loans thereunder and the Company continues to accrue management fees. The Company expects to not pay management fees through March 31, 2018. As of March 31, 2017 and December 31, 2016, $12.2 million and $11.5 million, respectively, of these management fees are reflected in long-term liabilities in the accompanying condensed consolidated balance sheets. The condensed consolidated statements of operations include management fees of $0.7 million for each of the three month periods ended March 31, 2017 and 2016, respectively. The Company paid no management fees under the management services agreement during the three month periods ended March 31, 2017 and 2016.  

Facilities Lease Agreements

The Company leases five of its facilities from entities owned by physician employees or affiliated physicians who are also former owners of the acquired practices. These leases terminate in April 2017, January 2018, December 2019, October 2020 and June 2022. In aggregate, the six leases provide for monthly aggregate base payments of approximately $85,000. Rent paid to the related entities was $0.3 million for each of the three month periods ended March 31, 2017 and 2016, respectively.

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Management and Financial Consultancy Services Agreement

On March 12, 2013, Daniel D. Crowley was appointed as the Chief Executive Officer and President of the Company. In connection with the appointment of Mr. Crowley, the Company entered into an agreement with Dynamic Healthcare Solutions (“DHS”), of which Mr. Crowley is the founder, sole owner and principal. Pursuant to the agreement, the Company pays DHS a monthly fee of $100,000, plus reasonable out of pocket expenses and hourly fees for DHS staff (other than Mr. Crowley) that provide services under the agreement. The agreement may be terminated by the board of managers of the Company with thirty days notice with or without cause and without the payment of termination fees. In addition, the agreement requires the Company to pay DHS a success fee in the event that a change of control of the Company occurs at any time during the term of the agreement or the one-year period following the termination of the agreement. The amount of the success fee would be based on the aggregate transaction value received by the Company at the time of the change of control event. Other than the agreement with DHS, Mr. Crowley does not receive any direct or indirect compensation or benefits from the Company. The Company paid $0.6 million and $0.5 million to DHS during the three months ended March 31, 2017 and 2016, respectively. A retainer of $0.2 million is included in deposits and other non-current assets as of March 31, 2017 and December 31, 2016.

Healthcare Administration Services

Effective December 1, 2013 the Company entered into an agreement with HealthSmart Benefit Solutions, Inc. (“HBS”), of which Mr. Crowley served as the Executive Chairman and President through July 2014. Mr. Crowley has not been affiliated with HBS since that time. Pursuant to the agreement, the Company paid fees to HBS of approximately $20,000 per month to process claims under its self-insured health benefits plan and to perform other health plan related services. Premiums for the Company’s stop loss coverage were collected by HBS and remitted to the coverage provider. Effective June 1, 2015, the Company transitioned the administration of its health plan benefits to another provider, however HBS continued to process claims through May 31, 2016, for dates of service prior to June 1, 2015. The Company paid $19,000 to HBS during the three months ended March 31, 2016.  The Company made no payments to HBS during the three months ended March 31, 2017.  No balance was owed by the Company to HBS as of March 31, 2017 and December 31, 2016.  

Acquisition Consulting Services

The Company has engaged Crowley Corporate Legal Strategy (“CCLS”), on an as needed basis, to provide legal services. Matt Crowley is a principal of CCLS and son of Daniel D. Crowley, the Company’s Chief Executive Officer. The Company paid to CCLS $17,000 and $23,000, during the three months ended March 31, 2017 and 2016, respectively.

Executive Consulting Agreement

The Company had a consulting agreement through February 2016 with Mr. James New, a current Board member and an owner of the Company’s limited liability company units and former CEO of the Company. Pursuant to the consulting agreement, Mr. New provided consulting services as requested by the Company for a fee of $12,500 per month.  In connection with the consulting agreement, the Company paid to Mr. New $25,000 during the three months ended March 31, 2016 and made no payments during the three months ended March 31, 2017.  No amounts were owed by the Company to Mr. New as of March 31, 2017 or December 31, 2016.

Broker of Record

OmegaComp has acted as broker of record to the Company with respect to health coverage since 2015. Daniel D. Crowley is Executive Chairman and majority owner of OmegaComp. OmegaComp received commissions from carriers of $72,000 and $84,000, during the three months ended March 31, 2017 and 2016, respectively, which amounts were included in premiums paid by the Company for insurances, benefits and services OmegaComp arranged on the Company’s behalf.

Chief Medical Officer

On October 29, 2015, prior to his appointment as the Company’s Chief Medical Officer, the Company issued a non-negotiable unsecured subordinated contingent note to Dr. F. Michael Walsh in connection with the acquisition of the pathology practice he owned. Pursuant to the contingent note, the Company agreed to pay to Dr. Walsh up to a maximum amount of $2.7 million if the acquired pathology practice met certain financial measures within certain periods of time. On June 13, 2016, the contingent note was amended to reduce the maximum amount payable thereunder to $2.4 million, and on June 15, 2016, the Company made a first payment of $650,000 under the note.   On January 27, 2017 the Company made a $50,000 partial payment under the second year of the note.  

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Client Interface Services

One of the Company’s members holds a minority ownership interest in an entity that the Company has engaged, from time to time, to provide client interface services.  The Company paid the entity $28,000 and $108,000 during the three months ended March 31, 2017, and 2016, respectively. As of March 31, 2017 and December 31, 2016 the Company owed to the entity $0.4 million and $8,000, respectively, for these services.

 

 

On July 6, 2011, the Company adopted the Aurora Diagnostics Holdings, LLC 2011 Equity Incentive Plan for the grant of options to purchase units of Aurora Diagnostics Holdings, LLC to employees, officers, managers, consultants and advisors of the Company and its affiliates. As of March 31, 2017, the Company has authorized the grant of up to 1,931,129 options and reserved the equivalent number of units for issuance upon the future exercise of awards pursuant to the plan. As of March 31, 2017, 1,474,500 options were outstanding and an additional 456,629 options were available for grant. Out of the total 1,474,500 options outstanding as of March 31, 2017, 1,037,000 were vested and 437,500 were unvested.

No options were granted or exercised and 13,000 options were forfeited during the three months ended March 31, 2017. Selling, general and administrative expenses included equity compensation expense of $32,000 and $50,000 for the three months ended March 31, 2017 and 2016, respectively. As of March 31, 2017, the total remaining unamortized equity compensation cost was approximately $11,000.

 

 

During the ordinary course of business, the Company has become and may in the future become subject to pending and threatened legal actions and proceedings. The Company may have liability with respect to its employees and its pathologists. Medical malpractice claims are generally covered by insurance. While the Company believes the outcome of any such pending legal actions and proceedings, individually or in the aggregate, will not have a material adverse effect on the Company’s financial condition, results of operations or liquidity, if the Company is ultimately found liable under any medical malpractice claims, there can be no assurance the Company’s medical malpractice insurance coverage will be adequate to cover any such liability. The Company had accrued approximately $2.3 million and $1.9 million as of March 31, 2017 and December 31, 2016, respectively, for future medical malpractice claims.  

The Company may also, from time to time, be involved with legal actions related to the acquisition of and affiliation with physician practices, the prior conduct of such practices, or the employment (and restriction on competition) of its physicians. There can be no assurance any costs or liabilities for which the Company becomes responsible in connection with such claims or actions will not be material or will not exceed the limitations of any applicable indemnification provisions or the financial resources of the indemnifying parties. Certain sellers have asserted the Company owes an aggregate of $2.7 million in connection with a contingent note issued in an acquisition. The Company has asserted the sellers owe the Company a repayment of $2.8 million. The Company’s management believes its calculations are correct, but at this time cannot estimate what additional amount will ultimately be paid or recovered, if any, in connection with these contingent notes.

In January 2016, the Company vacated two of its leased facilities.  The Company has not reached a settlement with the landlord of one of the leased facilities and recorded a non-cash charge of approximately $1.1 million in the first quarter of 2016 for the abandoned leasehold improvements and to accrue the present value of the future lease payments stipulated under the lease agreement.

In August 2015, the Company received a notice of non-compliance for payroll tax withholding related to a reorganization of two of its subsidiaries during 2011.  The Company believes its Form 941 filings for these subsidiaries in 2011 were appropriate and formally appealed approximately $0.5 million of additional taxes, interest and penalties accessed by the IRS in November 2015.  The Company cannot currently determine whether or not its appeal will be successful. If the Company’s appeal is unsuccessful, it may incur a charge of approximately $0.5 million for the additional taxes, interest and penalties.

Contingent Notes

As discussed in Note 7, in connection with certain of its acquisitions, the Company agreed to pay additional consideration in future periods based upon the attainment of stipulated levels of operating results by each of the acquired entities, as defined in their respective agreements. The computation of the annual operating results is subject to review and approval by the sellers prior to payment. In the event there is a dispute, the Company will pay the undisputed amount and then take reasonable efforts to resolve the dispute with the sellers. If the sellers are successful in asserting their dispute, the Company could be required to make additional payments in future periods.

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Future payments under contingent notes will be made if the practices achieve stipulated levels of results and contract retention as outlined in their respective agreements. Any future payments of contingent consideration will be reflected in the change in the fair value of the contingent consideration. As of March 31, 2017, the fair value of contingent consideration related to acquisitions was $12.4 million, representing the present value of approximately $16.0 million in estimated future payments through 2021.  

Purchase Obligations

The Company has entered into non-cancelable commitments to purchase reagents and other laboratory supplies. Under these agreements, the Company must purchase minimum amounts of reagents and other laboratory supplies through 2021.

At March 31, 2017, the remaining minimum purchase commitments are as follows:

 

 

In connection with certain of these commitments, the Company received lab testing equipment, to which the Company has either received title, or will receive title upon fulfillment of its purchase obligations under the respective commitment. The Company recorded the obligation under purchase commitment for the fair market value of the equipment, reduced by the cash paid. The remaining obligations under purchase commitments included in other liabilities in the accompanying condensed consolidated balance sheets were $1.3 million and $1.4 million as of March 31, 2017 and December 31, 2016, respectively.

 

 

Recurring Fair Value Measurements

As of March 31, 2017 and December 31, 2016, the fair value of contingent consideration related to acquisitions was $12.4 million and $10.7 million, respectively. The fair value of contingent consideration is derived using valuation techniques that incorporate unobservable inputs and are considered Level 3 items. The Company utilizes a present value of estimated future payments approach to estimate the fair value of the contingent consideration. Estimates for fair value of contingent consideration primarily involve two inputs, which are (i) the projections of the financial performance of the acquired practices that are used to calculate the amount of the payments and (ii) the discount rates used to calculate the present value of future payments. Changes in either of these inputs will impact the estimated fair value of contingent consideration. At March 31, 2017 the discount rates ranged from 15% to 19%.

 

The following is a summary of the Company’s fair value instruments categorized by their fair value input level as of March 31, 2017 (in thousands):

 

 

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The following is a summary of the Company’s fair value instruments categorized by their fair value input level as of December 31, 2016 (in thousands):

 

 

The following is a roll-forward of the Company’s Level 3 fair value instruments for the three months ended March 31, 2017 (in thousands):

 

 

Non-Recurring Fair Value Measurements

Certain assets that are measured at fair value on a non-recurring basis, including property and equipment and intangible assets, are adjusted to fair value only when the carrying values are greater than their fair values. The Company completed its latest annual impairment evaluations as of November 30, 2016 and recorded write-offs of goodwill to reflect the then current estimated fair value of the impaired reporting units. The fair values were derived with fair value models utilizing unobservable inputs that therefore are considered Level 3 items.

As of March 31, 2017 and December 31, 2016, the carrying amounts of cash and cash equivalents, accounts receivable, accounts payable, accrued interest and accrued expenses approximate fair value based on the short maturity of these instruments. As of March 31, 2017 and December 31, 2016, the fair value of the Company’s debt was $389.2 million and $369.1 million, respectively. The Company uses quoted market prices and yields for the same or similar types of borrowings in active markets when available to determine the fair value of the Company’s debt. These fair values are considered Level 2 items.

 

 

The Company is a Delaware limited liability company. For federal income tax purposes, the Company is treated as a partnership. Accordingly, the Company is generally not subject to income taxes and the income attributable to the limited liability company is distributed to the members in accordance with the terms of the operating agreement. However, certain of the Company’s subsidiaries are structured as corporations and therefore are subject to federal and state income taxes. The provision for income taxes for these subsidiaries is reflected in the Company’s condensed consolidated financial statements and includes federal and state taxes currently payable and changes in deferred tax assets and liabilities, excluding the establishment of deferred tax assets and liabilities related to acquisitions. The benefit for federal and state taxes was $0.4 million and $1.5 million for the three months ended March 31, 2017 and 2016, respectively.

 

 

The following information is presented as required by regulations of the Securities and Exchange Commission in connection with the Company’s 10.75% Existing Senior Notes due 2018. This information is not routinely prepared for use by management. The operating and investing activities of the separate legal entities included in the Company’s consolidated financial statements are fully interdependent and integrated. Accordingly, consolidating the operating results of those separate legal entities is not representative of what the actual operating results of those entities would be on a stand-alone basis. Operating expenses of those separate legal entities include intercompany charges for management fees and other services. Certain expense items that are applicable to the Company’s subsidiaries are typically recorded in the books and records of Aurora Diagnostics Holdings, LLC. For purposes of this footnote disclosure, such balances and amounts have been “pushed down” to the respective subsidiaries either on a specific identification basis, or when such items cannot be specifically attributed to an individual subsidiary, have been allocated on an incremental or proportional cost basis to Aurora Diagnostics Holdings, LLC and the Company’s subsidiaries.

 

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The following tables present consolidating financial information as of March 31, 2017 and December 31, 2016 and for the three months ended March 31, 2017 and 2016 for (i) Aurora Diagnostics Holdings, LLC, (ii) on a combined basis, the subsidiaries of the Company that are guarantors of the Company’s Existing Senior Notes (the “Subsidiary Guarantors”) and (iii) on a combined basis, the subsidiaries of the Company that are not guarantors of the Company’s Existing Senior Notes (the “Non-Guarantor Subsidiaries”). For presentation in the following tables, Subsidiary Guarantors includes revenue and expenses and assets and liabilities for those subsidiaries directly or indirectly 100% owned by the Company, including those entities that have contractual arrangements with affiliated physician groups. Essentially, all property and equipment reflected in the accompanying condensed consolidated balance sheets collateralize the Company’s credit facility. As such, as of March 31, 2017 and December 31, 2016, $1.9 million and $2.0 million, respectively, of property and equipment held by Non-Guarantor Subsidiaries are reflected under Subsidiary Guarantors in the following tables.

Condensed Consolidating Balance Sheets (in thousands):

 

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Condensed Consolidating Statements of Operations (in thousands):

 

 

 

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Condensed Consolidating Statements of Cash Flows (in thousands):

 

 

 

 

 

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You should read the following discussion and analysis of our financial condition and results of operations together with our financial statements and related notes included in Part I, Item 1 of this Quarterly Report on Form 10-Q. Some of the statements made in this Quarterly Report on Form 10-Q are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, or the Exchange Act. All statements other than statements of historical facts contained in this Quarterly Report, including statements regarding our future results of operations and financial position, or that describe our plans, goals, intentions, objectives, strategies, expectations, beliefs and assumptions, are forward-looking statements. The words “believe,” “may,” “might,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “expect,” “project,” “plan,” “objective,” “could,” “would,” “should” and similar expressions are intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy, short-term and long-term business operations and objectives, and financial needs. We caution that the forward-looking statements in this Quarterly Report on Form 10-Q are subject to a number of known and unknown risks, uncertainties and assumptions that may cause our actual results, performance or achievements to be materially different from any future results, performances or achievements expressed or implied by the forward-looking statements. Factors that could contribute to these differences include, among other things:

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Moreover, we operate in a very competitive and rapidly changing environment, and new risks emerge from time-to-time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this Quarterly Report may not occur, and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements.

You should not rely upon forward-looking statements as predictions of future events. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee that the future results, levels of activity, performance or events and circumstances reflected in the forward-looking statements will be achieved or occur. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of the forward-looking statements. We undertake no obligation to update publicly any forward-looking statements for any reason after the date of this Quarterly Report on Form 10-Q to conform these statements to actual results or changes in our expectations, unless otherwise required by law.

Overview

We are a leading independent pathology services and cancer diagnostics company. We provide integrated diagnostic consultations, information services and personalized medicine services tailored to the patients of our referring physicians, hospitals and hospital systems. We also provide research services to pharmaceutical companies and other research entities. Our highly-trained, subspecialized pathologists deliver comprehensive diagnostic opinions of a patient’s condition and work collaboratively with referring physicians to determine appropriate treatments. We have established long-standing relationships with our referring physicians as a result of our locally provided diagnostic services, frequent diagnostic consultations and flexible IT solutions that are customizable to our clients’ needs. Our client-centered approach to providing diagnostic services is driven by our belief that the practice of medicine and the delivery of healthcare are both personal and best delivered locally.

Through organic growth and a series of strategic acquisitions, we have achieved a large geographic footprint and a leading presence in our local markets. As of March 31, 2017, we operated 27 community-based pathology practices with over 160 board-certified pathologists on staff, and our clients included over 13,000 referring physicians and 110 hospitals across 45 states. Our referring physicians include dermatologists, obstetricians and gynecologists, family practitioners, gastroenterologists, urologists, general surgeons and oncologists. We also serve as laboratory medical director for over 350 laboratory sites across the country, including our 99 hospital clients, reflecting the recent addition of two new hospital clients in the Northeast and one on the West Coast.

In 2013, we established the Aurora Research Institute (“ARI”), a revenue-generating services platform that leverages the expertise of our pathologists, laboratory resources and sizeable library of biospecimens for the development of therapeutics and companion diagnostics for leading global pharmaceutical and biotechnology companies. For the quarter ended March 31, 2017, ARI contributed net revenue of $0.7 million, or approximately 1% of our total net revenue. For the year ended December 31, 2016, ARI contributed net revenue of $3.9 million, or approximately 1% of our total net revenue.

For the year ended December 31, 2016 and the three months ended March 31, 2017, we processed approximately 2.1 million and 514,000 accessions, respectively. An accession may include one or more specimens received by our pathology practices originated from a single patient visit to a referring physician concerning a particular condition. For the year ended December 31, 2016 and the three months ended March 31, 2017, we generated net revenue of $284.0 million and $67.8 million, respectively.

Key Factors Affecting Our Results of Operations

Services Mix

An important factor affecting our financial performance is the impact of changes in our services mix, including the conversion of global fee arrangements to technical component or professional component arrangements and changes in the accession volume across our various subspecialties. Under a global fee arrangement, we provide both technical and professional services. The technical component represents the cost of preparing a specimen for interpretation, while the professional component represents the cost of supervision and interpretation by our pathologists. We generally prefer global fee arrangements in which we provide both the professional and technical services components, as opposed to arrangements where we only perform either technical or professional services, because global arrangements result in higher revenue per accession. Additionally, changes in test volume across our various subspecialties can impact our revenue. For example, molecular testing, hematopathology, dermatopathology, gastrointestinal and

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genitourinary all have higher revenue per accession than women’s health pathology services and clinical tests. Women’s health services and clinical tests generally have lower revenue per accession. Therefore, increases in the percentage of accessions related to women’s health pathology services relative to the percentages of accessions generated by other subspecialties would generally decrease our average revenue per accession. Conversely, a higher volume of molecular testing would generally increase our average revenue per accession.

Payor Mix

Changes in our payor mix, as well as changes in the payors used by our referring physicians, can affect our revenue per accession and impact our financial results. We generally provide services on an in-network basis, where we perform services for patients within the networks of payors with which we have contracts. Services performed on an out-of-network basis comprised approximately 10% of our 2016 revenue. Our payors include governmental payors, such as Medicare and Medicaid; private insurance, including managed care organizations and commercial payors; and private payors, such as physicians and individual patients. Because we are generally obligated to bill for our services in the specific manner prescribed by each payor, who may each have different billing requirements, these differences can impact our financial results. Therefore, if more of our referring physicians use governmental payors who have historically had lower reimbursement rates as opposed to commercial payors who have historically had higher reimbursement rates, our revenue per accession may decrease. For the year ended December 31, 2016, based on cash collections, we estimate approximately 58% of our revenue was paid by private insurance, including managed care organizations and commercial payors; approximately 22% of our revenue was paid by Medicare; approximately 2% of our revenue was paid by Medicaid; and approximately 18% was paid by physicians and individual patients.

Reimbursement Rates

Changes to the reimbursement rates paid by our payors impact our net revenue per accession. When we bill our services to third party payors and uninsured patients, we use a company-generated fee schedule that is generally set at billing rates that are higher than our anticipated reimbursement rates. Our billings for services to third party payors are then reimbursed in accordance with the set or negotiated reimbursement rates of the applicable payor. On the other hand, when we bill our services to physicians, which are not reimbursed by third party payors, we use a negotiated fee schedule, and when we bill Medicare for specialized diagnostic services, we are subject to a Medicare physician fee schedule and, to a lesser degree, a clinical laboratory fee schedule, both of which are updated annually. Our revenue is recorded net of the estimated differences between the amount billed in accordance with the prescribed fee schedule and the estimated payment to be received from third party payors, including Medicare. As a result, any changes to the reimbursements rates for our services or the fee schedules at which we bill our services will impact our financial results. We have historically faced, and expect to continue to face, pressure on reimbursement rates as government payors and private insurers take steps to control the cost, use and delivery of health care services, including diagnostic testing services. Government regulations can impact our reimbursement rates and financial results.

On November 2, 2016, CMS issued its 2017 Fee Schedule.  In the 2017 Fee Schedule, CMS effectuated reductions to CPT Code 88305, which is the CPT Code we bill most frequently, of approximately 6.8%. Reimbursement rates for flow cytometry codes were also reduced by approximately 19%.  Based on our current level of reimbursement from Medicare, we estimate the changes to the 2017 Fee Schedule would result in a reduction of our annualized Medicare revenue of approximately $2.9 million.

From time to time we must renegotiate our reimbursements from commercial payors.  We recently renegotiated two contracts, which became effective in January and February of 2017, that allow us to retain our in-network status and become a preferred provider in the client’s network. We anticipate these new contracts could generate increased volume, but at lower rates that are more in-line with current market reimbursement rates. We do not anticipate that the increased volume will fully offset the impact of lower reimbursement on our 2017 revenue. Based on 2016 volume, we estimate the reimbursement rates reflected in these two new contracts could result in a reduction of approximately $2.3 million in our net revenue for 2017.

In response to the reductions by CMS, as well as reductions from private insurance companies, we have undertaken a program to increase efficiencies and reduce costs, including a reduction in our staffing.  We estimate the implementation of this program, which was fully implemented by January 1, 2017, will reduce our expenses by approximately $3.9 million annually.

Acquisitions

Since our formation in 2006, through March 31, 2017, we have acquired 32 diagnostic services companies throughout the United States. As a result of the significant number and size of our acquisitions, many of the changes in our consolidated results of operations and financial position discussed from period to period reflect revenue generated by the businesses we have acquired and costs related to these acquisitions. For additional information relating to recent acquisitions, see “—Recent Acquisitions.”

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Seasonality

Our results are also affected by seasonal trends and generally decline during the summer, winter and holiday periods. Furthermore, our results are subject to declines due to weather conditions, such as severe snow storms and flooding or excessively hot or cold spells, as well as general economic conditions, which can deter patients from visiting hospitals and our referring physicians. Seasonal fluctuations tend to vary by region, and, for example, we experience a greater decrease in our accession volume during the winter months in the northeast as compared to the southeast. In addition, we tend to experience a decrease in our accession volume at the beginning of each year as a result of the annual reset of health plan deductibles.

Emerging Growth Company

We qualify as an “emerging growth company” as defined in the Jumpstart Our Business Startups Act of 2012 (JOBS Act). As an emerging growth company, we have elected to provide reduced reporting and are not subject to other obligations generally applicable to public companies, including disclosure about our executive compensation arrangements and the auditor attestation requirement in the assessment of our internal control over financial reporting. In addition, we may take advantage of an extended transition period for complying with new or revised accounting standards under the JOBS Act. This election allows us to delay the adoption of new or revised accounting standards that have different effective dates for public and private companies until those standards apply to private companies.

The information that we provide may be different than what is available with respect to other public companies due to these reduced reporting obligations.

Results of Operations

The following table outlines our results of operations as a percentage of net revenue for the three months ended March 31, 2017 and 2016.

 

 

Our historical consolidated operating results do not reflect the results of operations of our 2016 acquisitions and 2017 Acquisition prior to the effective date of those acquisitions. As a result, our historical consolidated operating results may not be indicative of what our results of operations will be for future periods.

 

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Comparison of the Three Months Ended March 31, 2017 and 2016

Net revenue

Net revenue for the quarter ended March 31, 2017 was $67.8 million on accession volume of 514,000, inclusive of approximately $2.0 million of revenue and 11,000 accessions from the practices acquired in 2016. Net revenue at the practices we have operated for the full periods in both 2017 and 2016, which we refer to herein as our existing practices, decreased by approximately 4%, or $3.0 million, to approximately $65.8 million for the quarter ended March 31, 2017, compared to $68.8 million for the quarter ended March 31, 2016. Existing practice accession volume was 503,000, a decrease of approximately 3% for the quarter ended March 31, 2017, compared to 517,000 for the quarter ended March 31, 2016. The average revenue per accession for our existing practices for the quarter ended March 31, 2017 decreased by about 1%, to $131, compared to $133 for the same period in 2016. The decrease in existing practice revenue was primarily related to lower volume from certain continuing clients, as well as client attrition, and lower Medicare reimbursement under the 2017 Physician Fee Schedule.

Cost of services

Cost of services for the quarter ended March 31, 2017 was $37.8 million, including approximately $1.1 million for practices acquired in 2016. Cost of services at existing practices decreased approximately $1.0 million, or 3%, to $36.7 million for the quarter ended March 31, 2017, from $37.7 million for the quarter ended March 31, 2016, primarily as a result of lower personnel related costs.

As a result of the preceding factors, cost of services was 55.7% of net revenue for the quarter ended March 31, 2017, compared to 54.9% for the quarter ended March 31, 2016. Gross margin was 44.3% for the quarter ended March 31, 2017, compared to 45.1% for the quarter ended March 31, 2016.

Selling, general and administrative expenses

Selling, general and administrative expenses decreased approximately $1.5 million, or 8%, to $17.4 million for the quarter ended March 31, 2017, including approximately $0.3 million related to practices acquired in 2016, from approximately $18.9 million for the quarter ended March 31, 2016. Selling, general and administrative expenses for the quarter ended March 31, 2017, compared to the corresponding period in the prior year, was approximately $0.3 million higher at practices acquired in 2016 and approximately $1.7 million lower at our existing practices.  The decrease in selling, general and administrative expenses at existing practices reflected approximately $1.2 million for non-cash charges related to two leased locations vacated in the quarter ended March 31, 2016, as well as lower personnel related and billing costs.  Compared to the corresponding period in the prior year, selling, general and administrative expenses at corporate decreased by approximately $0.1 million due to lower personnel related costs.

As a result of the preceding factors, selling, general and administrative expenses were approximately 25.6% of net revenue for the quarter ended March 31, 2017, compared to 27.6% for the quarter ended March 31, 2016.

Provision for doubtful accounts

Our provision for doubtful accounts decreased approximately $0.5 million, or 11%, to $3.6 million for the quarter ended March 31, 2017, from $4.1 million for the quarter ended March 31, 2016. As a percentage of net revenue, the provision for doubtful accounts decreased to 5.3% for the quarter ended March 31, 2017, compared to 5.9% for the quarter ended March 31, 2016. The decrease in the provision for doubtful accounts for the quarter ended March 31, 2017 primarily related to continued improvements in our collections processes which have improved our collections results.  

The Company’s consolidated provision for doubtful accounts could be positively or negatively impacted by various factors including, among other things, changes in payor mix and the provision for doubtful accounts for practices that we acquire.

Intangible asset amortization expense

Amortization expense decreased to $4.2 million for the quarter ended March 31, 2017, from $4.9 million for the quarter ended March 31, 2016, as a result of certain intangible assets becoming fully amortized in 2016, partially offset by amortization of finite lived intangible assets recorded for practices acquired in 2016. We generally amortize our intangible assets over lives ranging from 3 to 15 years.

Management fees, related parties

Management fees to related parties were approximately $0.7 million for each of the quarters ended March 31, 2017 and March 31, 2016. Management fees are based on 1.0% of net revenue plus expenses.

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Impairment of goodwill and other intangible assets

In March 2017, we received a notice from one of our reporting unit’s customers that their hospital contract would not be renewed effective May 1, 2017. We expect the loss of the hospital contract effective May 1, 2017 will negatively impact the net revenue and profitability of the reporting unit to such an extent as to indicate potential impairment of the reporting unit’s recorded hospital contracts intangible assets and goodwill. Accordingly, as of March 31, 2017, we tested hospital contracts intangible assets and goodwill for impairment at the affected reporting unit and recorded non-cash impairment charges of $4.2 million to write down the carrying value of its hospital contracts intangible assets and $5.3 million to write down the carrying value of goodwill.

Merger and acquisition transaction costs

Merger and acquisition transaction costs increased by approximately $0.2 million, to $0.5 million for the quarter ended March 31, 2017, compared to $0.3 million the quarter ended March 31, 2016, reflecting a higher level of transaction activity.

Change in fair value of contingent consideration

For the quarter ended March 31, 2017 we recorded expense of $0.6 million for changes in the fair value of contingent consideration issued in connection with our acquisitions, compared to expense of $0.7 million for the quarter ended March 31, 2016. The change in fair value of contingent consideration results from revisions in our projections to reflect recent results, as well as other variables such as the discount rate, the valuation date and actual payments made.

Interest expense

Interest expense was approximately $10.3 million for the quarter ended March 31, 2017, compared to $10.5 million and March 31, 2016. The decrease related to reduced average balances in principal outstanding under the Company’s term loan as a result of quarterly principal repayments.

Provision (benefit) for income taxes

We are a Delaware limited liability company for federal and state income tax purposes, in accordance with the applicable provisions of the Internal Revenue Code. Accordingly, we generally have not been subject to income taxes, and the income attributable to us has been allocated to the members of Aurora Diagnostics Holdings, LLC in accordance with the terms of the Aurora Diagnostics Holdings, LLC Limited Liability Company Agreement. However, certain of our subsidiaries are structured as corporations and therefore are subject to federal and state income taxes. The benefit for federal and state income taxes for these subsidiaries, as reflected in our condensed consolidated financial statements, amounted to approximately $0.4 million for the quarter ended March 31, 2017, compared to $1.5 million for the quarter ended March 31, 2016, as a result of changes in taxable income primarily as a result of goodwill impairment and a valuation allowance recognized for certain of our subsidiaries structured as corporations.  

Liquidity and Capital Resources

Since inception, we have primarily financed operations through capital contributions from our equityholders, long-term debt financing and cash flow from operations.

On December 20, 2010, we issued $200.0 million in unsecured senior notes that mature on January 15, 2018, which we refer to as our Existing Senior Notes. The Existing Senior Notes bear interest at an annual rate of 10.75%, which is payable each January 15^th and July 15^th. In accordance with the indenture governing our Existing Senior Notes, we are subject to certain limitations on issuing additional debt and are subject to other customary affirmative and negative covenants. The Existing Senior Notes are currently redeemable at our option at 100% of par. The Existing Senior Notes rank equally in right of repayment with all of our other senior indebtedness, but are subordinated to our secured indebtedness to the extent of the value of the assets securing that indebtedness.  As of March 31, 2017, we had a total of $200.0 million aggregate principal amount of Existing Senior Notes outstanding.

On July 31, 2014 we entered into a $220.0 million credit facility with Cerberus Business Finance, LLC, which facility, as subsequently amended, we refer to as our senior secured credit facility. Our senior secured credit facility initially consisted of a $165.0 million initial term loan, $30.0 million revolving credit line and $25.0 million delayed draw term loan.  The delayed draw term loan facility was available through October 31, 2015 to pay for acquisitions, including acquisition related fees and expenses. Each of the term loan, revolving credit line and delayed draw term loan under the senior secured credit facility has a maturity of five years but is subject to a maturity date of October 14, 2017 if more than $2.6 million in aggregate principal amount of our Existing Senior Notes are not refinanced or their maturity is not extended, or if the credit facility is not amended and extended, prior to such date.  Pursuant to the Exchange Offer, we have offered holders of Existing Senior Notes the opportunity to exchange their Existing Senior Notes for New Notes and Warrants. See “Cash and Working Capital” below for details of the Exchange Offer.

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If the Exchange Offer is consummated, the Company intends to issue an aggregate amount of New Notes equal to the consideration offered in the Exchange Offer. The New Notes will be unsecured senior obligations of the Company and its wholly-owned subsidiary, Aurora Diagnostics Financing, Inc., which is acting as co-issuer of the New Notes. The New Notes will mature on January 15, 2020. The New Notes will accrue interest beginning on the issuance date at a rate of 10.75% per annum in cash plus payment-in-kind interest (“PIK Interest”) at a rate of 1.50% per annum, which PIK Interest rate shall increase to 3.00% from and after January 15, 2019. PIK Interest will be paid by increasing the principal amount of New Notes in an amount equal to the PIK Interest payable on the applicable interest payment date. The New Notes will bear interest on such increased principal amount from and after the applicable interest payment date of such PIK Interest. The issuers will pay interest on the New Notes on January 15 and July 15 of each year. The first interest payment date on the New Notes will be July 15, 2017 and will include the accrued and unpaid interest on any Existing Senior Notes exchanged in the Exchange Offer from January 15, 2017, the last interest payment date on the Existing Senior Notes, through, but not including, the settlement date of the Exchange Offer. The New Senior Notes will be immediately redeemable at the Company’s option at 100% of par, plus accrued interest. The New Notes will be guaranteed on an unsecured senior basis by the Company’s current and future domestic subsidiaries that guarantee the Company’s credit facility indebtedness or capital markets indebtedness. The New Notes will rank equally in right of repayment with all of the Company’s other senior indebtedness, but will be subordinated to the Company’s secured indebtedness to the extent of the value of the assets securing that indebtedness.

The indenture governing the New Notes will not require the Company to continue its reporting obligations with the SEC; therefore, at closing of the Exchange Offer, we intend to cease filing any such reports and will only provide the reports required, under the method required, by the indenture governing the New Notes.

Under the outstanding term loans, quarterly principal repayments of $0.5 million were required and paid from September 30, 2015 through December 31, 2016.  Quarterly principal repayments increased to $0.9 million on March 31, 2017, continuing through June 30, 2018 and to $1.3 million on September 30, 2018 and each quarter end thereafter, with the balance due at maturity. Prior to the second amendment on April 10, 2015, at our option, interest under the credit facility was either LIBOR, with a 1.25% floor, plus 7%, or at a base rate, with a 2.25% floor, plus 6%.

On April 10, 2015 we entered into a second amendment to our senior secured credit facility. This amendment added a $40.0 million delayed draw term loan B facility that was available through April 10, 2016 to pay for acquisitions, including acquisition related fees and expenses. The second amendment also increased the interest rate under the credit facility to LIBOR, with a 1.25% floor, plus 7.125%, or to the base rate, with a 2.25% floor, plus 6.125%. The senior secured credit facility is subject to a 2.25% per annum fee on the undrawn amount thereof, payable quarterly in arrears.

In connection with the acquisitions we consummated on July 15, 2015, we borrowed the remaining $15.3 million available under the delayed draw term loan. The amount we borrowed exceeded the total we paid for eligible acquisitions, inclusive of related expenses, by $5.4 million. Subsequent amendments extended the remaining $5.4 million availability under the $25.0 million delayed draw term loan from July 31, 2015 to October 31, 2015. We used the remaining $5.4 million for an acquisition completed on October 29, 2015.

As of March 31, 2017, we owed $161.1 million under the term loan, $25.0 million under the delayed draw term loan, $10.0 million under the delayed draw term loan B facility and $16.0 million under the revolving credit facility. As of March 31, 2017, we had $14.0 million available under our revolving credit facility.

The senior secured credit facility is secured by essentially all of our assets and unconditionally guaranteed by us and certain of the Company’s and subsequently acquired or organized domestic subsidiaries and is subject to certain financial covenants. The senior secured credit facility requires us to maintain a maximum leverage ratio (based upon the ratio of total funded debt to consolidated EBITDA, net of agreed cash amounts) and a minimum interest coverage ratio (based upon the ratio of consolidated EBITDA to net cash interest expense), each quarter based on the last four fiscal quarters. The maximum leverage ratio as of March 31, 2017 was 9.60:1.00 and becomes more restrictive each quarter through maturity. The minimum interest coverage ratio was 1.00:1.00 as of March 31, 2017 and increases to 1.05:1.00 on December 31, 2017. In addition, we are required to maintain liquidity (defined as availability under the revolving credit facility plus amounts in bank accounts that are subject to the agent’s perfected first priority liens) of at least $5.0 million at any time and $10.0 million on the last business day of each month. We are also subject to other restrictive covenants set forth in our senior secured credit facility.  Generally, we are permitted to make voluntary prepayments under our senior secured credit facility and to reduce the revolving loan commitments at any time. However, subject to certain exceptions, prepayments and commitment reductions are currently subject to a premium equal to 2.0%, which will be reduced to 1.0% effective August 1, 2017 and eliminated entirely after July 31, 2018.

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Subject to certain exceptions, we are required to prepay borrowings under the credit facility as follows:  (i) with 100% of the net cash proceeds we receive from the incurrence of debt obligations other than debt obligations otherwise permitted under the financing agreement, (ii) with 100% of the net cash proceeds in excess of $1 million in the aggregate in any fiscal year we receive from specified non-ordinary course asset sales or as a result of casualty or condemnation events, subject to reinvestment provisions, (iii) with 50% of our excess cash flows for each fiscal year, which commenced with the fiscal year ended December 31, 2015, and (iv) 100% of the net cash proceeds from the exercise of any “equity cure” with respect to the financial covenants contained in the financing agreement.

Our credit facility specifies maximum limits for our consolidated capital expenditures on an annual basis and includes negative covenants restricting or limiting our ability to, among other things, incur, assume or permit to exist additional indebtedness or guarantees; incur liens and engage in sale leaseback transactions; make loans and investments; declare dividends, make payments or redeem or repurchase capital stock; engage in mergers, acquisitions and other business combinations; prepay, redeem or purchase certain indebtedness; amend or otherwise alter terms of our indebtedness; sell assets; enter into transactions with affiliates and alter our business without prior approval of the lenders. The senior secured credit facility also contains customary default provisions that include material adverse events, as defined therein.

Contingent consideration for acquisitions

In connection with the majority of our acquisitions, we have agreed to pay additional consideration annually over future periods of three to six years, based upon contract retention and the attainment of stipulated levels of operating results by each of the acquired entities, as defined in their respective agreements. The computation of the annual operating results is subject to review and approval by sellers prior to payment. In the event there is a dispute, the Company will pay the undisputed amount and then take reasonable efforts to resolve the dispute with the sellers. If the sellers are successful in asserting their dispute, the Company could be required to make additional payments in future periods. We made contingent note payments of $0.3 million and $0.6 million in the three months ended March 31, 2017 and 2016, respectively.  

As of March 31, 2017, the total maximum future payments of contingent consideration issued in acquisitions was $19.5 million. Lesser amounts will be paid or no payments will be made for earnings below the maximum level of stipulated earnings or if the stipulated contracts are not retained. We utilize a present value of estimated future payments approach to estimate the fair value of the contingent consideration. These estimates involve significant projections regarding future performance of the acquired practices. If actual future results differ significantly from current estimates, the actual payments for contingent consideration will differ correspondingly. As of March 31, 2017, the fair value of contingent consideration related to acquisitions was $12.4 million, representing the present value of approximately $16.0 million in estimated future payments through 2021.

Medical Malpractice Insurance

We are insured on a claims-made basis up to our policy limits through a third party malpractice insurance policy. We establish reserves, on an undiscounted basis, for self-insured deductibles, claims incurred and reported and claims incurred but not reported (“IBNR”) during the policy period. We had recorded medical malpractice liabilities of $2.3 million as of March 31, 2017, which were included in accounts payable, accrued expenses and other current liabilities. We also record a receivable from our insurance carrier for expected recoveries. Expected insurance recoveries, which are included in prepaid expenses and other current assets, were $0.8 million as of March 31, 2017. So long as we maintain third party malpractice insurance policies, the IBNR claims will be covered by such third party policy up to the policy limits.

Cash and Working Capital

We require significant cash flow to service our debt obligations, including contingent notes. In addition to servicing our debt, we use cash to make acquisitions, purchase property and equipment and otherwise fund our operations. Cash used to fund our operations excludes the impact of non-cash items, such as the allowance for doubtful accounts, depreciation, impairments of goodwill and other intangible assets, changes in the fair value of the contingent consideration and non-cash stock-based compensation, and is impacted by the timing of our payments of accounts payable and accrued expenses and collections of accounts receivable.

As of March 31, 2017, we had cash and cash equivalents of $17.4 million and working capital of $11.8 million, and we had $14.0 million available under our revolving credit facility. Our senior secured credit facility matures on July 14, 2019, but is subject to an accelerated maturity date of October 14, 2017, and will become due in 2017, if more than $2.6 million in aggregate principal amount of our Existing Senior Notes are not refinanced or their maturity is not extended prior to October 14, 2017.

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On April 20, 2017, we entered into a seventh amendment to the credit facility with Cerberus Business Finance, LLC, to modify the provision that accelerated the maturity date of the credit facility to October 14, 2017 to provide that the maturity of the credit facility will be accelerated to October 14, 2017 only in the event that the maturity of more than $2.6 million in aggregate principal amount of Existing Senior Notes has not been extended to October 31, 2019 or a later date on or before October 14, 2017. In addition, pursuant to the seventh amendment, following the consummation of our Exchange Offer referred to below, we may redeem, repurchase or pay at maturity up to $2.6 million of Existing Senior Notes at any time and from time to time within eight months of such consummation, but only to the extent that such Existing Senior Notes remain outstanding following the consummation of the Exchange Offer.

On April 24, 2017, we commenced a private offer to exchange any and all of the Existing Senior Notes for a combination of New Notes and Warrants, and the solicitation of consents from registered holders of Existing Senior Notes to certain proposed amendments to the indenture governing the Existing Senior Notes to remove substantially all of the restrictive covenants and events of default from the indenture governing the Existing Senior Notes. Concurrently with the commencement of the Exchange Offer, we entered into a support agreement with holders of Existing Senior Notes owning approximately 98.7% of the aggregate outstanding principal amount of Existing Senior Notes. Pursuant to the support agreement, the holders party thereto, have agreed to validly tender all of their Existing Senior Notes in the Exchange Offer and provide consents to the proposed amendments to the indenture governing the Existing Senior Notes. The Exchange Offer expires at 5:00 p.m., New York City time, on May 22, 2017.

For every $1,000 principal amount of Existing Senior Notes tendered and not withdrawn prior to 5:00 p.m., New York City time on May 5, 2017, we will issue $1,000 principal of New Notes and Warrants to purchase 15.366 of the Company common units. For every $1,000 principal amount of Existing Senior Notes tendered after 5:00 p.m., New York City time, on May 5, 2017, up to 5:00 p.m., New York City time, on May 22, 2017, we will issue $970 principal of New Notes and Warrants to purchase 15.366 of Aurora Diagnostics Holdings, LLC common units. The Warrants will initially represent 12.5% of the outstanding common units of Aurora Diagnostics Holdings, LLC on a fully diluted basis prior to the issuance of the Warrants, assuming 100% participation in the Exchange Offer, and will expire on the tenth anniversary of their issuance date.

As of 5:00 p.m., New York City time, on May 5, 2017, $198.0 million aggregate principal amount of Existing Senior Notes, representing 99.0% of the outstanding Existing Senior Notes, had been validly tendered and not withdrawn. At that time, withdrawal rights expired and holders who tendered Existing Senior Notes prior to such time, including holders party to the support agreement, may no longer withdraw their tenders or revoke their consents. Accordingly, on May 5, 2017, Aurora Diagnostics Holdings, LLC, the co-issuer and the guarantors of the Existing Senior Notes and the trustee entered into a supplemental indenture containing the proposed amendments to the indenture governing the Existing Senior Notes, which became effective immediately, but will not become operative until the consummation of the Exchange Offer.

We intend to close the Exchange Offer no later than May 30, 2017, and exchange all tendered Existing Senior Notes for the New Notes and Warrants thereby avoiding the accelerated maturity of the credit facility.

As of March 31, 2017, the amounts due under our senior secured credit facility have been classified as long-term debt.  Furthermore, $200.0 million of our Existing Senior Notes maturing January 15, 2018, are expected to be exchanged or otherwise refinanced on a long-term basis and have been classified as long-term debt.

In light of the preceding plan to exchange our Existing Senior Notes, our management believes our current cash and cash equivalents, cash from operations and the amount available under our revolving credit facility will be sufficient to fund working capital requirements for the next 12 months. This belief assumes, among other things, that we will be able to close the Exchange Offer and therefore avoid acceleration of the maturity date of the senior secured credit facility, will continue to be successful in implementing our business strategy and that there will be no material adverse developments in our business, liquidity or capital requirements.. There is no assurance that we will be able to achieve our forecasted cash from operations. If one or more of these factors do not occur as expected, it could cause a default under one or more of the agreements governing our indebtedness. If our cash from operations and refinancing sources are insufficient to service our debt or to fund our other liquidity needs, we may be forced to reduce or delay our business activities, sell material assets, seek additional capital or be forced into insolvency or liquidation.

In addition, in order to access the funds available under our revolving credit facility, we must meet the financial tests and ratios contained in our senior secured credit facility. If we fail to meet these financial tests and ratios, our ability to access the amounts otherwise available under our revolving credit facility could be limited.

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Net Cash Used In Operating Activities

Net cash used in operating activities during the three months ended March 31, 2017 was $4.1 million, compared to $6.9 million during three nine months ended March 31, 2016. Net cash used in operating activities for the three months ended March 31, 2017 reflected a net loss of $16.2 million, $0.3 million for contingent note payments and certain adjustments for non-cash items, including $5.0 million of depreciation and amortization, $0.8 million of amortization of original issue discount and debt issue costs, $0.4 million of deferred tax benefit, $0.6 million of non-cash charges for the change in fair value of contingent consideration and $9.5 million of non-cash charges for the write-down of goodwill and other intangible assets at one of our reporting units. Net cash used in operating activities for the three months ended March 31, 2017 also reflected increases and decreases in working capital, excluding acquisitions, including a $0.5 million decrease in accounts receivable, a $0.8 million increase in prepaid expenses and other current assets, a $2.0 million increase in accounts payable, accrued expenses and other current liabilities, a $0.8 million increase in accrued compensation and a $5.6 million decrease in accrued interest. As of March 31, 2017 our DSO (Days Sales Outstanding) was 47 days, compared to 46 days of March 31, 2016, and 47 days as of December 31, 2016.  

Net Cash Used In Investing Activities

Net cash used in investing activities during the three months ended March 31, 2017 was $12.1 million compared to $7.9 million during the three months ended March 31, 2016. Net cash used in investing activities during the three months ended March 31, 2017 primarily consisted of $11.2 million net cash paid for business acquisitions, $0.8 million for purchases of property and equipment and $0.1 million of payments of deposits and other non-current assets.

Net Cash Provided By Financing Activities

Net cash provided by financing activities for the three months ended March 31, 2017 was $15.1 million compared to $9.1 million for the three months ended March 31, 2016. For the three months ended March 31, 2017, we borrowed $16.0 million under our revolving credit facility and repaid $0.9 million under the initial term loan.

Adjusted Earnings Before Interest, Taxes, Depreciation and Amortization (Adjusted EBITDA)

We define EBITDA as earnings before interest, taxes, depreciation and amortization, and Adjusted EBITDA as EBITDA further adjusted for impairment of goodwill, management fees, equity-based compensation, changes in fair value of contingent consideration, abandoned facility costs, merger and acquisition transaction costs, cost savings for reductions in force, implementation of a laboratory systems upgrade, pro forma acquired EBITDA, and certain other charges. We believe that disclosing EBITDA and Adjusted EBITDA provides additional information to investors, enhancing their understanding of our financial performance and providing them an important financial metric used to evaluate performance in the health care industry.

EBITDA and Adjusted EBITDA do not represent net income or cash flow from operating activities as those terms are defined by generally accepted accounting principles in the United States (“GAAP”) and do not necessarily indicate whether cash flows will be sufficient to fund cash needs. Further, they may not be comparable to the measures for any subsequent four-quarter period or any complete fiscal year.

EBITDA and Adjusted EBITDA are not determined in accordance with GAAP and should not be considered in isolation or as substitutes for measures of our financial performance as determined in accordance with GAAP, such as net income and operating income. Because other companies may calculate EBITDA and Adjusted EBITDA differently than we do, EBITDA and Adjusted EBITDA may not be comparable to similarly titled measures reported by other companies. EBITDA and Adjusted EBITDA have other limitations as analytical tools when compared to the use of net income, which we believe is the most directly comparable GAAP financial measure, including:

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The following is a reconciliation of net loss to Adjusted EBITDA (in thousands):

 

 

Off-Balance Sheet Arrangements

The Company does not have any off-balance sheet arrangements.

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Contractual Obligations

During the three months ended March 31, 2017, there were no material changes in our commitments or contractual liabilities outside of the ordinary course of business.

Health Care Regulatory and Reimbursement Changes

On April 16, 2015, President Obama signed the Medicare and CHIP Reauthorization Act (“MACRA”). MACRA repealed the provisions related to the Medicare SGR formula and implemented a new physician payment system that is designed to reward the quality of care. Payments will be adjusted beginning in 2019 to account for performance on certain quality metrics under the Merit-Based Incentive Payment Systems (“MIPS”) or to reflect physician participation in alternative payment models (“APMs”). For 2026 and subsequent years, qualified APM participants receive an annual 0.75% increase on Medicare physician payment rates, while those not participating receive a 0.25% annual payment increase, plus any applicable MIPS-based payment adjustments. In April 2016 CMS issued a proposed rule that would implement the requirements of MACRA, but as of yet it has not been implemented. At this time, we cannot determine how these changes may impact our business.

On November 2, 2016, the Centers for Medicare & Medicaid Services (“CMS”) issued its 2017 Physician Fee Schedule, which we refer to as the 2017 Fee Schedule.  In the 2017 Fee Schedule, CMS effectuated reductions to CPT Code 88305, which is the CPT Code we bill most frequently, of approximately 7%. Reimbursement rates for flow cytometry codes were also reduced by approximately 19%. Based on our current Medicare business mix, we estimate the changes to the 2017 Fee Schedule would result in a reduction of our annualized Medicare revenue of approximately $2.9 million. However, our product mix, payor mix and volume may change and the actual impact of the changes to the 2017 Physician Fee Rule may vary significantly from our estimates. This does not reflect any potential change that Congress might make in the future with regard to the conversion factor.

Congress and President Trump have proposed a number of legislative initiatives, including possible repeal and replacement of the ACA, although to date such measures have not been passed.

We have experienced isolated reductions in reimbursement from non-governmental third-party payors tied to the Medicare reductions. However, at this time we are unable to predict the extent to which non-governmental third-party payors will seek to reduce our reimbursement rates as a result of reductions in Medicare’s Physician Fee Schedule.

Recent Acquisitions

The following summarizes the acquisitions we have completed since January 1, 2016.

2016 Acquisitions

On March 31, 2016, we acquired 100% of the equity of a hospital-based pathology practice located in Oregon. On April 8, 2016, we acquired 100% of the equity of a second hospital-based pathology practice in Florida. In connection with these 2016 acquisitions, we paid total net cash of $7.2 million and issued contingent notes payable over three years. Payments under the contingent notes will be paid annually, up to a maximum of $1.5 million over the term of the note, subject to the future financial performance of the acquired practice and the retention of a key facility contract. We used the available cash under its $40.0 million delayed draw term loan B to pay the $7.2 million cash portion of the purchase price for the acquisition.

2017 Acquisition

On March 31, 2017, we acquired 100% of the equity of a hospital-based pathology practice located in Rhode Island and Massachusetts, (the “2017 Acquisition”). In connection with the 2017 Acquisition, we paid total net cash of $11.2 million and issued contingent notes payable over three years. Payments under the contingent notes will be paid annually, up to a maximum of $2.0 million over the term of the notes, subject to the future financial performance of the acquired practice and the retention of key facility contracts. We used the available cash under our $30.0 million revolving credit facility to pay the cash portion of the purchase price for the acquisition. As of March 31, 2017, the Company is still analyzing the acquisition and the allocation of the purchase price to the net assets acquired is preliminary and is expected to be finalized by December 31, 2017.

Additionally, on April 17, 2017, the Company acquired 100% of the equity of a hospital-based pathology practice located in New Jersey.  The Company paid cash of $4.5 million at closing primarily with funds borrowed under its revolving credit facility and issued contingent notes payable annually over three years, up to a total of $0.5 million. The Company has not completed its initial purchase price allocation for this acquisition.

 

 

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Our exposure to market risks results primarily from fluctuations in interest rates. There have been no material changes to our exposure to market risks from those disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016.

 

 

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) that are designed to ensure that the information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its principal executive and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. As of the end of the period covered by this report, the Company’s management carried out an evaluation, under the supervision and with the participation of its principal executive officer and principal financial officer, of the effectiveness of the Company’s disclosure controls and procedures. Based upon that evaluation, the Company’s principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures, as defined by Rule 13a-15(e) and Rule 15d-15(e) under the Exchange Act, were effective as of March 31, 2017.

Changes in Internal Control Over Financial Reporting

There have been no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) under the Securities Exchange Act) during the fiscal quarter ended March 31, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Inherent Limitations on Effectiveness of Controls

Our disclosure controls and procedures include components of our internal control over financial reporting. Our management, including our principal executive officer and principal financial officer, does not expect that our disclosure controls and procedures or our internal control over financial reporting will necessarily prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that we will detect all control issues and instances of fraud, if any exist.

 

 

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PART II

 

We are from time to time involved in litigation that we consider to be ordinary and incidental to our business. We may be named in various claims, disputes, legal actions and other proceedings involving malpractice, employment and other matters. A negative outcome in certain of the ongoing litigation could harm our business, financial condition, liquidity or results of operations. Further, prolonged litigation, regardless of which party prevails, could be costly, divert management’s attention or result in increased costs of doing business. While the outcome of pending legal actions cannot be predicted with certainty, we believe the outcome of these proceedings will not have a material adverse effect on our consolidated financial position, results of operations or liquidity.

 

 

In addition to the other information set forth in this report, you should carefully consider the factors discussed in the “Risk Factors” section of our Annual Report on Form 10-K for the fiscal year ended December 31, 2016, which could materially affect our business, financial condition, or results of operations. The risks described in our Annual Report on Form 10-K filed with the Securities and Exchange Commission for the fiscal year ended December 31, 2016 are not the only risks that we face. In addition, risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition, and/or results of operations. There have been no material changes in or additions to the risk factors included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016.

 

 

 

 

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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.

 

 

 

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