ITEM 1B.
UNRESOLVED STAFF COMMENTS
None.
Our corporate campus is located on approximately 16.5 acres in Mobile, Alabama and includes approximately 135,500 square feet of office space. Our main campus headquarters building consists of approximately 66,000 square feet of office and warehouse space. We also have eleven additional smaller campus buildings consisting of approximately 6,000 square feet of office space each and an additional campus building consisting of approximately 3,500 square feet. The Company also owns 11.3 acres of undeveloped real property adjacent to our corporate campus.
We lease the remainder of our facilities in various locations in the United States, including: Fairhope, Alabama; Frackville, Pennsylvania; Lanett, Alabama; Mobile, Alabama; and Monroe, Louisiana. In connection with our acquisition of Healthland Holding Inc. in January 2016, we assumed facility leases in: Denver, Colorado; Franklin, Tennessee; Glenwood, Minnesota; Marshall, Minnesota; Minneapolis, Minnesota; and Ridgeland, Mississippi.
We do not anticipate the need to lease additional office space in 2017, as we expect that our existing facilities will be sufficient to meet our needs until the end of 2017 and beyond.
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS
From time to time, we are involved in routine litigation that arises in the ordinary course of business. We are not currently involved in any claims outside the ordinary course of business that are material to our financial condition or results of operations.
ITEM 4.
ITEM 4.
MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market for CPSI Common Stock
As of March 14, 2017, CPSI had 121 stockholders of record (which does not include the number of beneficial owners whose shares are held in "street" names by broker-dealers and other nominees who are the record holders) and 13,533,183 shares of common stock outstanding.
CPSI’s common stock is listed on the NASDAQ Global Select Market under the symbol "CPSI." The following table sets forth, for the calendar quarters indicated, the high and low sales prices per share for CPSI’s common stock on the NASDAQ Global Select Market, and the cash dividends declared per share in each such quarter:
The last reported sales price of CPSI’s common stock as reported on the NASDAQ Global Select Market on March 14, 2017 was $26.10.
Dividends
On August 4, 2016, the Company announced that our Board of Directors adopted a variable dividend policy for the payment of quarterly dividends. The policy provides for dividends on a trailing quarterly basis in an amount based on a pre-established financial formula. During 2016, we paid quarterly dividends in the amount of $0.64. $0.64, $0.34, and $0.24, respectively, per share, compared to $0.64 per share for each quarter during 2015. We believe that paying dividends is an effective way of providing an investment return to our stockholders and a beneficial use of our cash. However, the declaration of dividends by CPSI is subject to the discretion of our Board of Directors. Our Board of Directors will take into account such matters as general business conditions, capital needs, our financial results, available liquidity and such other factors as our Board of Directors may deem relevant. Additionally, the terms of our Credit Agreement restrict our ability to pay dividends. See Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, “Liquidity and Capital Resources-Credit Agreement” included herein.
ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion of our financial condition and results of operations in conjunction with the "Selected Financial Data" and our financial statements and the related notes included elsewhere in this Annual Report. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including but not limited to those set forth under "Risk Factors" and elsewhere in this Annual Report.
Background
CPSI, founded in 1979, is a leading provider of healthcare information technology ("IT") solutions and services for rural and community hospitals and post-acute care facilities. With our January 2016 acquisition of Healthland Holding Inc. ("HHI"), CPSI is now the parent of five companies - Evident, LLC ("Evident"), TruBridge, LLC ("TruBridge"), Healthland Inc. ("Healthland"), American HealthTech, Inc. ("AHT"), and Rycan Technologies, Inc. ("Rycan"). Our combined companies are focused on helping improve the health of the communities we serve, connecting communities for a better patient care experience, and improving the financial operations of our customers. The individual contributions of each of our five wholly-owned subsidiaries towards this combined focus are as follows:
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Evident, formed in April 2015, provides comprehensive electronic health record ("EHR") solutions and services for rural and community hospitals, including those solutions previously sold under the CPSI name as well as an expanded range of offerings targeted specifically at rural and community healthcare organizations.
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TruBridge focuses exclusively on providing business management, consulting and managed IT services to rural and community healthcare organizations, regardless of their IT vendor.
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Healthland, acquired in the acquisition of HHI, provides integrated technology solutions and services to small rural, community, and critical access hospitals.
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AHT, acquired in the acquisition of HHI, is one of the nation's largest providers of financial and clinical technology solutions and services for post-acute care facilities.
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Rycan, acquired in the acquisition of HHI, provides revenue cycle management workflow and automation software to rural and community hospitals, healthcare systems, and skilled nursing organizations.
The combined company currently supports approximately 1,300 acute care facilities and over 3,300 post-acute care facilities with a geographically diverse customer mix within the domestic rural and community healthcare market. Our customers primarily consist of rural and community hospitals with 300 or fewer acute care beds, with hospitals having 100 or fewer beds comprising approximately 95% of our hospital EHR customer base.
As discussed in this Item under “Results of Operations by Segment” below, we now manage our operations using three operating segments, which are also our reportable segments: (1) acute care EHR, (2) post-acute care EHR and (3) TruBridge, Rycan, and other outsourcing.
Acute Care EHR
Our Acute Care EHR segment consists of acute care software solutions and support sales generated by Evident and Healthland.
Post-acute Care EHR
Our Post-acute Care EHR segment consists of post-acute care software solutions and support sales generated by AHT.
TruBridge, Rycan, and Other Outsourcing
Our TruBridge, Rycan, and Other Outsourcing segment primarily consists of business management, consulting and managed IT services sales generated by TruBridge and the sale of Rycan's revenue cycle management workflow and automation software.
Management Overview
Historically we have primarily sought revenue growth through sales of healthcare IT systems and related services to existing and new customers within our target market, a strategy that has resulted in a ten-year compounded annual growth rate in legacy revenues (i.e., revenues related to our legacy Evident and TruBridge operations) of approximately 4.5%. Important to our potential for continued long-term revenue growth is our ability to sell new and additional products and services to our existing customer base, including cross-selling opportunities presented with the acquisition of HHI. We believe that as our combined customer base grows, the demand for additional products and services, including business management, consulting and managed IT services, will also continue to grow, supporting further increases in recurring revenues. We also expect to drive revenue growth from new product development that we may generate from our product development activities.
In April 2015, we announced the formation of Evident, a wholly-owned subsidiary of CPSI. Evident provides EHR solutions previously sold under the CPSI name as well as an expanded range of offerings targeted specifically at rural and community healthcare organizations. Our objectives with the creation of Evident are to further define system and support differentiation in our core target market, broaden the positioning of our EHR solution and offer a new range of solutions to address current and upcoming needs of rural and community healthcare providers. With the formation of Evident came the introduction of our EHR solution under the name Thrive and our unique collaborative support model under the name LikeMind.
January 2016 marked an important milestone for CPSI, as we announced the completion of our acquisition of HHI, the first major acquisition in the Company's history. With this acquisition, CPSI now has a presence in well over 1,000 rural and community hospitals and over 3,300 post-acute care facilities, adding significantly to our already substantial recurring revenue base and further expanding our ability to generate organic recurring revenue growth through additional cross-selling opportunities now available within the combined company. While the acquisition of HHI has negatively affected our net income for 2016 as a result of related transaction costs and amortization expense, we believe that the addition of HHI and its clients and products will enhance our ability to grow our business and compete in the markets that we serve.
Our business model is designed such that, as revenue growth materializes, earnings and profitability growth are naturally bolstered through increased future margin realization. Once a hospital has installed our solutions, we continue to provide support services to the customer on an ongoing basis and make available to the customer our broad portfolio of business management, consulting, and managed IT services. The provision of these services typically requires fewer resources than the initial system installation, resulting in increased overall gross margins.
We also look to increase margins through cost containment measures where appropriate. For example, during 2015 we allowed natural workforce attrition to run its course within our system implementation employee base, selectively attempting to retain or replace only those positions considered by management to be critical to our continuing needs. Additionally, during the third quarter of 2015 we instituted a one-time, voluntary severance program offering those employees meeting certain predetermined criteria severance packages involving continuing periodic cash payments and healthcare benefits for varying periods, depending upon the individual's years of service with the Company. Lastly, we have instituted several changes related to our employee benefits offerings, including a spousal carve-out for healthcare benefits that took effect on January 1, 2016. The acquisition of HHI in January of 2016 presents us with additional opportunities to leverage the greater operating efficiencies of the combined entity in order to drive further earnings and profitability growth in the future.
Turbulence in the U.S. and worldwide economies and financial markets impacts almost all industries. While the healthcare industry is not immune to economic cycles, we believe it is more significantly affected by U.S. regulatory and national health projects than by the economic cycles of our economy. Additionally, healthcare organizations with a large dependency on Medicare and Medicaid populations, such as rural and community hospitals, have been affected by the challenging financial condition of the federal government and many state governments and government programs. Accordingly, we recognize that prospective hospital customers often do not have the necessary capital to make investments in information technology. Additionally, in response to these challenges, hospitals have become more selective regarding where they invest capital, resulting in a focus on strategic spending that generates a return on their investment. Despite these challenges, we believe healthcare information technology is often viewed as more strategically beneficial to hospitals than other possible purchases because the technology offers the possibility of a quick return on investment. Information technology also plays an important role in healthcare by improving safety and efficiency and reducing costs. Additionally, we believe most hospitals recognize that they must invest in healthcare information technology to meet current and future regulatory, compliance and government reimbursement requirements.
In recent years, there have been significant changes to provider reimbursement by the U.S. federal government, followed by commercial payers and state governments. There is increasing pressure on healthcare organizations to reduce costs and increase quality, replacing fee-for-service in part by enrolling in an advanced payment model, which could further encourage
adoption of healthcare IT and increase demand for business management, consulting, and managed IT services as the future success of these healthcare providers is greatly dependent upon their ability to engage patient populations and to coordinate patient care across a multitude of settings, while optimizing operating efficiency along the way.
American Recovery and Reinvestment Act of 2009
While ongoing financial challenges facing healthcare organizations have affected and are expected to continue to affect the rural and community hospitals that comprise our target market, we believe that the incentives offered by the American Recovery and Reinvestment Act of 2009 (the "ARRA") for the adoption of qualifying EHRs have increased and will continue to support demand for healthcare information technology and will have a positive impact on our business prospects through at least 2017. As of December 31, 2016, incentive payments totaling $35.7 billion have been made to aid healthcare organizations in modernizing their operations through the acquisition and wide-spread use of healthcare information technology. Eligible hospitals could begin receiving these incentive payments in any year from 2011 through 2016, but the total incentive payment is decreased for hospitals that started receiving payments in 2014 and later. Additionally, reimbursements under Medicare have been reduced for those eligible healthcare providers that did not begin to demonstrate meaningful use of an EHR by October 1, 2014.
The accelerated adoption of EHRs resulting from the ARRA's EHR incentive program has resulted in a narrowing market for new system installations and has accelerated the purchases of incremental applications by our existing customer base to satisfy the current meaningful use rules, thereby also narrowing the market for add-on sales to existing customers for meaningful use stage two-related incremental applications. Despite these narrowing markets, we expect to continue to benefit from the ARRA's EHR incentive program in the medium-to-long term as the expanded requirements for continued eligibility for incentive payments and related payment adjustments for those healthcare providers not in compliance with meaningful use rules are expected to result in both an expanded replacement market for EHRs and additional orders from our existing customer base to purchase incremental applications necessary to satisfy such expanded requirements, particularly as the stage three meaningful use rules become effective. The stage three requirements will be optional for 2017, with all providers required to comply with the stage three requirements beginning in 2018. However, as the EHR replacement market is not likely to develop rapidly and the market for add-on sales to existing customers for incremental stage three-related applications is not likely to significantly expand until the related stage three rules become effective, our system sales revenues and profitability may be materially and adversely affected during the short-term. Although we are pursuing other strategic initiatives designed to result in system sales revenue growth in the future in the form of selective expansion into English-speaking international markets, selective expansion within the 100 to 300 bed hospital market and targeted expansion for our ambulatory solutions, there can be no guarantee that such initiatives will prove successful or will benefit the Company in a sufficiently timely fashion to offset the short-term effects of the aforementioned narrowing markets.
Health Care Reform
In March 2010, President Obama signed into law the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010, collectively referred to herein as the "Health Reform Laws." This sweeping legislation implemented changes to the healthcare and health insurance industries from 2010 through 2015, requiring substantially all U.S. citizens and legal residents to have qualifying health insurance coverage starting in 2014 and providing the means by which it will be made available to them. The Health Reform Laws have had little direct impact on our internal operation and do not appear to have had a significant impact on the businesses of our hospital customers to date. However, we have not been able to determine at this point whether the ultimate impact will be positive, negative or neutral; it is likely that the Health Reform Laws will affect hospitals differently depending upon the populations they service. Rural and community hospitals typically service higher uninsured populations than larger urban hospitals and rely more heavily on Medicare and Medicaid for reimbursement. It remains to be seen whether the increase in the insured populations for rural and community hospitals, as well as the increase in Medicare and Medicaid reimbursements under the ARRA for hospitals that implement EHR technology, will be enough to offset cuts in Medicare and Medicaid reimbursements contained in the Health Reform Laws or as a result of sequestration or other federal legislation.
We believe healthcare reform initiatives will continue during the foreseeable future. If adopted, some aspects of previously proposed reforms, such as further reductions in Medicare and Medicaid payments, could adversely affect the businesses of our customers and thereby harm our business.
2016 Financial Overview
We generated revenues of $267.3 million from the sale of our products and services during 2016, compared to $182.2 million during 2015, an increase of 46.7% that is primarily attributed to contributions from the acquisition of HHI. Our net income decreased 78.5% from 2015, primarily due to the HHI-related transaction costs and amortization expense in the
combined amount of $18.4 million, while cash flow from operations decreased 93.3%, due to the aforementioned transaction costs and acquisition-related investments in working capital.
Second Generation Meaningful Use Installment Plans. Beginning in the fourth quarter of 2012, we began offering to our customers license agreements with payment terms that provide us with greater visibility into and control over the customer's meaningful use attestation process and significantly reduce the maximum timeframe over which customers must satisfy their full payment obligations in purchasing our system ("Second Generation Meaningful Use Installment Plans"). Under these arrangements, for the first two years following execution of the contract, a customer is only required to remit to us Medicare and Medicaid incentive payments (not to exceed the remaining balance under the arrangement) received for adoption of a qualifying EHR upon receipt of such funds. Upon the expiration of this two-year period, the remaining balance (if any) is required to be paid in full over a period not to exceed 12 months. As the overall payment period durations of the Second Generation Meaningful Use Installment Plans are consistent with that of our historical system sale financing arrangements, revenues under the Second Generation Meaningful Use Installment Plans are recognized upon installation of our EHR solution.
In addition to the Second Generation Meaningful Use Installment Plans discussed above, we have historically made financing arrangements available to customers on a case-by-case basis depending upon the various aspects of the proposed contract and customer attributes. These financing arrangements include other short-term payment plans and longer-term lease financing through us or third-party financing companies. For those customers not seeking a financing arrangement, the payment schedule of the typical contract is structured to provide for a scheduling deposit due at contract signing, with the remainder of the contracted fees due at various stages of the installation process (delivery of hardware, installation of software and commencement of training, and satisfactory completion of a monthly accounting cycle or end-of-month operation by and as applicable for each respective application).
We have also historically made our software applications available to customers through "Software as a Service" or "SaaS" configurations, including our Cloud Electronic Health Record ("Cloud EHR") offering. These offerings are attractive to some customers because this configuration allows them to obtain access to advanced software products without a significant initial capital outlay. Although the broader enterprise software marketplace has been experiencing an increasing trend of SaaS arrangements in the past few years, this trend has been slower to develop within our market for new system installations and add-on sales to existing customers. However, we experienced a substantial increase in the prevalence of such arrangements within our system sales arrangements in 2015, a trend we expect to continue for the foreseeable future. Unlike our historical perpetual license arrangements under which the related revenue is recognized effectively upon installation, the SaaS arrangements result in revenue being recognized monthly as the services are provided over the term of the arrangement. As a result, the effect of this trend on the Company's financial statements is reduced system sales revenues during the period of installation in exchange for increased recurring periodic revenues (reflected in system sales and support revenues) over the term of the SaaS arrangement.
Revenues
The Company allocates revenue to its multiple element arrangements, including software and software-related services, based on a hierarchy of evidence to support selling prices in accordance with U.S. GAAP. Revenue from general support agreements for post-contract support services (support and maintenance) and business management, information technology management and consulting services are recognized by the Company ratably over the term of the agreement.
System sales and support. Revenues from system sales and support are derived from the sale of information systems and the provision of related support services, including perpetual software licenses, conversion, installation and training services, hardware and peripherals, SaaS services, forms and supplies, software application support, hardware maintenance, and continuing education. We do not recognize revenue upon the execution of a sales contract. Revenue from the sale of the perpetual software license, conversion, and installation and training services is recognized on a module-by-module basis after the installation and training have been completed and the system is functioning as designed for each individual module. Revenue from the sale of hardware is recognized upon shipment of the hardware to the customer. Support services are provided pursuant to a support agreement under which we provide comprehensive system support and related services in exchange for a monthly fee based on the services provided. The initial term of these contracts typically ranges from three to five years, after which these contracts renew automatically on a year-to-year basis thereafter until terminated. Revenues from support services are recognized in the month when these services are performed. Our SaaS services, which include our Cloud EHR service, are provided on a remote basis by storing and maintaining servers at our headquarters or other third-party facilities that contain customers’ patient and administrative data. Revenues from our SaaS services are recognized in the month when these services are performed.
Business Management, Consulting and Managed IT Services. Our business management services include electronic billing, insurance services, statement processing, accounts receivable management, payroll processing, and contract management. Most of these business management services are sold pursuant to one-year customer agreements, with automatic one-year renewals until terminated. Additional services include hosting, backup recovery, medical coding, IT and business improvement consulting and other consulting and managed IT services if needed. Revenues from business management, consulting and managed IT services are recognized when these services are performed.
Reference is made to Note 2 to the consolidated financial statements included herein for additional discussion of our revenue recognition policies.
Costs of Sales
System Sales and Support. The principal costs associated with the design, development, sale and installation of our systems are employee salaries, benefits, travel expenses, third-party software costs and certain other overhead expenses. These costs are expensed as incurred. For the sale of equipment, we incur costs to acquire these products from the respective distributors or manufacturers. The costs related to the acquisition of equipment are capitalized into inventory and expensed upon the sale of the equipment utilizing the average cost method. The principal costs associated with our system support and maintenance services are employee salaries, benefits, procurement costs related to forms and supplies, and certain other overhead expenses. These costs are expensed as incurred.
Business Management, Consulting and Managed IT Services. The principal cost related to our statement processing services is third party processing costs. The principal costs related to our other business management, consulting and managed IT services are employee-related expenses, such as salaries and benefits, and telecommunication fees.
Results of Operations
The following table sets forth certain items included in our results of operations for each of the three years in the period ended December 31, 2016, expressed as a percentage of our total sales for these periods:
2016 Compared to 2015
Revenues. Total revenues for 2016 increased 46.7%, or $85.1 million, compared to 2015. This was largely attributable to $86.6 million of revenue contributions from the acquisition of HHI.
System sales and support revenues increased by 67.2%, or $79.5 million. System sales and support revenues were comprised of the following for the years ended December 31, 2016 and December 31, 2015, with increases in both system sales and support mostly attributable to $43.2 million and $42.2 million, respectively, of revenue contributions from the acquisition of HHI.
The combined $85.4 million of revenue contributions from the acquisition of HHI were partially offset by a $5.9 million decrease in revenues from CPSI-legacy operations, as add-on sales to existing customers for the Company's Emergency Department and Thrive Provider EHR solutions experienced a decline due to lower installation volumes during 2016. Related to the market for new system installations, CPSI-legacy operations completed financial and patient accounting system installations at 21 new hospital clients in 2016 (five of which were under Cloud EHR or other SaaS arrangements) compared to 16 during 2015 (eight of which were under Cloud EHR or other SaaS arrangements). Despite the increase in non-Cloud EHR new system installation activity, the related revenues remained relatively unchanged as the average installation value has decreased from 2015.
Business management, consulting and managed IT services revenues increased by 8.8%, or $5.6 million. Our hospital clients operate in an environment typified by rising costs and increased complexity and are increasingly seeking to alleviate themselves of the ever increasing administrative burden of operating their own business office functions, resulting in an expanded customer base for our private pay services (increasing 5.9%, or $0.8 million) and accounts receivable management services (increasing 11.9%, or $2.5 million). Additionally, the added complexity of the medical coding environment facing healthcare providers since ICD-10 became effective on October 1, 2015 has resulted in a substantial increase in demand for our medical coding services, resulting in an increase in these revenues of 79.4%, or $1.7 million. Lastly, the acquisition of HHI contributed $1.2 million of incremental revenues for 2016. These increases were partially offset by a decrease of 59.0%, or $0.5 million, in health information management consulting reflecting the 2015 ICD-10 compliance deadline mentioned above.
Costs of Sales. Total costs of sales increased by 47.3%, or $41.5 million. This increase was mostly attributable to $42.4 million of cost of sales contributions from the acquisition of HHI. As a percentage of total revenues, costs of sales increased to 48.4% from 48.1%.
Costs of system sales and support increased by 70.5%, or $37.0 million due mostly to $41.0 million of costs of sales contributions from the acquisition of HHI, partially offset by a 7.6%, or $4.0 million, decrease in costs related to CPSI-legacy operations, mostly the result of decreased payroll and related costs due to managed attrition in the trailing twelve months and decreased travel costs associated with the aforementioned decrease in add-on sales for CPSI-legacy operations. The gross margin on system sales and support decreased to 54.7% from 55.7%, primarily due to the margin profile associated with the HHI system sales and support revenues. The gross margin on system sales and support generated by HHI operations was 51.1% in 2016. Comparatively, the gross margin on system sales and support generated by CPSI-legacy operations was 56.9% during 2016, increasing slightly from 55.7% in 2015. The difference between the system sales and support gross margins of HHI operations and CPSI-legacy operations is the byproduct of a decreased support customer base for HHI compared to CPSI-legacy, resulting in a sales mix for HHI that is more heavily weighted towards the more cost-intensive system sales revenues.
Our costs associated with business management, consulting and managed IT services increased 12.8%, or $4.5 million, with the largest contributing factor being an increase in payroll costs of 23.6%, or $4.9 million, as a result of adding more employees during the trailing twelve months in order to support and develop our growing customer base and increase capacity in advance of anticipated future increases in demand. The increase in payroll costs was partially offset by a decrease of 61.5%, or $1.7 million, in temporary labor costs during 2016 due to intentional efforts to fulfill our incremental labor needs through direct hiring as opposed to contract or temporary labor. Lastly, the acquisition of HHI contributed $0.6 million in costs during 2016. The gross margin on these services decreased to 42.8% in 2016, from 44.8% in 2015. This margin compression is primarily due to headcount growth related to our accounts receivable management services outpacing the related revenue
growth, as recent bookings have not fully converted into revenues as of December 31, 2016, but nevertheless require immediate investment in capacity.
Product Development Costs. Product development expense consists primarily of compensation and other employee-related costs (including stock-based compensation) and infrastructure costs incurred, but not capitalized, for new product development and product enhancements. Product development costs increased 129.3%, or $18.4 million, with nearly all of this increase related to contributions from the acquisition of HHI.
Sales and Marketing Expenses. Sales and marketing expenses increased 48.5%, or $8.9 million, with the largest contributing factor being $7.1 million of contributions from the acquisition of HHI. Additionally, payroll and related costs and travel costs associated with our CPSI-legacy operations have increased a combined $1.8 million due to the expansion of our sales force.
General and Administrative Expenses. General and administrative expenses increased 45.6%, or $16.8 million, with the largest contributing factor being $8.2 million of transaction costs in 2016 associated with our acquisition of HHI compared to $3.0 million in 2015. Other contributing factors were $1.8 million increase in payroll expenses, a $3.5 million increase in employee health expenses, a $0.8 million increase in legal and accounting expenses, a $0.7 million increase in retirement plan benefits, a $1.7 million increase in rent expenses, a $1.2 million increase in utilities, and a $0.5 million increase due to an added user group conference, all related to the HHI acquisition. In addition, despite $1.9 million in bad debt recoveries related to HHI pre-acquisition receivables, bad debt increased $1.3 million in 2016 primarily due to increased accounts receivable from the inclusion of HHI and severe collectability determinations related to two customers filing bankruptcy.
Amortization of Acquisition-Related Intangibles. Amortization expense associated with acquisition-related intangible assets were new to the Company during 2016 as a result of the HHI acquisition, resulting in $10.2 million of expenses.
As a percentage of total revenues, total operating expenses increased to 46.3% in 2016, compared to 38.1% in 2015.
Total Other Income (Expense). Total other income (expense) decreased from income of $0.4 million during 2015 to expense of $6.4 million during 2016, as the debt obligations entered into to facilitate the acquisition of HHI have resulted in interest expense of $6.6 million during 2016, with no such expense during 2015, as the Company had no outstanding debt obligations during the 2015 period.
As a result of the foregoing factors, income before taxes decreased by 68.7%, or $17.5 million, from 2015.
Income Taxes. Our effective income tax rates for 2016 and 2015 were 50.8% and 28.0%, respectively. During 2015, we recorded beneficial adjustments related to our reserves for uncertain tax positions due to then-recent developments in the examination by the Internal Revenue Service of our federal returns for tax years 2004 through 2009, primarily in relation to research credits claimed on those returns. These beneficial adjustments reduced the effective tax rate for 2015 by 4.8%. Comparatively, during 2016, the identification of nondeductible facilitative transaction costs has resulted in combined additional income tax expense of $1.4 million, increasing the period’s effective tax rate by 17.7%.
Net Income. Net income for 2016 decreased by 78.5%, or $14.4 million, to a net income of $3.9 million, or $0.29 per basic and diluted share, compared with net income of $18.3 million, or $1.62 per basic and diluted share, for 2015. Net income represented 1.5% of revenue for 2016, compared to 10.1% of revenue for 2015.
Results of Operations by Segment. We operate in three reportable segments: (1) Acute Care EHR, (2) Post-acute Care EHR and (3) TruBridge, Rycan, and Other Outsourcing. See Note 18 for additional information on our segment reporting. The following table presents a summary of our operating segment information for the years ending December 31, 2016 and 2015, respectively:
Acute Care EHR
Acute Care EHR revenues increased by 35.9%, or $42.5 million, from 2015, due mostly to $48.4 million of revenue contributions from the acquisition of HHI, partially offset by a $5.9 million decrease in revenues from CPSI-legacy operations, as add-on sales to existing customers for the Company's Emergency Department and Thrive Provider EHR solutions experienced a decline due to lower installation volumes.
Acute Care EHR costs of sales increased by 43.3%, or $22.7 million, from 2015, due mostly to $26.7 million of costs of sales contributions from the acquisition of HHI, partially offset by a 7.6%, or $4.0 million, decrease in costs related to CPSI-legacy operations, mostly the result of decreased payroll and related costs due to managed attrition in the trailing twelve months and decreased travel costs associated with the aforementioned decrease in add-on sales for CPSI-legacy operations.
The gross margin on Acute Care EHR revenues decreased from 55.7% during 2015 to 53.2% during 2016, mostly due to the differing margin profiles between CPSI-legacy operations and those generated by HHI operations. CPSI-legacy gross margins from Acute Care EHR revenues increased slightly from 55.7% during 2015 to 56.9% during 2016, compared to gross margins from Acute Care EHR revenues generated by HHI operations of 44.7% during 2016. The significant difference between the Acute Care EHR gross margins of HHI operations and CPSI-legacy operations is the byproduct of a significantly decreased support customer base for HHI compared to CPSI-legacy, resulting in a sales mix that is now more heavily weighted towards the more cost-intensive system sales revenues.
Post-acute Care EHR
The Company's acquisition of HHI in January 2016 marked the Company's entrance into the Post-acute Care EHR marketplace and, as a result, there were no related revenues or costs of sales for 2015. Business remained relatively stable throughout 2016.
TruBridge, Rycan, and Other consulting
TruBridge, Rycan and Other Outsourcing revenues increased by 21.3%, or $13.6 million, as compared to 2015, due mostly to $9.2 million of revenue contributions from the acquisition of HHI. Revenues related to TruBridge-legacy operations increased 6.9%, or $4.4 million, as compared to 2015, primarily driven by the expanding customer base for our private pay services (increasing 5.9%, or $0.7 million, as compared to 2015) and accounts receivable management services (increasing 11.9%, or $2.5 million, as compared to 2015) as healthcare industry dynamics are resulting in a growing population of healthcare providers seeking to alleviate themselves of the administrative burden of operating their own business office functions. Additionally, the Company has generated a $1.7 million increase in revenues associated with medical coding services driven by the added coding complexities introduced by ICD-10, which became effective on October 1, 2015. These increases were partially offset by a decrease of 59.0%, or $0.5 million, in health information management consulting reflecting the 2015 ICD-10 compliance deadline mentioned above.
TruBridge, Rycan and Other Outsourcing costs of sales increased by 21.2%, or $7.5 million, as compared to 2015, as the acquisition of HHI has contributed additional costs of sales of $4.3 million and costs of sales related to TruBridge-legacy operations have increased 9.0%, or $3.2 million. The increased costs within TruBridge-legacy operations is primarily due to an increase in payroll costs of 23.6%, or $4.9 million, as a result of adding more employees during the trailing twelve months in order to support and develop our growing customer base and increase capacity in advance of anticipated future increases in demand. The increase in payroll costs was partially offset by a decrease of 61.5%, or $1.7 million, in temporary labor costs due to intentional efforts to fulfill our incremental labor needs through direct hiring as opposed to contract or temporary labor.
The gross margin on TruBridge, Rycan and Other Outsourcing revenues remained relatively flat, increasing slightly from 44.8% during 2015 to 44.9% during 2016.
2015 Compared to 2014
Revenues. Total revenues decreased 11.0%, or $22.6 million. This was largely attributed to a $30.3 million decrease in system sales and support revenues due to the narrowing markets for new system installations and add-on sales to existing customers for stage two-related incremental applications. The decrease in system sales and support revenues was partially offset by a $7.7 million increase in business management, consulting and managed IT services revenues due to increased demand for and market acceptance of our services coupled with selective expansion of our service offerings within these categories.
System sales and support revenues decreased by 20.4%, or $30.3 million, with system sales revenues decreasing by 39.9%, or $30.9 million. Due to the accelerated adoption of EHRs resulting from the ARRA's EHR incentive program, we experienced a significant decrease in new system installations during 2015, as we completed financial and patient accounting system installations at 16 new hospital clients during 2015 (eight of which were under Cloud EHR or other SaaS arrangements) compared to 24 during 2014 (two of which were under Cloud EHR or other SaaS arrangements). This decrease in the number of new system installations was partially offset by an increase in support revenues of 1.0%, or $0.7 million, due to an increase in recurring revenues as a result of a larger customer base and an increase in support rates from contractually agreed upon CPI rate increases.
Business management, consulting and managed IT services revenues increased by 13.7%, or $7.7 million. The increase is primarily due to an expanded customer base for our private pay services (increasing 4.9%, or $0.6 million), accounts receivable management services (increasing 28.2%, or $4.6 million), revenue cycle management consulting services and health information management consulting services (increasing a combined 43.0%, or $0.7 million), and cloud computing services (a component of managed IT services, increasing 19.3%, or $0.3 million). Lastly, the continued maturation of medical coding services (a component of consulting services) resulted in revenues of $2.1 million during 2015 compared to only $0.9 million in 2014.
Costs of Sales. Total costs of sales decreased by 3.4%, or $3.1 million. As a percentage of revenues, costs of sales increased from 44.3% to 48.1%.
Costs of system sales and support decreased by 11.2%, or $6.6 million. The decrease in costs of system sales and support was primarily due to a decrease in travel costs of 33.9%, or $3.0 million, as a result of the decrease in new system installations and add-on sales. Also as a result of the lower installation volume, software licenses, hardware, and installation equipment rentals decreased by $0.9 million. Payroll and related expenses decreased $2.7 million, as a result of natural workforce attrition. The gross margin on system sales and support decreased to 55.7% in 2015 from 60.3% in 2014, as the significant decline in system sales revenues coupled with a heavily fixed cost structure have resulted in significant margin deterioration.
Our costs associated with business management, consulting and managed IT services increased 11.0%, or $3.5 million, with the largest contributing factor being an increase in payroll, related payroll costs and temporary labor of $2.5 million in order to support and develop our growing customer base and increase capacity in advance of anticipated demand. Stock-based compensation expense increased by $0.2 million as a result of additional grants of restricted stock to our executive officers and certain key employees during the trailing twelve months. Lastly, third party statement processing costs increased $0.8 million, due to the expansion in our customer base for private pay services and accounts receivable management services. The gross margin on these services increased to 44.8% in 2015 from 43.5% in 2014.
Product Development Costs. Product development costs decreased 2.7%, or $0.4 million, from 2014 due to decreased payroll costs resulting from natural attrition.
Sales and Marketing Expenses. Sales and marketing expenses decreased 7.1%, or $1.4 million. This decrease is primarily attributable to a decrease in commission expense of 27.1%, or $2.0 million, due to decreased revenue from new system installations and add-on sales. The decrease in commission expense was partially offset by a $0.6 million increase in stock-based compensation expense as a result of additional grants of restricted stock to our executive officers and certain key employees during the trailing twelve months.
General and Administrative Expenses. General and administrative expenses increased 22.7%, or $6.8 million, with the largest contributing factors being $3.0 million of transaction costs incurred related to our acquisition of HHI, which was completed in January 2016, and $2.0 million of severance expense related to a one-time voluntary termination program instituted by the Company during the third quarter of 2015. Costs associated with healthcare benefits offered to our employees increased $2.0 million mostly due to increases in both the volume and severity of insurance claims made on behalf of participants in our self-insurance healthcare plan. Legal and accounting fees increased $0.7 million due to one-time, nonrecurring expenses and stock-based compensation expensed increased $0.4 million due to additional grants of restricted stock to our executive officers, certain key employees and non-employee directors during the trailing twelve months. These costs were partially offset by a $0.5 million decrease in costs related to our incentive bonus program for certain members of management as profitability growth deteriorated from 2014 to 2015. Additionally, increased earned-time-off utilization resulted in a $0.8 million decrease in payroll and related expenses, as we instituted changes in our earned-time-off policy during 2015 that lowered the maximum amount of earned-time-off an employee would be allowed to carry over from 2015 to 2016. This policy change provided our employees with an added incentive to fully utilize existing earned-time-off balances throughout 2015 in order to avoid forfeiture of earned-time-off at the conclusion of 2015.
Amortization of Acquisition-Related Intangibles. Amortization expense associated with acquisition-related intangible assets were new to the Company during 2016.
As a percentage of total revenues, total operating expenses increased to 38.1% in 2015, compared to 31.4% in 2014.
Total Other Income (Expense). Total other income (expense) increased from income of $0.2 million during 2014 to $0.4 million during 2015.
As a result of the foregoing factors, income before taxes decreased by 48.7%, or $24.2 million, from 2014.
Income Taxes. Our effective income tax rate for the years ended December 31, 2015 and 2014 was 28.0% and 33.8%, respectively. This decrease in effective income tax rate was primarily due to beneficial adjustments in the amount of $1.2 million recorded during 2015 related to our reserves for uncertain tax positions, benefiting our effective tax rate by 4.8%. The federal returns for tax years 2004 through 2009 were previously under examination by the IRS, primarily in relation to research credits claimed on those returns. The IRS completed these examinations during 2015, resulting in enhanced clarity regarding the sustainability of our uncertain tax positions for all years. The completion of these examinations prompted a beneficial change in our measurement of reserves for uncertain tax positions.
Net Income. Net income for 2015 decreased by 44.3%, or $14.6 million, to a net income of $18.3 million, or $1.62 per basic and diluted share, compared with net income of $32.9 million, or $2.94 per basic and diluted share, for 2014. Net income represented 10.1% of revenue for 2015, compared to 16.1% of revenue for 2014.
Results of Operations by Segment. We operate in three reportable segments: (1) Acute Care EHR, (2) Post-acute Care EHR and (3) TruBridge, Rycan, and Other Outsourcing. See Note 18 for additional information on our segment reporting. The following table presents a summary of our operating segment information for the years ended December, 2015 and 2014, respectively:
Acute Care EHR
Acute Care EHR revenues decreased by 20.4%, or $30.3 million, from 2014, due mostly to a decrease of $30.9 million in new installations partially offset by an increase in support revenue of $0.7 million. Due to the accelerated adoption of EHRs resulting from the ARRA's EHR incentive program, we experienced a significant decrease in new system installations during 2015, as we completed financial and patient accounting system installations at 16 new hospital clients during 2015 (eight of which were under Cloud EHR or other SaaS arrangements) compared to 24 during 2014 (two of which were under Cloud EHR or other SaaS arrangements). The increase in support recurring revenues were a result of a larger customer base and an increase in support rates from contractually agreed upon CPI rate increases.
Acute Care EHR costs of sales decreased by 11.1%, or $6.6 million. The decrease in costs was primarily due to a decrease in travel costs of 33.9%, or $3.0 million, as a result of the decrease in new system installations and add-on sales. Also as a result of the lower installation volume, software licenses, hardware, and installation equipment rentals decreased by $0.9 million. Payroll and related expenses decreased $2.7 million, as a result of natural workforce attrition.
The gross margin on Acute Care EHR revenues decreased from 60.3% during 2014 to 55.7% during 2015, as the significant decline in system sales revenues coupled with a heavily fixed cost structure have resulted in significant margin deterioration.
Post-acute Care EHR
The Company's acquisition of HHI in January 2016 marked the Company's entrance into the Post-acute Care EHR marketplace and, as a result, there were no related revenues or costs of sales for 2015 and 2014.
TruBridge, Rycan, and Other consulting
TruBridge, Rycan and Other Outsourcing revenues increased by 13.7%, or $7.7 million, as compared to 2014. The increase is primarily due to an expanded customer base for our private pay services (increasing 4.9%, or $0.6 million), accounts receivable management services (increasing 28.2%, or $4.6 million), revenue cycle management consulting services and health information management consulting services (increasing a combined 43.0%, or $0.7 million), and cloud computing services (a component of managed IT services, increasing 19.3%, or $0.3 million). Lastly, the continued maturation of medical coding services (a component of consulting services) resulted in revenues of $2.1 million during 2015 compared to only $0.9 million in 2014.
TruBridge, Rycan and Other Outsourcing costs of sales increased by 11.0%, or $3.5 million, with the largest contributing factor being an increase in payroll, related payroll costs and temporary labor of $2.5 million in order to support and develop our growing customer base and increase capacity in advance of anticipated demand. Stock-based compensation expense increased by $0.2 million as a result of additional grants of restricted stock to our executive officers and certain key employees during the trailing twelve months. Lastly, third party statement processing costs increased $0.8 million, due to the expansion in our customer base for private pay services and accounts receivable management services.
The gross margin on TruBridge, Rycan and Other Outsourcing revenues increased from 43.5% during 2014 to 44.8% during 2015,
Liquidity and Capital Resources
Sources of Liquidity
As of December 31, 2016, our principal sources of liquidity consisted of cash and cash equivalents of $2.2 million and our remaining borrowing capacity under the Revolving Credit Facility (as defined below) compared to $25.0 million of cash and cash equivalents and investments of $10.8 million as of December 31, 2015. As noted previously, in January 2016 we completed our acquisition of HHI. In conjunction with the acquisition, we entered into a syndicated credit agreement (the "Credit Agreement,") described further below, with Regions Bank ("Regions") serving as administrative agent, which provided for a $125 million term loan facility (the "Term Loan Facility") and a $50 million revolving credit facility (the "Revolving Credit Facility" and, together with the Term Loan Facility, the "Credit Facilities"). The cash portion of the purchase price for our acquisition of HHI was funded by the $125 million Term Loan Facility and $25 million borrowed under the Revolving Credit Facility, as well as available cash on hand (net of cash of the acquired entities) of $15.8 million (inclusive of financing costs and seller's transaction expenses). As of December 31, 2016, we had $154.9 million in principal amount of indebtedness outstanding under the Credit Facilities.
We believe that our cash and cash equivalents of $2.2 million as of December 31, 2016, the future operating cash flows of the newly combined entity, and our remaining borrowing capacity under the Revolving Credit Facility of $17 million as of December 31, 2016, taken together, provide adequate resources to fund ongoing cash requirements for the next twelve months. We cannot provide assurance that our actual cash requirements will not be greater than we expect as of the date of filing of this Form 10-K. If sources of liquidity are not available or if we cannot generate sufficient cash flow from operations during the next twelve months, we may be required to obtain additional sources of funds through additional operational improvements, capital market transactions, asset sales or financing from third parties, a combination thereof or otherwise. We cannot provide assurance that these additional sources of funds will be available or, if available, would have reasonable terms.
Operating Cash Flow Activities
2016 Compared to 2015. Net cash provided by operating activities decreased 93.3%, or $28.8 million, from $30.9 million provided by operations for 2015 to $2.1 million provided by operations for 2016, primarily due to the impact of the HHI acquisition. During 2016, we invested heavily in improving the working capital of the HHI entities post-acquisition in order to normalize the aging of vendor payables and improve acquired vendor relationships, resulting in a combined cash outflow related to changes in accounts payable and other liabilities of $12.8 million in 2016, whereas the movement of these working capital components improved operating cash flows by $1.3 million in 2015. Additionally, the acquisition of HHI included significant deferred revenue balances at the date of acquisition, for which the subsequent revenue recognition has had no benefit to our operating cash flows. Consequently, our operating cash flows have been negatively affected by the net impact of deferred revenue balances in the amount of $13.7 million, compared to this impact during 2015 of $2.1 million. Lastly, the Company has incurred $8.2 million of transaction costs, the vast majority of which have been in cash, associated with the HHI acquisition during 2016, with only $3.0 million of such costs during 2015.
2015 Compared to 2014. Net cash provided by operating activities decreased 20.8%, or $8.1 million, primarily due to the previously mentioned 44.3%, or $14.6 million, decrease in net income. The impact of the decreased net income on our operating cash flows was partially muted by the timing of cash collections on previously existing Second Generation Meaningful Use Installment Plans coupled with the continued decreasing prevalence of Second Generation Meaningful Use Installment Plans within the population of system sales revenues. Although the customer demand for financing arrangements is expected to continue during the next twelve months (albeit at a lower frequency than in recent years), the waning demand for Second Generation Meaningful Use Installment Plans has resulted in more sporadic customer demand for financing arrangements. This sporadic demand for financing arrangements could result in increases in our financing receivables in future periods which, although offset by periodic collections of previously outstanding amounts, could temporarily have a negative impact on our net cash provided by operating activities.
Investing Cash Flow Activities
2016 Compared to 2015. Net cash used in investing activities increased to $151.8 million in 2016 from only $0.6 million in 2015. We utilized cash (net of cash acquired) of $162.6 million for the acquisition of HHI during 2016, partially offset by sales of investments in available-for-sale securities of $10.9 million in this period. Investing cash flow activities in 2015 were primarily limited to $0.4 million of capital expenditures. We believe that our existing physical facilities provide us with ample infrastructure to continue and grow our existing operations and, as such, we do not anticipate the need for significant capital expenditures during 2017.
2015 Compared to 2014. Net cash used in investing activities decreased to $0.6 million in 2015 from $1.5 million in 2014. We used cash for the purchase of $0.4 million of property and equipment during 2015, mostly related to increasing storage capacity at our off-site server locations and the continued build-out of our new location in Frackville, Pennsylvania. During 2014, we used cash for the purchase of $1.5 million of property and equipment, mostly related to renovation projects at our corporate campus in Mobile, Alabama.
Financing Cash Flow Activities
2016 Compared to 2015. During 2016, our financing activities provided net cash of $127.0 million, as net proceeds of $146.6 million from our new Credit Agreement were used to fund a portion of the HHI purchase price. We withdrew an additional $10.0 million from the Revolving Credit Facility to fund the aforementioned investments in HHI working capital. We declared and paid dividends in the amount of $25.1 million in 2016. Financing cash flow activities in 2015 were primarily limited to the payment of $28.9 million in dividends. During 2016, our Board of Directors adopted a variable dividend policy for the payment of quarterly dividends. The policy provides for dividends on a trailing quarterly basis in an amount based on a pre-established financial formula.
We believe that paying dividends is an effective way of providing an investment return to our stockholders and a beneficial use of our cash. However, the declaration of dividends by CPSI is subject to compliance with the terms of our Credit Agreement and the discretion of our Board of Directors which may decide to change or terminate the Company's dividend policy at any time. Our Board of Directors will continue to take into account such matters as general business conditions, capital needs, our financial results and such other factors as our Board of Directors may deem relevant.
2015 Compared to 2014. Net cash used in financing activities increased to $29.1 million in 2015 from $25.4 million in 2014. We declared and paid dividends in the aggregate amount of $28.9 million during 2015 compared to $25.5 million in 2014, as we increased our dividend rate 12.3% to $0.64 per share from $0.57 per share.
Credit Agreement
As noted above, in conjunction with our acquisition of HHI in January 2016, we entered into a Credit Agreement which provided for a $125 million Term Loan Facility and a $50 million Revolving Credit Facility. As of December, 2016, we had $121.9 million in principal amount outstanding under the Term Loan Facility and $33 million in principal amount outstanding under the Revolving Credit Facility.
The Term Loan Facility bears interest at a rate per annum equal to an applicable margin plus, at our option, either (1) the Adjusted LIBOR rate for the relevant interest period, (2) an alternate base rate determined by reference to the greatest of (a) the prime lending rate of Regions, (b) the federal funds rate for the relevant interest period plus one half of one percent per annum and (c) the one month LIBOR rate plus one percent per annum, or (3) a combination of (1) and (2). The applicable margin will range from 2.25% to 3.50% for LIBOR loans and 1.25% to 2.50% for base rate loans, in each case based on our consolidated leverage ratio (as defined in the Credit Agreement). Interest on the outstanding principal of the Term Loan Facility will be payable on the last day of each month, in the case of each base rate loan, and on the last day of each interest period (but no less
frequently than every three months), in the case of LIBOR loans. Principal payments are due on the last day of each fiscal quarter beginning March 31, 2016, with quarterly principal payments of approximately $0.8 million in 2016, approximately $1.6 million in 2017, approximately $2.3 million in 2018, approximately $3.1 million in 2019 and approximately $3.9 million in 2020, with the remainder due at maturity on January 8, 2021 or such earlier date as the obligations under the Credit Agreement become due and payable pursuant to the terms of the Credit Agreement (the “Maturity Date”).
Borrowings under the Revolving Credit Facility bear interest at a rate per annum equal to an applicable margin plus, at our option, either (1) the Adjusted LIBOR rate for the relevant interest period or (2) an alternate base rate determined by reference to the greatest of (a) the prime lending rate of Regions, (b) the federal funds rate for the relevant interest period plus one half of one percent per annum and (c) the one month LIBOR rate plus one percent per annum. The applicable margin will range from 2.25% to 3.50% for LIBOR loans and 1.25% to 2.50% for base rate loans, in each case based on our consolidated leverage ratio. Interest on borrowings under the Revolving Credit Facility is payable on the last day of each month, in the case of each base rate loan, and on the last day of each interest period (but no less frequently than every three months), in the case of LIBOR loans. The Revolving Credit Facility includes a $5 million swingline sublimit, with swingline loans bearing interest at the alternate base rate plus the applicable margin. Any principal outstanding under the Revolving Credit Facility is due and payable on the Maturity Date.
The Term Loan Facility and amounts borrowed under the Revolving Credit Facility are secured pursuant to a Pledge and Security Agreement, dated January 8, 2016, among the parties identified as obligors therein and Regions, as collateral agent (the “Security Agreement”), on a first priority basis by a security interest in substantially all of the tangible and intangible assets (subject to certain exceptions) of the Company and certain subsidiaries of the Company, as guarantors (collectively, the “Subsidiary Guarantors”), including certain registered intellectual property and the capital stock of certain of the Company’s direct and indirect subsidiaries. Our obligations under the Credit Agreement are also guaranteed by the Subsidiary Guarantors.
The Credit Agreement provides incremental facility capacity of $50 million, subject to certain conditions. The Credit Agreement includes a number of restrictive covenants that, among other things and in each case subject to certain exceptions and baskets, impose operating and financial restrictions on the Company and the Subsidiary Guarantors, including the ability to incur additional debt; incur liens and encumbrances; make certain restricted payments, including paying dividends on the Company's equity securities or payments to redeem, repurchase or retire the Company's equity securities (which are subject to our compliance, on a pro forma basis to give effect to the restricted payment, with the fixed charge coverage ratio and consolidated leverage ratio described below); enter into certain restrictive agreements; make investments, loans and acquisitions; merge or consolidate with any other person; dispose of assets; enter into sale and leaseback transactions; engage in transactions with affiliates; and materially alter the business we conduct. In addition, the Company is required to comply with a minimum fixed charge coverage ratio of 1.25:1.0 throughout the duration of the Credit Agreement and a maximum consolidated leverage ratio (as defined in the Credit Agreement, as amended) of 3.50:1.0 through September 30, 2017, 3.00:1.0 from October 1, 2017 through September 30, 2018, and 2.50:1.0 thereafter. The Credit Agreement also contains customary representations and warranties, affirmative covenants and events of default. We believe that we were in compliance with the covenants contained in the Credit Agreement as of December 31, 2016.
The Credit Agreement requires the Company to mandatorily prepay the Term Loan Facility and amounts borrowed under the Revolving Credit Facility with (i) 100% of net cash proceeds from certain sales and dispositions, subject to certain reinvestment rights, (ii) 100% of net cash proceeds from certain issuances or incurrences of additional debt, (iii) 50% of net cash proceeds from certain issuances or sales of equity securities, subject to a step down to 0% if the Company’s consolidated leverage ratio is no greater than 2.50:1.0, and (iv) beginning with the fiscal year ending December 31, 2016, 50% of excess cash flow (minus certain specified other payments), subject to a step down to 0% of excess cash flow if the Company’s consolidated leverage ratio is no greater than 2.50:1.0. As of December 31, 2016 our leverage ratio was at a level that does not require us to make mandatory repayments of cash flows. The Company is permitted to voluntarily prepay the Term Loan Facility and amounts borrowed under the Revolving Credit Facility at any time without penalty, subject to customary “breakage” costs with respect to prepayments of LIBOR rate loans made on a day other than the last day of any applicable interest period.
Off-Balance Sheet Arrangements
We had no off-balance sheet arrangements, as defined by Item 303(a)(4) of SEC Regulation S-K, as of December 31, 2016 or December 31, 2015.
The Company has other lease rights and obligations that it accounts for as operating leases that may be reclassified as balance sheet arrangements under accounting pronouncements recently finalized by the FASB.
Contractual Obligations
As of December 31, 2016, our material obligations requiring payments in the future are set forth below to reflect (i) our real estate lease obligations (ii) our capital lease obligations, and (iii) the Company’s debt obligations under the Credit Facilities entered into on January 8, 2016 in connection with the Company’s acquisition of HHI and its wholly-owned subsidiaries, and related interest payments as follows:
Interest on debt obligations for floating rate instruments, as calculated above, assumes rates in effect at December 31, 2016 remain constant.
Critical Accounting Policies
General. Our discussion and analysis of our financial condition and results of operations are based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. We are required to make some estimates and judgments that affect the preparation of these financial statements. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, but actual results may differ from these estimates under different assumptions or conditions.
Revenue Recognition. We generate revenue from the following sources:
•
The sale of information systems and the provision of related support services, including perpetual software licenses, conversion, installation and training services, hardware and peripherals, SaaS services, forms and supplies, software application support, hardware maintenance, and continuing education.
•
The provision of business management services, which includes electronic billing, statement processing, payroll processing, accounts receivable management, contract management and insurance services, as well as Internet service provider ("ISP") services and consulting and managed IT services (collectively, "other professional IT services").
We recognize revenue in accordance with the accounting principles required by the Software topic and Revenue Recognition subtopic of the Financial Accounting Standards Board ("FASB") Accounting Standards Codification (the "Codification") and those prescribed by the Securities and Exchange Commission, as well as the accounting principles relevant to multiple-element arrangements in the Revenue Recognition topic and Multiple-Element Arrangements subtopic of the Codification. These standards require that four basic criteria must be met before revenues can be recognized: (1) persuasive evidence that an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the fee is fixed and determinable; and (4) collectability is reasonably assured. The recognition of revenue pursuant to these criteria involves estimates and judgments regarding:
1)
The allocation of total arrangement consideration to the various elements of our multiple-element arrangements, including, for certain elements, estimates and judgments regarding vendor-specific objective evidence ("VSOE") of fair value, which we base on either the price charged when the same element is sold separately or the price established by management having the relevant authority to do so, for an element not yet sold separately. VSOE calculations are updated and reviewed regularly depending on the nature of the product or service. We base VSOE for the related undelivered elements on either renewals or stand-alone sales as appropriate.
2)
Our determination that total fees for our products and services are fixed or determinable, which we base on signed contracts and orders.
3)
Our assessment that collection of amounts due is reasonably assured, which we base on our standard payment terms and collection history.
Risks associated with these estimates and judgments and the effects thereof include: (1) if VSOE of fair value of any undelivered element does not exist, all revenue is deferred until VSOE of fair value of the undelivered element is established or the element has been delivered and (2) if the fees are not fixed or determinable, or if collection is not reasonably assured, then the revenue recognized in various periods will be less than amounts that would have been otherwise recognizable using the residual method provided under the Codification. See Note 2 to the financial statements for further discussion of our revenue recognition policies.
Although we believe that our approach to estimates and judgments regarding revenue recognition is reasonable, actual results could differ and we may be exposed to increases or decreases in revenue that could be material.
Allowance for Doubtful Accounts. Trade accounts receivable are stated at the amount the Company expects to collect and do not bear interest. The collectability of trade receivable balances is regularly evaluated based on a combination of factors such as customer credit-worthiness, past transaction history with the customer, current economic industry trends and changes in customer payment patterns, resulting in the establishment of general reserves. Additionally, if it is determined that a customer will be unable to fully meet its financial obligation, such as in the case of a bankruptcy filing or other material event impacting its business, a specific reserve for bad debt may be recorded to reduce the related receivable to the amount expected to be recovered.
Although we believe that our approach to estimates and judgments regarding our allowance for doubtful accounts is reasonable, actual results could differ and we may be exposed to increases or decreases in required reserves that could be material.
Allowance for Credit Losses. The Company has sold information and patient care systems to certain healthcare providers under short-term payment plans and sales-type leases. The Company establishes an allowance for credit losses for these financing receivables based on the historical level of customer defaults under such financing arrangements. Additionally, if it is determined that a customer will be unable to meet its financial obligation, such as in the case of a bankruptcy filing or other material event impacting its business, a specific reserve may be recorded to reduce the related receivable to the amount expected to be recovered. Reference is made to Note 11 to the financial statements for further information about our financing receivables.
Although we believe that that our approach to estimates and judgments regarding our allowance for credit losses is reasonable, actual results could differ and we may be exposed to increases or decreases in required reserves that could be material.
Estimates. The Company uses estimates to record certain transactions and liabilities. These estimates are generally based on management’s best judgment, past experience, and utilization of third party services such as actuarial and other expert services. Because these estimates are subjective and variable, actual results could differ significantly from these estimates. Significant estimates included in our financial statements include those for self-insurance reserves under our health insurance plan, reserves for uncertain tax positions, bad debt and credit allowances, legal liability exposure or lack thereof, and accrued expenses.
Business combinations, including purchased intangible assets. The Company accounts for business combinations at fair value. Acquisition costs are expensed as incurred and recorded in general and administrative expenses. Measurement period adjustments relate to adjustments to the fair value of assets acquired and liabilities assumed based on information that we should have known at the time of acquisition. All changes to purchase accounting that do not qualify as measurement period adjustments are included in current period earnings.
The fair value amount assigned to an intangible asset is based on an exit price from a market participant’s viewpoint, and utilizes data such as discounted cash flow analysis and replacement cost models. We review acquired intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable.
Goodwill is recorded as the difference, if any, between the aggregate consideration paid for an acquisition and the fair value of the identifiable net tangible and intangible assets acquired. Goodwill is not amortized but is evaluated for impairment annually or more frequently if indicators of impairment are present or changes in circumstances suggest that impairment may exist. The first step of the goodwill impairment test compares the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, the goodwill of the reporting unit is not considered to be impaired. If the carrying amount of the reporting unit exceeds its fair value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss, if any. The second step of the goodwill impairment
test, used to measure the amount of impairment loss, compares the implied fair value of the affected reporting unit’s goodwill with the carrying value of that goodwill.
Critical estimates in valuing certain intangible assets and the fair value of the reporting unit during goodwill impairment tests include, but are not limited to, identifying reporting units, historical and projected customer retention rates, anticipated growth in revenue from the acquired customers, expected future cash outflows, the allocation of those cash flows to identifiable intangible assets, estimated useful lives of these intangible assets, and a probability-weighted income approach based on scenarios in estimating achievement of operating results.
Significant judgments in testing goodwill for impairment also include assigning assets and liabilities to the reporting unit and determining the fair value of each reporting unit based on management’s best estimates and assumptions, as well as other information compiled by management, including valuations that utilize customary valuation procedures and techniques.
Management’s best estimates and assumptions are employed in determining the appropriateness of these assumptions as of the acquisition date and for each subsequent period.
Future business and economic conditions, as well as differences actually related to any of the assumptions, could materially affect the financial statements through impairment of goodwill or intangible assets, and acceleration of the amortization period of the purchased intangible assets, which are finite-lived assets.
Quantitative and Qualitative Disclosures about Market and Interest Rate Risk
Our exposure to market risk relates primarily to the potential change in the British Bankers Association London Interbank Offered Rate ("LIBOR"). We had $154.9 million of outstanding borrowings under our Credit Facilities with Regions Bank at December 31, 2016. The Term Loan Facility and Revolving Credit Facility bear interest at a rate per annum equal to an applicable margin plus (1) the Adjusted LIBOR rate for the relevant interest period, (2) an alternate base rate determined by reference to the greatest of (a) the prime lending rate of Regions, (b) the federal funds rate for the relevant interest period plus one half of one percent per annum and (c) the one month LIBOR rate plus one percent per annum, or (3) a combination of (1) and (2). Accordingly, we are exposed to fluctuations in interest rates on borrowings under the Credit Facilities. A one hundred basis point change in interest rate on our borrowings outstanding as of December 31, 2016 would result in a change in interest expense of approximately $1.6 million annually.
We did not have investments as of December 31, 2016. We do not utilize derivative financial instruments to manage our interest rate risks.
Recent Accounting Pronouncements
Reference is made to Note 2 to the consolidated financial statements for a discussion of accounting pronouncements that have been recently issued which we have not yet adopted.
ITEM 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this Item is contained in Item 7 herein under the heading "Quantitative and Qualitative Disclosures about Market and Interest Rate Risk."
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. Computer Programs and Systems, Inc.’s ("CPSI") internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. CPSI’s internal control over financial reporting includes those policies and procedures that:
(i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of CPSI;
(ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of CPSI are being made only in accordance with authorizations of management and directors of CPSI; and
(iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of CPSI’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of CPSI’s internal control over financial reporting as of December 31, 2016. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (2013).
In its assessment, management identified control deficiencies in its business combination processes that constituted material weaknesses, as there is a reasonable possibility that such processes potentially would not prevent or detect a material misstatement of the Company’s consolidated financial statements on a timely basis. As a result, management has concluded that our internal control over financial reporting was not effective as of December 31, 2016.
We excluded Rycan Technologies, Inc., which was included in our consolidated financial statements, from our assessment of internal control over financial reporting as of December 31, 2016 because it was acquired by the Company in a purchase business combination on January 8, 2016. The assets of Rycan Technologies, Inc. excluded from our assessment represented less than 1% of the Company’s total assets as of December 31, 2016 and approximately 3% of the Company’s consolidated total revenues for the year ended December 31, 2016.
The independent registered public accounting firm, Grant Thornton LLP, has audited the consolidated financial statements of the Company as of and for the year ended December 31, 2016, and has also issued its report on the effectiveness of the Company’s internal control over financial reporting included in this report on page 57.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Board of Directors and Stockholders
Computer Programs and Systems, Inc.:
We have audited the internal control over financial reporting of Computer Programs and Systems, Inc. (a Delaware corporation) and subsidiaries (the “Company”) as of December 31, 2016, based on criteria established in the 2013 Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. Our audit of, and opinion on, the Company’s internal control over financial reporting does not include the internal control over financial reporting of Rycan Technologies, Inc., a wholly-owned subsidiary, whose financial statements reflect total assets and revenues constituting approximately 1 percent and 3 percent, respectively, of the related consolidated financial statement amounts as of and for the year ended December 31, 2016. As indicated in Management’s Report, Rycan Technologies, Inc. was acquired during 2016. Management’s assertion on the effectiveness of the Company’s internal control over financial reporting excluded internal control over financial reporting of Rycan Technologies, Inc.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
A material weakness is a deficiency, or combination of control deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. The following material weakness has been identified and included in management’s assessment.
Certain control deficiencies were identified in management’s processes relating to accounting for business combinations that constituted a material weakness in internal controls as there is a reasonable possibility that such processes potentially would not prevent or detect a material misstatement of the Company’s consolidated financial statements on a timely basis.
In our opinion, because of the effect of the material weakness described above on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as of December 31, 2016, based on criteria established in the 2013 Internal Control-Integrated Framework issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of the Company as of and for the year ended December 31, 2016, and our report dated March 15, 2017 expressed an unqualified opinion on those financial statements.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON CONSOLIDATED FINANCIAL STATEMENTS
Board of Directors and Stockholders
Computer Programs and Systems, Inc.:
We have audited the accompanying consolidated balance sheets of Computer Programs and Systems, Inc. (a Delaware corporation) and its subsidiaries (the “Company”) as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2016. Our audits of the basic consolidated financial statements included the financial statement schedule listed in the index appearing under Item 8. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Computer Programs and Systems, Inc. and its subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2016, based on criteria established in the 2013 Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 14, 2016 expressed an adverse opinion thereon.
COMPUTER PROGRAMS AND SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
The accompanying notes are an integral part of these consolidated financial statements.
COMPUTER PROGRAMS AND SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
The accompanying notes are an integral part of these consolidated financial statements.
COMPUTER PROGRAMS AND SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
COMPUTER PROGRAMS AND SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
COMPUTER PROGRAMS AND SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
COMPUTER PROGRAMS AND SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS - (Continued)
(In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
COMPUTER PROGRAMS AND SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2016
1. NATURE OF OPERATIONS
Computer Programs and Systems, Inc. ("CPSI" or the "Company") is a healthcare information technology solutions provider which was formed and commenced operations in 1979. The Company provides, on an integrated basis, enterprise-wide clinical management, access management, patient financial management, health information management, strategic decision support, resource planning management and enterprise application integration solutions to healthcare organizations throughout the United States. Additionally, CPSI provides other information technology solutions, including business management services, remote hosting, networking technologies and other related services.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements of CPSI include the accounts of TruBridge, LLC ("TruBridge"), Evident, LLC ("Evident"), and Healthland Holding Inc. ("HHI"), all of which are wholly-owned subsidiaries of CPSI. The accounts of HHI include those of its wholly-owned subsidiaries, Healthland Inc. ("Healthland"), Rycan Technologies, Inc. ("Rycan"), and American HealthTech, Inc. ("AHT"). All significant intercompany balances and transactions have been eliminated.
Presentation
Effective January 1, 2016, we adopted a revised presentation of sales revenues and the associated costs of sales in our consolidated statements of income, which we believe is better aligned with and representative of the amount and profitability of our revenue streams, as well as the way we manage our business, review our operating performance and market our products. Specifically:
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The Company's sales revenues and costs of sales amounts formerly included within the captions "System sales" and "Support and maintenance" are now included within the caption "System sales and support" within the consolidated statements of income;
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The Company's product development costs formerly included within the captions of "System sales" and "Support and maintenance" within the "Costs of sales" section of the consolidated statements of income are now included within the caption "Product development" within the "Operating expenses" section of the consolidated statements of income; and
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The Company's sales-facilitative costs associated with business management, consulting and managed IT services formerly included within the caption "Business management, consulting and managed IT services" within the "Costs of sales" section of the consolidated statements of income are now included within the caption "Sales and marketing" within the "Operating expenses" section of the consolidated statements of income.
These reclassifications had no effect on previously reported total sales revenues, operating income, income before taxes or net income. In addition, in 2016, we changed the rounding of our financial statements from ones to thousands.
Amounts presented for the years ending December 31, 2015 and 2014, respectively, have been reclassified to conform to the current presentation. The following table provides the amounts reclassified for the year ended December 31, 2015:
The following table provides the amounts reclassified for the year ended December 31, 2014:
Cash and Cash Equivalents
Cash and cash equivalents can include time deposits and certificates of deposit with original maturities of three months or less that are highly liquid and readily convertible to a known amount of cash. These assets are stated at cost, which approximates market value, due to their short duration or liquid nature.
Investments
The Company accounts for investments in accordance with Financial Accounting Standards Board ("FASB") Codification topic, Investments - Debt and Equity Securities. Accordingly, investments are classified as available-for-sale securities and are reported at fair value, with unrealized gains and losses excluded from earnings and reported in a separate component of stockholders’ equity. The Company’s management determines the appropriate classifications of investments in fixed maturity securities at the time of acquisition and re-evaluates the classifications at each balance sheet date. An average cost method is used for purposes of determining the cost of investments sold.
Income Taxes
We account for income taxes in accordance with FASB Codification topic, Income Taxes. Under this topic, deferred income taxes are determined utilizing the asset and liability approach. This method gives consideration to the future tax consequences associated with differences between financial accounting and tax bases of assets and liabilities. The effect on the deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. We recognize interest and penalties accrued related to unrecognized tax benefits in the consolidated statements of income as a component of the provision for income taxes.
We also make a provision for uncertain income tax positions in accordance with the Income Taxes Codification topic. These provisions require that a tax position taken in a tax return be recognized in the financial statements when it is more likely than not (i.e., a likelihood of more than fifty percent) that the position would be sustained upon examination by tax authorities. A recognized tax position is then measured at the largest amount of benefit that is greater than fifty percent likely of being realized upon settlement. The topic also requires that changes in judgment that result in subsequent recognition, derecognition, or change in a measurement date of a tax position taken in a prior annual period (including any related interest and penalties) be recognized as a discrete item in the interim period in which the change occurs.
Valuation allowance are recorded when, in the opinion of management, it is more likely than not that all or a portion of the deferred tax assets will not be realized. These valuation allowances can be impacted by changes in tax laws, changes to statutory tax rates, and future taxable income, and are based on our judgment, estimates, and assumptions.
Accounts Receivable and Allowance for Doubtful Accounts
Trade accounts receivable are stated at the amount the Company expects to collect and do not bear interest. The Company establishes a general allowance for doubtful accounts based on collections history. In the case of a bankruptcy filing or other similar event indicating the collectability of specific customer accounts is no longer probable, a specific reserve for bad debt may be recorded to reduce the related receivable to the amount expected to be recovered.
Financing Receivables
Financing receivables are comprised of short-term payment plans and sales-type leases. Short-term payment plans are stated at the amount the Company expects to collect and do not bear interest. Sales-type leases are initially recorded at the present value of the related minimum lease payments, computed at the interest rate implicit in the lease, and are presented net of unearned income. Unearned income is amortized over the lease term to produce a constant periodic rate of return on the net investment in the lease (the interest method).
An allowance for credit losses has been established for our financing receivables based on the historical level of customer defaults under such arrangements. In the case of a bankruptcy filing or other similar event indicating the collectability of specific customer accounts is no longer probable, a specific reserve may be recorded to reduce the related receivable to the amount expected to be recovered. Customer payments are considered past due if a scheduled payment is not received within contractually agreed upon terms, with amounts reclassified to accounts receivable when they become due. As a result, we evaluate the credit quality of our financing receivables on an ongoing basis utilizing an aging of receivables and write-offs, customer collection experience, the customer’s financial condition and known risk characteristics impacting the respective customer base, as well as existing economic conditions, to determine if any further allowance is necessary. Amounts are specifically charged off once all available means of collection have been exhausted.
Inventories
Inventories are stated at lower of cost or market using the average cost method. The Company’s inventories are comprised of computer equipment, forms and supplies. For cash flow presentation, inventory used by the Company and capitalized as property and equipment is shown as a change in inventory.
Property and Equipment
Property and equipment is recorded at cost, less accumulated depreciation. Additions and improvements to property and equipment that materially increase productive capacity or extend the life of an asset are capitalized. Maintenance, repairs and minor renewals are expensed as incurred. Upon retirement or other disposition of such assets, the related costs and accumulated depreciation are removed from the respective accounts and any resulting gain or loss is included in the results of operations.
Depreciation expense is computed using the straight-line method over the asset’s useful life, which is generally 5 years for computer equipment, furniture, and fixtures and 30 years for buildings. Leasehold improvements are depreciated over the shorter of the asset’s useful life or the remaining lease term. The Company reviews for the possible impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Depreciation expense is reported in the consolidated statements of income as a component of costs of sales and operating expenses.
Goodwill
Goodwill is recorded as the difference between the aggregate consideration paid for the acquisition of a business and the fair value of the identifiable net tangible and intangible assets acquired. Goodwill is not amortized but is evaluated for impairment annually or more frequently if indicators of impairment are present or changes in circumstances suggest that impairment may exist. We evaluate the carrying value of our goodwill annually on October 1. The first step of the goodwill impairment test compares the fair value of the reporting unit with its carrying amount, including goodwill. If fair value of our reporting unit exceeds its carrying amount, the goodwill of the reporting unit is not considered impaired. If the carrying amount of our reporting unit exceeds its fair value, a second step of the goodwill impairment test is performed to measure the amount of impairment loss, if any. The second step of the goodwill impairment test compares the implied fair value of the affected reporting unit's goodwill with the carrying amount of that goodwill. No impairments have been recognized.
Purchased Intangible Assets
Purchased intangible assets are acquired in connection with a business acquisition, and are amortized over their estimated useful lives based on the pattern of economic benefit expected from each asset. We concluded for certain purchased intangible assets that the pattern of economic benefit approximated the straight-line method, and therefore, the use of the straight-line method was appropriate, as the majority of the cash flows will be recognized ratably over the estimated useful lives and there is no degradation of the cash flows over time.
Business Combinations
We apply business combination accounting when we acquire a business. Business combinations are accounted for at fair value. The associated acquisition costs are expensed as incurred and recorded in general and administrative expenses; restructuring costs associated with a business combination are expenses; contingent consideration is measured at fair value at the acquisition date, with changes in fair value after the acquisition date affecting earnings; changes in deferred tax asset valuation allowances and income tax uncertainties after the measurement period affect income tax expense; and goodwill is determined as the excess of the fair value of the consideration conveyed in the acquisition over the fair value of the net assets acquired. The accounting for business combinations requires estimates and judgments as to expectations for future cash flows of the acquired business, and the allocation of those cash flows to identifiable intangible assets, in determining the estimated fair value for assets and liabilities acquired. The fair values assigned to tangible and intangible assets acquired and liabilities assumed, are based on management's estimates and assumptions, including valuations that utilize customary valuation procedures and techniques. If the actual results differ from the estimates and judgments used in these estimates, the amounts recorded in the financial statements could result in a possible impairment of the intangible assets and goodwill, or require acceleration of the amortization expense of finite-lived intangible assets. The results of the acquired businesses' operations are included in the Consolidated Statements of Income of the combined entity beginning on the date of the acquisition. We have applied this acquisition method to the transactions described in Note 3 - Business Combinations.
Deferred Revenue
Deferred revenue represents amounts received from customers under licensing agreements and implementation fees for which the revenue recognition process has not been completed.
Revenue Recognition
The Company recognizes revenue in accordance with U.S. GAAP, principally those required by the Software topic and Revenue Recognition subtopic of the FASB Codification and those prescribed by the SEC.
The Company's revenue is generated from two sources:
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System Sales and Support - the sale of information systems and the provision of system support services. The sale of information systems includes perpetual software licenses, conversion, installation and training services,
hardware and peripherals, "Software as a Service" (or "SaaS") services, and forms and supplies. System support services includes software application support, hardware maintenance, and continuing education.
•
Business Management, Consulting and Managed IT Services - the provision of business management services, which includes electronic billing, statement processing, payroll processing, accounts receivable management, contract management and insurance services, as well as Internet service provider ("ISP") services and consulting and managed IT services (collectively, "other professional IT services").
System Sales and Support
The Company enters into contractual obligations to sell perpetual software licenses, conversion, installation and training services, hardware and software application support and hardware maintenance services. On average, the Company is able to complete a system installation in three to four weeks. The methods employed by the Company to recognize revenue, which are discussed by element below, achieve results materially consistent with the provisions of Accounting Standards Update ("ASU") 2009-13, Multiple-Deliverable Revenue Arrangements, due to the relatively short period during which there are multiple undelivered elements, the relatively small amount of non-software related elements in the system sale arrangements, and the limited number of contracts in-process at the end of each reporting period. The Company recognizes revenue on the elements noted above as follows:
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Perpetual software licenses and conversion, installation and training services - The selling price of perpetual software licenses and conversion, installation and training services is based on management’s best estimate of selling price. In determining management’s best estimate of selling price, we consider the following: (1) competitor pricing, (2) supply and demand of installation staff, (3) overall economic conditions, and (4) our pricing practices as they relate to discounts. With the exception of certain arrangements with extended payment terms that were entered into in 2012 and that are not comparable to our historical or current arrangements (see Note 11), the method of recognizing revenue for the perpetual license of the associated modules included in the arrangement, and the related conversion, installation and training services over the term the services are performed, is on a module by module basis as the related perpetual licenses are delivered and the respective conversion, installation and training for each specific module is completed, as this is representative of the pattern of provision of these services.
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Hardware - We recognize revenue for hardware upon shipment. The selling price of hardware is based on management’s best estimate of selling price, which consists of cost plus a targeted margin.
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Software application support and hardware maintenance - We have established vendor-specific objective evidence ("VSOE") of the fair value of our software application support and hardware maintenance services by reference to the price our customers are required to pay for the services when sold separately via renewals. Support and maintenance revenue is recognized on a straight-line basis over the term of the maintenance contract, which is generally three to five years.
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SaaS services - The Company accounts for SaaS arrangements in accordance with the requirements of the Hosting Arrangement section under the Software topic and Revenue Recognition subtopic of the Codification. The Codification states that the software elements of SaaS services should not be accounted for as a hosting arrangement "if the customer has the contractual right to take possession of the software at any time during the hosting period without significant penalty and it is feasible for the customer to either run the software on its own hardware or contract with another party unrelated to the vendor to host the software." Each SaaS contract entered into by the Company includes a system purchase and buyout clause, and this clause specifies the total amount of the system buyout. In addition, a clause is included in the contract which states that should the system be bought out by the customer, the customer would be required to enter into a general support agreement (for post-contract support services) for the remainder of the original SaaS term. Accordingly, the Company has concluded that SaaS customers do not have the right to take possession of the system without significant penalty (i.e., the purchase price of the system), resulting in the determination that these contracts are service contracts for which revenue is recognized when the services are performed.
Business Management, Consulting and Managed IT Services
Business management services consist of electronic billing, statement processing, payroll processing, accounts receivable management, contract management and insurance services. While business management service arrangements are contracts separate from the system sale and support contracts, these contracts are often executed within a short time frame of each other. The amount of the total arrangement consideration allocated to these services is based on VSOE of fair value by
reference to the rate at which our customers renew as well as the rate at which the services are sold to customers when the business management services agreement is not executed within a short time frame of the system sale and support contracts. If VSOE of fair value does not exist for these services, we allocate arrangement consideration based on third-party evidence ("TPE") of selling price or, if neither VSOE nor TPE is available, estimated selling price. Because the pricing is transaction based (per unit pricing), customers are billed and revenue recognized as services are performed based on transaction levels.
The Company will occasionally provide ISP and other professional IT services. Depending on the nature of the services provided, these services may be considered software elements or non-software elements. The selling price of services considered to be software elements is based on VSOE of the fair value of the services by reference to the price our customers are required to pay for the services when sold separately. The selling price of services considered to be non-software elements is based on third-party evidence of selling price of similar services. Revenue from these elements is recognized as the services are performed.
Stock-Based Compensation
The Company accounts for stock-based compensation according to the provisions of FASB Codification topic, Compensation - Stock Compensation, which establishes accounting for stock-based awards exchanged for employee services. Accordingly, stock-based compensation cost is measured at the grant date based on the fair value of the award, and is recognized as an expense over the employee’s or non-employee director’s requisite service period.
Product Development Costs
Product development costs are expensed as incurred. Product development costs totaled approximately $32.6 million, $14.2 million, and $14.6 million for the years ended December 31, 2016, 2015 and 2014, respectively.
Advertising Costs
Advertising costs are expensed as incurred. Advertising expense was approximately $0.2 million, $0.2 million, and $0.1 million for the years ended December 31, 2016, 2015 and 2014, respectively, and is recorded in sales and marketing expenses in the accompanying consolidated statements of income.
Shipping and Handling Costs
Shipping and handling costs are expensed as incurred and included in general and administrative expenses and costs of business management, consulting and managed IT services. Shipping and handling costs totaled approximately $0.4 million, $0.4 million, and $0.6 million for the years ended December 31, 2016, 2015 and 2014, respectively.
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires that management make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosures of contingent assets and liabilities at the date of the financial statements, and the reported revenues and expenses during the reporting periods. Actual results could differ from those estimates.
Segment Reporting
Operating segments are identified as components of an enterprise about which separate discrete financial information is evaluated by the chief operating decision maker, which we refer to as the CODM, or decision-making group in assessing performance and making decisions regarding resource allocation. The Company has prepared operating segment information based on the manner in which management disaggregates the Company's operations for making internal operating decisions. See Note 18.
New Accounting Standards Adopted in 2016
In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern, which requires management of an entity to evaluate, in connection with preparing financial statements for each annual and interim reporting period, whether there are conditions or events, considered in the aggregate, that raise substantial doubt about such entity's ability to continue as a going concern within one year after the date that the financial statements are issued (or within one year after the date that the financial statements are available to be issued when applicable), and provide related disclosures.
ASU2014-15 is effective for the annual period ending after December 15, 2016, and for annual and interim periods thereafter. We adopted this new guidance effective on December 31, 2016 and the adoption did not have any impact on our consolidated financial statements.
In April 2015, the FASB issued ASU 2015-03, Simplifying the Presentation of Debt Issuance Costs, which changes the presentation of debt issuance costs in financial statements. Under this guidance, an entity will present such costs in the balance sheet as a reduction of the related debt liability rather than as an asset. This guidance is effective for fiscal years and interim periods within those years beginning after December 15, 2015, which is effective for the Company as of the first quarter of our fiscal year ending December 31, 2016. Refer to Note 13 for further information regarding debt issuance costs.
In September 2015, the FASB issued ASU 2015-16, Simplifying the Accounting for Measurement-Period Adjustments, that eliminates the requirement to restate prior period financial statements for measurement period adjustments. The new guidance requires that the cumulative impact of a measurement period adjustment (including the impact on prior periods) be recognized in the reporting period in which the adjustment is identified. The new standard will be applied prospectively to measurement period adjustments that occur after the effective date. This guidance is effective for fiscal years and interim periods within those years beginning after December 15, 2015, which is effective for the Company as of the first quarter of our fiscal year ending December 31, 2016. The adoption of ASU 2015-16 did not have a material effect on our financial statements.
In November 2015, the FASB issued ASU 2015-17, Balance Sheet Classification of Deferred Taxes, to simplify the presentation of deferred income taxes. The standard eliminates the current requirement for organizations to present deferred tax assets and liabilities as current and noncurrent in a classified balance sheet. Instead, organizations will be required to classify all deferred tax assets and liabilities as noncurrent. This guidance is effective for fiscal years and interim periods within those years beginning after December 15, 2016, with early adoption permitted. The Company has chosen to early adopt ASU 2015-17 as of the first quarter of our fiscal year ending December 31, 2016 by prospectively applying the update. The adoption of ASU 2015-17 did not have a material effect on our financial statements.
New Accounting Standards Yet to be Adopted
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, to clarify the principles for recognizing revenue and to develop a common revenue standard for U.S. GAAP and International Financial Reporting Standards. The standard outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes the most current revenue recognition guidance. This guidance will be effective for fiscal years and interim periods within those years beginning after December 15, 2017, which is effective for the Company as of the first quarter of our fiscal year ending December 31, 2018. We are in the very early stages of our initial assessment of our systems, data and processes that will be affected by the implementation of this new standard, having engaged third party consultants to assist in evaluating the related impact that the implementation of this standard will have on our financial statements. As a result, we are unable at this time to conclude as to whether the implementation of this standard will have a material effect on our financial statements.
In July 2015, the FASB issued ASU 2015-11, Simplifying the Measurement of Inventory. The amended guidance requires entities to measure inventory at the lower of cost or net realizable value. Net realizable value is the estimated selling price in ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. The requirement would replace the current lower of cost or market evaluation. Accounting guidance is unchanged for inventory measured using last-in, first-out (“LIFO”) or the retail method. The amended guidance will be effective for fiscal years beginning after December 15, 2016, and interim periods within fiscal years beginning after December 15, 2017. The amended guidance should be applied prospectively with earlier application permitted. The Company is currently evaluating the impact that the implementation of this standard will have on its financial statements, but preliminary assessments have results in a conclusion that the adoption of this ASU will not have a material effect on our financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases, 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 new guidance will require the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous U.S. GAAP. This guidance will be effective for fiscal years and interim periods within those years beginning after December 15, 2018, which is effective for the Company as of the first quarter of our fiscal year ending December 31, 2019. The Company is currently evaluating the impact that the implementation of this standard will have on its financial statements.
In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, which simplifies the accounting for share-based payment transactions, including income tax consequences, classification of awards as either equity or liabilities, and the classification of awards on the statement of cash flows. This guidance will be effective for fiscal years and interim periods within those years beginning after December 15, 2016, which is effective for the Company as of the first quarter of our fiscal year ending December 31, 2017. ASU 2016-09 requires registrants to recognize all income tax effects of share-based awards in the statement of operations when the awards are vested or are settled, which will impact our future results of operations and earnings per share. We are not able to determine the magnitude of such an impact as it will depend on the future prices of our common stock and awards activity.
In August 2016, the FASB issued ASU 2016-15, Classifications of Certain Cash Receipts and Cash Payments, which clarifies cash flow classification for eight specific issues, including debt prepayment or extinguishment costs, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, and proceeds from settlement of corporate-owned life insurance policies. This guidance will be effective for fiscal years and interim periods within those years beginning after December 15, 2017, which is effective for the Company as of the first quarter of our fiscal year ending December 31, 2018. The Company is currently evaluating the impact that the implementation of this standard will have on its financial statements.
3. BUSINESS COMBINATION
Acquisition of HHI
On January 8, 2016, we acquired all of the assets and liabilities of HHI, including its wholly-owned subsidiaries, Healthland, AHT and Rycan. Healthland provides electronic health records ("EHR") and clinical information management solutions to over 350 hospital customers. AHT is a provider of clinical and financial solutions in the post-acute care market, serving over 3,300 skilled nursing facilities. Rycan offers SaaS-based revenue cycle management workflow and automation software to over 290 hospital customers.
We believe the acquisition of HHI:
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strengthens our position in providing healthcare information systems to community healthcare organizations with approximately 1,200 combined hospital customers;
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introduces CPSI to the post-acute care market; and
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expands the products offered by and capabilities of TruBridge with the addition of Rycan and its suite of revenue cycle management software products.
These factors, combined with the synergies and economies of scale expected from combining the operations of CPSI and HHI, were the basis for the acquisition.
Consideration for the acquisition included cash (net of cash of the acquired entities) of $162.6 million, 1,973,880 shares of common stock of CPSI ("CPSI Common Stock"), and the assumption by CPSI of stock options that became exercisable for 174,972 shares of CPSI Common Stock. During 2015, we incurred approximately $3.0 million of pre-tax costs in connection with the acquisition of HHI. During the year ended December 31, 2016, we incurred approximately $8.2 million, of pre-tax acquisition costs in connection with the acquisition of HHI. Acquisition costs are included in general and administrative expenses in our consolidated statements of income.
Our acquisition of HHI was treated as a purchase in accordance with Accounting Standards Codification (the "Codification") 805, Business Combinations, of the FASB, which requires allocation of the purchase price to the estimated fair values of assets and liabilities acquired in the transaction. Our allocation of the purchase price is based on management's judgment after evaluating several factors, including a valuation assessment.
The allocation of the purchase price paid for HHI is as follows:
The intangible assets in the table above are being amortized on a straight-line basis over their estimated useful lives. The amortization is included in amortization of acquisition-related intangibles in our consolidated statements of income. Of the goodwill acquired, $23.3 million is expected to be tax deductible.
The fair value measurements of tangible and intangible assets and liabilities were based on significant inputs not observable in the market and thus represent Level 3 measurements within the fair value measurement hierarchy (see Note 17). Level 3 inputs included, among others, discount rates that we estimated would be used by a market participant in valuing these assets and liabilities, projections of revenues and cash flows, client attrition rates and market comparables.
The gross contractual amount of accounts receivable of HHI at the date of acquisition was $9.4 million.
Our consolidated statement of income for the year ended December 31, 2016 includes revenues of approximately $86.6 million, and pre-tax income of approximately $12.2 million, attributed to the acquired business since the January 8, 2016 acquisition date.
The following unaudited pro forma revenue, net income and earnings per share amounts for the years ended December 31, 2016 and 2015 give effect to the HHI acquisition as if it had been completed on January 1, 2015. The pro forma financial information is presented for illustrative purposes only and is not necessarily indicative of what the operating results actually would have been during the periods presented had the HHI acquisition been completed during the periods presented. In addition, the unaudited pro forma financial information does not purport to project future operating results. The pro forma information does not fully reflect: (1) any anticipated synergies (or costs to achieve synergies) or (2) the impact of non-recurring items directly related to the HHI acquisition.
Pro forma net income was calculated by adjusting the results for the applicable period to reflect (i) the additional amortization that would have been charged assuming the fair value adjustments to intangible assets had been applied on January 1, 2015 and (ii) adjustments to amortized revenue during fiscal 2016 and 2015 as a result of the acquisition date valuation of assumed deferred revenue. The pro forma results for each period also reflect the pro forma adjustment to
interest expense as a result of the issuance of new debt to finance the acquisition and elimination of Healthland debt in conjunction with the acquisition.
The Company incurred $5.5 million in 2016 acquisition-related costs, which are included in general and administrative expense in the Company’s statement of income for the year ended December 31, 2016, that is reflected in pro forma net income for the year ended December 31, 2015. Severance and integration costs of $2.7 million were not included in the acquisition costs for the purpose of calculating the pro forma results.
4. INVESTMENTS
The Company did not have investments at December 31, 2016. Investments were comprised of the following at December 31, 2015:
The following table shows the Company’s investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous loss position at December 31, 2015:
5. PROPERTY AND EQUIPMENT
Property and equipment were comprised of the following at December 31, 2016 and 2015:
6. OTHER ACCRUED LIABILITIES
Other accrued liabilities were comprised of the following at December 31, 2016 and 2015:
The accrued contingent consideration depicted above represents the potential earnout incentive for former Rycan shareholders related to the purchase of Rycan by HHI in 2015. We have estimated the fair value of the contingent consideration based on the amount of revenue we expect to be earned by Rycan through the year ending December 31, 2018.
7. NET INCOME PER SHARE
The Company presents basic and diluted earnings per share ("EPS") data for its common stock. Basic EPS is calculated by dividing the net income attributable to stockholders of the Company by the weighted average number of shares of common stock outstanding during the period. Diluted EPS is determined by adjusting the net income attributable to stockholders of the Company and the weighted average number of shares of common stock outstanding during the period for the effects of all dilutive potential common shares, including awards under stock-based compensation arrangements.
The Company's unvested restricted stock awards (see Note 9) are considered participating securities under FASB Codification topic, Earnings Per Share, because they entitle holders to non-forfeitable rights to dividends until the awards vest or are forfeited. When a company has a security that qualifies as a "participating security," the Codification requires the use of the two-class method when computing basic EPS. The two-class method is an earnings allocation formula that determines EPS for each class of common stock and participating security according to dividends declared (or accumulated) and participation rights in undistributed earnings. In determining the amount of net income to allocate to common stockholders, income is allocated to both common stock and participating securities based on their respective weighted average shares outstanding for the period, with net income attributable to common stockholders ultimately equaling net income less net income attributable to participating securities. Diluted EPS for the Company's common stock is computed using the more dilutive of the two-class method or the treasury stock method.
The following is a calculation of the basic and diluted EPS for the Company's common stock, including a reconciliation between net income and net income attributable to common stockholders:
8. INCOME TAXES
The Company accounts for income taxes in accordance with the FASB’s Codification topic, Income Taxes. These provisions require a company to determine whether it is more likely than not that a tax position will be sustained upon examination based on the technical merits of the position. If the more-likely-than-not threshold is met, a company must measure the tax position to determine the amount to recognize in the financial statements.
We applied these provisions to all tax positions for which the statute of limitations remained open. A reconciliation of the beginning and ending amount of unrecognized tax benefits for uncertain tax positions, included as a component of "Income taxes payable" or "Prepaid income taxes" (as determined by the status of the Company's overall federal and state income tax position at the respective balance sheet dates) within the consolidated balance sheets, is as follows:
The Company's uncertain tax positions have historically been limited to the uncertainty regarding the eventual sustainability of federal research and development tax credits claimed on historical federal returns. The federal returns for tax years 2004 through 2009 were previously under examination by the Internal Revenue Service ("IRS"), primarily in relation to such credits claimed on those returns. The IRS completed these examinations during 2015, resulting in enhanced clarity regarding the sustainability of our uncertain tax positions for all years. The completion of these examinations prompted a beneficial change in our measurement of reserves for uncertain tax positions. As a result, as of December 31, 2016, there is no amount of unrecognized tax benefits that, if recognized, would affect the tax rate.
The federal returns for tax years 2013 through 2015 remain open to examination, and the tax years 2012 through 2015 remain open to examination by certain other taxing jurisdictions to which the Company is subject.
Deferred income taxes arise from the temporary differences in the recognition of income and expenses for tax purposes. A valuation allowance is established when the Company believes that it is more likely than not that some portion of its deferred tax assets will not be realized. Deferred tax assets and liabilities were comprised of the following at December 31, 2016 and 2015:
Significant components of the income tax provision for the years ended December 31, 2016, 2015 and 2014 were as follows:
The difference between income taxes at the U.S. federal statutory income tax rate of 35% and those reported in the consolidated statements of income for the years ended December 31, 2016, 2015 and 2014 are as follows:
Our effective tax rates for the years ended December 31, 2016, 2015 and 2014 were 50.75%, 28.04% and 33.81%, respectively. Our effective tax rate for the year ended December 31, 2016 was uncharacteristically high, primarily due to permanent non-deductible acquisition transaction costs of $3.8 million. The significantly reduced effective tax rate for the year ended December 31, 2015 is mostly due to beneficial adjustments recorded during 2015 related to our reserves for uncertain tax positions. As stated previously, the federal returns for tax years 2004 through 2009 had previously been under examination by the IRS, primarily in relation to research credits claimed on those returns. The IRS completed these examinations during 2015, consequently resulting in enhanced clarity regarding the sustainability of our uncertain tax positions for all years. The completion of these examinations prompted a change in our measurement of reserves for uncertain tax positions that benefited our effective tax rate by approximately 4.8% during 2015.
We have federal net operating loss carryfowards related to the acquisition of HHI of $82.9 million and $70.5 million at January 8, 2016 and December 31, 2016, respectively, which expire at various dates from 2028 to 2035. We have state net operating loss carryforwards related to the acquisition of HHI of $47.6 million and $46.5 million at January 8, 2016 and December 31, 2016, respectively, which expire at various dates from 2017 and 2035.
Realization of deferred tax assets associated with the state net operating loss carryforward is dependent upon generating sufficient taxable income prior to their expiration. We believe it is more likely than not that the benefit from certain state NOL carryforwards will not be realized. In recognition of this risk, we have provided a valuation allowance on the deferred tax assets related to these state NOL carryforwards of $1.6 million at January 8, 2016 and December 31, 2016.
9. STOCK-BASED COMPENSATION
The Company's stock-based compensation awards are in the form of restricted stock and performance share awards made pursuant to the Company's 2005 Restricted Stock Plan, 2012 Restricted Stock Plan for Non-Employee Directors, and 2014 Incentive Plan (the "Plans"). Stock-based compensation cost is measured at the grant date based on the fair value of the award, and is recognized as an expense over the employee’s or non-employee director’s requisite service period. As of December 31, 2016, there were a total of 351,437 shares of common stock reserved under the Plans for issuance under future share-based payment arrangements.
The following table details total stock-based compensation expense for the years ended December 31, 2016, 2015 and 2014, included in the consolidated statements of income:
As of December 31, 2016, there was $5.5 million of unrecognized compensation cost related to non-vested stock-based compensation arrangements granted under the Plans, which is expected to be recognized over a weighted-average period of 1.58 years.
Cash flows resulting from excess or deficient tax benefits are required to be classified as a part of cash flows from financing activities. Excess tax benefits are realized tax benefits from tax deductions for the vested portion of restricted stock awards that are in excess of the deferred tax asset attributable to stock compensation costs for such restricted stock awards. Conversely, deficient tax benefits are realized tax benefits from tax deductions for the vested portion of restricted stock awards that are less than the deferred tax asset attributable to stock compensation costs for such restricted stock awards. In addition to tax benefits related to the vested portion of restricted stock awards, the Company also pays dividends on unvested restricted stock. As a result, excess (deficient) tax benefits of approximately $210,000, $(176,000), $167,000, have been classified as financing cash inflows (outflows) for the years ended December 31, 2016, 2015 and 2014, respectively.
Restricted Stock
The Company grants restricted stock to executive officers, certain key employees and non-employee directors under the Plans with the fair value of the awards representing the fair value of the common stock on the date the restricted stock is granted. Shares of restricted stock generally vest in equal annual installments over the applicable vesting period, which ranges from one to five years. The Company records expenses for these grants on a straight-line basis over the applicable vesting periods.
A summary of restricted stock activity under the Plans during the years ended December 31, 2016, 2015 and 2014 is as follows:
Performance Share Awards
In 2014, the Company began to grant performance share awards to executive officers and certain key employees under the 2014 Incentive Plan. The number of shares of common stock earned and issuable under the award is determined at the end of each performance period, based on the Company's achievement of performance goals predetermined by the Compensation Committee of the Board of Directors at the time of grant. If certain levels of the performance criteria are met, the award results in the issuance of shares of restricted stock corresponding to such level, which shares are then subject to time-based vesting pursuant to which the shares of restricted stock vest in equal annual installments over the applicable vesting period, which is generally three years for restricted stock issued pursuant to performance share awards.
In the event that the Company's financial performance meets the predetermined target for the performance criteria, the Company will issue each award recipient the number of restricted shares equal to the target award specified in the individual's underlying performance share award agreement. In the event the financial results of the Company exceed the predetermined target, additional shares up to the maximum award may be issued. In the event the financial results of the Company fall below the predetermined target, a reduced number of shares may be issued. If the financial results of the Company fall below the threshold performance level, no shares will be issued.
The recipients of performance share awards do not receive dividends or possess voting rights during the performance period and, accordingly, the fair value of the performance share awards is the quoted market value of the Company stock on the grant date less the present value of the expected dividends not received during the relevant period. Expense is recognized using the accelerated attribution (graded vesting) method over the period beginning on the date the Company determines that it is probable that the performance criteria will be achieved and ending on the last day of the vesting period for the restricted stock issued in satisfaction of such awards. In the event the Company determines it is no longer probable that the minimum performance level will be achieved, all previously recognized compensation expense related to the applicable awards is reversed in the period such a determination is made.
A summary of performance share award activity under the 2014 Incentive Plan for the years ended December 31, 2016, 2015, and 2014, is as follows, based on the target award amounts set forth in the performance share award agreements:
10. CONCENTRATION OF CREDIT RISK
Financial instruments, which potentially subject the Company to concentration of credit risk, consist principally of temporary cash investments and trade receivables. The Company places its temporary cash investments with credit-worthy, high-quality financial institutions.
The Company’s customer base is concentrated in the healthcare industry. Customers are located throughout the United States. The Company requires no collateral or other security to support customer accounts receivable. An allowance for doubtful accounts has been established for potential credit losses based on historical collection experience.
The Company maintains its cash and cash equivalents in bank deposit accounts, which, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts and does not believe it is exposed to any significant credit risk on cash and cash equivalents.
11. FINANCING RECEIVABLES
Short-Term Payment Plans
The Company has sold information and patient care systems to certain healthcare providers under Second Generation Meaningful Use Installment Plans (see below) with maximum contractual terms of three years and expected terms of less than one year and other arrangements requiring fixed monthly payments over terms ranging from 3 to 12 months ("Fixed Periodic Payment Plans"). These receivables, collectively referred to as short-term payment plans and included in the current portion of financing receivables, were comprised of the following on December 31, 2016 and 2015:
The significant decrease in amounts due under short-term payment plans from December 31, 2015 to December 31, 2016 is due to those factors described under the caption "Second Generation Meaningful Use Installment Plans" below.
Sales-Type Leases
Additionally, the Company leases its information and patient care systems to certain healthcare providers under sales-type leases expiring in various years through 2023. These receivables typically have terms from two to seven years, bear interest at various rates, and are usually collateralized by a security interest in the underlying assets. Since the Company has a history of successfully collecting amounts due under the original payment terms of these extended payment arrangements without making any concessions to its customers, the Company satisfies the requirement for revenue recognition. The Company’s history with these types of extended payment term arrangements supports management’s assertion that revenues are fixed and determinable and collection is probable.
The components of these lease receivables were as follows on December 31:
Future minimum lease payments to be received subsequent to December 31, 2016 are as follows:
Credit Quality of Financing Receivables and Allowance for Credit Losses
The following table is a roll-forward of the allowance for financing credit losses for the years ended December 31, 2016 and 2015:
The Company’s financing receivables are comprised of a single portfolio segment, as the balances are all derived from short-term payment plan arrangements and sales-type leasing arrangements within our target market of rural and community hospitals. The Company evaluates the credit quality of its financing receivables based on a combination of factors, including, but not limited to, customer collection experience, economic conditions, the customer’s financial condition, and known risk characteristics impacting the respective customer base of rural and community hospitals, the most notable of which relate to enacted and potential changes in Medicare and Medicaid reimbursement rates as rural and community hospitals typically generate a significant portion of their revenues and related cash flows from beneficiaries of these programs. In addition to specific account identification, the Company utilizes historical collection experience to establish the allowance for credit losses. Financing receivables are written off only after the Company has exhausted all collection efforts. The Company has been successful in collecting its financing receivables and considers the credit quality of such arrangements to be good, especially as the underlying assets act as collateral for the receivables.
Customer payments are considered past due if a scheduled payment is not received within contractually agreed upon terms. To facilitate customer collection and credit monitoring efforts, financing receivable amounts are invoiced and reclassified to trade accounts receivable when they become due, with all invoiced amounts placed on nonaccrual status. As a result, all past due amounts related to the Company’s financing receivables are included in trade accounts receivable in the accompanying consolidated balance sheets. The following is an analysis of the age of financing receivables amounts (excluding short-term payment plans) that have been reclassified to trade accounts receivable and were past due as of December 31, 2016 and December 31, 2015:
From time to time, the Company may agree to alternative payment terms outside of the terms of the original financing receivable agreement due to customer difficulties in achieving the original terms. In general, such alternative payment arrangements do not result in a re-aging of the related receivables. Rather, payments pursuant to any alternative payment arrangements are applied to the already outstanding invoices beginning with the oldest outstanding invoices as the payments are received.
Because amounts are reclassified to trade accounts receivable when they become due, there are no past due amounts included within the financing receivables or the financing receivables, current portion, net amounts in the accompanying consolidated balance sheets.
The Company utilizes an aging of trade accounts receivable as the primary credit quality indicator for its financing receivables, which is facilitated by the reclassification of customer payment amounts to trade accounts receivable when they become due. The table below categorizes customer financing receivable balances (excluding short term payment plans), none of which are considered past due, based on the age of the oldest payment outstanding that has been reclassified to trade accounts receivable:
First Generation Meaningful Use Installment Plans
During 2012, the Company entered into multiple customer license agreements with payment terms requiring the customer to remit to the Company incentive payments (not to exceed the remaining balance of the contract price) received under the American Recovery and Reinvestment Act of 2009 (the "ARRA") for adoption of qualifying electronic health records ("EHRs"), with only nominal payment amounts required until the customer’s receipt of such incentive payments ("First Generation Meaningful Use Installment Plans"). If no such incentive payments are received by the customer or if such payments are not sufficient to pay the remaining balance under the arrangement, payments continue at contracted nominal amounts until the balance of the contract price is paid in full. Because of the significant difference in the underlying economics of these arrangements compared to our historical financing receivables, management determined that these arrangements were not comparable to historical arrangements. In accordance with the Software topic and Revenue Recognition subtopic of the Codification, the Company recognized revenue related to these arrangements as the amounts become due. Cash flows from these First Generation Meaningful Use Installment Plans are excluded from the Company’s financing receivables and deferred revenue in the accompanying consolidated balance sheets. As of the year ending December 31, 2016, all anticipated cash flows from these First Generation Meaningful Use Installment Plans have been collected.
Second Generation Meaningful Use Installment Plans
Beginning in the fourth quarter of 2012, we ceased offering First Generation Meaningful Use Installment Plans to our customers, opting instead for license agreements with payment terms that provide us with greater visibility into and control over the customer’s meaningful use attestation process and significantly reducing the maximum timeframe over which customers must satisfy their full payment obligations in purchasing our system (“Second Generation Meaningful Use Installment Plans”). As the overall payment period durations of the Second Generation Meaningful Use Installment Plans are consistent with that of our historical system sale financing arrangements, revenues under the Second Generation Meaningful Use Installment Plans are recognized upon installation of our EHR solution. Although these arrangements provide for a maximum payment term of three years, management has determined the expected term for these arrangements to be less than one year due to (a) historical collection patterns of required EHR incentive payment amounts and (b) the estimated significance of those amounts, the receipt of which is expected to result in minimal or no remaining balance for the related arrangements. As a result, all related amounts are included as a component of financing receivables, current portion, net in the accompanying consolidated balance sheets and as a component of short-term payment plans within this Note 11.
The reduction of incentive amounts available in each successive year under the ARRA's EHR incentive program has naturally resulted in these arrangements losing their economic appeal to both the Company and our customers, resulting in decreased demand from our customers for Second Generation Meaningful Use Installment Plans and a decreased willingness on our part to finance the purchase of our solutions through such arrangements. This decreased demand, coupled with payments received under such arrangements during the year ended December 31, 2016, has resulted in the overall significant decrease in our financing receivables balance related to short-term payment plans from December 31, 2015 to December 31, 2016.
12. INTANGIBLE ASSETS AND GOODWILL
Our purchased definite-lived intangible assets as of December 31, 2016 are summarized as follows:
The following table represents the remaining amortization of definite-lived intangible assets as of December 31, 2016:
The following table sets forth the change in the carrying amount of goodwill by segment for the year ended December 31, 2016:
13. LONG-TERM DEBT
There was no long-term debt at December 31, 2015. Long-term debt was comprised of the following at December 31, 2016:
As of December 31, 2016, the carrying value of debt approximates the fair value due to the variable interest rate.
Credit Agreement
In conjunction with our acquisition of HHI on January 8, 2016, we entered into a syndicated credit agreement on the same date (the "Credit Agreement"), with Regions Bank ("Regions") serving as administrative agent, which provided for a $125,000,000 term loan facility (the "Term Loan Facility") and a $50,000,000 revolving credit facility ("Revolving Credit Facility"). The cash portion of the purchase price for HHI was partially funded by the $125,000,000 Term Loan Facility and $25,000,000 borrowed under the Revolving Credit Facility.
The Term Loan Facility bears interest at a rate per annum equal to an applicable margin plus (1) the Adjusted LIBOR rate for the relevant interest period, (2) an alternate base rate determined by reference to the greatest of (a) the prime lending rate of Regions, (b) the federal funds rate for the relevant interest period plus one half of one percent per annum and (c) the one-month LIBOR rate plus one percent per annum, or (3) a combination of (1) and (2). Interest on the outstanding principal of the Term Loan Facility is payable on the last day of each month, in the case of each base rate loan, and on the last day of each interest period (but no less frequently than every three months), in the case of LIBOR loans. Principal payments are due on the last day of each fiscal quarter beginning March 31, 2016, with the remainder due at maturity on January 8, 2021 (the "Maturity Date"). Anticipated annual future maturities of the Term Loan Facility, Revolving Credit Facility, and capital lease obligation are as follows as of December 31, 2016:
Borrowings under the Revolving Credit Facility bear interest at a rate similar to that of the Term Loan Facility, with interest payment dates similar to that of the Term Loan Facility. The Revolving Credit Facility includes a $5 million swingline sublimit, with swingline loans bearing interest at the alternate base rate plus the applicable margin. Any principal outstanding under the Revolving Credit Facility is due and payable on the Maturity Date.
The Term Loan Facility and amounts borrowed under the Revolving Credit Facility are secured pursuant to a Pledge and Security Agreement, dated January 8, 2016, among the parties identified as Obligors therein and Regions, as collateral agent (the “Security Agreement”), on a first priority basis by a security interest in substantially all of the tangible and intangible assets (subject to certain exceptions) of the Company and certain subsidiaries of the Company, as guarantors (collectively, the “Subsidiary Guarantors”), including certain registered intellectual property and the capital stock of certain
of the Company’s direct and indirect subsidiaries. Our obligations under the Credit Agreement are also guaranteed by the Subsidiary Guarantors.
The Credit Agreement provides incremental facility capacity of $50 million, subject to certain conditions. The Credit Agreement includes a number of restrictive covenants that, among other things and in each case subject to certain exceptions and baskets, impose operating and financial restrictions on the Company and the Subsidiary Guarantors, including the ability to incur additional debt; incur liens and encumbrances; make certain restricted payments, including paying dividends on its equity securities or payments to redeem, repurchase or retire its equity securities; enter into certain restrictive agreements; make investments, loans and acquisitions; merge or consolidate with any other entity; dispose of assets; enter into sale and leaseback transactions; engage in transactions with its affiliates; and materially alter the business it conducts. In addition, the Company is required to comply with a minimum fixed charge coverage ratio throughout the duration of the Credit Agreement and a maximum consolidated leverage ratio. The Credit Agreement also contains customary representations and warranties, affirmative covenants and events of default.
The Credit Agreement requires the Company to mandatorily prepay the Term Loan Facility and amounts borrowed under the Revolving Credit Facility with (i) 100% of net cash proceeds from certain sales and dispositions, subject to certain reinvestment rights, (ii) 100% of net cash proceeds from certain issuances or incurrences of additional debt, (iii) 50% of net cash proceeds from certain issuances or sales of equity securities, subject to a step down to 0% if the Company’s consolidated leverage ratio is no greater than 2.50:1.0, and (iv) beginning with the fiscal year ending December 31, 2016, 50% of excess cash flow (minus certain specified other payments), subject to a step down to 0% of excess cash flow if the Company’s consolidated leverage ratio is no greater than 2.50:1.0. The Company is permitted to voluntarily prepay the Term Loan Facility and amounts borrowed under the Revolving Credit Facility at any time without penalty, subject to customary “breakage” costs with respect to prepayments of LIBOR rate loans made on a day other than the last day of any applicable interest period. As of December 31, 2016, we believe that we were in compliance with all debt covenants contained in the Credit Agreement.
14. BENEFIT PLANS
In January 1994, the Company adopted the CPSI 401(k) Retirement Plan that covers all eligible employees of the Company who have completed one year of service. The plan allows eligible employees to contribute up to 60% of their pre-tax earnings up to the statutory limit prescribed by the Internal Revenue Service. The Company matches a discretionary amount determined by the Board of Directors. The Company contributed approximately $2.8 million, $2.2 million, and $2.2 million to the plan for the years ended December 31, 2016, 2015 and 2014, respectively.
The Company provides certain health and medical benefits to eligible employees, their spouses and dependents pursuant to a benefit plan funded by the Company. Each participating employee contributes to the Company’s costs associated with such benefit plan. The Company’s obligation to fund this benefit plan and pay for these benefits is limited through the Company’s purchase of an insurance policy from a third-party insurer. The amount established as a reserve is intended to recognize the Company’s estimated obligations with respect to its payment of claims and claims incurred but not yet reported under the benefit plan. Management believes that the recorded liability for medical self-insurance at December 31, 2016 and 2015 is adequate to cover the losses and claims incurred, but these reserves are based on estimates and the amount ultimately paid may be more or less than such estimates.
15. OPERATING LEASES
The Company leased office space during 2016 in various locations in Alabama, Louisiana, Pennsylvania, Minnesota, Colorado, Tennessee, and Mississippi. These leases have terms expiring from 2016 through 2024 but do contain optional extension terms.
The future minimum lease payments payable under these operating leases subsequent to December 31, 2016 are as follows:
Total rent expense for the years ended December 31, 2016, 2015, and 2014 was $2.7 million, $1.0 million, $0.9 million, respectively.
16. COMMITMENTS AND CONTINGENCIES
From time to time, the Company is involved in routine litigation that arises in the ordinary course of business. Management does not believe it is reasonably possible that such matters will have a material adverse effect on the Company’s financial statements.
17. FAIR VALUE
FASB Codification topic, Fair Value Measurements and Disclosures, establishes a framework for measuring fair value and expands financial statement disclosures about fair value measurements. Fair value is the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. The Codification topic does not require any new fair value measurements, but rather applies to all other accounting pronouncements that require or permit fair value measurements. The Codification topic requires that assets and liabilities carried at fair value be classified and disclosed in one of the following three categories:
Level 1: Quoted market prices in active markets for identical assets or liabilities.
Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data.
Level 3: Unobservable inputs that are not corroborated by market data.
The Company did not have available-for-sale securities at December 31, 2016. The accrued contingent consideration depicted below represents the potential earnout incentive for former Rycan shareholders, relating to the purchase of Rycan by HHI in 2015. We have estimated the fair value of the contingent consideration based on the amount of revenue we expect to be earned by Rycan through the year ending December 31, 2018. The Company did not have a contingent consideration liability at December 31, 2015.
The fair values of the Company’s available-for-sale securities are based on matrix pricing for the year ended December 31, 2015, which uses observable market-based inputs (such as benchmark yields) in addition to quoted prices in active markets to derive fair values. As a result, these inputs are classified as Level 2 within the fair value hierarchy. We generally apply fair value techniques on a non-recurring basis associated with (1) valuing potential impairment loss related to financing receivables accounted for pursuant to Codification topic, Leases, and (2) valuing potential impairment loss related to long-
lived assets accounted for pursuant to Codification topic, Property, Plant and Equipment, when events or circumstances indicate a possible impairment.
The following table summarizes the carrying amounts and fair values of certain assets at December 31, 2015:
The carrying amount of other financial instruments reported in the consolidated balance sheets for current assets and current liabilities approximates their fair values because of the short-term nature of these instruments.
18. SEGMENT REPORTING
In connection with our acquisition of HHI, we re-evaluated our methodology for allocating revenues and cost of sales and chose to allocate these items to three operating segments which better align with the reporting structure utilized by our chief operating decision makers ("CODM") in the management of resource allocation and performance assessment. Our Chief Executive Officer and Chief Growth Officer are the Company's CODM. Effective for our first quarter of 2016, we revised our reportable segments. Prior to this change, we used one reportable segment.
We now utilize three operating segments, "Acute Care EHR", "Post-acute Care EHR" and "TruBridge, Rycan, and Other Outsourcing", based on our three distinct business units with unique market dynamics and opportunities. Revenues and cost of sales are primarily derived from the provision of services and sales of our proprietary software, and our CODM assesses the performance of these three segments at the gross profit level. Operating expenses and items such as interest, income tax, capital expenditures and total assets are managed at a consolidated level and thus are not included in our operating segment disclosures. Accounting policies for each of the reportable segments are the same as those used on a consolidated basis.
The following table presents a summary of the revenues and gross profits of our three operating segments for the year ended December 31, 2016, 2015 and 2014:
19. SUBSEQUENT EVENTS
Declaration of Dividends
On February 9, 2017, the Company announced a dividend for the first quarter of 2017 in the amount of $0.25 per share. The dividend was paid on March 10, 2017 to stockholders of record as of the close of business on February 23, 2017.
20. QUARTERLY FINANCIAL STATEMENTS (UNAUDITED)
The following table presents a summary of our results of operations for our eight most recent quarters ended December 31, 2016. The information for each of these quarters is unaudited and has been prepared on a basis consistent with the audited financial statements. This information includes all adjustments, consisting only of normal recurring adjustments, we consider necessary for fair presentation of this information when read in conjunction with the audited financial statements and related notes. Our operating results have varied on a quarterly basis and may fluctuate significantly in the future.
SCHEDULE II
COMPUTER PROGRAMS AND SYSTEMS, INC.
VALUATION AND QUALIFYING ACCOUNTS
(In thousands)
(1)
Adjustments to allowance for change in estimates.
(2)
Uncollectible accounts written off, net of recoveries.
(1)
Adjustments to allowance for change in estimates.
(2)
Uncollectible accounts written off, net of recoveries.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES.
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to provide reasonable assurance that the information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), is recorded, processed, summarized and reported within the time periods specified in the rules and forms promulgated by the Securities and Exchange Commission, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Because of the inherent limitations to the effectiveness of any system of disclosure controls and procedures, no evaluation of disclosure controls and procedures can provide absolute assurance that all control issues and instances of fraud, if any, with a company have been prevented or detected on a timely basis. Even disclosure controls and procedures determined to be effective can only provide reasonable assurance that their objectives are achieved.
As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) pursuant to Rule 13a-15 of the Exchange Act. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective as of December 31, 2016 due to the material weaknesses in internal control over financial reporting related to our business combinations processes.
Remediation of Previously Identified Material Weakness
During the year ended December 31, 2016, we implemented internal control procedures to address previously identified material weaknesses related to the revenue recognition of one of the entities acquired in the HHI acquisition. In connection with the identification of material weaknesses in our internal control over financial reporting, we evaluated, designed and implemented controls and procedures to address these weaknesses. These measures included:
•
Converting the billing processes and systems for the affected HHI revenue streams to CPSI-legacy billing processes and systems to provide transaction-level controls enforcing revenue recognition upon delivery (as required by U.S. GAAP) as opposed to billing;
•
Implementing monitoring controls over the affected HHI revenue streams, similar to those already implemented for CPSI-legacy revenue streams, as an additional proof of the effectiveness of the aforementioned transaction-level controls; and
•
Improving our control environment by enforcing to our accounting and financial reporting personnel and select members of management the necessity for sound revenue recognition practices, beginning at the transaction-level, and ensure that the appropriate individuals within management with the appropriate knowledge and experience are involved in any decisions related to billing practices that deviate from our standard billing processes and systems.
As of the end of the previous fiscal 2016 interim periods, we had not yet determined that these internal control changes had operated effectively for a sufficient period of time to conclude that the material weaknesses previously identified had been remediated. During the fourth quarter of our year ended December 31, 2016, we completed our assessment of the operating effectiveness of these controls. After completing our assessment of the design and operating effectiveness of these new controls and procedures, we concluded that we have remediated the previously identified material weaknesses as of December 31, 2016.
Material Weakness - Business Combinations
During the three months ended December 31, 2016, the Company identified a material weakness related to the Company’s business combination process. The Company identified deficiencies in its controls over review of third-party valuations and properly establishing and accounting for opening balance sheet amounts. Due to the complexity and materiality of the transaction and the subjectivity of the estimates inherent in the process, management has concluded that these processes potentially would not prevent or detect a material misstatement on a timely basis. A potential misstatement would primarily affect the value recorded for goodwill and purchased intangibles, and to a lesser extent, other purchased assets, and the depreciation and amortization associated with those assets.
We are currently evaluating the controls and procedures we will design and put in place to address and remediate this material weakness and plan to implement appropriate measures as part of this effort. These controls and procedures may include engagement of independent consultants to aid the Company in its review of future business combinations for proper accounting, conducting training sessions for key financial personnel regarding the acquisition accounting, or implementing additional review procedures over the business combination accounting related to the overall completeness and accuracy of third-party valuation. We have do not regularly conclude business combinations, so it is uncertain as to when we will be able to remedy this material weakness. Successful remediation of this material weakness requires review and evidence of the effectiveness of the related internal control processes as part of our periodic assessments of our internal control over financial reporting. As we continue to evaluate and work to enhance our internal control over financial reporting, we may determine that additional measures should be taken to address the material weakness described above or other control deficiencies, or that we should modify the remediation plan.
Changes in Internal Control over Financial Reporting
On January 8, 2016, we acquired Healthland Holding Inc. ("HHI"), as further described in Note 3 of the notes to the consolidated financial statements. We continue to integrate policies, processes, people, technology and operations for our combined operations, and we will continue to evaluate the impact of any related changes to internal control over financial reporting during the fiscal year.
Except for any changes in internal controls related to the integration of the HHI businesses into CPSI, such as the addition of internal controls related to debt, intangible assets, goodwill and consolidation, and the steps taken to remediate the material weaknesses identified above, there were no other changes in the Company’s internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)) during the year ended December 31, 2016 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Consistent with the guidance issued by the Securities and Exchange Commission that an assessment of internal control over financial reporting of a recently acquired business may be omitted from management’s evaluation, management has excluded from its assessment Rycan Technologies, Inc., which we acquired on January 8, 2016. The assets of Rycan Technologies, Inc. excluded from our assessment represented less than 1% of the Company’s total assets as of December 31, 2016 and approximately 3% of the Company’s consolidated total revenues for the year ended December 31, 2016.
Management’s Annual Report on Internal Control Over Financial Reporting
This report is included in Item 8 on page 56 and is incorporated herein by reference.
Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting
This report is included in Item 8 on page 57 and is incorporated herein by reference.
ITEM 9B.
ITEM 9B.
OTHER INFORMATION.
None.
PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
We have adopted a Code of Business Conduct and Ethics applicable to all of our directors, officers (including our Chief Executive Officer and senior financial officers) and employees. We have also adopted a separate code of ethics with additional guidelines and responsibilities applicable to our Chief Executive Officer and senior financial officers, known as the Code of Ethics for CEO and Senior Financial Officers. Copies of the Code of Business Conduct and Ethics and the Code of Ethics for CEO and Senior Financial Officers are available on CPSI’s web site at www.cpsi.com in the "Corporate Information" section under "Corporate Governance."
Other information required by this Item regarding executive officers is included in Part I of this Form 10-K under the caption "Executive Officers" in accordance with Instruction 3 of the Instructions to Paragraph (b) of Item 401 of Regulation S-K.
Other information required by this Item is incorporated by reference pursuant to General Instruction G(3) of Form 10-K from CPSI’s definitive Proxy Statement for the 2017 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A.
The information required by this Item is incorporated by reference pursuant to General Instruction G(3) of Form 10-K from CPSI’s definitive Proxy Statement for the 2017 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this Item is incorporated by reference pursuant to General Instruction G(3) of Form 10-K from CPSI’s definitive Proxy Statement for the 2017 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A.
Securities Authorized for Issuance Under Equity Compensation Plans
Information regarding securities authorized for issuance under our equity compensation plans is incorporated by reference to the Proxy Statement for the 2017 Annual Meeting of Stockholders of the Company (the "2017 Proxy Statement") to be filed by the Company with the SEC under the Exchange Act.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this Item is incorporated by reference pursuant to General Instruction G(3) of Form 10-K from CPSI’s definitive Proxy Statement for the 2017 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this Item is incorporated by reference pursuant to General Instruction G(3) of Form 10-K from CPSI’s definitive Proxy Statement for the 2017 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)(1) and (2) and (c) - Financial Statements and Financial Statement Schedules.
Financial Statements: The Financial Statements and related Financial Statements Schedule of CPSI are included herein in Part II, Item 8.
(a)(3) and (b) - Exhibits.
The exhibits listed on the Exhibit Index beginning on page 97 of this Form 10-K are filed herewith or are incorporated herein by reference.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, on this the 15th day of March, 2017.
COMPUTER PROGRAMS AND SYSTEMS, INC.
By:
/s/ J. Boyd Douglas
J. Boyd Douglas
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Exhibit Index
*
Management compensation plan or arrangement