Item 1.
Business.
The information provided in this Annual Report on Form 10-K for the year ended December 31, 2015, including the consolidated financial statements and notes thereto, is that of Aurora Diagnostics Holdings, LLC and its subsidiaries and affiliates. The terms “we,” “us,” “our,” “Aurora Diagnostics,” “Aurora Holdings,” and the “Company” typically refer to Aurora Diagnostics Holdings, LLC and its subsidiaries, as well as the professional associations and professional corporations which are separate legal entities that it controls through contractual arrangements.
Corporate History
We were organized in the State of Delaware as a limited liability company on June 2, 2006 to develop and operate as a diagnostic services company. We have grown our business significantly since our founding, driven largely by the acquisition of local and regional pathology laboratories across the United States within these acquired operations. Since our formation, we have completed 28 acquisitions of diagnostic services companies and currently operate 24 primary laboratory locations across the United States.
Overview
We are a specialized diagnostics company providing services that play a key role in the diagnosis of cancer and other diseases. Our experienced pathologists deliver comprehensive diagnostic reports of a patient’s condition and consult frequently with referring physicians to help determine the appropriate treatment. Our diagnostic reports often enable the early detection of disease, allowing referring physicians to make informed and timely treatment decisions that improve their patients’ health in a cost-effective manner.
We are a leading specialized diagnostics company, focused on the anatomic pathology market. We are well-positioned in the higher-growth subspecialties of anatomic pathology, with a leading market position in dermatopathology and in the women’s health pathology subspecialty, and a growing market position in hematopathology and hospital pathology services. Our strengths in anatomic pathology are complemented by our specialized clinical and molecular diagnostics offerings, which enable us to provide a broad selection of diagnostic services to our referring physicians.
Substantially all of our consolidated net revenue for each of the years ended December 31, 2013, 2014 and 2015 resulted from providing diagnostic related services to our clients. The majority of our revenue in 2015 was derived from providing diagnostic related services in the non-hospital outpatient channel of the anatomic pathology market. We also have contracts with 81 hospitals under which we provide inpatient and outpatient professional anatomic pathology services. For some of our hospital contracts, we also provide medical director services and technical slide preparation services.
Our business model builds upon the expertise of our experienced pathologists to provide seamless, reliable and comprehensive pathology and molecular diagnostics offerings to referring physicians. We typically have established long-standing relationships with our referring physicians as a result of focused localized delivery of diagnostic services, personalized responses and frequent consultations, and flexible information technology, or IT, solutions that are customizable to our clients’ needs. Our IT and communications platform enables us to deliver routine diagnostic reports to our clients generally within 24 hours of specimen receipt, helping to improve patient care. In addition, our IT platform enables us to track and monitor volume trends from referring physicians.
Through a series of strategic acquisitions, we have achieved a national footprint and a leading presence in our local markets, upon which we are building a more integrated and larger-scale diagnostics company. Currently, with 24 primary laboratories across the United States, we have reached a scale that has enabled us to process approximately 2.1 million accessions for the year ended December 31, 2015.
Our Services
Anatomic pathology typically requires a pathologist to make a specific diagnosis. Anatomic pathologists are medical doctors who specialize in the study of disease. Anatomic pathologists do not treat patients, but rather assist other physicians in determining the correct diagnosis of their patient’s ailments. A pathologist’s diagnosis represents a critical factor in determining a patient’s future care. In addition, anatomic pathologists may consult with attending physicians regarding treatment plans. In these capacities, the anatomic pathologist often serves as the “physician’s physician,” thereby creating long-term relationships.
Anatomic pathologists perform their duties in laboratories, including independent free-standing local laboratories, hospital laboratories, regional and national laboratories, in ambulatory surgery centers and in a variety of other settings. Referring physicians take specimens from patients, and those specimens are transported to a laboratory by courier or an overnight delivery service. Once received at the laboratory, a specimen is processed and mounted onto a slide by laboratory technologists for examination by a pathologist. Once the pathologist examines a specimen, the pathologist typically records the results of testing performed in the form of a report to be transmitted to the referring physician. Since specimens are transportable and technology facilitates communication, samples can be diagnosed by a pathologist from a remote location. Therefore, pathologists are generally not needed “on-site” to make a diagnosis. This enhances utilization of available capacity in outpatient and inpatient laboratories and allows the practice to service a wider geographic area.
An anatomic pathologist must have an understanding of a broad range of medicine. An anatomic pathologist may perform diagnostic testing services for a number of subspecialty testing markets such as dermatopathology, urologic pathology, women’s health pathology, gastrointestinal pathology, hematopathology or surgical pathology. While physical examination or radiology procedures may suggest a diagnosis for many diseases, the definitive diagnosis is generally established by the anatomic pathologist.
As a result of recent emphasis on personalized medicine and the resultant successes of targeted therapies, human biospecimens are in high demand and now required for most phases of the drug and diagnostic development process - from preclinical discovery experiments through late-stage clinical validation studies. Launched in April of 2013, the Aurora Research Institute (ARI) leverages Aurora’s nationwide network of 155 pathologists, 24 specialty laboratories, and 81 hospital affiliates to further therapeutic and diagnostic research and development efforts in markets across the United States. ARI specializes in providing contract research services and bio specimens to pharmaceutical and diagnostic companies conducting research studies. This access along with expert pathologist consultations in all subspecialties of pathology is a valuable resource to pharmaceutical, biotech, and medical device companies engaged in research or product validation studies. ARI has grown since its launch in 2013, completing more than 200 projects during 2015.
Sales and Marketing; Client Service
The selection of a pathologist to perform diagnostic testing services is primarily made by individual referring physicians. We maintain a sales and marketing team of 85 professionals who are highly-trained and organized by subspecialty to better meet the needs of our referring physicians. We have designed our compensation structure to incentivize our sales representatives to not only secure new physician clients, but also to maintain and enhance relationships with existing physician clients. As a result, our sales and marketing team has enabled us to expand nationally and leverage our extensive offering of diagnostic services across our markets.
We currently focus our marketing and sales efforts primarily on dermatologists, urologists and gynecologists, as well as gastroenterologists, hematologists and oncologists. The physicians on which our marketing and sales efforts are focused include both non-hospital-based and hospital-based physicians. Our sales representatives concentrate on a geographic area based on the number of existing clients and client prospects, which we identify using several national physician databases that provide physician address information, patient demographic information and other data.
At the beginning of a new client relationship, one of our sales representatives visits a prospective physician client and describes in detail our differentiated service offerings, focusing on our experienced pathologists, local presence, rapid turn-around times, comprehensive diagnostic reports, client service and IT solutions. Our sales representatives focus on the specialties offered by their respective divisions, which allows them not only to discuss our specialized diagnostic services, but also to describe diagnostic developments and new products and technologies in their practice areas.
We also maintain a client service team of 46 professionals who are highly-trained and organized by subspecialty. Our dedicated client service team provides ongoing support to our clients and, in particular, the office staff of our referring physicians. Our client service team enables us to augment the long-standing relationships between our pathologists and their clients to maintain a more stable base of referrals. These service teams provide our clients with a personal, knowledgeable and consistent point of contact within our company. Client service team members coordinate the provision of services, ensure testing supplies are replenished, answer administrative and billing questions, and resolve service issues. We believe these additional client contacts greatly enhance client satisfaction and strengthen overall client relationships.
We offer a comprehensive test menu so each physician specialist can order the best test available to make an accurate diagnosis and appropriate treatment decisions. We currently focus our marketing and sales efforts by subspecialty. Our product offerings have been developed to meet the unique needs of each subspecialty. Our representatives are extensively trained in the specific subspecialty they service and are knowledgeable about our test offerings and new diagnostic technologies available in the market by subspecialty. This provides additional value to our physician clients and their staff, as our representatives become a resource to our client’s practice.
Dermatopathology accounted for approximately 43 percent of our revenue in 2015, and the remaining 57 percent of our revenue primarily consisted of other subspecialties, including urology, gastroenterology, hematology oncology, women’s health pathology and hospital pathology services. Our operational, marketing and sales efforts are, in general, organized and focused on subspecialties.
Relationships with Referring Physicians and Third-Party Payors
Substantially all of our revenue consists of payments or reimbursements for specialized diagnostic services rendered to referring physicians. Our referring physicians, whom we refer to as our clients, are our primary customers. No single group of our clients accounted for a number of referrals in 2015 that was material to us. Accordingly, we are not dependent on any single or small group of our clients for referrals, revenue or otherwise. We receive referrals at the discretion of our clients, and our clients are under no obligation to make referrals to us. Furthermore, we generally have no contractual or other formalized legal arrangements with our clients.
We receive most of our revenue in the form of reimbursement from third-party payors. While third-party payors are not our clients or customers, our contractual arrangements with third-party payors, along with the customer relationships and the specific services we provide, enable the generation of our revenue. Accordingly, such arrangements are, in the aggregate, material to us.
For the year ended December 31, 2015, based on cash collections, we derived approximately 58 percent of our revenue from private insurance, including managed care organizations and other healthcare insurance providers. For the year ended December 31, 2015, none of these sources individually accounted for more than 10 percent of our revenue. While our reimbursements from private insurance sources are material to our business in the aggregate, we do not consider any individual private insurance source to be material to us.
We generally receive reimbursements from private third-party payors on a laboratory-by-laboratory basis. Our laboratories typically enter contracts with third-party payors that provide for us to be reimbursed at agreed-upon rates based on the services we perform. Our laboratories’ contracts with private insurers are typically subject to termination by the insurers for cause, including, among other things, upon our laboratories’ exclusion from government payor programs, and, in some cases, without cause. The insurers under such contracts typically have a right to change the applicable reimbursement rates we receive under the contract. In cases where our laboratories do not have contracts with particular private third-party payors, we receive reimbursements for services we perform at rates and on terms applicable to such payors’ out-of-network providers.
For the year ended December 31, 2015, based on cash collections, we derived approximately 24 percent of our revenue from government payor programs, including Medicare and Medicaid. Accordingly, reimbursements from government payor programs are material to our business. This makes our business dependent on our ability to participate in the government programs and on the reimbursement rates we receive under such programs.
We generally receive reimbursements from government third-party payors on a laboratory-by-laboratory basis. Our laboratories typically participate with government third-party payors that provide for us to be reimbursed at applicable rates based on the services we perform and other factors. Our laboratories’ participation with governmental payors are typically subject to termination by the government for cause, and our governmental payors have a right to change the applicable reimbursement rates we receive under such programs.
Competition
The anatomic pathology market is highly competitive. Competition in our industry is based on several factors, including price, clinical expertise, quality of service, third party payor contracts, client relationships, breadth of testing menu, speed of turnaround of test results, reporting and IT systems, reputation in the medical community and ability to employ qualified personnel. Our competitors include local and regional pathology groups, national laboratories, hospital-based pathology groups and specialty physician groups.
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Local and Regional Pathology Groups. Local and regional pathology groups typically provide a relatively narrow menu of test services to community physicians and, in certain cases, to hospital-based pathologists.
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National Laboratory Companies. National laboratories typically offer a full suite of tests for a variety of medical professionals, including general practitioners, hospitals and pathologists. National laboratories have identified anatomic pathology as a focus area for future growth and will continue to be a competitive challenge going forward.
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Hospital Pathologists. Pathologists working in hospitals typically provide most of the diagnostic services required for hospital inpatients and, sometimes, hospital outpatients. Hospital pathologists act as medical directors for the hospital’s clinical and histology laboratories. Typically, hospital pathologists provide these services to hospitals under exclusive and long-term contractual arrangements.
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Specialty Physician Groups. In recent years a number of specialty physician groups (dermatologists, urologists and gastroenterologists in particular) have built their own laboratories and in-sourced pathology services. This has been a significant source of competition in prior years and may continue to impact the anatomic pathology landscape in the future. However, decreases in reimbursement rates in recent years seem to have diminished this trend.
There is an evolving trend among pathologists to form larger practices to provide a broader range of outpatient and inpatient services and enhance the utilization of the practices’ pathologists. We believe this trend can be attributed to several factors, including cost containment pressures by governmental and other third-party payors, increased competition, managed care and the increased costs and complexities associated with operating a medical practice. Moreover, given the current trends of increasing outpatient services, outsourcing and the consolidation of hospitals, pathologists are seeking to align themselves with larger practices that can assist providers in the evolving health care environment. Larger practices can offer pathologists certain advantages, such as obtaining and negotiating contracts with hospitals and other providers, managed care providers and national clinical laboratories; marketing and selling of professional services; providing continuing education and career advancement opportunities; making available a broad range of specialists with whom to consult; providing access to capital and business and management experience; establishing and implementing more efficient and cost effective billing and collection procedures; and expanding the practice’s geographic coverage area. Each of these factors supports the pathologists in the efficient management of the complex and time-consuming non-medical aspects of their practice. As a result, we believe that there are substantial consolidation opportunities in the anatomic pathology market as smaller pathology providers seek access to the resources of diagnostics companies with a more comprehensive selection of services for referring physicians.
Seasonality
Our business is affected by seasonal trends and generally declines during summer and winter months, the year-end holiday period and other major holidays. Adverse weather conditions can also influence our business.
Information Systems
IT provides systems that streamline internal operations and provide customized IT solutions to meet the needs of our clients. We offer IT solutions primarily through our proprietary system, ConnectDx. ConnectDx is a customizable application platform that provides a gateway for delivering patient reports. We offer multiple electronic delivery channels that include electronic interfaces, client EMR interfacing and web portal capabilities. ConnectDx is the core hub that connects diagnosis outcomes for all Aurora Diagnostic customers. We support approximately 600 live client interfaces through 106 EMR vendors. We also provide traditional methods of patient report delivery which include local printed reports and faxing services.
Most of our IT solutions are implemented on a laboratory by laboratory basis. After an acquisition, we generally transition our acquired laboratories to a common accounting system and software package for financial processing and reporting within 60 days of closing. Generally, the LIS and billing platforms of our acquired laboratories, as well as all their day-to-day laboratory operations, continue to operate as they did pre-acquisition. We bill for our services using the existing billing systems of the acquired laboratories or, in some locations, we use an outsourced vendor to provide billing services.
Corporate Structure
We derive substantially all of our revenue from our laboratory practices, which we own either directly through our wholly owned subsidiaries or through contractual arrangements with our affiliated practices. The manner in which we acquire and operate a particular practice is determined primarily by the corporate practice of medicine restrictions of the state in which the practice is located and other applicable regulations. We exercise diligence and care in structuring our practices and arrangements with providers in an effort to comply with applicable federal and state laws and regulations, and we believe that our current practices and arrangements comply in all material respects with applicable laws and regulations. However, due to uncertainties in the law, there can be no assurance that our practices and arrangements would be deemed to be in compliance with applicable laws and regulations, and any noncompliance could result in a material adverse effect on us.
In 2015, we derived approximately 43 percent of our revenue from our affiliated practices. Through our contractual arrangements described below, our Board of Managers and management formulate strategies and policies which are implemented locally on a day-to-day basis by each of our affiliated practices. The following descriptions of our contractual arrangements with our affiliated practices are only summaries, which do not contain all of the information that may be important to you. For additional information, you should refer to the forms of our management, nominee, non-alienation and services agreements, copies of which have been filed as exhibits to our Registration Statement on Form S-4 filed with the SEC on September 12, 2011.
We have entered into long-term management agreements with each of our eleven affiliated practices, which are located in Massachusetts, Michigan, Minnesota, Nevada, Texas, North Carolina, South Carolina and Florida. Pursuant to these management agreements, we manage and control the non-medical functions of our affiliated practices, including:
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recruiting, training, employing and managing the technical and support staff;
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developing and equipping laboratory facilities;
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establishing and maintaining courier services to transport specimens;
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negotiating and maintaining contracts with hospitals, managed care organizations and other payors;
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providing financial reporting and administration, clerical, purchasing, payroll, billing and collection, information systems, sales and marketing, risk management, employee benefits, legal, tax and accounting services; and
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monitoring compliance with applicable laws and regulations.
Accordingly, our management agreements effectively give us total control over the operations of our affiliated practices, except with respect to decisions involving the medical judgment of our affiliated practices’ physicians. We do not control the medical diagnoses, medical treatments or other activities involving the exercise of medical judgment by our affiliated practices’ physicians.
From an operational standpoint, we typically prepare an annual operating plan for each of our affiliated practices pursuant to which the practice’s capital and operating budgets, scope and pricing of services, staffing and compensation of employees, support services, billing and collection procedures, patient acceptance policies and procedures, quality assurance and utilization assessment programs, compliance policies and risk management programs, and financial and strategic growth planning are established.
The scope of services for each affiliated practice is established in connection with the preparation of the practice’s annual operating plan, which we establish in consultation with and with the assistance of the practice’s laboratory director, who implements the practice’s operating plan and performs such other duties or requirements assigned by us.
The compensation of each affiliated practice’s licensed medical professionals is a component of the respective practice’s annual operating plan, which we prepare with the practice’s laboratory director as set forth above. The practice’s policies with respect to the retention of employees are also established by us and the practice’s laboratory director, provided that additional affiliated practice professionals may only be retained with our consent.
Each of our management agreements are long term contractual arrangements and cannot be terminated by our affiliated practice without cause. We receive a management fee from each of our affiliated practices for the services we provide pursuant to the management agreements. For nine of our affiliated practices, our management fee is equal to the practice’s net revenue less its expenses, which include physician salaries and other professional expenses. For the remaining two affiliated practices, our management fee is determined annually based on our estimate of each practice’s demand for management services during the upcoming year. For these practices, we may adjust the fee in the event that the services we provided were greater or less than the services that were anticipated. Subject to the requirements of applicable law, the adjustment of our management fees is entirely at our discretion.
We bear the economic risk associated with our affiliated practices. Under the provisions of our management agreements, we are generally obligated to pay all expenses of our affiliated practices, including any management fees, a portion of corporate overhead or other costs. We must absorb all losses of our affiliated practice entities. We are not entitled to recover, from the affiliated practices’ nominee owners, physicians or other parties, any losses incurred by our affiliated practices.
In addition, we have entered into contractual arrangements with the licensed physicians that own our affiliated practices. These contractual arrangements, which consist of nominee agreements and non-alienation agreements, govern the ownership of our affiliated practices by our physicians. These physicians may not vote or transfer their ownership interests in our affiliated practices or distribute or encumber the assets of our affiliated practices without our prior authorization. In addition, we have the irrevocable and unconditional right to cause the physicians to transfer their ownership interests in our affiliated practices to our designee for nominal consideration. Through these contractual arrangements, we maintain controlling voting and financial interests in our affiliated practices. Each of our affiliated practices is owned by physicians pursuant to these agreements with the exception of our laboratories in Nevada, where each of our affiliated practices is owned by a trust of which one of our wholly owned subsidiaries is the sole beneficiary.
We have acquired practices in Michigan, Massachusetts and in Texas, where the corporate practice of medicine is restricted by state law. In each case, we entered into a nominee agreement with one of the selling physicians, pursuant to which such physician holds the practice’s equity interest as our designated nominee on our behalf. We also, either directly or through one of our wholly owned subsidiaries, entered into a long-term management agreement with each of the affiliated practices on the terms described above, pursuant to which we manage and control the non-medical functions of the practices.
In Florida, which does not prohibit the corporate practice of medicine, we, through one of our wholly owned subsidiaries, directly purchased substantially all of the assets of a practice, including the fixed assets, customer lists, contract rights and goodwill and other intangibles of the practice. After consummation of the acquisition, we determined to enter into a non-alienation agreement with the shareholders of the professional entity from which we previously purchased assets, pursuant to which we acquired controlling voting and financial interests in the professional entity on terms substantially the same as our nominee agreements in Michigan and Texas. We also, through one of our wholly owned subsidiaries, entered into a long-term management agreement with the affiliated practice on terms substantially the same as our management agreements in Michigan and Texas.
We have practices in North Carolina, South Carolina and Minnesota, each of which restricts the corporate practice of medicine. In each case, we, through a wholly owned subsidiary, directly acquired the laboratory. Because we cannot directly employ physicians in these states, in each case the selling physicians formed a de novo physician group that employs our pathologists. Similar to our contractual arrangements with our affiliated practices in Michigan and Texas, we entered into nominee agreements with the physicians who hold the equity interests in the physician groups on our behalf, and we entered into long-term management agreements with the physician groups. In addition, each laboratory that we acquired entered into a long-term services agreement with the physician group, pursuant to which the physician group provides professional pathology services to our laboratory on an exclusive basis. Each of our services agreements has an initial term of 50 years and cannot be terminated by the physician group without cause. Under these services agreements, we pay each physician group a service fee approximately equal to the compensation and professional expenses attributable to our pathologists employed by the group.
In Nevada, where the corporate practice of medicine is restricted, we acquired all of the common stock of our affiliated practices through trusts. We, through one of our wholly owned subsidiaries, are the sole beneficiary of the trusts and receive all income from the trusts. We generally have the right, at our sole discretion, to replace the trustees, withdraw assets from the trusts, modify the terms of the trust agreements, or terminate the trusts and direct the trustees to distribute the income and any assets from the trusts. No assets of the trusts can be sold or otherwise disposed of without our consent. In addition, we entered into a long-term management agreement with each of our affiliated practices that are owned directly by the trusts. These agreements are substantially the same as our management agreements in other states.
In addition to the foregoing affiliated practices, in Alabama, which does not prohibit the corporate practice of medicine, we, through a wholly owned subsidiary, directly acquired a laboratory. Although we can directly employ physicians in Alabama, we contract with an unaffiliated de novo entity formed by the selling physicians that employs our pathologists. Similar to our practices in North Carolina, South Carolina and Minnesota, our laboratory entered into a long-term services agreement with the unaffiliated physician group, pursuant to which the physician group provides professional pathology services to our laboratory on an exclusive basis. In contrast to our practices in North Carolina, South Carolina and Minnesota, however, we did not enter into a nominee or management agreement with the physician group. While we do not have a controlling voting or financial interest in the physician group, we have the right to consult with the physician group regarding business decisions and to approve or disapprove the retention or discharge of all employees by the physician group. The services agreement has an initial term of 25 years and cannot be terminated by the physician group without cause. We currently pay the physician group a service fee based upon a percentage of revenue, subject to a minimum, as defined in the agreement.
Our affiliated practice entities are included in our consolidated financial statements, which can be found in Part II, Item 8 of this Annual Report.
Contracts and Relationships with Providers
We employ our pathologists, control the practice entities that employ our pathologists or contract with pathologists on an independent contractor basis to provide diagnostic services in our laboratories. While we exercise legal control over our practices, we do not exercise control over, or otherwise influence, the medical judgment or professional decisions of any pathologist associated with our practices.
Our pathologist employment agreements typically have terms of between 3 and 5 years and generally can be terminated by either party without cause upon between 90 and 180 days notice. Our pathologists generally receive base compensation, health and welfare benefits generally available to our employees and, in some cases, annual performance bonuses. Our pathologists are required to hold a valid license to practice medicine in the jurisdiction in which they practice. We are responsible for billing patients, physicians and payors for services rendered by our pathologists. Most of our pathologist employment agreements contain restrictive covenants, including non-competition, non-solicitation and confidentiality covenants.
Our business is dependent on the recruitment and retention of pathologists, particularly those with subspecialties like dermatopathology. While we have generally been able to recruit and retain pathologists in the past, no assurance can be given that we will be able to continue to do so successfully or on terms similar to our current arrangements. The relationship between our pathologists and their respective local medical communities is important to the operation and continued profitability of our practices. In the event that a significant number of pathologists terminate their relationships with us or become unable or unwilling to continue their employment, our business could be materially harmed.
We manage and control all of the non-medical functions of our practices. We are not licensed to practice medicine. The practice of medicine is conducted solely by the physicians in our practices.
Billing and Reimbursement
Billing
Billing for diagnostic services is generally highly complex. Laboratories must bill various payors, such as private insurance companies, managed care companies, governmental payors such as Medicare and Medicaid, physicians, hospitals and employer groups, each of which may have different billing requirements. Additionally, the audit requirements we must meet to ensure compliance with applicable laws and regulations, as well as our internal compliance policies and procedures, add further complexity to the billing process, resulting in additional costs to us.
Reimbursement
Depending on the billing arrangement and applicable law, the party that reimburses us for our services may be:
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a third party who provides coverage to the patient, such as an insurance company, managed care organization or a governmental payor program;
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the physician or other authorized party (such as a hospital or another laboratory) who ordered the testing service or otherwise referred the services to us; or
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the patient.
For the year ended December 31, 2015, we derived approximately 58 percent of our revenue from private insurance, including managed care organizations and other healthcare insurance providers, 24 percent from governmental payor programs, including Medicare and Medicaid, and 18 percent from other sources.
In 2015, approximately 22 percent of our annual revenue was derived from the Medicare program, which is overseen by the Centers for Medicare & Medicaid Services, or CMS. Because a large percentage of our revenue is derived from the Medicare program, the Medicare coverage and reimbursement rules are significant to our operations. Reimbursement under the Medicare program for the diagnostic services that we offer is subject to either the national Medicare clinical laboratory fee schedule, which we refer to as the CLFS, or the national Medicare physician fee schedule, which we refer to as the PFS, each of which is subject to geographic adjustments and is updated annually. The PFS is designed to set compensation rates for those medical services provided to Medicare beneficiaries that require a degree of physician supervision. Clinical diagnostic laboratory tests furnished to non-hospital patients are paid according to the CLFS.
Most of the services that we provide are anatomic pathology services, which are reimbursed separately under the PFS, and beneficiaries are responsible for applicable coinsurance and deductible amounts. The PFS is based on assigned relative value units for each procedure or service, and an annually determined conversion factor is applied to the relative value units to calculate the reimbursement. The Sustainable Growth Rate (SGR) formula used to calculate the fee schedule conversion factor usually would result in a decrease in PFS payments, unless Congress acts to prevent such reductions. For example, the SGR formula was used to calculate the 2012 and 2013 PFS resulting in scheduled reimbursement cuts of 27 percent. However, in both years Congress took action to delay the implementation of these reductions. Congress passed legislation that prevented the implementation of these scheduled reductions and continued the existing payment levels through December 31, 2013. For 2014, CMS had projected the reimbursement cut resulting from the SGR formula would be approximately 20 percent, unless Congress acted to prevent the reduction. On December 18, 2013, Congress passed legislation that enacted a 0.5 percent increase in the conversion factor, effective until March 31, 2014. On April 1, 2014, President Obama signed the Protecting Access to Medicare Act of 2014, or PAMA. PAMA extended the 0.5 percent increase through March 31, 2015 and made other changes to laboratory reimbursement discussed below.
On April 16, 2015 President Obama signed the Medicare and CHIP Reauthorization Act (MACRA). The MACRA repealed the provisions related to the Medicare SGR formula and implements a new physician payment system that is designed to reward the quality of care. In addition, it extended the then-current Medicare Physician Fee Schedule rates through June 2015 and increased them by 0.5 percent for the remainder of 2015. Beginning in January 1, 2016, the rates are to be increased annually by 0.5 percent, through 2019. For 2020 through 2025 rates will be frozen, although payment will be adjusted to account for performance on certain quality metrics under the Merit-Based Incentive Payment Systems (MIPS) or to reflect physician participation in alternative payment models (APMs). For 2026 and subsequent years, qualified APM participants receive an annual 0.75% increase on Medicare physician payment rates, while those not participating receive a 0.25% annual payment increase, plus any applicable MIPS-based payment adjustments. At this time, it is too early to determine how these changes may impact our business this year and thereafter.
Finally, the Budget Control Act of 2011 created a Joint Select Committee on Deficit Reduction, which was tasked with recommending proposals to reduce spending. Under the law, the Joint Committee’s failure to achieve a targeted deficit reduction, or Congress’ failure to pass the Committee’s recommendations without amendment by December 23, 2011, would result in automatic across-the-board cuts to most discretionary programs. Automatic cuts also would be made to Medicare and would result in aggregate reductions in Medicare payments to providers of up to two percent per fiscal year, starting in 2013 and continuing through 2021. Because the Joint Committee was not able to agree on a set of deficit reduction recommendations on which Congress could vote, cuts went into effect in April 2013. This reduction was extended by PAMA through 2024. We have estimated the impact of sequestration has been approximately $1.1 million in our annual Medicare revenue.
Our reimbursement is also affected by policies that are enacted by CMS. In 2013, CMS announced its process for pricing over 100 new CPT codes for molecular diagnostics, which the American Medical Association had adopted in 2012. CMS stated it would pay for the new molecular codes based on the CLFS, rather than the PFS as some stakeholders had urged. CMS also required that the Medicare Administrative Contractors “gapfill” the new codes and set an appropriate price for them. That “gapfilling” process took place during 2013 and CMS announced the new prices for these codes in September 2013. The median of the prices set by the contractors became the new prices for these codes, effective January 1, 2014.
In early 2014, CMS also made two proposals that could affect the reimbursement for our laboratory services. First, CMS proposed a change in how it calculated the Relative Value Units (RVUs) used to calculate payments under the PFS. Under this proposal, where a service was paid at a lower rate in the hospital based on the hospital Outpatient Prospective Payment System than it was under the PFS, CMS proposed to reduce the RVUs for that service in order to equalize the payment between the two systems. This change, if implemented, would have resulted in an approximate cut of 25 percent in aggregate payments to independent laboratories. In the Final Physician Rule for 2014, however, CMS chose not to implement this proposal, although it stated that it would develop a revised proposal that it would propose in the future.
In the 2014 Proposed Rule, CMS also explained that it was concerned that payments for many codes paid under the CLFS had not been revised to reflect technological advances that have occurred since the CLFS was first implemented in 1984. As a result, CMS proposed a procedure under which it would adjust the amount paid for various laboratory services to reflect technological changes. CMS stated it expected it would take about five years to review all codes on the CLFS. CMS adopted this proposal in the Final 2014 Physician Fee Schedule Rule. However, in PAMA, Congress eliminated CMS’s authority to adjust prices based on technological changes; therefore, CMS has stated that it will not implement this adjustment procedure. PAMA also required that clinical laboratory reimbursement be changed to better reflect current market rates and established a process for making these changes, which requires laboratories to report the rates paid by third-party payors. The requirements of PAMA are discussed below under the heading “Recent Developments, Health Care Regulatory and Reimbursement Changes” in Part II, Item 7 of this Annual Report.
In addition, CMS made several other changes in 2014 Physician Fee Schedule Rule that impacted our business. First, CMS implemented a policy that will set the payment for the examination of 10 or more prostate biopsies into a single “bundled” payment amount, rather than paying separately for each individual procedure as had been done previously. This resulted in a significant reduction in reimbursement on each of these procedures. In addition, as a result of recent changes in the descriptions for certain CPT codes that we commonly bill for, CMS developed new prices for Immunohistochemistry procedures, which are a common staining procedure used in pathology and for FISH (Fluorescent In Situ Hybridization) testing. Each of these changes resulted in reductions in the reimbursement received for these procedures.
Also, beginning in 2015, CMS stopped paying separately for the technical component of many pathology services furnished to outpatients. Instead, the technical component payments were included in the total amount paid the hospital. This change could have an impact on our arrangements with those hospitals with whom we do business, and could increase pressure for more favorable payment terms.
Emerging Growth Company
We qualify as an “emerging growth company” as defined in the Jumpstart Our Business Startups Act of 2012 (JOBS Act). As an emerging growth company, we are subject to reduced reporting and other obligations generally applicable to public companies, including reduced disclosure about our executive compensation arrangements and exemption from the auditor attestation requirement in the assessment of our internal control over financial reporting. In addition, we may take advantage of an extended transition period for complying with new or revised accounting standards under the JOBS Act. This election allows us to delay the adoption of new or revised accounting standards that have different effective dates for public and private companies until those standards apply to private companies.
The information that we provide may be different than what is available with respect to other public companies due to these reduced reporting burdens.
Government Regulation and Compliance Infrastructure
The services that we provide are heavily regulated by both federal and state governmental authorities. Failure to comply with the applicable regulations can subject us to significant civil and criminal penalties, loss of license, or the requirement that we repay amounts previously paid to us. The significant areas of regulation include the following:
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the federal Anti-Kickback Statute, which prohibits persons from knowingly and willfully soliciting, receiving, offering or providing remuneration, directly or indirectly, in cash or in kind, in exchange for or to induce either the referral of an individual for, or the purchase, order or recommendation of, any goods or service for which payment may be made under governmental payor programs such as Medicare and Medicaid;
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the federal False Claims Act, which prohibits individuals or entities from knowingly presenting to, or causing to be presented to, the federal government, claims for payment that are false or fraudulent;
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the Health Insurance Portability and Accountability Act, or HIPAA, which established comprehensive federal standards with respect to the use and disclosure of protected health information;
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the Health Information Technology for Economic and Clinical Health Act, or HITECH Act, which was passed as part of the American Recovery and Reinvestment Act and which strengthens many of the requirements applicable to privacy and security, among other things;
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the Stark Law, which prohibits a physician from making a referral to an entity for certain designated health services reimbursed by Medicare or Medicaid if the physician (or a member of the physician’s family) has a financial relationship with the entity and which also prohibits the submission of any claim for reimbursement for designated health services furnished pursuant to a prohibited referral;
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the federal Civil Monetary Penalty Law, which prohibits the offering of remuneration or other inducements to beneficiaries of federal health care programs to influence the beneficiaries’ decisions to seek specific governmentally reimbursable items or services or to choose particular providers;
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the Clinical Laboratory Improvement Amendments, which requires that laboratories be certified by the federal government or by a federally-approved accreditation agency;
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the anti-markup rule, which prohibits a physician or supplier billing the Medicare program from marking up the price of a purchased diagnostic service performed by another physician or supplier who does not “share a practice” with the billing physician or supplier;
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state law equivalents of the above, such as anti-kickback and false claims laws that may apply to items or services reimbursed by any third-party payor, including commercial insurers;
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state laws that prohibit the corporate practice of medicine and the splitting or sharing of fees between physicians and non-physicians;
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state laws that govern the manner in which licensed physicians can be organized to perform and bill for medical services;
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the reassignment rules, which preclude Medicare payment for covered services to anyone other than the patient, physician, or other person who provided the service, with limited exceptions; and
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state laws that prohibit other specified practices, such as billing an entity that does not have ultimate financial responsibility for the service, waiving coinsurance or deductibles, billing Medicaid a higher charge than the lowest charge offered to another payor, and placing professionals who draw blood, or phlebotomists, in the offices of referring physicians.
Compliance with government rules and regulations is a significant concern throughout our industry, in part due to evolving interpretations of these rules and regulations. We seek to conduct our business in compliance with all statutes and regulations applicable to our operations. To this end, we have created a Compliance Committee and have designated a Compliance Officer to assist with reviews of regulatory compliance procedures and policies throughout our business. Our executive management team is responsible for the oversight and operation of our compliance efforts. The Compliance Officer is responsible for administering and monitoring compliance with our Standards of Conduct. We provide periodic training programs to our personnel to promote the observance of our policies, which are designed to ensure compliance with the statutes and regulations applicable to us.
Intellectual Property
Our intellectual property consists primarily of trademarks and trade secrets. The marks AURORA DIAGNOSTICS and CONNECTDX THE INFORMATION GATEWAY & Design are our most recognizable trademarks. Those trademarks are registered with the U.S. Patent and Trademark Office along with the marks DERMDX, GASTRODX, HEMADX, TREATMENTDX, URODX and WOMEN’SDX. Also, the names of our individual labs are registered in their respective states. We institute legal action where necessary to prevent others from using or registering confusingly similar trademarks. Our intellectual property also includes the copyright in and to our Tiger TCPC software, which is registered with the U.S. Copyright Office.
Segment Reporting and Geographic Areas
Our operations consist of one reportable segment. All of the Company’s revenue is attributable to customers located in the United States, and all of the Company’s long-lived assets are located in the United States.
Employees
As of December 31, 2015, we had 1,105 employees, which consisted of 139 pathologists, 776 laboratory technicians and staff, 59 corporate office personnel and 131 sales, marketing and client service personnel. In addition to our 139 employed pathologists, we have contractual arrangements with a physician practice that, as of December 31, 2015, employed 16 pathologists, each of which exclusively provides pathology services to our Alabama laboratory. None of our employees are subject to collective bargaining agreements. We consider our relationships with our employees to be good.
Item 1A.
Item 1A.
Risk Factors.
The statements under this heading describe the most significant risks to the Company’s business identified by management and should be considered carefully in conjunction with the discussion under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Notes to Consolidated Financial Statements” included in Part II, Item 7 and Part II, Item 8, respectively, of this Annual Report on Form 10-K.
The following is a discussion of risks and uncertainties that the Company believes could, individually or in the aggregate, cause its actual results to differ materially from expected and past results. However, predicting or identifying all such risks and uncertainties is not possible. As a result, the following factors should not be considered to be a complete discussion of the Company’s risks and uncertainties.
Risks Relating to Our Business
Changes in medical treatment, reimbursement rates and other market conditions in the dermatopathology market could adversely affect our business.
We derive a significant portion of our revenue from our dermatopathology subspecialty, which makes us particularly sensitive to changes in medical treatment, reimbursement rates and other market conditions in the dermatopathology market. Our revenue is particularly sensitive to changes that affect the number of or reimbursement for dermatopathology-related services. In 2015, we derived approximately 43 percent of our revenue from our dermatopathology subspecialty services, primarily from biopsies of the skin. If there is a significant development in the prevention of skin cancer, or an adverse development in the reimbursement rate for skin biopsies, it could have a material adverse effect on our business.
Changes in governmental reimbursement policies may adversely affect reimbursement for diagnostic services and could have a material adverse impact on our business.
Reimbursement levels for health care services are subject to continuous and often unexpected changes in policies, and we face a variety of efforts by government payors to reduce utilization and reimbursement for diagnostic testing services. Changes in governmental reimbursement may result from statutory and regulatory changes, retroactive rate adjustments, administrative rulings, competitive bidding initiatives, and other policy changes.
The U.S. Congress has considered, at least yearly in conjunction with budgetary legislation, changes to one or both of the Medicare fee schedules under which we receive reimbursement, which include the PFS and CLFS. For example, currently there is no copayment or coinsurance required for clinical laboratory services, although there is for our physician services. However, Congress has periodically considered imposing a 20 percent coinsurance on clinical laboratory services. If enacted, this would require us to attempt to collect this amount from patients, although in many cases the costs of collection would exceed the amount actually received.
In 2010, the U.S. Congress passed legislation relating to health care reform, referred to as the Patient Protection and Affordable Care Act, or the ACA, which provided for two separate reductions in the reimbursement rates for our clinical laboratory services, each of which reduce the annual Consumer Price Index-based update that would otherwise determine our reimbursement for clinical laboratory services. CMS has stated that the combined reduction resulting from these provisions was 0.25 percent for 2015 and has recently announced the update would actually increase slightly, by 0.10 percent for 2016. In addition, in the Middle Class Tax Relief and Job Creation Act of 2012, Congress mandated an additional change in the reimbursement for clinical laboratory services. That legislation required CMS to rebase the CLFS to effect an additional two percent reduction in clinical laboratory fees.
Reimbursement for our anatomic pathology services is governed by the physician fee schedule. On April 16, 2015, President Obama signed the MACRA that will replace the old SGR formula with a new system that is designed to reward the quality of care. At this time, it is not known how these changes may affect our business beyond 2016.
A substantial portion of our anatomic pathology services are billed under a few codes (CPT 88305, 88305TC and 88305-26) and our revenue and business may be adversely affected if the reimbursement rates associated with these codes are reduced. For example, in the 2012 Final Rule, CMS requested that the American Medical Association’s RVS Update Committee (RUC) reexamine the relative value units (RVUs) for certain common pathology codes, including these codes. The 2013 Final Rule included a reduction of approximately 33 percent in the global billing code for 88305 and a 52 percent reduction in the technical component of that code.
Under the headings “Billing and Reimbursement” in Part I, Item 1 of this Annual Report and “Recent Developments, Health Care Regulatory and Reimbursement Changes” in Part II, Item 7 of this Annual Report, we have summarized a number of recent and potential changes in government reimbursement policies that may adversely affect reimbursement for diagnostic services, including without limitation:
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changes to the PFS and CLFS;
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cuts in reimbursement arising as a result of The Budget Control Act of 2011;
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the adoption of pricing for new CPT codes and the “gapfilling” process;
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proposals to reduce RVUs used to calculate payments under the PFS to lower hospital based rates;
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potential adjustments to payments under the CLFS to reflect technological advances;
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proposals to bundle prostate biopsies;
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new pricing for immunohistochemistry procedures and FISH testing; and
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bundling of technical component services furnished to hospital outpatients.
These and other changes to government reimbursement policies could have a material adverse impact on our business. Even when reimbursement rates are not reduced, policy changes add to our costs by increasing the complexity and volume of administrative requirements. Medicaid reimbursement, which varies by state, is also subject to administrative and billing requirements and budget pressures. Recently, state budget pressures have caused states to consider several policy changes that may impact our financial condition and results of operations, such as delaying payments, reducing reimbursement, restricting coverage eligibility and service coverage, and imposing taxes on our services.
Non-governmental third-party payors have taken steps to control the utilization and reimbursement of diagnostic services.
We also face efforts by non-governmental third-party payors, including health plans, to reduce utilization of diagnostic testing services and reimbursement for diagnostic services. For instance, third-party payors often use the payment amounts under the Medicare fee schedules as a reference in negotiating their payment amounts. In some cases, our fee schedules with third-party payors are linked to the current Medicare fee schedules, and therefore reductions in the Medicare fee schedules could lead to reductions in reimbursement from some of our third-party payors. As described above, CMS’ 2013 Final Rule included a reduction in the Medicare fee schedules of approximately 33 percent in the global billing code for 88305 and a 52 percent reduction in the technical component of that code, which resulted in a significant reduction in our reimbursement from Medicare. CMS made significant further reductions in reimbursement for certain codes we bill under the 2014 and 2015 Medicare fee schedules. We have experienced isolated reductions in reimbursement from non-governmental third-party payors tied to the Medicare reductions. However, the recent reduction in Medicare reimbursement rates, and future reductions in Medicare reimbursement rates, could result in a reduction in the reimbursements we receive from such third-party payors and have a material adverse impact on our business.
In addition, changes in test coverage policies of and reimbursement from other third-party payors may also occur independently from changes in Medicare. Such reimbursement and coverage changes in the past have resulted in reduced prices, added costs and reduced accession volume and have added more complex and new regulatory and administrative requirements.
The health care industry has also experienced a trend of consolidation among health insurance plans, resulting in fewer, larger health plans with significant bargaining power to negotiate fee arrangements with health care providers like us. Some of these health plans, as well as independent physician associations, have demanded that laboratories accept discounted fee structures or assume a portion or all of the financial risk associated with providing diagnostic testing services to their members through capitated payment arrangements. In addition, some health plans have limited the preferred provider organization or point-of-service laboratory network to only a single national laboratory to obtain improved fee-for-service pricing. The increased consolidation among health plans also has increased the potential adverse impact of ceasing to be a contracted provider with any such insurer.
We expect that efforts to reduce reimbursements, impose more stringent cost controls and reduce utilization of diagnostic testing services will continue. These efforts may have a material adverse effect on our business and results of operations.
Increased internalization of diagnostic testing by our clients or patients, including the use of new testing technologies by our clients or patients, could adversely affect our business.
Our clients, such as referring physicians and hospitals, may internalize diagnostic testing or technologies that have historically been performed by diagnostic laboratory companies like us. Our industry has experienced a recent market trend in which physicians and hospitals perform the technical and/or professional components of their laboratory testing needs in their own offices. If this trend continues or becomes more pronounced and our clients internalize diagnostic testing functions or technologies that we currently perform or use, and we do not develop new or alternative functions or technologies that are attractive to our clients, it may reduce the demand for our diagnostic testing services and adversely affect our business.
In addition, advances in technology may lead to the development of more cost-effective tests that can be performed outside of a commercial laboratory, such as point-of-care tests that can be performed by physicians in their offices; tests that can be performed by hospitals in their own laboratories; or home testing that can be performed by patients in their homes. Any advance in technology could reduce demand for our services or render them obsolete.
Compliance costs associated with the Clinical Laboratory Improvement Amendments of 1988, or CLIA, make it cost-prohibitive for many physicians to operate clinical laboratories in their offices. However, diagnostic tests approved or cleared by the U.S. Food and Drug Administration, or FDA, for home use are automatically deemed to be “waived” tests under CLIA and may be performed by our referring physicians and their patients with minimal regulatory oversight under CLIA. Test kit manufacturers could seek to increase sales to both our referring physicians and their patients of test kits approved by the FDA for point-of-care testing or home use. Development of such technology and its use by our clients could decrease our revenue and have a material adverse effect on our business.
Failure to timely or accurately bill for our services or collect outstanding payments could have a material adverse effect on our business.
Billing for diagnostic services is complex. We bill numerous payors, including physicians, patients, insurance companies, Medicare, and Medicaid, according to applicable law, billing requirements and, as applicable, contractual arrangements. This complexity is further compounded by the fact that we currently generate bills using multiple billing systems and are subject to rapidly changing requirements for auditing, external compliance, and internal compliance policies and procedures. Furthermore, in the future, we may convert the legacy billing systems of businesses we have acquired to one or more common platforms.
Most of our provision for doubtful accounts in 2015, which totaled 6.3 percent of revenue, resulted from the failure of patients to pay their bills, including copayments and deductibles. Failure to timely or correctly bill could lead to lack of reimbursement for services or an increase in the aging of our accounts receivable, which could adversely affect our results of operations. Increases in write-offs of doubtful accounts, delays in receiving payments, potential retroactive adjustments, and penalties resulting from audits by payors would also adversely affect our financial condition. Failure to comply with applicable laws relating to billing governmental health care programs could also lead to various penalties, including exclusion from participation in Medicare or Medicaid programs, asset forfeitures, civil and criminal fines and penalties, and the loss of various licenses, certificates, and authorizations necessary to operate our business, any of which could have a material adverse effect on our business.
Our use of multiple billing systems and the potential conversion of legacy systems of businesses we have acquired may result in inconsistent data, slower collections, exposure to billing compliance violations and unexpected down times for releasing bills for payment.
Changes in payor mix may adversely affect reimbursement for diagnostic services and could have a material adverse impact on our business.
Most of our services are billed to a party other than the physician that ordered the test. In 2013, 2014 and 2015, based on cash collections, we estimate that we received 23 percent, 22 percent and 24 percent, respectively, of our revenue from Medicare and Medicaid. In 2015, based on cash collections, we estimate that 58 percent of our revenue was paid by non-governmental third-party payors, including health plans. If we bill a higher percentage of our services to payors who reimburse at rates lower than our current payors, our results of operations and financial condition would suffer.
Changes in the mix of diagnostic testing services that we provide have and could continue to negatively impact our net revenue per accession and our profitability.
We typically provide global pathology services in which we provide both the technical component and the professional component of services with respect to our accessions. In recent years, increasing numbers of referring physicians have converted to arrangements in which we perform only the technical component or the professional component of services with respect to our accessions, as opposed to global pathology services. In these cases, our net revenue per accession has declined due to the fact that we no longer receive the entire global fee for the service, but instead receive fees for only the technical component or the professional component of each accession. If the volume or percentage of accessions for which we perform global pathology services decreases, it could continue to decrease our average net revenue per accession and gross profit percentage.
Diagnostic testing services that we perform in certain subspecialties involving clinical lab services, such as women’s health pathology, have lower average net revenue per accession and gross profit percentage than those in other subspecialties. A change in our service mix that results in an increase in the percentage of services we perform in women’s health pathology could result in a decrease in our average net revenue per accession and gross profit percentage. The average revenue per accession of our organic business may decline in the future as a result of changes in service mix, including growth in women’s health pathology services. In addition, our growth rates and average revenue per accession may be positively or negatively impacted by the reimbursement market, service mix and average revenue per accession of acquisitions completed in the future.
Our financial and billing systems limit our ability to monitor and precisely report historical revenue by subspecialty. This inability, which could continue into future periods, may make it difficult or impossible for us to accurately assess changes in our service mix or the impact of such changes.
Integration of our operations with newly acquired businesses may be difficult and costly.
Since our inception, we have acquired 28 existing diagnostic services businesses, including four acquisitions in 2014 and two in 2015. We expect to evaluate potential strategic acquisitions of diagnostic services and other businesses that might augment our existing specialized diagnostic testing services. These acquisitions have involved and could continue to involve the integration of a separate company that previously operated independently and had different systems, processes and cultures. As such, many of our systems, such as our laboratory information systems and billing systems, are not standardized and some aspects of the day-to-day operations of our laboratories continue to be conducted on a decentralized basis.
The process of integrating businesses we acquire may substantially disrupt both our existing businesses and the businesses we acquire. This disruption may divert management from the operation of our business or may cause us to lose key employees or clients. Additionally, we may have difficulty consolidating facilities and infrastructure, standardizing information and other systems and coordinating geographically-separated facilities and workforces, resulting in a decline in the quality of services.
Any past or future acquisitions, and the related integration efforts, may be difficult, costly or unsuccessful. In each case, our existing business and the businesses we acquire may be adversely affected. Even if we are able to successfully integrate businesses we have acquired, we may not be able to realize the benefits that we expect from them.
Businesses we acquire or have acquired may have significant unknown or contingent liabilities that could adversely impact our operating results.
Businesses we acquire or have acquired may have unknown or contingent liabilities or liabilities that are in excess of the amounts that we originally estimated. Although we generally seek indemnification from the sellers of businesses we acquire for matters that are not properly disclosed to us, we may not successfully obtain indemnification. Even in cases where we are able to obtain indemnification, we may be subject to liabilities greater than the contractual limits of our indemnification or the financial resources of the indemnifying party. In the event that we are responsible for liabilities substantially in excess of any amounts recovered through rights to indemnification, this could adversely impact our operating results.
We have recorded a significant amount of intangible assets, which may never generate the returns we expect.
Our acquisitions have resulted in significant increases in net identifiable intangible assets and goodwill. Net identifiable intangible assets, which include customer relationships, healthcare facility agreements and non-compete agreements acquired in acquisitions, were approximately $65.7 million at December 31, 2015, representing 25 percent of our total assets. Goodwill, which relates to the excess of cost over the fair value of the net assets of the businesses acquired, was $125.2 million at December 31, 2015, representing approximately 48 percent of our total assets. Goodwill and net identifiable intangible assets are recorded at fair value on the date of acquisition and, under Financial Accounting Standards Board Statement (FASB) Accounting Standards Codification 350, are reviewed at least annually for impairment. Impairment may result from, among other things, deterioration in performance of the acquired company, adverse market conditions, adverse changes in applicable laws or regulations, including changes that restrict the activities of the acquired business, and a variety of other circumstances. The amount of any impairment must be written off. We evaluated our recorded goodwill and identifiable intangible assets as of November 30, 2013, November 30, 2014, June 30, 2015 and November 30, 2015, which resulted in our recording impairment charges of $53.9 million, $27.5 million, $39.6 million and $17.1 million, respectively. We may never realize the full value of our intangible assets. Any future determination requiring the write-off of a significant portion of intangible assets would have an adverse effect on our financial condition and results of operations.
Failure of our IT or communication systems, or the failure of these systems to keep pace with technological advances or changes in regulation and policies related to our IT or communication systems, could adversely impact our business.
Our laboratory operations depend significantly on the uninterrupted performance of our IT and communication systems. Sustained system failures or interruption of our systems in one or more of our laboratories could disrupt our ability to process laboratory requisitions, handle client service, perform testing, provide our reports or test results in a timely manner, or bill the appropriate party for our services.
Our efforts to invest in new or improved IT systems and billing systems may be costly and require time and resources for implementation. While we have begun implementing a plan to standardize and improve our laboratory information systems and billing systems, we expect that it will take several years to complete full implementation. Our efforts to invest in new or improved IT systems and billing systems may not ultimately be successful, and our failure to properly implement our plan to standardize and improve our laboratory information systems and billing systems could adversely impact our business.
Public and private initiatives to create electronic medical record standards and to mandate standardized coding systems for the electronic exchange of information, including test orders and test results, could require costly modifications to our existing IT systems. We expect that any standards that might be adopted or implemented would allow us adequate time to comply with such standards. However, any failure or delay in implementing standards may result in a loss of clients and business opportunities, which could adversely impact our business.
Failure to adequately safeguard data, including patient data that is subject to regulations related to patient privacy, could adversely impact our business.
The success of our business depends on our ability to obtain, process, analyze, maintain and manage data, including sensitive information such as patient data. If we do not adequately safeguard that information and it were to become available to persons or entities that should not have access to it, our business could be impaired, our reputation could suffer and we could be subject to fines, penalties and litigation. Although we have implemented security measures, our infrastructure is vulnerable to computer viruses, break-ins and similar disruptive problems caused by our clients or others that could result in interruption, delay or cessation of service. Break-ins, whether electronic or physical, could potentially jeopardize the security of confidential client and supplier information stored physically at our locations or electronically in our computer systems. Such an event could damage our reputation, cause us to lose existing clients and deter potential clients. It could also expose us to liability to parties whose security or privacy has been infringed, to regulatory actions by CMS or the U.S. Department of Health and Human Services (HHS), or to civil or criminal sanctions. The occurrence of any of the foregoing events could adversely impact our business.
The American Recovery and Reinvestment Act of 2009 imposed additional obligations on health care entities with respect to data privacy and security, including new notifications in case of a breach of privacy and security standards. We are unable to predict the extent to which these new obligations may prove technically difficult, time-consuming or expensive to implement.
Failure to attract and retain experienced and qualified personnel could adversely affect our business.
Our success depends on our ability to attract, retain and motivate experienced anatomic pathologists, histotechnologists, cytotechnologists, skilled laboratory and IT staff, experienced sales representatives and other personnel. Competition for these employees is strong, and if we are not able to attract and retain qualified personnel it could have a material adverse effect on our business.
We are dependent on the expertise of our local medical directors and our executive officers. The loss of these individuals could have a material adverse effect on our business.
Our sales representatives have developed and maintain close relationships with a number of health care professionals, and our specialized approach to marketing our services positions our sales representatives to have a deep knowledge of the needs of the referring physicians they serve. Given the nature of the relationships we seek to develop with our clients, losses of sales representatives may cause us to lose clients.
Failure to adequately scale our infrastructure to meet demand for our diagnostic services or to support our growth could create capacity constraints and divert resources, resulting in a material adverse effect on our business.
Increases in demand for our diagnostic services, including unforeseen or significant increases in demand due to client or accession volume, could strain the capacity of our personnel and infrastructure. Any strain on our personnel or infrastructure could lead to inaccurate test results, unacceptable turn-around times or client service failures. Furthermore, although we are not currently subject to these capacity constraints, if demand increases for our diagnostic services, we may not be able to scale our personnel or infrastructure accordingly. Any failure to handle increases in demand, including increases due to client or accession volumes, could lead to the loss of established clients and have a material adverse effect on our business.
We may expand by establishing laboratories in additional geographic markets. In addition to acquisition or development costs, this will require us to spend considerable time and money to expand our infrastructure and to hire and retain experienced anatomic pathologists, histotechnologists, cytotechnologists, skilled laboratory and IT staff, experienced sales representatives, client service associates and other personnel for our additional laboratories. We will also need federal, state and local certifications, as well as supporting operational, logistical and administrative infrastructure. Even after new laboratories are operational, it may take time for us to derive the same economies of scale we have in our existing laboratories. Moreover, we may suffer reduced economies of scale in our existing laboratories as we seek to balance the amount of work allocated to each facility and expand those laboratories. An expansion of our laboratories or systems could divert resources, including the focus of our management, away from our current business.
Failure to effectively continue or manage our strategic and organic growth could have an adverse impact on our business.
Our business strategy may include continuing to selectively acquire existing diagnostic services businesses. Since our inception, we have acquired 28 existing diagnostic services businesses. To continue this strategic growth, we will need to continue to identify appropriate businesses to acquire and successfully undertake the acquisition of these businesses on reasonable terms. Consolidation and competition within our industry, among other factors, may make it difficult or impossible to identify businesses to acquire on a timely basis, or at all. Our inability to acquire additional independent labs could hinder our growth and have a material adverse effect on our business.
We may also seek organic growth through the expansion of our sales force, the development of de novo laboratories, or strategic extension of our operations into markets such as the inclusion of new tests in our testing menu. Because of limitations in available capital and competition within our industry, among other factors, we may not be able to implement any or all of these organic growth strategies on a reasonable schedule, or at all. Our failure to achieve organic growth could have a material adverse effect on our business.
Our net revenue has grown from $3.5 million in 2006 to $263.7 million in 2015. To manage our growth, we must continue to implement and improve our operational and financial systems and to expand, train, manage and motivate our employees. We may not be able to effectively manage the expansion of our operations, and our systems, procedures or controls may not be adequate to support our operations. Our management may not be able to rapidly scale the infrastructure necessary to exploit the market opportunity for our services. Our inability to manage growth could have a material adverse effect on our business.
Failure to participate as a provider with payors or operating as a non-contracted provider could have a material adverse effect on our business.
The health care industry has experienced a trend of consolidation among health care insurers, resulting in fewer, larger insurers with significant bargaining power in negotiating fee arrangements with health care providers like us. Managed care providers often restrict their contracts to a small number of laboratories that may be used for tests ordered by physicians in the managed care provider’s network. If we do not have a contract with a managed care provider, we may be unable to gain those physicians as clients, and it could adversely affect our business.
In cases in which we do contract with a specified insurance company as a participating provider, we are considered “in-network,” and the reimbursement of third-party payments is governed by contractual relationships.
In cases in which we do not have a contractual relationship with an insurance company or we are not an approved provider for a government program, we have no contractual right to collect for our services and such payors may refuse to reimburse us for our services. This could lead to a decrease in accession volume and a corresponding decrease in our revenue. In instances where we are an out-of-network provider, reductions in reimbursement rates for non-participating providers could also adversely affect us. Third-party payors with whom we do not participate as a contracted provider may also require that we enter into contracts, which may have pricing and other terms that are materially less favorable to us than the terms under which we currently operate. While accession volume may increase as a result of these contracts, our revenue per accession may decrease.
Use of our diagnostic services as a non-participating provider also typically results in greater copayments for the patient unless we elect to treat them as if we were a participating provider in accordance with applicable law. Treating such patients as if we were a participating provider may adversely impact results of operations because we may be unable to collect patient copayments and deductibles. In some states, applicable law prohibits us from treating these patients as if we were a participating provider. As a result, referring physicians may avoid use of our services, which could result in a decrease in accession volume and adversely affect revenue.
Our revenues are dependent on us receiving reimbursements from third-party payors and our failure to qualify for or obtain reimbursements from third-party payors could have a material adverse effect on our business.
Our ability to qualify for or obtain reimbursement from third-party payors is dependent on factors that may include, among other things, our compliance with the terms of applicable agreements with such third-party payors, our compliance with applicable laws, our participation in government payor programs and our satisfaction of necessary billing standards. Our failure to qualify for or obtain reimbursements from third-party payors could undermine our ability to generate revenue and have a material adverse effect on our business.
Failure to raise additional capital or generate the significant capital necessary to continue our growth could reduce our ability to compete and could harm our business.
We currently expect that our existing cash and cash equivalents, together with the availability under our senior secured credit facility, will be sufficient to meet our anticipated cash needs through 2016. After that, we may need to raise additional funds, and we may not be able to obtain additional debt or equity financing on favorable terms, if at all. If we need additional capital and cannot raise it on acceptable terms, we may not, among other things, be able to:
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continue to expand our sales and marketing;
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develop or acquire complementary technologies, services, products or businesses;
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expand operations both organically and through acquisitions;
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hire, train and retain employees;
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service our existing debt obligations or continue to comply with compliance covenants thereunder; or
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respond to competitive pressures or unanticipated working capital requirements.
Our failure to do any of these things could seriously harm our business, financial condition and results of operations.
We may be unable to obtain, maintain or enforce our intellectual property rights and may be subject to intellectual property litigation that could adversely impact our business.
We may be unable to obtain or maintain adequate proprietary rights for our products and services or to enforce our proprietary rights successfully, and we cannot assure you that our products or methods do not infringe the intellectual property rights of third parties. Infringement and other intellectual property claims and proceedings brought against us, whether successful or not, could result in substantial costs and harm our reputation. Such claims and proceedings could also distract and divert management and key personnel from other tasks important to the success of our business. In the event of an adverse determination in an intellectual property suit or proceeding, or our failure to license essential technology, our sales could be harmed and/or our costs could increase, which would harm our financial condition.
Economic conditions in the United States could adversely impact our operating results and financial condition.
Continued uncertain economic conditions in the United States as a result of declining oil prices or other factors could adversely affect our operating results and financial condition. Among other things, the potential decline in federal and state revenue that could result from these conditions could create additional pressures to contain or reduce reimbursements for our services from Medicare, Medicaid and other government sponsored programs. Increased job losses and elevated unemployment rates in the United States could result in a smaller percentage of our patients being covered by commercial payors and a larger percentage being covered by lower-paying Medicaid programs. To the extent that payors are adversely affected by declines in economic conditions, we may experience further pressure on commercial rates, delays in fee collections and a reduction in the amounts we are able to collect. In addition, increases in interest rates could make it difficult to obtain credit in the future. Any or all of these factors, as well as other consequences of declining economic conditions, could adversely impact our operating results and financial condition.
Competition in our industry from existing or new companies and failure to obtain and retain clients could have a material adverse impact on our business.
Our success depends on our ability to obtain and retain clients and maintain accession volume. A reduction in the number of our clients, or in the tests ordered or specimens submitted by our clients, without offsetting increases or growth, could impact our ability to maintain or grow our business and could have a material adverse effect on our business.
While there has been significant consolidation in recent years in the diagnostic testing industry, the industry remains fragmented and highly-competitive both in terms of price and service. We primarily compete with various clinical test providers, anatomic pathology practices, hospital-affiliated laboratories, commercial clinical laboratories and physician-office laboratories. This competition is based primarily on price, clinical expertise, quality of service, client relationships, breadth of testing menu, speed of turnaround of test results, reporting and IT systems, reputation in the medical community and ability to employ qualified personnel. Some of our competitors may have greater technical, financial and other resources than we do. Our failure to successfully compete on any of these factors could result in a loss of clients and adversely affect our ability to grow.
Replication of our business model by competitors may adversely affect growth and profitability. Barriers to entry in anatomic pathology markets include the need to form strong relationships with referring physicians, hire experienced pathologists, make capital investments and acquire IT. These barriers may not be sufficient to prevent or deter new entrants to our market, and competitors could replicate or improve some or all aspects of our business model and either cause us to lose market share in the areas where we compete or inhibit our growth, which could have a material adverse effect on our business.
Failure to acquire rights to new technologies, products or tests, or discontinuations or recalls of existing technologies, products or tests, could negatively impact our testing volume and net revenues.
The diagnostic testing industry is characterized by rapid changes in technology, frequent introductions of new products and diagnostics tests and evolving industry standards and client demands for new diagnostic technologies. Other companies or individuals, including our competitors, may obtain patents or other intellectual property rights that could prevent, limit or interfere with our ability to develop, perform or sell our tests or operate our business or increase our costs. Advances in technology may result in the creation of enhanced diagnostic tools that enable other laboratories, hospitals, physicians, patients or third parties to provide specialized diagnostic services that are superior to ours or more patient-friendly, efficient or cost-effective. These developments may result in a decrease in the demand for our tests or cause us to reduce the prices for our tests. We may be unable to develop or introduce new tests on our own, which means that our success may depend, in part, on our ability to license new and improved technologies on favorable terms. We may be unable to continue to negotiate acceptable licensing arrangements, and arrangements that we do conclude may not yield commercially successful diagnostic tests. If we are unable to acquire rights to these testing methods at competitive rates, our research and development costs may increase as a result. In addition, if we are unable to develop and introduce, or acquire rights to, new tests, technology and services to expand our testing business, our testing methods may become outdated when compared with our competition and our testing volume and revenues may be materially and adversely affected.
If manufacturers discontinue or recall reagents, test kits or instruments we use to perform diagnostic services, such discontinuations or recalls could adversely affect our costs, testing volume and revenues.
Our Principal Equityholders may have interests that differ from your interests.
Circumstances may occur in which the interests of our equityholders could be in conflict with those of our noteholders. For example, our equityholders, including KRG Capital Partners and Summit Partners, may have an interest in pursuing acquisitions, divestitures, financing or other transactions that, in their judgment, could enhance their equity investments, even though such transactions might involve risks to our noteholders. Additionally, certain of our equityholders, including KRG Capital Partners and Summit Partners, have significant knowledge of our business operations and strategy and are not prohibited from making investments in any of our competitors.
Regulatory Risks
New and proposed federal or state health care reform measures could adversely affect our operating results and financial condition.
The U.S. Congress and state legislatures continue to focus on health care reform. The Accountable Care Act, referred to as the ACA, which was enacted in 2010, represented a broad health care reform initiative, which was not fully implemented until 2014. Many states are still determining whether, and how, to adopt various requirements applicable to them. In 2012, the Supreme Court upheld the constitutionality of the health care reform law, with the exception of certain provisions dealing with the expansion of Medicaid coverage under the law. In 2015, the Court upheld the ability of the federal government to pay subsidies to individuals enrolled in federal, as opposed to state, health insurance exchanges. Congress has also proposed a number of legislative initiatives, including possible repeal of the health reform law.
We cannot predict whether any of the possible changes to the federal and state health care reform legislation, if implemented, will have a material impact on us. Further, we cannot predict whether federal or state governments will enact any additional laws to effect health care reform and, if any such new laws were enacted, what their terms would be and whether or in what ways any new laws would affect us. However, it is possible that new laws could increase our costs, decrease our revenue, expose us to expanded liability or require us to revise the ways in which we conduct our business, any of which could adversely affect our operating results and financial condition.
If we fail to comply with the complex federal, state and local government laws and regulations that apply to our business, we could suffer severe consequences that could adversely affect our operating results and financial condition.
Our operations are subject to extensive federal, state and local government regulations, all of which are subject to change. These government laws and regulations currently include, among others, those described under the heading “Government Regulation and Compliance Infrastructure” in section Part I, Item 1. Business, in this Annual Report.
We believe that we operate in material compliance with these laws and regulations. However, these laws and regulations are complex and, among other things, practices that are permissible under federal law may not be permissible in all states. In addition, these laws and regulations are subject to interpretation by courts and enforcement agencies. Our failure to comply could lead to civil and criminal penalties, exclusion from participation in Medicare and Medicaid, and possible prohibitions or restrictions on our laboratories’ ability to provide diagnostic services, and any such penalties, exclusions, prohibitions or restrictions could have a material adverse effect on our arrangements with managed care organizations and private payors.
If we fail to comply with state corporate practice of medicine laws, we could suffer severe consequences.
The laws of many states prohibit business corporations, including us and our subsidiaries, from owning corporations that employ physicians, or from exercising control over the medical judgments or decisions of physicians. These laws and their interpretations vary from state to state and are enforced by both the courts and regulatory authorities, each with broad discretion. The manner in which we operate each practice is determined primarily by the corporate practice of medicine restrictions of the state in which the practice is located, other applicable regulations and commercial considerations.
We believe that we are currently in material compliance with the corporate practice of medicine laws in each of the states in which we operate. Nevertheless, it is possible that regulatory authorities or other parties may assert that we are engaged in the unauthorized corporate practice of medicine. If such a claim were successfully asserted in any jurisdiction, we could be subject to civil and criminal penalties, which could exclude us from participating in Medicare, Medicaid and other governmental health care programs, or we could be required to restructure our contractual and other arrangements.
Failure to comply with complex federal and state laws and regulations related to submission of claims for our services could result in significant monetary damages and penalties and exclusion from the Medicare and Medicaid programs.
Our failure to comply with applicable laws and regulations could result in our inability to receive payment for our services or result in attempts by third-party payors, such as Medicare and Medicaid, to recover payments from us that have already been made. Submission of claims in violation of certain statutory or regulatory requirements can result in penalties, including civil monetary penalties of up to $10,000 for each item or service billed to Medicare in violation of the legal requirement, and exclusion from participation in Medicare and Medicaid. Government authorities may also assert that violations of laws and regulations related to submission of claims violate the federal False Claims Act or other laws related to fraud and abuse, including submission of claims for services that were not medically necessary. We could be adversely affected if it was determined that the services we provided were not medically necessary and not reimbursable, particularly if it were asserted that we contributed to the physician’s referrals of unnecessary services to us. It is also possible that the government could attempt to hold us liable under fraud and abuse laws for improper claims submitted by an entity for services that we performed if we were found to have knowingly participated in the arrangement that resulted in submission of the improper claims.
Our business could be harmed by the loss or suspension of a license or imposition of a fine or penalties under, or future changes in, the law or regulations of the Clinical Laboratory Improvement Amendments or those of Medicare, Medicaid or other federal, state or local agencies.
The diagnostic testing industry is subject to extensive regulation, and many of these statutes and regulations have not been interpreted by the courts. CLIA requires that laboratories be certified by the federal government or by a federally-approved accreditation agency every two years. CLIA mandates specific standards in the areas of personnel qualifications, administration, proficiency testing, patient test management, quality control, quality assurance and inspections. CLIA regulations include special rules applicable to cytology testing, such as pap smears, including workload limits, specialized proficiency testing requirements that apply not just to the laboratory, but also to the individuals performing the tests, specialized personnel standards and quality control procedures. A laboratory may be sanctioned based on its failure to participate in an acceptable proficiency testing program, unsatisfactory performance in proficiency testing or for prohibited activities related to proficiency testing, such as failing to test the proficiency testing samples in the same manner as patient specimens or communicating with other laboratories regarding proficiency testing results. The sanction for failure to comply with CLIA requirements, including proficiency testing violations, may be suspension, revocation or limitation of a laboratory’s CLIA certificate, as well as the imposition of significant fines and criminal penalties. While imposition of certain CLIA sanctions may be subject to appeal, few, if any, such appeals have been successful. A CLIA certificate is necessary to conduct business. As a result, any CLIA sanction or our failure to renew a CLIA certificate could have a material adverse effect on our business. Although each laboratory facility is separately certified by CLIA, if the CLIA certificate of any our laboratories is revoked, CMS could seek revocation of our other laboratories’ CLIA certificates based on their common ownership or operation with the laboratory facility whose certificate was revoked. Some states have enacted analogous state laws that are stricter than CLIA.
Changes in laws and regulations that address billing arrangements for our services could have a material adverse effect on our revenue.
While we do not bill referring physicians for our services when those services are covered under a government program, in some cases, we do, where permissible, bill referring physicians for services that are not covered under a government program. Laws and regulations in several states currently preclude us from billing referring physicians, either by requiring us to bill directly the third-party payor or other person ultimately responsible for payment for the service, or by prohibiting or limiting the referring physician’s or other purchaser’s ability to bill a greater amount than the amount paid for the service. An increase in the number of states whose laws prevent such arrangements could adversely affect us by encouraging physicians to furnish such services directly. Currently, Medicare does not require beneficiaries to pay coinsurance for clinical laboratory testing or subject such tests to a deductible. From time to time, legislation has been proposed that would subject diagnostic services to coinsurance and deductibles. Such legislation could be enacted in the future. Legislation subjecting diagnostic services to coinsurance or deductibles could adversely affect our revenue given the anticipated difficulty in collecting such amounts from Medicare beneficiaries. In addition, we could be subject to potential fraud and abuse violations if adequate procedures to bill and collect copayments were not established and followed.
We are increasingly subject to initiatives to recover improper payments and overpayments and such initiatives could result in significant monetary damages and penalties and exclusion from the Medicare and Medicaid programs.
Government payors have increased initiatives to recover improper payments and overpayments. For example, in March 2005, CMS initiated a demonstration project using Recovery Audit Contractors, or RACs, who are paid a contingent fee to detect and correct improper Medicare payments. As part of their duties, RACs collect overpayments from Medicare providers, including those providers who were paid for services that were not medically necessary or were incorrectly coded. As of January 1, 2010, the RAC program began to operate throughout the United States on a permanent basis, and they were granted the authority to pursue improper payments made on or after October 1, 2007. In addition, state Medicaid Programs will now also be required to have their own RAC programs. Furthermore, in 2011, CMS finalized a rule that will implement significant anti-fraud provisions included in the health care reform legislation, which will, among other things, strengthen current limits on who can enroll as a provider under Medicare, allow Medicare to suspend payments where a credible allegation of fraud exists, and permit Medicare and Medicaid to implement a temporary moratorium on new providers when necessary to prevent fraud and abuse. In August 2015 we settled claims by the Veterans Administration of overpayments based on one laboratory’s decision to bill for the professional component of clinical pathology services which, claims the Veterans Administration, is not allowed under its reimbursement rules. Although the Company believes its billing practices were not inappropriate, it agreed to a final settlement with the Veterans Administration for this claim in the amount of $1.2 million, which is being paid in monthly installments of $100,000.
Governmental investigations to which we may become subject could have a material adverse effect on our business.
Governmental investigations of laboratories have been ongoing for a number of years and are expected to continue. In fact, a substantial increase in funding of Medicare and Medicaid program integrity and anti-fraud efforts has been proposed. Investigations of our laboratories, regardless of their outcome, could damage our reputation and adversely affect important business relationships that we have with third parties, as well as have a material adverse effect on our business.
Failure to comply with environmental, health and safety laws and regulations could adversely affect our ability to operate and result in fines, litigation or other consequences.
We are subject to licensing and regulation under numerous federal, state and local laws and regulations relating to the protection of the environment and human health and safety. Our use, generation, manufacture, handling, transportation, storage and disposal of chemicals and medical specimens, such as human tissue, infectious and hazardous waste, and radioactive materials, as well as the health and safety of our laboratory employees, are covered under these laws and regulations.
In particular, the federal Occupational Safety and Health Administration has established extensive requirements relating to workplace safety for health care employers, including certain laboratories, whose workers may be exposed to blood-borne pathogens such as HIV and the hepatitis B virus. These requirements, among other things, require work practice controls, protective clothing and equipment, training, medical follow-up, vaccinations and other measures designed to minimize exposure to, and the transmission of, bloodborne pathogens. In addition, the Needlestick Safety and Prevention Act requires, among other things, that we include in our safety programs the evaluation and use of engineering controls such as safety needles if found to be effective at reducing the risk of needlestick injuries in the workplace.
We cannot entirely eliminate the risk of accidental injury, contamination or sabotage from working with hazardous materials or wastes. Our general liability insurance or workers’ compensation insurance policies may not cover damages and fines arising from biological or hazardous waste exposure or contamination. In the event of contamination or injury, we could be held liable for damages or subject to fines in an amount exceeding our resources, and our operations could be suspended or otherwise adversely affected.
Failure to comply with federal, state and local laws and regulations could subject us to denial of the right to conduct business, fines, criminal penalties and/or other enforcement actions which would have a material adverse effect on our business. In addition, the current environmental, health and safety requirements applicable to our business, facilities and employees could be revised to become more stringent, and new laws and requirements could be adopted in the future. Thus, compliance with applicable environmental, health and safety laws and regulations could become both more costly and more difficult in the future.
Failure to comply with the Health Insurance Portability and Accountability Act security and privacy regulations may increase our costs.
HIPAA and related regulations establish comprehensive federal standards with respect to the use and disclosure of protected health information by health plans, health care providers and health care clearinghouses. Additionally, HIPAA establishes standards to protect the confidentiality, integrity and availability of protected health information.
Federal privacy regulations restrict our ability to use or disclose patient identifiable laboratory data, without patient authorization for purposes other than payment, treatment or health care operations, as defined by HIPAA. In February 2014, HIPAA was amended to require that laboratories make available to patients or the patient’s representative, upon request, copies of completed test reports that the laboratory can identify as belonging to the patient. These privacy and security regulations provide for significant fines and other penalties for wrongful use or disclosure of protected health information, including civil and criminal fines and penalties. We believe we are in substantial compliance with the privacy regulations. However, the documentation and process requirements of the privacy regulations are complex and subject to interpretation and our efforts in this respect are ongoing. Our failure to comply with the privacy regulations could subject us to sanctions or penalties. Although the HIPAA statute and regulations do not expressly provide for a private right of damages, we could also incur damages under state laws to private parties for the wrongful use or disclosure of confidential health information or other private information. We have policies and procedures to comply with the HIPAA regulations and state laws. In addition, we must also comply with non-U.S. laws governing the transfer of health care data relating to citizens of other countries.
Changes in regulations or failure to follow regulations requiring the use of “standard transactions” for health care services issued under the Health Insurance Portability and Accountability Act could adversely affect our profitability and cash flows.
Pursuant to HIPAA, the Secretary of HHS has issued final regulations designed to facilitate the electronic exchange of information in certain financial and administrative transactions. HIPAA transaction standards are complex and subject to differences in interpretation by payors. For instance, some payors may interpret the standards to require us to provide certain types of information, including demographic information not usually provided to us by physicians. As a result of inconsistent application of transaction standards by payors or our inability to obtain certain billing information not usually provided to us by physicians, we could face increased costs and complexity, a temporary disruption in receipts and ongoing reductions in reimbursements and revenues. Any future requirements for additional standard transactions, such as claims attachments or use of a national provider identifier, could prove technically difficult, time-consuming or expensive to implement.
We may be subject to liability claims for damages and other expenses not covered by insurance that could adversely impact our operating results.
The provision of diagnostic testing services to patients may subject us to litigation and liability for damages based on an allegation of malpractice, professional negligence in the performance of our treatment and related services, the acts or omissions of our employees, or other matters. Our exposure to this litigation and liability for damages increases with growth in the number of our laboratories and tests performed. Potential judgments, settlements or costs relating to potential future claims, complaints or lawsuits could result in substantial damages and could subject us to the incurrence of significant fees and costs. Our insurance may not be sufficient or available to cover these damages, costs or expenses. Our business, profitability and growth prospects could suffer if we face negative publicity or if we pay damages or defense costs in connection with a claim that is outside the scope of any applicable insurance coverage, including claims related to contractual disputes and professional and general liability claims.
Our insurance costs may increase over the next several years, and our coverage may not be sufficient to cover claims and losses.
We maintain a program of insurance coverage against a broad range of risks in our business. In particular, we maintain professional liability insurance, subject to deductibles. The premiums and deductibles under our insurance may increase over the next several years as a result of general business rate increases, coupled with our continued growth. We are unable to predict whether such increases in premiums and deductibles will occur and the amount of any such increases, but such increases could adversely impact our earnings. The liability exposure of operations in the health care services industry has increased, resulting not only in increased premiums, but also in limited liability on behalf of the insurance carriers. Our ability to obtain the necessary and sufficient insurance coverage for our operations upon expiration of our insurance policies may be limited, and sufficient insurance may not be available on favorable terms, if at all. We could be materially and adversely affected by any of the following: our inability to obtain sufficient insurance for our operations; the collapse or insolvency of one or more of our insurance carriers; further increases in premiums and deductibles; and an inability to obtain one or more types of insurance on acceptable terms.
Risks Relating to Our Indebtedness
Our failure to comply with the financial tests and ratios contained in the agreements governing our senior secured credit facility and senior notes could result in an acceleration of our indebtedness.
We currently expect to meet the financial tests and ratios contained in the agreements governing our amended senior secured credit facility and senior notes at least through the end of 2016. Nonetheless, we may not achieve all of our business goals and objectives and events beyond our control could affect our ability to meet these financial tests and ratios. Any failure by us to meet all applicable financial tests and ratios could result in an event of default with respect to our amended senior secured facility or our senior notes. This could lead to the acceleration of the maturity of our outstanding loans or notes and the termination of the commitments to make further extensions of credit. Each of these would have a material adverse effect on our business. Furthermore, our amended senior secured credit facility, which is scheduled to mature on July 31, 2019, is subject to an accelerated maturity date of October 14, 2017 and would require repayment in 2017 if our senior notes are not refinanced or their maturity is not extended prior to October 14, 2017.
We are highly leveraged, and our substantial indebtedness could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or in our industry, and prevent us from meeting our debt obligations, including our obligations under our senior secured credit facility, our senior notes and our contingent notes issued in acquisitions.
As of December 31, 2015, our total indebtedness was $389.3 million, including $200.0 million outstanding under our senior notes, $189.0 million outstanding under our senior secured credit facility, consisting of $164.0 million outstanding under the term loan and $25.0 million outstanding under the delayed draw term loan. In addition, as of December 31, 2015, the fair value of contingent consideration issued in our acquisitions was $13.1 million and we had $30.0 million available to be borrowed under our revolving credit facility and $40.0 million available through April 10, 2016 to be borrowed for acquisitions under our delayed draw term loan B. Our indebtedness could have important consequences, which could adversely impact our business, results of operations and financial condition, including:
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increase our vulnerability to general adverse economic and industry positions;
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subject us to covenants that limit our ability to fund future working capital, capital expenditures, research and development costs and other general corporate requirements;
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require us to devote a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures, research and development efforts and other general corporate purposes;
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limit our ability to obtain additional financing to fund future acquisitions;
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limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;
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impede our ability to obtain the necessary approvals to operate our business in compliance with the numerous laws and regulations to which we are subject;
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place us at a competitive disadvantage relative to our competitors that have less debt outstanding; and
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limit our ability to borrow additional funds for operational or strategic purposes (including to fund future acquisitions), among other things, under the financial and other restrictive covenants in our indebtedness.
Our credit facility bears interest at variable rates that are linked to changing market interest rates. As a result, an increase in market interest rates above the specified floor would increase our interest expense and our debt service obligations.
Despite our current indebtedness levels, we and our subsidiaries may be able to incur substantially more debt.
We and our subsidiaries may be able to incur substantially more additional indebtedness in the future, including our access to approximately $70.0 million additional borrowing capacity under our senior secured revolving credit facility, inclusive of $40.0 million which is available through April 10, 2016 to pay consideration for acquisitions under the delayed draw term loan B facility, which was entered into on April 10, 2015. Although the terms of our debt agreements contain covenants limiting indebtedness, these covenants are subject to a number of significant exceptions and qualifications, and if we incur additional debt, secure existing or future debt, or recapitalize our debt, we might further exacerbate the risks associated with our substantial indebtedness.
The computation of amounts owed under the contingent notes could lead to disputes that could disrupt our operations and damage our relationships with our pathologists.
In connection with our acquisitions, we agreed to pay additional consideration in future periods based upon the attainment of stipulated levels of operating results of the acquired entities. The computation of the annual operating results and the amount owed under such agreements is subject to review and approval by sellers prior to payment. This computation could lead to a dispute with the sellers who are often our pathologists. For example, as further described in Note 10 of our Consolidated Financial Statements in this Annual Report, certain sellers have claimed that we owed additional amounts in connection with contingent notes. These types of disputes could disrupt our operations, damage our relationships with our pathologists and have a material adverse effect on our business.
The agreements governing our senior secured credit facility and senior notes contains, and future debt agreements may contain, various covenants that limit our discretion in the operation of our business.
Our agreements and the related instruments governing borrowings under our senior secured credit facility and senior notes contain, and the agreements and instruments governing any future debt agreements of ours may contain, various restrictive covenants that, among other things, require us to comply with or maintain certain financial tests and ratios and restrict our ability to:
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incur more debt;
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redeem or repurchase stock, pay dividends or make other distributions;
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make certain investments;
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create liens;
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enter into transactions with affiliates;
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make acquisitions;
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merge or consolidate;
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transfer or sell assets; and
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make fundamental changes in our corporate existence and principal business.
Any failure by us to comply with all applicable covenants could result in an event of default with respect to our senior secured facility, our senior notes or future debt agreements. This could lead to the acceleration of the maturity of our outstanding loans or notes and the termination of the commitments to make further extensions of credit. Even if we are able to comply with all applicable covenants, the restrictions on our ability to operate our business at our sole discretion could harm our business by, among other things, limiting our ability to take advantage of financing, mergers, acquisitions and other corporate opportunities.
Item 1B.
Item 1B.
Unresolved Staff Comments.
Not applicable.
Item 2.
Item 2.
Properties.
We lease our corporate headquarters at 11025 RCA Center Drive, Suite 300, Palm Beach Gardens, FL 33410 (approximately 16,200 square feet), and we lease 29 other facilities: four in Florida, six in Alabama, one in Arizona, one in Georgia, one in Massachusetts, three in Michigan, one in Minnesota, two in Nevada, one in New Hampshire, one in New Jersey, one in New York, two in North Carolina, one in Ohio, one in South Carolina, one in Texas and two in Virginia. These facilities are used for laboratory operations, administrative, billing and collections operations and storage space. The 30 facilities have lease terms expiring from 2016 to 2026.
Item 3.
Item 3.
Legal Proceedings.
As further described in Note 10 to our consolidated financial statements contained herein, we have been and are currently a party to certain legal proceedings. In the normal course of our business, we may be named in various claims, disputes, legal actions and other proceedings involving malpractice, employment and other matters from time to time. A negative outcome in certain of the ongoing litigation could harm our business, financial condition, liquidity or results of operations. Further, prolonged litigation, regardless of which party prevails, could be costly, divert management’s attention or result in increased costs of doing business.
Item 4.
Item 4.
Mine Safety Disclosures.
None.
PART II
Item 5.
Item 5.
Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
We are a privately held company and do not currently have any securities listed on any securities exchange. As of March 21, 2016, we have 14 holders of record of our common membership units. We are permitted to make distributions to our members in accordance with the LLC Agreement, but we have not made any distributions during the past three years.
Item 6.
Item 6.
Selected Financial Data.
The following selected historical consolidated financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and the related notes included in this Annual Report. The selected historical consolidated financial data included in this section are not intended to replace the consolidated financial statements and the related notes included in this Annual Report.
The consolidated statements of operations data for the fiscal years 2013, 2014 and 2015, and consolidated balance sheet data as of fiscal year end 2014 and 2015, were derived from Aurora Holdings’ audited consolidated financial statements that are included elsewhere in this Annual Report. The consolidated statements of operations data for the fiscal years ended December 31, 2011 and 2012 and consolidated balance sheet data as of December 31, 2011, 2012 and 2013, were derived from Aurora Holdings’ audited consolidated financial statements not included in this Annual Report. As indicated in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and disclosed in the audited consolidated financial statements included in this Annual Report, we have made a number of acquisitions. The selected historical consolidated financial data includes the results of operations of those acquisitions subsequent to the acquisition date. The historical results presented below are not necessarily indicative of financial results to be achieved in future periods.
(1)
In July 2011, we adopted the Aurora Diagnostics Holdings, LLC 2011 Equity Incentive Plan, which we refer to as the 2011 Plan. The 2011 Plan provides for the grant of options to purchase units of Aurora Holdings to eligible participants. Through December 31, 2015, we have granted a total of 3,632,619 options to employees under the 2011 Plan, of which 2,087,619 have been forfeited since the grant date. For the years ended December 31, 2013, 2014 and 2015, selling general and administration expenses included compensation costs of $0.3 million, $0.5 million and $0.2 million, respectively, for these awards.
(2)
We test goodwill for impairment annually, or more frequently if circumstances indicate our goodwill may have been impaired. As a result of our testing we recorded non-cash impairment charges to write-down our recorded goodwill by $19.2 million, $0.9 million, $93.0 million, $46.0 million, $52.9 million, $27.3 million, $39.6 million and $17.1 million as of September 30, 2011, June 30, 2012, September 30, 2012, November 30, 2012, November 30, 2013, November 30, 2014, June 30, 2015 and November 30, 2015, respectively. During the year ended December 31, 2011, the non-cash impairment charges included $10.3 million related to our discontinued operation.
We also test for impairment of our other intangible assets whenever events occur indicating the recorded balances of our other intangible assets may not be recoverable. As a result of our testing we recorded non-cash impairment charges to write-down our other intangible assets by $5.3 million, $0.2 million, $21.6 million, $7.9 million, $1.0 million and $0.2 million as of September 30, 2011, June 30, 2012 September 30, 2012, November 30, 2012, November 30, 2013 and November 30, 2014, respectively.
(3)
During the year ended December 31, 2011, we decided to delay the completion of our initial public offering. As a result, we recognized a non-cash charge of $4.4 million to write off the previously deferred offering costs.
(4)
During 2012, we entered into a second amendment to our credit facility. In connection with the second amendment, we repaid approximately $11.9 million of $114.4 million then outstanding under our term loan credit facility and elected to reduce the maximum amount available under the revolving credit facility from $110 million to $60 million. As a result, we recorded a non-cash write-off of the pro rata portion of unamortized original issue discount and debt issue costs of approximately $0.8 million.
In July 2014, we again refinanced our credit facility and recorded a non-cash charge to write off $1.6 million of unamortized deferred debt issue costs and $0.8 million of original issue discount.
(5)
In 2014, we sold our leased clinical lab facility and other assets and recorded a gain of approximately $1.0 million.
(6)
Aurora Holdings is a Delaware limited liability company taxed as a partnership for federal and state income tax purposes in accordance with the applicable provisions of the Internal Revenue Code. Accordingly, Aurora Holdings was not generally subject to income taxes. The income attributable to Aurora Holdings was allocated to the members of Aurora Holdings in accordance with the terms of the existing Aurora Holdings limited liability company agreement, which we refer to as the LLC Agreement. However, certain of our subsidiaries are corporations, file separate returns and are subject to federal and state income taxes. The provision for income taxes for these subsidiaries is reflected in our consolidated financial statements and includes federal and state taxes currently payable and changes in deferred tax assets and liabilities, excluding the establishment of deferred tax assets and liabilities related to the acquisitions.
Adjusted EBITDA is defined as earnings before interest, taxes, depreciation and amortization (EBITDA), further adjusted to exclude unusual items and other cash or non-cash adjustments. We believe that disclosing Adjusted EBITDA provides additional information to investors, enhancing their understanding of our financial performance and providing them an important financial metric used to evaluate performance in the health care industry. Our senior secured credit facility contains financial covenants measured against Adjusted EBITDA. Our definition and calculation of Adjusted EBITDA in this Annual Report is consistent with the definition and calculation contained in our senior secured credit facility and the indenture governing our Senior Notes.
Adjusted EBITDA does not represent net income or cash flow from operations as those terms are defined by GAAP and does not necessarily indicate whether cash flows will be sufficient to fund cash needs. As a result, the measure can be disproportionately affected by a particularly strong or weak quarter. Further, it may not be comparable to the measure for any subsequent four-quarter period or any complete fiscal year.
Adjusted EBITDA is not a recognized measurement under GAAP and should not be considered as a substitute for measures of our financial performance as determined in accordance with GAAP, such as net income and operating income. Because other companies may calculate Adjusted EBITDA differently than we do, Adjusted EBITDA may not be comparable to similarly titled measures reported by other companies. Adjusted EBITDA has other limitations as an analytical tool when compared to the use of net income, which we believe is the most directly comparable GAAP financial measure, including:
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Adjusted EBITDA does not reflect the provision of income tax expense in our various jurisdictions;
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Adjusted EBITDA does not reflect the interest expense we incur;
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Adjusted EBITDA does not reflect any attribution of costs to our operations related to our investments and capital expenditures through depreciation and amortization charges;
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Adjusted EBITDA does not reflect the cost of compensation we provide to our employees in the form of stock option awards; and
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Adjusted EBITDA excludes expenses that we believe are unusual or non-recurring, but which others may believe are normal expenses for the operation of a business.
The following is a reconciliation of net income to Adjusted EBITDA (in thousands):
(A)
In accordance with our New Credit Facility and our prior senior secured credit facility and the indenture governing our Senior Notes, management fees payable to affiliates are excluded from Adjusted EBITDA.
(B)
For the years ended December 31, 2011, 2013, 2014 and 2015, we recorded charges of $12.5 million, $1.1 million, $4.9 million and $1.7 million, respectively, and for the year ended December 31, 2012 we recorded a gain of $4.2 million related to non-cash changes in the estimated fair value of contingent consideration issued in connection with our acquisitions completed after January 1, 2009. These changes in the estimate of the fair value relate to numerous variables such as the discount rate, remaining pay out period and the projected performance for each acquisition.
(C)
During the years ended December 31, 2011, 2012, 2013, 2014 and 2015, we recorded non-cash impairment charges of $24.5 million, $169.6 million, $53.9 million, $27.5 million and $56.7 million, respectively, related to goodwill and other intangible assets. During the years ended December 31, 2011 and 2012, the non-cash impairment charges included $10.3 million and $1.1 million, respectively, related to our discontinued operation. During the year ended December 31, 2011, we decided to delay the completion of our initial public offering. As a result, we recognized a non-cash charge of $4.4 million to write off the previously deferred offering costs.
(D)
Other charges also includes an add-back for acquisition and business development costs as reported in our consolidated statements of operations.
(E)
For the year ended December 31, 2012, net loss included $0.8 million for write-offs of deferred debt issue costs. For the year ended December 31, 2014, we again refinanced our credit facility and recorded a non-cash charge to write off $1.6 million of unamortized deferred debt issue costs and $0.8 million of original issue discount.
(F)
Amount represents EBITDA of our discontinued operation, which was sold on August 31, 2012. The year ended December 31, 2012 includes $1.0 million for the loss on the sale of the discontinued operation.
(G)
The Adjusted EBITDA for the year ended December 31, 2011 excludes the results of operations of acquisitions completed in 2011 prior to their acquisition date. For purposes of calculating compliance ratios for our prior senior secured credit facility, the Adjusted EBITDA for the year ended December 31, 2011 would include approximately $4.6 million of additional Adjusted EBITDA related to operations of our 2011 acquisitions as if they were acquired on January 1, 2011. The Adjusted EBITDA for the year ended December 31, 2011 does not reflect any adjustments to add back $1.6 million of severance and other charges as prescribed by our prior senior secured credit facility and the indenture governing our Senior Notes.
The Adjusted EBITDA for the year ended December 31, 2012 does not reflect any adjustments to add back $2.5 million of severance and other charges as prescribed by our prior senior secured credit facility and the indenture governing our Senior Notes.
The Adjusted EBITDA for the year ended December 31, 2013 does not reflect any adjustments to add back $8.7 million of other amounts as prescribed by our prior senior secured credit facility and the indenture governing our Senior Notes, including approximately $4.8 million for pro forma adjustments related to reduction in force initiatives.
The Adjusted EBITDA for the year ended December 31, 2014 does not reflect adjustments to add back $6.1 million of other amounts as prescribed by our New Credit Facility and the indenture governing our Senior Notes, including approximately $2.9 million for pro forma adjustments related to our acquisitions in 2014.
The Adjusted EBITDA for the year ended December 31, 2015 does not reflect adjustments to add back approximately $9.0 million of other amounts as prescribed by our New Credit Facility and the indenture governing our Senior Notes, including approximately $3.8 million for pro forma adjustments related to our acquisitions in 2015.
Item 7.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Some of the statements made in this Annual Report are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements other than statements of historical facts contained in this Annual Report on Form 10-K, including statements regarding our future results of operations and financial position, or that describe our plans, goals, intentions, objectives, strategies, expectations, beliefs and assumptions, are forward-looking statements. The words “believe,” “may,” “might,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “expect,” “project,” “plan,” “objective,” “could,” “would,” “should” and similar expressions are intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy, short-term and long-term business operations and objectives, and financial needs. We caution that the forward-looking statements in this Annual Report are subject to a number of known and unknown risks, uncertainties and assumptions that may cause our actual results, performance or achievements to be materially different from any future results, performances or achievements expressed or implied by the forward-looking statements. Factors that could contribute to these differences include, among other things:
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changes in medical treatment or reimbursement rates or utilization for our anatomic and clinical pathology markets;
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changes in payor regulations, policies or payor mix;
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changes in regulation or regulatory policies;
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competition for our diagnostic services, including the internalization of testing functions and technologies by our clients;
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the failure to successfully collect for our services;
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payor efforts to reduce utilization and reimbursement rates;
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changes in product mix;
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failure to successfully integrate or fully realize the anticipated benefits from our acquisitions within the expected time frames;
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the discovery of unknown or contingent liabilities from acquired businesses;
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the failure of our acquired assets to generate the level of expected returns;
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disruptions or failures of our IT solutions or infrastructure;
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the failure to adequately safeguard data;
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loss of key executives, pathologists and technical personnel;
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growth in demand for our services that exceeds our ability to adequately scale our infrastructure;
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a decline in our rate of strategic or organic growth;
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the loss of in-network status with or our the inability to collect from health care insurers;
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the availability of additional capital resources;
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increased competition in our industry or the failure to maintain relationships with clients, including referring physicians and hospitals, and with payors;
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the protection of our intellectual property;
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general economic, business or regulatory conditions affecting the health care and diagnostic testing services industries;
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the introduction of new or failure of old technologies, products or tests;
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federal or state health care reform initiatives;
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violation of, failure to comply with, or changes in federal and state laws and regulations related to, submission of claims for our services, fraud and abuse, patient privacy, corporate practice of medicine, billing arrangements for our services and environmental, health and safety;
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attainment of licenses required to test patient specimens from certain states or the loss or suspension of licenses;
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our inability to obtain liability insurance coverage or claims for damages in excess of our coverage;
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future increases in liability insurance coverage;
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our substantial level of indebtedness and ability to incur substantially more debt;
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covenants in our debt agreements; and
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the other risks and uncertainties discussed under the heading “Risk Factors” in Part I, Item 1A of this Annual Report and elsewhere in this Annual Report.
Moreover, we operate in a very competitive and rapidly changing environment, and new risks emerge from time-to-time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this Annual Report may not occur, and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements.
You should not rely upon forward-looking statements as predictions of future events. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee that the future results, levels of activity, performance or events and circumstances reflected in the forward-looking statements will be achieved or occur. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of the forward-looking statements. We undertake no obligation to update publicly any forward-looking statements for any reason after the date of this Annual Report to conform these statements to actual results or changes in our expectations, unless otherwise required by law.
General
We are a specialized diagnostics company providing services that play a key role in the diagnosis of cancer and other diseases. Our experienced pathologists deliver comprehensive diagnostic reports of a patient’s condition and consult frequently with referring physicians to help determine the appropriate treatment. Our diagnostic reports often enable the early detection of disease, allowing referring physicians to make informed and timely treatment decisions that improve their patients’ health in a cost-effective manner. Through our pathologist-operated laboratory practices, we provide physician-based general anatomic and clinical pathology, dermatopathology, molecular diagnostic services and other esoteric testing services to physicians, hospitals, clinical laboratories and surgery centers. Our operations consist of one reportable segment.
Statement of Operations Overview
Net Revenue
Substantially all of our revenue consists of payments or reimbursements for specialized diagnostic services rendered to patients of our referring physicians, and these revenue are affected primarily by changes in case volume, which we refer to as accession volume, payor mix and reimbursement rates. Accessions are measured as the number of patient cases, and each accession may include multiple specimens. Net revenue per accession is impacted mainly by changes in reimbursement rates and test and payor mix. Accession volume varies from period to period based on the referral patterns of our referring physicians and the frequency of their ordering, the relative mix of the referring physicians’ anatomic pathology specialties, and the type and number of tests ordered. Accession volume is also affected by seasonal trends and generally declines during the summer. winter and holiday periods. Furthermore, accession volume is also subject to declines due to weather conditions, such as severe snow storms and flooding or excessively hot or cold spells, as well as general economic conditions, which can deter patients from visiting our referring physicians.
Our billings for services reimbursed by third-party payors, including Medicare, and patients are based on a company-generated fee schedule that is generally set at higher rates than our anticipated reimbursement rates. Our billings to physicians, which are not reimbursed by third-party payors, represent less than 10 percent of net revenue and are billed based on negotiated fee schedules that set forth what we charge for our services. Reimbursement under Medicare for specialized diagnostic services is subject to a Medicare physician fee schedule and, to a lesser degree, a clinical laboratory fee schedule, both of which are updated annually. Our billings to insured patients include co-insurance and deductibles as dictated by the patient’s insurance coverage. Billings for services provided to uninsured patients are based on our company-generated fee schedule. Our revenue is recorded net of the estimated differences between the amount billed and the estimated payment to be received from third party payors, including Medicare. We do not have any capitated payment arrangements, which are arrangements under which we are paid a contracted per person rate regardless of the services we provide. We generally provide services on an in-network basis, where we perform services for persons within the networks of payors with which we have contracts. Services performed on an out-of-network basis, where we perform services for persons outside of the networks of payors with which we have contracts, comprised less than 15 percent of our 2015 revenue. We may face continuing pressure on reimbursement rates as government payors and private insurers have taken steps and may continue to take steps to control the cost, use, and delivery of health care services, including diagnostic testing services. Changes in payor mix could lead to corresponding changes in revenue based on the differences in reimbursement rates.
Compliance with applicable laws and regulations, as well as internal policies and procedures, adds further complexity and costs to our operations. Furthermore, we are generally obligated to bill in the specific manner prescribed by each governmental payor and private insurer, who may each have different billing requirements. Reimbursements for anatomic pathology services are received from governmental payors, such as Medicare and Medicaid; private insurance, including managed care organizations and commercial payors; and private payors, such as physicians and individual patients. For the year ended December 31, 2015, based on cash collections, we estimate approximately 58 percent of our revenue were paid by private insurance, including managed care organizations and commercial payors; approximately 24 percent of our revenue were paid by Medicare and Medicaid; and approximately 18 percent were paid by physicians and individual patients. For the year ended December 31, 2014, we estimate approximately 60 percent of our revenue were paid by private insurance, 22 percent of our revenue were paid by Medicare and Medicaid; and approximately 18 percent were paid by physicians and individual patients.
In most cases, we provide a global testing service which includes both the technical slide preparation and professional diagnosis. We also fulfill requests from physicians for only the technical component of our services, or TC, which principally includes technical slide preparation and the non-professional items associated with our diagnostic services, including equipment, supplies and technical personnel, or the professional component of our services, or PC, which principally includes review and diagnosis by a pathologist. If a physician requires only the TC services such as slide preparation, we prepare the slide and then return it to the referring physician for assessment and diagnosis.
Cost of Services
Cost of services consists of physician costs, including compensation, benefits and medical malpractice insurance and other physician related costs. In addition, cost of services includes costs related to the technical preparation of specimens and transcription of reports, depreciation, courier and distribution costs, and all other costs required to fulfill the diagnostic service requirements of our referring physicians and their patients.
Cost of services generally increases with accession volume and reflects the additional staffing, equipment, supplies and systems needed to process the increased volume and maintain client service levels. A major component of cost of services is physician costs which, for the year ended December 31, 2015, represented approximately 43 percent of our total cost of services. In the future, we may experience increases in physician costs to retain existing physicians, to replace departing physicians or to hire new physicians to support accession growth. A significant portion of our cost of services is fixed. A lesser portion is variable, which will fluctuate in relation to our revenue.
Selling, General and Administrative Expenses
Selling, general and administrative expenses consist primarily of general lab and corporate overhead, billing, information technology, accounting, human resources, and sales and marketing expenses. We continue to incur costs to maintain and update our information systems technology at our existing and acquired labs. We expect sales and marketing and IT expenses to increase faster than revenue as we hire additional personnel and invest in lab and billing information systems to support our efforts to achieve revenue growth and retain existing customer relationships. As we grow, either through acquisition or organic growth and we expand in size, we expect selling, general and administrative expenses as a percent of revenue to reduce over time.
Provision for Doubtful Accounts
The provision for doubtful accounts and the related allowance are adjusted periodically, based upon an evaluation of historical collection experience with specific payors for particular services, anticipated collection levels with specific payors for new services, industry reimbursement trends, accounts receivable aging and other relevant factors. The majority of our provision for doubtful accounts relates to our estimate of uncollectible amounts from patients who are uninsured or fail to pay their coinsurance or deductible obligations. Changes in these factors in future periods could result in increases or decreases in our provision for doubtful accounts and impact our results of operations, financial position and cash flows.
In an effort to maximize our collections of accounts receivable, we take a number of steps to collect amounts, including coinsurance and deductibles, owed by third party payors, government payors, referring physicians and patients. The process generally includes:
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verification of complete insurance information and patient demographics,
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active management and follow up on denials,
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delivery of scheduled statements to patients, and/or
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forwarding significant past due accounts to outside collection agencies.
Due to the fact that we operate on multiple billing platforms, we evaluate collectability and the related adequacy of our allowance for doubtful accounts using information from multiple sources. Not all of our systems produce the same level of information by payor or by aging classification and, therefore, we are unable to provide consolidated accounts receivable agings by payor class. However, we believe that sufficient information exists in each respective billing system to make reasonable estimates of our provision for doubtful accounts. In the future, we may convert legacy billing systems from businesses we have acquired to one or more common billing platforms. This could allow for the consolidation of billing data and information on a consistent basis.
Recent Developments
Health Care Regulatory and Reimbursement Changes
In the 2014 Final Physician Fee Schedule Rule CMS calculated the 2014 conversion factor using the Sustainable Growth Rate method, or SGR. The new conversion factor for 2014 represented a 20.1 percent reduction from the 2013 conversion factor. On December 18, 2013, Congress passed legislation that enacted a 0.5 percent increase in the conversion factor, which was effective through March 31, 2014. On April 1, 2014, President Obama signed the Protecting Access to Medicare Act of 2014, or PAMA. PAMA extended the 0.5 percent increase through March 31, 2015 and made other changes to laboratory reimbursement discussed below.
On April 16, 2015 President Obama signed the Medicare and CHIP Reauthorization Act (MACRA). MACRA repealed the provisions related to the Medicare SGR formula and implemented a new physician payment system that is designed to reward the quality of care. In addition, it extended the then-current Medicare Physician Fee Schedule rates through June, 2015, and then increased them by 0.5 percent for the remainder of 2015. Furthermore, the rates are to be increased annually by 0.5 percent, beginning January 1, 2016, through 2019. For 2020 through 2025, the rates will be frozen, although payments will be adjusted to account for performance on certain quality metrics under the Merit-Based Incentive Payment Systems (MIPS) or to reflect physician participation in alternative payment models (APMs). For 2026 and subsequent years, qualified APM participants receive an annual 0.75% increase on Medicare physician payment rates, while those not participating receive a 0.25% annual payment increase, plus any applicable MIPS-based payment adjustments. At this time, it is too early to determine how these changes may impact our business.
In the 2014 Physician Fee Schedule Rule, CMS also changed CPT codes for certain stains we commonly use and reduced the RVUs related to those codes. These changes, as well as other limits on other commonly-used CPT codes, resulted in decreased Medicare reimbursement for some of our services. We estimated the changes to the 2014 Physician Fee Schedule resulted in a reduction of our annualized Medicare revenue of approximately $3 million. We have experienced isolated reductions in reimbursement from non-governmental third-party payors tied to the Medicare reductions. However, at this time we are unable to predict the extent to which non-governmental third-party payors will seek to reduce our reimbursement rates as a result of reductions in Medicare’s Physician Fee Schedule.
In PAMA, Congress instituted a new process for the review of rates paid for clinical laboratory services, which will replace CMS’s plan to adjust payments based on technological advances. This process only applies to services paid based on the CLFS and would not affect the Medicare reimbursement for those of our services that are paid for under the Physician Fee Schedule. Beginning in 2016, laboratories will be required to report to CMS the prices that they receive from third-party payors and the volumes of the tests paid at each payment level. Payments reported must include any discounts, rebates, coupons or other price concessions, and any changes in prices paid during the applicable time period must also be reported. Reporting must reflect payments from private payors, Medicare Advantage plans and Medicaid managed plans. This reporting process will be repeated every three years, except for tests that are considered Advanced Diagnostic Laboratory Tests, or ADLTs, for which prices must be reported annually. ADLTs are tests performed by a single laboratory and which consist of an analysis of multiple biomarkers of DNA, RNA or proteins combined with a unique algorithm; tests cleared or approved by FDA; or other tests defined by the Secretary of Health and Human Services. PAMA required CMS to issue a Final Rule by June 30, 2015 establishing the data collection requirements. CMS did not meet that deadline and issued a Proposed Rule on October 1, 2015. As a result, CMS may be unable to meet some of the remaining deadlines in the law.
Beginning in 2017, laboratory tests will be paid at the weighted median of all the reported prices; however, the reductions will be phased in over time. From 2017 through 2019, reductions cannot be more that 10 percent of the amount paid in the prior year. From 2020 through 2022, reductions cannot be more than 15 percent of the amount paid in the prior year. When new tests are introduced, they will either be paid based on gapfilling or crosswalking unless they are ADLTs. ADLTs will be paid at their list price for their first three quarters and then will be paid at the new weighted median of the market price. If the initial list price is more than 130% of the new price, then CMS may recoup the difference. In addition, PAMA requires numerous other changes that will affect the coding and coverage for new tests and calls for the establishment of a new technical advisory panel to make recommendations to CMS on payment and coverage issues. Based on our volume of clinical tests, we do not expect the changes to the CLFS to have a material impact on our revenue.
In the 2015 Physician Fee Rule, CMS enacted additional payment changes. Although it had indicated previously that it considered flow cytometry, a test that we commonly bill, to be potentially misvalued and therefore, overpaid, CMS did not change the payment for that code in the Final Rule. CMS did, however, change how it pays for prostate biopsy codes, which is also a test that we bill relatively often, and stated that it did consider that code to be potentially misvalued. In addition, it made substantial reductions in certain other codes, including the codes applicable to FISH (fluorescent in situ hybridization), which we also bill; however, those cuts were offset by the increases in other codes, including CPT 88305, which is the most common code that we bill. CMS also stated that it does not intend to implement the policy that it proposed in the 2014 Proposed Fee Schedule Rule that would have limited certain physician payments to the amounts paid in the hospital setting. Finally, CMS announced that it is withdrawing its authority to amend laboratory rates to reflect technological changes as mandated by PAMA.
On October 30, 2015, CMS issued its Final Physician Fee Schedule Rule for 2016, which adopted new policies that will go into effect in January 2016. Our review of the Final Rule suggests that the impact of the changes could be an increase of approximately $2.0 million in our annualized Medicare revenue, inclusive of acquisitions completed in 2014 and 2015. However, our product mix, payor mix and volume may change and the actual impact of the changes to the 2016 Physician Fee Rule may vary significantly from our estimates. This does not reflect any potential change that Congress might make in the future with regard to the conversion factor.
The Budget Control Act of 2011 created a Joint Select Committee on Deficit Reduction, which was tasked with recommending proposals to reduce spending. Under the law, the Joint Committee’s failure to achieve a targeted deficit reduction, or Congress’ failure to pass the Committee’s recommendations without amendment by December 23, 2011, would result in automatic across-the-board cuts to most discretionary programs. Automatic cuts also would be made to Medicare and would result in aggregate reductions in Medicare payments to providers of up to two percent per fiscal year, starting in 2013 and continuing through 2021. Because the Joint Committee was not able to agree on a set of deficit reduction recommendations on which Congress could vote, cuts went into effect in April 2013. This reduction was extended by PAMA through 2024. We have estimated the impact of sequestration, has been approximately $1.1 million to our annual Medicare revenue.
Acquisitions
Through December 31, 2015, we have acquired 28 diagnostic services companies throughout the United States, with our most recent acquisition completed on October 29, 2015. The following summarizes the acquisitions we completed in 2014 and 2015.
2014 Acquisitions
We acquired 100 percent of the equity of two separate pathology practices on June 30, 2014, a third pathology practice on September 30, 2014, and a fourth pathology practice on October 31, 2014 for an aggregate cash purchase price of $16.0 million. In three of the transactions, we issued additional consideration payable over three years. The additional consideration for two of these acquisitions is based on the future performance of the acquired practice. The total acquisition date fair value of the additional consideration issued for the 2014 acquisitions was $1.4 million, representing the present value of estimated future payments of $2.0 million. We funded the cash portion of the June 30, 2014 acquisitions using funds drawn under our previous revolving credit facility. We funded the cash portion of the September 30, 2014 acquisition using $9.7 million drawn on our new delayed draw term loan and the October 31, 2014 acquisition with cash on hand.
2015 Acquisitions
On July 31, 2015 we acquired the assets of two pathology practices and a billing service, all located in Texas. On October 29, 2015 we acquired 100 percent of the equity of a pathology practice in Ohio. We paid $15.4 million of cash in aggregate at closing and issued contingent notes payable over from three to six years. Payments under the contingent notes will be paid annually, up to a maximum of $11.9 million, subject to the retention of certain key facility contracts, financial results and the cash received under specified client contracts. We primarily used the funds available under our $25.0 million delayed draw term loan to pay the $15.4 million cash portion of the purchase price for the acquisitions.
As a result of the significant number and size of the acquisitions, many of the changes in our consolidated results of operations and financial position in 2015, compared to 2014, and in 2014, compared to 2013, discussed below relate to the acquisitions completed in 2014 and 2015.
Results of Operations
The following table outlines, for the periods presented, our results of operations as a percentage of net revenue.
Our historical consolidated operating results do not reflect the results of operations of our 2014 and 2015 acquisitions prior to the effective date of those acquisitions. As a result, our historical consolidated operating results may not be indicative of what our results of operations will be for future periods. Also, effective January, 1, 2015, we adjusted the way we count our accession volume to better reflect our revenue per accession. Accession counts for all prior periods have been revised to reflect our current methodology.
Comparison of the Year Ended December 31, 2015 and 2014
Net Revenue
Net revenue increased approximately $21.1 million, or 8.7 percent, to $263.7 million for the year ended December 31, 2015, from $242.6 million for the year ended December 31, 2014. Revenue from labs that we operated for the full years 2014 and 2015, which we refer to herein as our existing labs, increased approximately $5.3 million, or 2.2 percent, while the acquisitions contributed approximately $4.8 million and $20.6 million to net revenue in the years ended December 31, 2014 and 2015, respectively, which is a net increase of $15.8 million.
Total accessions increased by 109,000 to 2,076,000 for the year ended December 31, 2015, compared to 1,967,000 for the year ended December 31, 2014. Existing lab accessions increased by 6,000 for the year ended December 31, 2015, compared to the year ended December 31, 2014, while labs acquired in 2014 and 2015 contributed 141,000 and 38,000 accessions for the years ended December 31, 2015 and 2014, respectively, which is a net increase of 103,000 accessions. The average revenue per accession at our existing labs increased to approximately $125 for the year ended December 31, 2015, from $123 for the year ended December 31, 2014. The increase in net revenue at our existing labs was due primarily to changes in testing mix, higher revenue from the Aurora Research Institute, or ARI, and higher reimbursement from Medicare.
On October 30, 2015, CMS issued its Final Physician Fee Schedule Rule for 2016, which adopted new policies that will go into effect in January 2016. Our initial review of the Final Rule suggests that the impact of the changes could be an increase of approximately $2.0 million in our annualized Medicare revenue, inclusive of acquisitions completed in 2014 and 2015.
We expect the average revenue per accession of our existing business to fluctuate primarily as the result of changes in service mix, including women’s health services and clinical tests, which generally have lower revenue per accession, molecular tests which generally have higher revenue per accession and the conversion of global fee arrangements to technical component (TC) or professional component (PC) arrangements. In addition, our growth rates and average revenue per accession may be positively or negatively impacted by the reimbursement market and the average revenue per accession of acquisitions completed in the future.
Cost of Services
Cost of services increased approximately $10.4 million, or 7.9 percent, to $142.7 million for the year ended December 31, 2015 from $132.3 million for the year ended December 31, 2014. Cost of services at labs acquired in 2014 and 2015 was $10.4 million and $2.5 million for the years ended December 31, 2015 and 2014, respectively. Cost of services for our existing labs increased approximately $2.5 million, or 1.9 percent, to $132.2 million for the year ended December 31, 2015, compared to $129.7 million for the year ended December 31, 2014. The increase in costs of services at our existing labs, inclusive of ARI, primarily related to higher personnel related expenses, technical processing costs and physician consulting fees, partially offset by reductions in lab supplies costs associated with improved supplies contracts.
As a percentage of net revenue, cost of services was 54.1 percent and 54.5 percent for the years ended December 31, 2015 and 2014, respectively, and our gross margins were 45.9 percent and 45.5 percent for the years ended December 31, 2015 and 2014, respectively. Our gross margin may be negatively impacted by lower average revenue per accession and increases in pathologist compensation and replacement costs. Cost of services and our related gross profit percentages may be positively or negatively impacted by market conditions and our service mix.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased approximately $5.1 million, or 8.2 percent, to $66.9 million for the year ended December 31, 2015 from $61.8 million for the year ended December 31, 2014. Selling, general and administrative expenses for labs acquired in 2014 and 2015 were $2.5 million and $0.5 million for the years ended December 31, 2015 and 2014, respectively. Selling, general and administrative expenses at corporate increased by approximately $4.0 million while expenses at our existing labs decreased by approximately $0.9 million for the year ended December 31, 2015 compared to 2014. Corporate selling, general and administrative costs increased primarily due higher personnel related costs, including increased temporary personnel and travel costs, as well as increased legal and consulting fees. Selling, general and administrative expense decreased at our existing labs primarily attributable to the $1.2 million for a legal settlement with the U.S. Veterans Administration recognized in 2014, partially offset by higher personnel related costs and billing fees in 2015.
As a percentage of net revenue, selling, general and administrative expenses were 25.4 percent and 25.5 percent for the years ended December 31, 2015 and 2014, respectively.
Provision for Doubtful Accounts
Our provision for doubtful accounts was $16.6 million for each of the years ended December 31, 2015 and 2014. As a percentage of net revenue, the provision for doubtful accounts was 6.3 percent for the year ended December 31, 2015, compared to 6.8 percent for the year ended December 31, 2014. The decrease in the provision for doubtful accounts as a percentage of net revenue primarily related to changes in our collections processes which have improved our collections results. The Company’s provision for doubtful accounts could be positively or negatively impacted by changes in payor mix.
Intangible Asset Amortization Expense (Amortization)
Amortization expense increased by approximately $0.9 million, to $19.0 million for the year ended December 31, 2015, from $18.1 million for the year ended December 31, 2014 as a result of intangible assets acquired in 2014 and 2015, partially offset by certain intangible assets becoming fully amortized. We amortize our intangible assets over weighted average lives ranging from 3 to 15 years.
Management Fees, related parties
Management fees increased by approximately $0.1 million, to $2.6 million for the year ended December 31, 2015, from $2.5 million for the year ended December 31, 2014 as a result of higher net revenue. Management fees are based on 1.0 percent of net revenue plus expenses. Since April 2013, the Company has accrued but not paid management fees in accordance with the terms of its credit agreements. For each of the years ended December 31, 2015 and 2014, we paid expenses of less than $0.1 million, but paid no management fees, and the Company expects to pay no management fees through December 31, 2016. As of December 31, 2015, $8.6 million of these management fees are reflected in long-term liabilities in the accompanying consolidated balance sheet.
Impairment of Goodwill and Other Intangible Assets
At June 30, 2015, we identified indications of impairment at two of our reporting units. One of the reporting units exhibited lower margins and both of the reporting units experienced lower volume as a result of competition to such an extent as to indicate potential impairment. We believe the reduction in volume due to attrition in the client base resulted in reductions in the fair values of the reporting units below their carrying values. We tested goodwill for impairment at these two reporting units as of June 30, 2015 and recorded non-cash impairment charges of $39.6 million to write down the carrying value of goodwill.
At November 30, 2015, we tested goodwill for potential impairment and determined three of our reporting units had carrying values in excess of their estimated fair values. As a result, we recorded non-cash impairment charges of $17.1 million to write down the carrying value of goodwill at these three reporting units. Regarding these reporting units, we believe various factors, including the expected loss of a significant client, higher projected costs and reductions in projected private insurance reimbursement rates resulted in a reduction in the fair value of the reporting units below their carrying value.
At November 30, 2014, we tested goodwill and intangible assets for potential impairment and recorded non-cash impairment charges of $27.5 million resulting from a write-down of $27.3 million in the carrying value of goodwill and a write-down of $0.2 million in the carrying value of intangible assets. The write-down of the goodwill and intangible assets related to five of our reporting units. The impairments at these reporting units were primarily the result of client attrition, as well as the cumulative effect of reductions in reimbursement from governmental payors in 2013 and 2014.
As of December 31, 2015, we had goodwill and net intangible assets of $190.9 million. Many factors, including competition, general economic conditions, health care reform, third party payment patterns and industry consolidation, could have a negative impact on one or more of our reporting units. Therefore, we may experience additional impairment charges in future periods.
Gain on Sale of Leased Facility
On December 31, 2014, we sold certain assets, including equipment and other assets, pertaining to our sole clinical laboratory facility for approximately $0.9 million. This leased facility was our only location that exclusively performed clinical laboratory testing. We also entered into a laboratory services agreement with the purchaser of the clinical laboratory facility effective January 1, 2015, under which we are outsourcing clinical laboratory testing to the purchaser. As a result of the facility sale, we recorded a gain on sale of facility of approximately $1.0 million for the year ended December 31, 2014.
Change in Fair Value of Contingent Consideration
For the year ended December 31, 2015, we recorded net non-cash charges of $1.7 million, compared to non-cash charges of $4.9 million for the year ended December 31, 2014, to recognize changes in the estimated fair values of contingent consideration issued in connection with our acquisitions completed after January 1, 2009. These charges relate to changes in the estimated fair value, including numerous variables such as the discount rate, remaining pay out period and the projected performance for each acquisition.
In April 2015, we finalized a settlement agreement with the sellers in one of our acquisitions. As a result of the settlement we recorded a charge of approximately $5.4 million in the change in fair value of contingent consideration in the year ended December 31, 2014.
Acquisition and Business Development Costs
Transaction costs associated with our acquisitions and business development costs decreased to $0.9 million for the year ended December 31, 2015, compared to $1.0 million for the year ended December 31, 2014, as a result of a decline in acquisition activity during 2015.
Interest Expense
Interest expense for the year ended December 31, 2015 was $41.0 million, compared to $36.0 million for the year ended December 31, 2014. The higher interest expense related to higher average balances outstanding under our credit facility term loans. Additionally, interest rates under our current credit facility entered into on July 31, 2014 are higher, currently at 8.375 percent, than our prior credit facility, which was paid off on July 31, 2014 with a portion of the proceeds from the current credit facility.
Write-off of Deferred Debt Issue Costs and Loss on Extinguishment of Debt
As noted in the preceding paragraph, on July 31, 2014 we entered into a new credit facility and used a portion of the proceeds to repay all amounts outstanding under our prior credit facility. In connection with the retirement of our previous credit facility, we recorded a non-cash charge of $1.6 million to write off the unamortized balance of deferred issuance costs and a non-cash loss on extinguishment of debt of $0.8 million for the related original issue discount.
Benefit for Income Taxes
We are a Delaware limited liability company taxed as a partnership for federal and state income tax purposes, in accordance with the applicable provisions of the Internal Revenue Code. Accordingly, we generally have not been subject to income taxes, and the income attributable to us has been allocated to the members of Aurora Holdings in accordance with the terms of the LLC Agreement. However, certain of our subsidiaries are structured as corporations and therefore are subject to federal and state income taxes. The benefit for federal and state income taxes for these subsidiaries, as reflected in our consolidated financial statements, amounted to a benefit of $0.9 million and $4.1 million for the years ended December 31, 2015 and 2014, respectively.
Comparison of the Year Ended December 31, 2014 and 2013
Net Revenue
Net revenue decreased approximately $5.6 million, or 2.3 percent, to $242.6 million for the year ended December 31, 2014, from $248.2 million for the year ended December 31, 2013. Revenue from labs that we operated for the full years 2013 and 2014 decreased approximately $10.4 million, or 4.2 percent, while the acquisitions in 2014 contributed approximately $4.8 million to net revenue.
Total accessions declined by 37,000 to 1,967,000 for the year ended December 31, 2014, compared to 2,004,000 for the year ended December 31, 2013. Accessions at existing labs declined by 75,000 for the year ended December 31, 2014, compared to the year ended December 31, 2013, while labs acquired in 2014 contributed 38,000 accessions for the year ended December 31, 2014. The average revenue per accession at our existing labs decreased to $123 for the year ended December 31, 2014, from $124 for the year ended December 31, 2013. The decrease in net revenue at our existing labs was due primarily to client attrition and lower volume from continuing clients, which offset revenue from new clients and hospital contracts, as well as lower reimbursement, chiefly from Medicare reductions, including changes to the 2014 Fee Schedule and sequestration, which became effective in April 2013. These decreases in revenue were partially offset by $1.8 million higher revenue from the Aurora Research Institute, or ARI.
Cost of Services
Cost of services decreased approximately $1.8 million, or 1.4 percent, to $132.3 million for the year ended December 31, 2014 from $134.1 million for the year ended December 31, 2013. Cost of services at labs acquired in 2014 was $2.5 million for the year ended December 31, 2014. Cost of services for our existing labs decreased approximately $4.3 million, or 3.3 percent, to $129.8 million for the year ended December 31, 2014. The decrease in costs of services at our existing labs primarily related to lower personnel related costs from reductions in headcount, lower medical liability insurance, and reductions in lab supplies costs associated with lower volume, partially offset by higher costs for the expansion of ARI.
As a percentage of net revenue, cost of services was 54.5 percent and 54.0 percent for the years ended December 31, 2014 and 2013, respectively, and our gross margins were 45.5 percent and 46.0 percent for the years ended December 31, 2014 and 2013, respectively. Our gross margin may be negatively impacted by lower average revenue per accession and increases in pathologist compensation and replacement costs. Cost of services and our related gross profit percentages may be positively or negatively impacted by market conditions and our service mix.
Selling, General and Administrative Expenses
Selling, general and administrative expenses decreased approximately $3.1 million, or 4.8 percent, to $61.8 million for the year ended December 31, 2014 from $64.9 million for the year ended December 31, 2013. Selling, general and administrative expenses for labs acquired in 2014 were $0.5 million for the year ended December 31, 2014. Selling, general and administrative expenses at corporate increased by approximately $1.1 million while expenses at our existing labs decreased by approximately $4.7 million for the year ended December 31, 2014 compared to 2013. Selling, general and administrative expense reductions at our existing labs were attributable to lower personnel related costs as a result of reductions in headcount, lower costs for electronic medical records systems donations which were ceased in the first quarter of 2014 and lower billing fees primarily attributable to the decrease in revenue, partially offset by a charge of $1.2 million for a proposed legal settlement with the U.S. Veterans Administration. Corporate selling, general and administrative costs reflected higher compensation costs, including share based compensation, partially offset by lower legal costs.
As a percentage of net revenue, selling, general and administrative expenses were 25.5 percent and 26.2 percent for the years ended December 31, 2014 and 2013, respectively.
Provision for Doubtful Accounts
Our provision for doubtful accounts decreased $0.3 million, or 2.0 percent, to $16.6 million for the year ended December 31, 2014, from $16.9 million for the year ended December 31, 2013. The decrease in the provision for doubtful accounts primarily related to changes in our payor mix and lower net revenue. As a percentage of net revenue, the provision for doubtful accounts was 6.8 percent for each of the years ended December 31, 2014 and 2013. The Company’s provision for doubtful accounts could be positively or negatively impacted by changes in payor mix.
Intangible Asset Amortization Expense (Amortization)
Amortization expense decreased by approximately $0.5 million, to $18.1 million for the year ended December 31, 2014, from $18.6 million for the year ended December 31, 2013 as a result of certain intangible assets becoming fully amortized, as well as $1.0 million and $0.2 million of impairments of finite lived intangible assets recorded in November 2013 and November 2014, respectively. The decreases were partially offset by approximately $0.4 million of amortization related to the 2014 acquisitions. We amortize our intangible assets over weighted average lives ranging from 3 to 15 years.
Management Fees, related parties
Management fees were comparable for the years ended December 31, 2014 and 2013, at approximately $2.5 million. Management fees are based on 1.0 percent of net revenue plus expenses. Since April 2013, the Company has accrued but not paid management fees in accordance with the terms of its credit agreements. For each of the years ended December 31, 2014 and 2013, we paid expenses of less than $0.1 million, but paid no management fees.
Impairment of Goodwill and Other Intangible Assets
At November 30, 2014, we tested goodwill and intangible assets for potential impairment and recorded non-cash impairment charges of $27.5 million resulting from a write-down of $27.3 million in the carrying value of goodwill and a write-down of $0.2 million in the carrying value of intangible assets. The write-down of the goodwill and intangible assets related to five of our reporting units. The impairments at these reporting units were primarily the result of client attrition, as well as the cumulative effect of reductions in reimbursement from governmental payors in 2013 and 2014.
At November 30, 2013, we tested goodwill and intangible assets for potential impairment and recorded non-cash impairment charges of $53.9 million resulting from a write-down of $52.9 million in the carrying value of goodwill and a write-down of $1.0 million in the carrying value of intangible assets. The write-down of the goodwill and intangible assets related to seven of our reporting units. The impairments at these reporting units were primarily the result of the reduction in Medicare reimbursement rates effective for 2014.
Gain on Sale of Leased Facility
On December 31, 2014, we sold certain assets, including equipment and other assets, pertaining to our sole clinical laboratory facility for approximately $0.9 million. This leased facility was our only location that exclusively performed clinical laboratory testing. We also entered into a laboratory services agreement with the purchaser of the clinical laboratory facility effective January 1, 2015, under which we are outsourcing clinical laboratory testing to the purchaser. As a result of the facility sale, we recorded a gain on sale of facility of approximately $1.0 million for the year ended December 31, 2014.
Change in Fair Value of Contingent Consideration
For the year ended December 31, 2014, we recorded net non-cash charges of $4.9 million, compared to non-cash charges of $1.1 million for the year ended December 31, 2013, to recognize changes in the estimated fair values of contingent consideration issued in connection with our acquisitions completed after January 1, 2009. The gain and charge relate to changes in the estimated fair value, including numerous variables such as the discount rate, remaining pay out period and the projected performance for each acquisition.
In April 2015, we finalized a settlement agreement with the sellers in one of our acquisitions. As a result of the settlement we recorded a charge of approximately $5.4 million in the change in fair value of contingent consideration in the year ended December 31, 2014.
Acquisition and Business Development Costs
Transaction costs associated with our acquisitions and business development costs increased to $1.0 million for the year ended December 31, 2014, compared to approximately $0.2 million for the year ended December 31, 2013, as a result of a higher level of acquisition activity during 2014.
Interest Expense
Interest expense for the year ended December 31, 2014 was $36.0 million, compared to $32.8 million for the year ended December 31, 2013. The higher interest expense related to higher average balances outstanding under our credit facility. Additionally, interest rates under our current credit facility entered into on July 31, 2014 were higher than the prior credit facility, which was paid off on July 31, 2014 with a portion of the proceeds from the current credit facility.
Write-off of Deferred Debt Issue Costs and Loss on Extinguishment of Debt
On July 31, 2014 we entered into a new credit facility and used a portion of the proceeds to repay all amounts outstanding under our prior credit facility. In connection with the retirement of our previous credit facility, we recorded a non-cash charge of $1.6 million to write off the unamortized balance of deferred issuance costs and a non-cash loss on extinguishment of debt of $0.8 million for the related original issue discount.
Benefit for Income Taxes
We are a Delaware limited liability company taxed as a partnership for federal and state income tax purposes, in accordance with the applicable provisions of the Internal Revenue Code. Accordingly, we generally have not been subject to income taxes, and the income attributable to us has been allocated to the members of Aurora Holdings in accordance with the terms of the LLC Agreement. However, certain of our subsidiaries are structured as corporations and therefore are subject to federal and state income taxes. The benefit for federal and state income taxes for these subsidiaries, as reflected in our consolidated financial statements, amounted to a benefit of $4.1 million and $3.9 million for the years ended December 31, 2014 and 2013, respectively.
Liquidity and Capital Resources
Since inception, we have primarily financed operations through capital contributions from our equityholders, long term debt financing and cash flow from operations.
On December 20, 2010, we issued $200.0 million in unsecured Senior Notes that mature on January 15, 2018. The Senior Notes bear interest at an annual rate of 10.75 percent, which is payable each January 15th and July 15th. In accordance with the indenture governing our Senior Notes, we are subject to certain limitations on issuing additional debt and are required to submit quarterly and annual financial reports. The Senior Notes are currently redeemable at our option at 102.688 percent of par, plus accrued interest. The redemption price decreases to 100 percent of par on January 15, 2017. The Senior Notes rank equally in right of repayment with all of our other senior indebtedness, but are subordinated to our secured indebtedness to the extent of the value of the assets securing that indebtedness.
On July 31, 2014 we entered into a new $220.0 million credit facility with Cerberus Business Finance, LLC, which we refer to as the New Credit Facility. The New Credit Facility consists of a $165.0 million initial term loan, $30.0 million revolving credit line and $25.0 million delayed draw term loan. The delayed draw term loan facility, as amended, was available through October 31, 2015 to pay the consideration for acquisitions, as permitted under the New Credit Facility, including acquisition related fees and expenses. Each of the term loan, revolving credit line and delayed draw term loan under the New Credit Facility has a maturity of five years but is subject to a maturity date of October 14, 2017 if our Senior Notes are not refinanced or their maturity is not extended prior to such date. Under the outstanding term loans, quarterly principal repayments of $0.5 million became due commencing on September 30, 2015 through December 31, 2016. Quarterly principal repayments increase to $0.9 million on March 31, 2017 through June 30, 2018 and to $1.3 million on September 30, 2018 and each quarter end thereafter, with the balance due at maturity. Prior to the second amendment on April 10, 2015, at our option, interest under the New Credit Facility was either LIBOR, with a 1.25% floor, plus 7%, or at a base rate, with a 2.25% floor, plus 6%. The New Credit Facility is secured by essentially all of our assets and unconditionally guaranteed by us and certain of the Company’s existing and subsequently acquired or organized domestic subsidiaries and is subject to certain financial covenants.
We used $145.6 million of the $165.0 million proceeds to retire our previous revolving credit facility due May 2015 and term loan facility due May 2016, including accrued interest and fees. The proceeds under the New Credit Facility were reduced by discounts of $5.1 million. Additionally, we used $3.9 million of the proceeds to pay issuance costs in connection with the New Credit Facility. In connection with the retirement of our previous credit facility, we recorded a non-cash charge of $1.6 million to write off the unamortized balance of deferred issuance costs and a non-cash loss on extinguishment of debt of $0.8 million for the related original issue discount.
On April 10, 2015 we entered into a second amendment to the New Credit Facility. The second amendment to the New Credit Facility added a $40 million delayed draw term loan B facility which is available through April 10, 2016 to pay consideration for acquisitions, as permitted under the New Credit Facility, including acquisition related fees and expenses. The second amendment also increased the interest rate under the New Credit Facility to LIBOR, with a 1.25% floor, plus 7.125%, or to the base rate, with a 2.25% floor, plus 6.125%. The New Senior Secured Credit Facility is subject to a 2.25% per annum fee on the undrawn amount thereof, payable quarterly in arrears.
The Company borrowed $9.7 million under the delayed draw term loan during 2014. The Company entered into third and fourth amendments to its New Credit Facility that extended the period that the Company was able to use the remaining availability under the $25.0 million delayed draw term loan from July 31, 2015, to October 31, 2015. In connection with the acquisitions consummated by the Company on July 15, 2015 and October 29, 2015, the Company borrowed the remaining $15.3 million available under the delayed draw term loan.
As of December 31, 2015, the balance outstanding under our term loan facility was $164.0 million and the balance outstanding under the delayed draw term loan facility was $25.0 million. As of December 31, 2015 we were in compliance with our loan covenants. As of December 31, 2015, no amounts were outstanding and we had $30.0 million available under our revolving credit facility and $40 million available for acquisitions under our delayed draw term loan B facility.
Generally, we are permitted to make voluntary prepayments under the New Credit Facility and to reduce the existing revolving loan commitments at any time. However, subject to certain exceptions, prepayments and commitment reductions are subject to a premium equal to 3.0% of the term loans prepaid and revolving credit commitments reduced through July 31, 2016. The premium is reduced to 2.0% effective August 1, 2016, further reduced to 1.0% effective August 1, 2017 and eliminated entirely after July 31, 2018.
Subject to certain exceptions, we are required to prepay borrowings under the New Credit Facility as follows: (i) with 100% of the net cash proceeds we receive from the incurrence of debt obligations other than debt obligations otherwise permitted under the financing agreement, (ii) with 100% of the net cash proceeds in excess of $1 million in the aggregate in any fiscal year we receive from specified non-ordinary course asset sales or as a result of casualty or condemnation events, subject to reinvestment provisions, (iii) with 50% of our excess cash flows for each fiscal year commencing with the fiscal year ending December 31, 2015 and (iv) 100% of the net cash proceeds from the exercise of any “equity cure” with respect to the financial covenants contained in the financing agreement.
The New Credit Facility requires us to maintain a maximum leverage ratio (based upon the ratio of total funded debt to consolidated EBITDA, net of agreed cash amounts) and a minimum interest coverage ratio (based upon the ratio of consolidated EBITDA to net cash interest expense), each quarter based on the last four fiscal quarters. The maximum leverage ratio as of December 31, 2015 was 10.20:1.00 and becomes more restrictive each quarter through maturity. The interest coverage ratio was 1.00:1.00 as of December 31, 2015 and increases to 1.05:1.00 on December 31, 2017. In addition, we are required to maintain liquidity (defined as availability under the revolving credit facility plus amounts in bank accounts that are subject to the agent’s perfected first priority liens) of at least $5.0 million at any time and $10.0 million on the last business day of each month. Our compliance with the maximum leverage ratio and the minimum interest coverage ratio is subject to customary “equity cure” rights.
The New Credit Facility specifies maximum limits for our consolidated capital expenditures on an annual basis and includes negative covenants restricting or limiting our ability to, among other things, incur, assume or permit to exist additional indebtedness or guarantees; incur liens and engage in sale leaseback transactions; make loans and investments; declare dividends, make payments or redeem or repurchase capital stock; engage in mergers, acquisitions and other business combinations; prepay, redeem or purchase certain indebtedness; amend or otherwise alter terms of our indebtedness; sell assets; enter into transactions with affiliates and alter our business without prior approval of the lenders. The New Credit Facility also contains customary default provisions that include material adverse events, as defined therein. We have determined that the risk of subjective acceleration under the material adverse events clause is remote and therefore have classified the outstanding principal in long-term debt based on scheduled repayments.
In connection with the final settlement of one of our contingent notes, effective June 26, 2013, we agreed to pay $2.0 million in 24 equal monthly installments, plus 8 percent interest on the unpaid balance, through June 2015. As of December 31, 2015, this subordinated note was fully repaid.
Long-term debt consists of the following as of December 31, 2015 (in thousands):
As of December 31, 2015, future maturities of long-term debt are as follows (in thousands):
*
The estimated future debt principal payments in 2019 reflect the maturity of the Company’s New Credit Facility which is subject to a maturity date of October 14, 2017 and would be repaid in 2017 if the Company’s Senior Notes are not refinanced or their maturity is not extended prior to October 14, 2017.
Contingent Consideration
In connection with the majority of our acquisitions, we have agreed to pay additional consideration annually over future periods of three to six years based upon contract retention and the attainment of stipulated levels of operating results by each of the acquired entities, as defined in their respective agreements. The computation of the annual operating results is subject to review and approval by sellers prior to payment. In the event there is a dispute, the Company will pay the undisputed amount and then take reasonable efforts to resolve the dispute with the sellers. If the sellers are successful in asserting their dispute, the Company could be required to make additional payments in future periods. For the years ended December 31, 2013, 2014 and 2015, we paid consideration under contingent notes of $21.0 million, $5.8 million and $4.5 million, respectively. During 2014 we received $1.2 million of repayments of contingent notes.
As of December 31, 2015, the total maximum future payments of contingent consideration issued in acquisitions was $21.8 million. Lesser amounts will be paid or no payments will be made for earnings below the maximum level of stipulated earnings or if the stipulated contracts are not retained. We utilize a present value of estimated future payments approach to estimate the fair value of the contingent consideration. These estimates involve significant projections regarding future performance of the acquired practices. If actual future results differ significantly from current estimates, the actual payments for contingent consideration will differ correspondingly. Any future payments of contingent consideration will be reflected in the change in the fair value of the contingent consideration. As of December 31, 2015, the fair value of contingent consideration related to acquisitions was $13.1 million, representing the present value of approximately $18.7 million in estimated future payments through 2021.
In April 2015, we finalized a settlement agreement with the sellers in one of our acquisitions. As a result of the settlement we recorded a charge of approximately $5.4 million in the change in fair value of contingent consideration in the year ended December 31, 2014. In connection with the settlement, we paid cash of $0.9 million to the sellers within 5 days of settlement and modified the contingent notes to extend payments for an additional two years.
Medical Malpractice Insurance
We are insured on a claims-made basis up to our policy limits through a third party malpractice insurance policy. We establish reserves, on an undiscounted basis, for self-insured deductibles, claims incurred and reported and claims incurred but not reported (IBNR) during the policy period. We had recorded medical malpractice liabilities of $3.2 million and $2.2 million as of December 31, 2014 and 2015, respectively, which were included in accounts payable, accrued expenses and other current liabilities. We also record a receivable from our insurance carrier for expected recoveries. Expected insurance recoveries, which are included in prepaid expenses and other current assets, were $1.1 million and $0.3 million as of December 31, 2014 and 2015, respectively. So long as we maintain third party malpractice insurance policies, the IBNR claims will be covered by such third party policy up to the policy limits.
Cash and Working Capital
We require significant cash flow to service our debt obligations, including contingent notes. In addition to servicing our debt, we use cash to make acquisitions, purchase property and equipment and otherwise fund our operations. Cash used to fund our operations excludes the impact of non-cash items, such as the allowance for doubtful accounts, depreciation, impairments of goodwill and other intangible assets, changes in the fair value of the contingent consideration and non-cash stock-based compensation, and is impacted by the timing of our payments of accounts payable and accrued expenses and collections of accounts receivable.
As of December 31, 2015, we had cash and cash equivalents of $19.1 million and working capital of $11.4 million. We had $30.0 million available under our revolving credit facility and $40.0 million available under our delayed draw term loan B facility. The delayed draw term loan B facility is available through April 10, 2016 to pay the consideration for acquisitions, as permitted under the New Credit Facility. We believe our current cash and cash equivalents together with cash from operations and the amount available under our revolving credit facility will be sufficient to fund our working capital requirements through 2016. In order to access the amounts available under our revolving credit facility, we must meet the financial tests and ratios contained in our New Credit Facility. We currently expect to meet these financial tests and ratios at least through the end of 2016. Nonetheless, we may not achieve all of our business goals and objectives and events beyond our control could affect our ability to meet these financial tests and ratios and limit our ability to access the amounts otherwise available under our revolving credit facility.
Cash Provided By Operating Activities
Net cash provided by operating activities during the year ended December 31, 2015 was $2.3 million compared to $7.8 million during the year ended December 31, 2014. Net cash provided by operating activities for the year ended December 31, 2015 reflected a net loss of $83.4 million and certain adjustments for non-cash items, including $56.7 million for write-offs of goodwill and other intangible assets, $23.3 million of depreciation and amortization, $3.2 million of amortization of debt issue costs and original issue discount, $0.2 million of equity compensation costs and a $1.7 million increase in the fair value of contingent consideration, partially offset by a net decrease of $1.9 million of deferred income tax liabilities. Net cash provided by operating activities for the year ended December 31, 2015 also reflected a $0.5 million decrease in prepaid income taxes and other prepaid expenses, a $0.6 million increase in accrued interest, a $1.1 million increase in accounts payable, accrued expenses and other liabilities, and a $0.3 million increase in accrued compensation. As of December 31, 2015, our DSO (Days Sales Outstanding) were 43 days compared to 44 days as of December 31, 2014.
Cash Used In Investing Activities
Net cash used in investing activities during the year ended December 31, 2015 was $22.1 million compared to $21.8 million during the year ended December 31, 2014. Net cash used in investing activities during the year ended December 31, 2015 primarily consisted of $15.3 million net cash paid for acquisitions, $4.5 million of contingent note payments and $2.3 million of purchases of property and equipment.
Cash Provided By Financing Activities
Net cash provided by financing activities for the year ended December 31, 2015 was $12.5 million compared to $39.0 million for the year ended December 31, 2014. For the year ended December 31, 2015, we borrowed $15.0 million under our delayed draw term loan and paid $0.9 million of debt issuance costs, $0.6 million of principal under subordinated notes and capital leases and repaid $1.0 million on our term loan facility.
Contractual Obligations and Commitments
The following table sets forth our long-term contractual obligations and commitments as of December 31, 2015 (in thousands):
(1)
The estimated future debt principal payments in 2019 reflect the maturity of the Company’s New Credit Facility which is subject to a maturity date of October 14, 2017 and would be repaid in 2017 if the Company’s Senior Notes are not refinanced or their maturity is not extended prior to October 14, 2017.
(2)
Estimated interest payments on our Term Loans calculated using the current effective interest rates (LIBOR (subject to a floor of 1.375 percent), plus 7.00 percent per annum) multiplied by the outstanding balances as of December 31, 2015, reduced by scheduled principal repayments.
Off Balance Sheet Arrangements
None.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with GAAP, which requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reported periods. We have provided a description of all our significant accounting policies in Note 1 to our audited consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K. We believe that of these significant accounting policies, the following may involve a higher degree of judgment or complexity.
Net Revenue and Accounts Receivable
Substantially all of our revenue consists of payments or reimbursements for specialized diagnostic services rendered to patients of our referring physicians. Our billings for services reimbursed by third-party payors, including Medicare, and patients are based on a company-generated fee schedule that is generally set at higher rates than our anticipated reimbursement rates. Our billings to physicians are billed based on negotiated fee schedules that set forth what we charge for our services. Reimbursement under Medicare for our services is subject to a Medicare physician fee schedule and, to a lesser degree, a clinical laboratory fee schedule, both of which are updated annually. Our billings to patients include co-insurance and deductibles as dictated by the patient’s insurance coverage. Billings for services provided to uninsured patients are based on our company-generated fee schedule. We do not have any capitated payment arrangements, which are arrangements under which we are paid a contracted per person rate regardless of the services we provide.
Our net revenue is recorded net of contractual allowances, which represent the estimated differences between the amount billed and the estimated payment to be received from third party payors, including Medicare. Adjustments to the estimated contractual allowances, which are based on actual receipts from third-party payors, including Medicare, are recorded upon settlement. Our billing is currently processed through multiple systems. We have an ongoing process to evaluate and record our estimates for contractual allowances based on information obtained from each of these billing systems. This information includes aggregate historical billing and contractual adjustments, billings and contractual adjustments by payor class, accounts receivable by payor class, aging of accounts receivable, historical cash collections and related cash collection percentages by payor and/or aggregate cash collections compared to gross charges. In addition, we may take into account the terms and reimbursement rates of our larger third party payor contracts and allowables under government programs in determining our estimates.
The process for estimating the ultimate collection of accounts receivable associated with our services involves significant assumptions and judgment. The provision for doubtful accounts and the related allowance are adjusted periodically, based upon an evaluation of historical collection experience with specific payors for particular services, anticipated collection levels with specific payors for new services, industry reimbursement trends, accounts receivable aging and other relevant factors. The majority of our provision for doubtful accounts relates to our estimate of uncollectible amounts from patients who are either uninsured and may fail to pay their coinsurance or deductible obligations. Changes in these factors in future periods could result in increases or decreases in our provision for doubtful accounts and impact our results of operations, financial position and cash flows.
The degree of information used in making our estimates varies based on the capabilities and information provided by each of our billing systems. Due to our multiple billing systems and the varying degree of billing information and system capabilities, the following should be noted regarding our estimates of allowances for contractual adjustments and doubtful accounts.
First, our billing systems are unable to quantify amounts pending approval from third parties. However, we generally operate in most markets as an in-network provider, and we estimate that approximately 90 percent of our diagnostic testing services are paid for by locally-focused in-network providers. As of December 31, 2015 our DSO (Days Sales Outstanding) averaged 43 days.
We also make our provisions for contractual adjustments based on our aggregate historical contractual write-off experience for a particular laboratory as recorded and reported in that laboratory’s billing system. This estimate is not done on a patient-by-patient or payor-by-payor basis. The actual aggregate contractual write-offs are recorded as a reduction in our allowance for contractual adjustments account in the period in which they occur. At the end of each accounting period, we analyze the adequacy of our allowance for contractual adjustments based on the information reported by our individual laboratories’ respective billing systems.
In addition, our current laboratory billing systems generally do not provide reports on contractual adjustments by date of service. Accordingly, we are unable to directly compare the aggregate estimated provision for contractual adjustments to the actual adjustments recorded in its various laboratory billing systems at the patient level. However, we do analyze the aggregate provision for contractual adjustments as a percentage of gross charges for each laboratory’s billing system compared to the last twelve months’ actual contractual writes-offs as a percentage of gross charges to determine that our estimated percentages are a reasonable basis for recording our periodic provisions for contractual adjustments.
Further, in determining the provision of doubtful accounts, we analyze the historical write-off percentages for each of our laboratories as recorded in our billing systems. We record an estimated provision for doubtful accounts for each accounting period based on our historical experience ratios. Actual charge-offs reduce our allowance for doubtful accounts in the period in which they occur. At each balance sheet date, we evaluate the adequacy of our allowance for doubtful accounts based on the information provided by the billing system for each of our laboratories. In conducting this evaluation, we consider, if available, the aging and payor mix of our accounts receivables.
Finally, in order to assess the reasonableness of the periodic estimates for the provision for contractual adjustments and doubtful accounts, we compare our actual historical contractual write-off percentages and our bad debt write-off percentages to the estimates recorded for each of our laboratories. In addition, at the end of each accounting period, we evaluate the adequacy of our contractual and bad debt allowances based on the information reported by the billing system for each of our laboratories to ensure that our reserves are adequate on a consolidated basis.
As of December 31, 2015, for each 1.0 percent change in our estimate for the allowance for contractual adjustments, net revenue would have increased or decreased approximately $0.9 million. As of December 31, 2015, for each 1.0 percent change in our estimate for the allowance for doubtful accounts, our provision for doubtful accounts would have increased or decreased by approximately $0.5 million.
Fair Value of Contingent Consideration Issued in Acquisitions
The fair value of contingent consideration is derived using valuation techniques that incorporate unobservable inputs. We utilize a present value of estimated future payments approach to estimate the fair value of the contingent consideration. Estimates for fair value of contingent consideration primarily involve two inputs, which are (i) the projections of the financial performance of the acquired practices that are used to calculate the amount of the contingent payments and (ii) the discount rates used to calculate the present value of future payments.
Projections of future performance of the acquired practices involve significant assumptions and judgment. If future results differ significantly from current projections, future payments for contingent consideration will differ correspondingly. In developing projections, we consider historical results and trends and factors that are likely to impact future results. On a quarterly basis, we review the actual results for the acquired practices in relation to our prior projections and assess whether current projections should be adjusted higher or lower in light of recent results. We also consider any events or changes in circumstances that may have occurred which could affect future performance.
The discount rates used in estimating the fair value of contingent consideration incorporate current market interest rates adjusted for company specific risks at the acquired labs. At December 31, 2015 the discount rates used ranged from 15.8 percent to 20.1 percent.
Annual Impairment Testing of Goodwill and Intangibles
Goodwill is our single largest asset. We evaluate the recoverability and measure the potential impairment of our goodwill annually on November 30th, or when events or circumstances dictate, more frequently. The annual impairment test is a two-step process that begins with the estimation of the fair value of the reporting unit. For purposes of testing goodwill for impairment, each of our acquired practices is considered a separate reporting unit. To estimate the fair value of the reporting units, we utilize a discounted cash flow model as the primary approach to value supported by a market approach guideline public company method, or the GPC Method, which is used as a reasonableness test. We believe that a discounted cash flow analysis is the most appropriate methodology to test the recorded value of long-term assets with a demonstrated long-lived value. The results of the discounted cash flow provide reasonable estimates of the fair value of the reporting units because this approach is based on each respective unit’s actual results and reasonable estimates of future performance, and also takes into consideration a number of other factors deemed relevant by management, including but not limited to, expected future market revenue growth and operating profit margins. We have consistently used these approaches in determining the value of goodwill. We consider the GPC Method as an adequate reasonableness test which utilizes market multiples of industry participants to corroborate the discounted cash flow analysis. We believe this methodology is consistent with the approach that any strategic market participant would utilize if they were to value one of our reporting units.
The first step of the goodwill impairment process screens for potential impairment and the second step measures the amount of the impairment, if any. Our estimate of fair value considers (i) the financial projections and future prospects of our business, including its growth opportunities and likely operational improvements, and (ii) comparable sales prices, if available. As part of the first step to assess potential impairment, we compare our estimate of fair value for the reporting unit to the book value of the reporting unit. If the book value is greater than our estimate of fair value, we would then proceed to the second step to measure the impairment, if any. The second step compares the implied fair value of goodwill with its carrying value. The implied fair value is determined by allocating the fair value of the reporting unit to all of the assets and liabilities of that unit as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the purchase price paid to acquire the reporting unit. The excess of the fair value of the reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill. If the carrying amount of the reporting unit’s goodwill is greater than its implied fair value, an impairment loss will be recognized in the amount of the excess.
On a quarterly basis, we perform a review of our business to determine if events or changes in circumstances have occurred which could have a material adverse effect on our fair value and the fair value of our goodwill. If such events or changes in circumstances were deemed to have occurred, we would perform an impairment test of goodwill as of the end of the quarter consistent with the annual impairment test and record any noted impairment loss.
We also consider the economic outlook for the healthcare services industry and various other factors during the testing process, including hospital and physician contract changes, local market developments, changes in third-party payor payments, and other publicly available information.
Intangible assets acquired as the result of a business combination are recognized at fair value, as an asset apart from goodwill if the asset arises from contractual or other legal rights, or if it is separable. Intangible assets, principally representing the fair value of customer relationships, health care facility agreements and non-competition agreements acquired, are capitalized and amortized on the straight-line method over their expected useful life, which generally ranges from 3 to 15 years.
We recognize impairment losses for intangible assets when events or changes in circumstances indicate the carrying amount may not be recoverable. We continually assesses whether an impairment in the carrying value of the intangible assets has occurred. If the undiscounted future cash flows over the remaining amortization period of an intangible asset indicate the value assigned to the intangible asset may not be recoverable, we reduce the carrying value of the intangible asset. We would determine the amount of any such impairment by comparing anticipated discounted future cash flows from acquired businesses with the carrying value of the related assets. In performing this analysis, we consider such factors as current results, trends and future prospects, in addition to other relevant factors.
Recent Accounting Pronouncements
New accounting pronouncements that we have recently adopted, as well as those that have been recently issued but not yet adopted by us, are included under the heading “Recent Accounting Standards Updates” in Note 1 to the Financial Statements in this Annual Report.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk.
We maintain our cash balances at high quality financial institutions. The balances in our accounts may periodically exceed amounts insured by the Federal Deposit Insurance Corporation, which insures deposits of up to $250,000 as of December 31, 2015. We do not believe we are exposed to any significant credit risk and have not experienced any losses.
As of December 31, 2015, we had outstanding balances of $189.0 million under our New Credit Facility maturing July 2019, which accrues interest at a variable rate of LIBOR (subject to a floor of 1.25 percent) plus 7.125 percent per annum. As of December 31, 2015, the short term LIBOR rate used as the base for calculating the interest rates for our New Credit Facility was approximately 0.416 percent. As such, changes in the LIBOR rates would not impact our interest expense until the 1.25 percent floor is exceeded. Based upon the balances outstanding under our revolving credit facility and term loan as of December 31, 2015, for every 100 basis point increase in the LIBOR rates over the 1.25 percent floor, we would incur approximately $1.9 million of additional annual interest expense.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Report of Independent Registered Public Accounting Firm
To the Members
Aurora Diagnostics Holdings, LLC
Palm Beach Gardens, Florida
We have audited the accompanying consolidated balance sheets of Aurora Diagnostics Holdings, LLC as of December 31, 2015 and 2014 and the related consolidated statements of operations, members’ deficit, and cash flows for each of the three years in the period ended December 31, 2015. In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedule listed in Item 15a for each of the three years in the period ended December 31, 2015. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated 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 consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated 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 Aurora Diagnostics Holdings, LLC as of December 31, 2015 and 2014, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2015, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule for each of the three years in the period ended December 31, 2015, 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.
/s/ Crowe Horwath LLP
Tampa, Florida
March 21, 2016
Aurora Diagnostics Holdings, LLC
Consolidated Balance Sheets
(in thousands, except for member units)
See Notes to Consolidated Financial Statements.
Aurora Diagnostics Holdings, LLC
Consolidated Statements of Operations
Years Ended December 31, 2013, 2014 and 2015
(in thousands)
See Notes to Consolidated Financial Statements.
Aurora Diagnostics Holdings, LLC
Consolidated Statements of Members’ Deficit
Years Ended December 31, 2013, 2014 and 2015
(in thousands, except for member units)
See Notes to Consolidated Financial Statements.
Aurora Diagnostics Holdings, LLC
Consolidated Statements of Cash Flows
Years Ended December 31, 2013, 2014 and 2015
(in thousands)
(Continued)
Aurora Diagnostics Holdings, LLC
Consolidated Statements of Cash Flows (Continued)
Years Ended December 31, 2013, 2014 and 2015
(in thousands)
See Notes to Consolidated Financial Statements.
Note 1.
Nature of Business; Working Capital; Facility Sale; Significant Accounting Policies and Recent Accounting Standards
Nature of business
Aurora Diagnostics Holdings, LLC and subsidiaries (the “Company”) was organized in the State of Delaware as a limited liability company on June 2, 2006 to operate as a diagnostic services company. The Company’s practices provide physician-based general anatomic and clinical pathology, dermatopathology and molecular diagnostic services and other esoteric testing services to physicians, hospitals, clinical laboratories and surgery centers. The Company’s operations consist of one reportable segment.
The Company operates in a highly regulated industry. The manner in which licensed physicians can organize to perform and bill for medical services is governed by state laws and regulations. Businesses like the Company often are not permitted to employ physicians or to own corporations that employ physicians or to otherwise exercise control over the medical judgments or decisions of physicians.
In states where the Company is not permitted to directly own a medical services provider or for other commercial reasons, it performs only non-medical administrative and support services, does not represent to the public or its clients that it offers medical services and does not exercise influence or control over the practice of medicine. In those states, the Company conducts business through entities that it controls, and it is these affiliated entities that employ the physicians who practice medicine. In such states, the Company generally enters into a contract that restricts the owners of the affiliated entity from transferring their ownership interests in the affiliated entity and otherwise provides the Company or its designee with a controlling voting or financial interest in the affiliated entity and its laboratory operations. This controlling financial interest generally is obtained pursuant to a long-term management services agreement between the Company and the affiliated entity. Under the management services agreement, the Company exclusively manages all aspects of the operation other than the provision of medical services. Generally, the affiliated entity has no operating assets because the Company acquired all of its operating assets at the time it acquired the related laboratory operations. In accordance with the relevant accounting guidance, these affiliated entities are included in the consolidated financial statements of Aurora Diagnostics Holdings, LLC.
Working Capital
The Company requires significant cash flow to service its debt obligations. The reductions in Medicare reimbursement for 2013 and 2014, and the corresponding reduction in reimbursement from non-governmental payors, had a significant negative impact on the Company’s cash flows.
On July 31, 2014, as further described in Note 7, the Company entered into a new $220.0 million credit facility (the “New Credit Facility”) with Cerberus Business Finance, LLC. The New Credit Facility consists of a $165.0 million initial term loan, $30.0 million revolving credit line and $25.0 million delayed draw term loan. Each of the term loan, revolving credit line and delayed draw term loan under the New Credit Facility has a maturity of five years but is subject to an earlier maturity if the Company’s existing Senior Notes are not refinanced or their maturity is not extended prior to October 14, 2017. The Company used $145.6 million of the proceeds to retire its Barclays Bank PLC revolving credit facility due May 2015 and term loan facility due May 2016, including accrued interest and fees. Additionally, the Company borrowed $25.0 million under the new delayed draw term loan to fund acquisitions in 2014 and 2015.
On April 10, 2015, the Company entered into a second amendment to the New Credit Facility. The second amendment to the New Credit Facility added a $40 million delayed draw term loan B facility which is available through April 10, 2016 to pay consideration for acquisitions, as permitted under the New Credit Facility, including acquisition related fees and expenses.
As of December 31, 2015, the Company had $30.0 million available under its revolving credit facility and an additional $40.0 million available under its delayed draw term loan B for acquisitions through April 10, 2016. In order to access the amounts available under its revolving credit facility, the Company must meet the financial tests and ratios contained in its senior secured credit facility. If the Company fails to meet these financial tests and ratios, its ability to access the amounts otherwise available under its revolving credit facility could be limited.
Sale of Leased Facility
On December 31, 2014, the Company sold certain assets, including equipment and other assets, pertaining to its sole clinical laboratory facility for $0.9 million. This leased facility was the Company’s only location which exclusively performed clinical laboratory testing. The Company also entered into a laboratory services agreement with the purchaser of the clinical laboratory facility effective January 1, 2015, under which the Company is outsourcing the clinical laboratory testing to the purchaser. As a result of the facility sale, the Company recorded a gain of approximately $1.0 million for the year ended December 31, 2014.
Summary of Significant Accounting Policies
Principles of consolidation: The accompanying consolidated financial statements of the Company include the accounts of Aurora Diagnostics Holdings, LLC, its wholly-owned subsidiaries and companies in which the Company has a controlling financial interest by means other than the direct record ownership of voting stock. All accounts and transactions between the entities have been eliminated in consolidation.
Accounting estimates: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses. Due to the inherent uncertainties in this process, actual results could differ from those estimates.
Fair value of financial instruments: As of December 31, 2014 and 2015, the carrying amounts of cash and cash equivalents, accounts receivable, accounts payable, accrued interest and accrued expenses approximate fair value based on the short maturity of these instruments. Refer to Note 11 for discussion of the fair value of the Company’s contingent consideration issued in acquisitions and long-term debt.
Revenue recognition and accounts receivable: The Company recognizes revenue at the time services are performed. Unbilled receivables are recorded for services rendered during, but billed subsequent to, the reporting period. Revenue is reported at the estimated realizable amounts from patients, third-party payors and others for services rendered. Revenue under certain third-party payor agreements is subject to audit and retroactive adjustments. Provisions for estimated third-party payor settlements and adjustments are estimated in the period the related services are rendered and adjusted in future periods as final settlements are determined. The provision for doubtful accounts and the related allowance are adjusted periodically based upon an evaluation of historical collection experience with specific payors for particular services, anticipated collection levels with specific payors for new services, industry reimbursement trends, and other relevant factors. Changes in these factors in future periods could result in increases or decreases in the Company’s provision for doubtful accounts and impact its results of operations, financial position and cash flows. In 2013, 2014 and 2015, approximately 23 percent, 22 percent and 24 percent, respectively, of the Company’s consolidated net revenues were generated by Medicare and Medicaid programs.
Segment Reporting: The Company operates throughout the United States in one reportable segment, the medical laboratory industry. Medical laboratories offer a broad range of testing services to the medical profession. The Company’s testing services are categorized based upon the nature of the test: general anatomic pathology, clinical pathology, dermatopathology, molecular diagnostic services and other esoteric testing services to physicians, hospitals, clinical laboratories and surgery centers. The Company’s revenue consists of payments or reimbursements for these services. For the year ended December 31, 2013, net revenue consisted of 60 percent from private insurance, including managed care organizations and commercial payors, 23 percent from Medicare and Medicaid and 17 percent from physicians and individual patients. For the year ended December 31, 2014, net revenue consisted of 60 percent from private insurance, 22 percent from Medicare and Medicaid and 18 percent from physicians and individual patients. For the year ended December 31, 2015, net revenue consisted of 58 percent from private insurance, 24 percent from Medicare and Medicaid and 18 percent from physicians and individual patients.
Cash and cash equivalents: The Company considers deposits and investments that have original maturities of less than three months, when purchased, to be cash equivalents. The Company maintains its cash balances at high quality financial institutions. At December 31, 2014 and 2015, the Company’s balances in its accounts exceeded amounts insured by the Federal Deposit Insurance Corporation, which insures amounts of up to $250,000. The Company does not believe it is exposed to any significant credit risk and has not experienced any losses.
Property and equipment: Property and equipment is stated at cost. Routine maintenance and repairs are charged to expense as incurred, while costs of betterments and renewals are capitalized. Depreciation is calculated on a straight-line basis, over the estimated useful lives of the respective assets, which range from 3 to 10 years. Leasehold improvements are amortized over the shorter of the term of the related lease, or the useful life of the asset.
Goodwill: Goodwill represents the excess of cost over the fair value of net tangible and identifiable intangible assets acquired in business combinations. The Company reviews goodwill for impairment at the reporting unit level annually on November 30th, or when events or circumstances dictate, more frequently. The impairment review for goodwill consists of a qualitative assessment and then a two-step process of first determining the fair value of the reporting unit and comparing it to the carrying value of the net assets allocated to the reporting unit. If the fair value of the reporting unit exceeds the carrying value, no further analysis or write-down of goodwill is required. If the fair value of the reporting unit is less than the carrying value of the net assets, the implied fair value of the reporting unit is allocated to all the underlying assets and liabilities, including both recognized and unrecognized tangible and intangible assets, based on their fair value. If necessary, goodwill is then written down to its implied fair value.
As further discussed in Note 5, the Company performed impairment testing of goodwill and intangible assets as of November 30, 2013, 2014 and 2015 and recorded goodwill impairment charges of $52.9 million, $27.3 million and $17.1 million, respectively. Additionally, as of June 30, 2015, the Company identified indicators of impairment at two of its reporting units, tested goodwill for impairment at these two reporting units and recorded non-cash impairment charges of $39.6 million to write down the carrying value of goodwill.
Intangible assets: Intangible assets acquired as the result of a business combination are recognized at fair value, as an asset apart from goodwill if the asset arises from contractual or other legal rights, or if it is separable. Intangible assets, principally representing the fair value of customer relationships, health care facility agreements and non-competition agreements acquired, are capitalized and amortized on the straight-line method over their expected useful life, which generally ranges from 3 to 15 years.
The Company reviews its finite lived intangible assets for impairment whenever events indicate the recorded value of the intangible assets may not be recoverable. If the undiscounted cash flows attributable to the intangible asset exceed the carrying value, no further analysis or write-down of the intangible asset is required. If the carrying value of the intangible asset exceeds the undiscounted cash flows attributable to the intangible asset, then the Company recognizes an impairment loss to reduce the recorded value down to, but not below, the estimated fair value of the intangible asset. In connection with its goodwill impairment testing on November 30, 2013 and November 30, 2014, the Company identified certain intangible assets that were determined to be impaired and recorded non-cash impairment charges of $1.0 Million and $0.2 million, respectively, to write down the carrying value of other intangible assets.
Long-lived assets: The Company recognizes impairment losses for long-lived assets when events or changes in circumstances indicate the carrying amount of an asset may not be recoverable.
Deferred debt issue costs: The Company recognizes the direct costs of issuing debt financing as deferred debt issue costs, which are included in other assets in its consolidated balance sheets. Deferred debt issue costs are amortized to interest expense using the effective interest method over the term of the related debt.
As further discussed in Note 7, on December 20, 2010, the Company issued $200.0 million in unsecured senior notes, which it refers to as the Senior Notes, and incurred $6.5 million of related costs. These costs are being amortized to interest expense using the effective interest method through the January 15, 2018 maturity date.
In connection with the $220.0 million New Credit Facility entered into on July 31, 2014, the Company incurred $4.8 million of direct costs, which were deferred and are being amortized to interest expense using the effective interest method over the term of the new credit facility, which has a maturity of five years, or earlier under certain circumstances. The Company used a portion of the proceeds from the new credit facility to retire its credit facility with Barclays and recorded a non-cash charge of $1.6 million to write off the unamortized balance of the deferred issuance costs related to the Barclays credit facility and a non-cash loss on extinguishment of debt of $0.8 million for the related original issue discount.
As further discussed in Note 7, on April 10, 2015, the Company entered into a second amendment to the New Credit Facility which added a $40 million delayed draw term loan B facility. In connection with the second amendment the Company incurred an additional $0.9 million of direct costs related to the $40 million delayed draw term loan B facility, which were deferred and are being amortized to interest expense using the effective interest method over the remaining term of the New Credit Facility.
Interest expense from the amortization of deferred debt issue costs was $1.9 million, $1.9 million and $2.1 million for the years ended December 31, 2013, 2014 and 2015, respectively. The Company has $6.1 million in net deferred debt issue costs remaining at December 31, 2015, consisting of $4.2 million related to the New Credit Facility and $1.9 million related to the Senior Notes. Deferred debt issue costs as of December 31, 2014 and 2015 consist of the following (in thousands):
Medical malpractice claims insurance: The Company is insured on a claims-made basis up to its policy limits through a third party malpractice insurance policy. The Company establishes reserves, on an undiscounted basis, for self-insured deductibles, claims incurred and reported and claims incurred but not reported (IBNR) during the policy period. The Company had recorded medical claims liabilities of $3.2 million and $2.2 million as of December 31, 2014 and 2015, respectively, which are included in accounts payable, accrued expenses and other current liabilities. The Company also records a receivable from its insurance carrier for expected recoveries. Expected insurance recoveries, which are included in prepaid expenses and other current assets were $1.1 million and $0.3 million, as of December 31, 2014 and 2015, respectively. Medical claims insurance costs were $1.9 million, $1.8 million and $1.5 million for the years ended December 31, 2013, 2014 and 2015, respectively, inclusive of adjustments to the Company’s reserves for medical claims.
Income taxes: The Company is a Delaware limited liability company taxed as a partnership for federal and state income tax purposes in accordance with the applicable provisions of the Internal Revenue Code. Accordingly, the Company is generally not subject to income taxes, and the income attributable to the limited liability company is allocated to the members in accordance with the terms of the Company’s Second Amended and Restated Limited Liability Company Agreement, dated July 6, 2011, which it refers to as the LLC Agreement. In addition, any tax distributions related to the income allocated to each member would be paid out quarterly. However, certain of the Company’s subsidiaries are structured as corporations, file separate returns, and therefore are subject to federal and state income taxes. The provision for income taxes for these subsidiaries is reflected in the Company’s consolidated financial statements and includes federal and state taxes currently payable and changes in deferred tax assets and liabilities excluding the establishment of deferred tax assets and liabilities related to acquisitions. Deferred income taxes represent the estimated future tax effects resulting from the temporary difference between the carrying values (as reflected in the financial statements) and the tax reporting basis of the related assets and liabilities. The Company does not recognize a tax benefit, unless the Company concludes that it is more likely than not that the benefit will be sustained on audit by the taxing authority based solely on the technical merits of the associated tax position. If the recognition threshold is met, the Company recognizes a tax benefit measured at the largest amount of the tax benefit that the Company believes has greater than a 50 percent likelihood of being realized. The Company records interest and penalties in income tax expense.
Concentration of credit risk: Financial instruments that potentially subject the Company to concentrations of credit risk are cash and accounts receivable. The Company’s policy is to place cash in highly-rated financial institutions. Concentration of credit risk with respect to accounts receivable is mitigated by the diversity of the Company’s payers and their dispersion across many different geographic regions. While the Company has receivables due from federal and state governmental agencies, the Company does not believe such receivables represent a credit risk since the related healthcare programs are funded by federal and state governments and given that payment is primarily dependent on the Company’s submission of appropriate documentation.
Distributions to members and allocation of profits and losses: Profits and losses are allocated to the members in accordance with certain provisions contained in the LLC Agreement. Distributions are also made in accordance with the terms of the LLC Agreement.
Recent Accounting Standards Updates
In May 2014, the Financial Accounting Standards Board (FASB) issued ASU 2014-09, “Revenue from Contracts with Customers (Topic 606),” which will replace numerous requirements in U.S. GAAP and provide companies with a single revenue recognition model for recognizing revenue from contracts with customers. The core principle of the new standard is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. ASU 2014-09 will be effective for interim and annual reporting periods beginning after December 15, 2017. The two permitted transition methods under the new standard are the full retrospective method, in which case the standard would be applied to each prior reporting period presented, or the modified retrospective method, in which case the cumulative effect of applying the standard would be recognized at the date of initial application. We have not yet selected a transition method. We are currently evaluating the potential changes from this ASU to our future financial reporting and disclosures.
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.” Under the new guidance, management will be required to assess an entity’s ability to continue as a going concern, and to provide related footnote disclosures in certain circumstances. The provisions of this ASU are effective for annual and interim periods beginning after December 15, 2016. The adoption of ASU 2014-15 is not expected to have a material effect on the Company’s financial position, results of operations or cash flows.
In February 2015, the FASB issued ASU 2015-02, “Consolidation (Topic 810): Amendments to the Consolidation Analysis.” ASU 2015-02 changes the analysis that a reporting entity must perform to determine whether it should consolidate certain types of legal entities. This update is effective for interim and annual periods beginning after December 15, 2015. The adoption of ASU 2015-02 is not expected to have a material effect on the Company’s financial position, results of operations or cash flows.
In April 2015, the FASB issued ASU 2015-03, “Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs.” The amendments in this update require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this standards update. The new guidance is effective for annual reporting periods beginning after December 15, 2015, including interim periods within that reporting period. An entity should apply the guidance either retrospectively to each prior reporting period presented or retrospectively with the cumulative adjustment at the date of the initial application. Had the Company adopted ASU 2015-03, the deferred debt issue costs and long-term debt would have been reduced by approximately $6.6 million and $5.6 million as of December 31, 2014 and 2015, respectively.
In August 2015, the FASB issued ASU 2015-15, “Interest-Imputation of Interest (Subtopic 835-30): Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements-Amendments to SEC Paragraphs Pursuant to Staff Announcement at June 18, 2015 EITF Meeting (SEC Update),” clarifying the SEC’s views on the presentation and subsequent measurement of debt issuance costs related to line-of-credit arrangements. ASU 2015-15 allows for an entity to defer and present debt issuance costs associated with line-of-credit arrangements as an asset and subsequently amortize the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangements. This ASU was effective upon issuance. The Company adopted ASU 2015-15, and the adoption did not have a material effect on the Company’s financial position, results of operations or cash flows.
In April 2015, the FASB issued ASU 2015-05, “Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement.” ASU 2015-05 is meant to help entities evaluate the accounting for fees paid by a customer in a cloud computing arrangement by providing guidance as to whether an arrangement includes the sale or license of software. This update is effective for interim and annual periods beginning after December 15, 2015. The Company is evaluating the impact of the adoption of this update on our consolidated financial statements and related disclosures.
In May 2015, the FASB issued ASU 2015-08, “Business Combinations (Topic 805): Pushdown Accounting - Amendments to SEC Paragraphs Pursuant to Staff Accounting Bulletin No. 115.” The amendments in ASU 2015-08 amend various SEC paragraphs included in the FASB’s Accounting Standards Codification (the “Codification”) to reflect the issuance of Staff Accounting Bulletin No. 115, which rescinds portions of the interpretive guidance included in the SEC’s Staff Accounting Bulletins series and brings existing guidance into conformity with ASU No. 2014-17, “Business Combinations (Topic 805): Pushdown Accounting,” which provides an acquired entity with an option to apply pushdown accounting in its separate financial statements upon occurrence of an event in which an acquirer obtains control of the acquired entity. The amendments in the update are effective upon issuance, and the Company adopted the amendments in ASU 2015-08, effective May 8, 2015. The adoption of ASU 2015-08 did not have a material effect on the Company’s financial position, results of operations or cash flows.
In June 2015, the FASB issued ASU 2015-10, “Technical Corrections and Improvements.” ASU 2015-10 covers a wide range of Topics in the Codification. The amendments in this Update represent changes to clarify the Codification, correct unintended application of guidance, or make minor improvements to the Codification that are not expected to have a significant effect on current accounting practice or create a significant administrative cost on most entities. Transition guidance varies based on the amendments. The amendments that require transition guidance are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted, including adoption in an interim period. All other amendments were effective upon issuance. The Company has adopted ASU 2015-10, and the adoption did not have a material effect on the Company’s financial position, results of operations or cash flows.
In September 2015, the FASB issued ASU 2015-16, “Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments.” The standard requires that adjustments made to provisional amounts recognized in a business combination be recorded in the period such adjustments are determined, rather than retrospectively adjusting previously reported amounts. ASU 2015-16 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2015, and early adoption is permitted. The Company has adopted ASU 2015-16, and the adoption did not have a material effect on the Company’s financial position, results of operations or cash flows.
In November 2015, the FASB issued ASU 2015-17, “Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes.” ASU 2015-17 requires that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The Company has elected to adopt this standard prospectively effective with the beginning of the quarter ended December 31, 2015. The application of ASU 2015-17 to the Company’s December 31, 2015 Consolidated Balance Sheets resulted in a decrease to current deferred tax assets and non-current deferred tax liabilities of $0.7 million.
In February 2016, the FASB issued ASU 2016-02, “Leases” (topic 842). The FASB issued this update to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The updated guidance is effective for annual periods beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption of the update is permitted. The Company is evaluating the impact of the adoption of this update on our consolidated financial statements and related disclosures.
Note 2.
Acquisitions
The Company has made strategic acquisitions of small local laboratories to achieve greater economies of scale and expand or augment its geographic presence. In connection with its acquisition and business development related activities during 2013, 2014 and 2015, the Company has expensed $0.2 million, $1.0 million and $0.9 million, respectively, of acquisition and business development costs in the accompanying consolidated statements of operations.
2014 Acquisitions
The Company acquired 100 percent of the equity of two separate pathology practices on June 30, 2014, a third pathology practice on September 30, 2014, and a fourth pathology practice on October 31, 2014 for an aggregate cash purchase price of $16.0 million. In three of the transactions, the Company issued additional consideration payable over three years. The additional consideration for two of these acquisitions is based on the future performance of the acquired practice. The total acquisition date fair value of the additional consideration issued for the 2014 acquisitions was $1.4 million representing the present value of estimated future payments of $2.0 million. The Company funded the cash portion of the June 30, 2014 acquisitions using funds drawn under its previous revolving credit facility. The Company funded the cash portion of the September 30, 2014 acquisition using $9.7 million drawn on its delayed draw term loan and the October 31, 2014 acquisition with cash on hand.
2015 Acquisitions
On July 15, 2015, the Company acquired the assets of two pathology practices and a billing service, all located in Texas. On October 29, 2015, the Company acquired 100 percent of the equity of a pathology practice in Ohio. The Company paid a total of $15.4 million of cash in aggregate at closing and issued contingent notes payable over from three to six years. Payments under the contingent notes will be paid annually, up to a maximum of $11.9 million, subject to the retention of certain key facility contracts, financial results and the cash received under specified client contracts. The Company used the available cash under its $25.0 million delayed draw term loan to pay the $15.4 million cash portion of the purchase price for the acquisitions. The Company’s allocation of the purchase price to the net assets acquired is preliminary, pending final evaluation of the acquired accounts receivable and is expected to be finalized no later than June 30, 2016.
Intangible assets acquired as the result of a business combination are recognized at fair value as an asset apart from goodwill if the asset arises from contractual or other legal rights or if it is separable. The Company’s intangible assets, which principally consist of the fair value of customer relationships, health care facility agreements and non-competition agreements acquired in connection with the acquisition of diagnostic companies, are capitalized and amortized on the straight-line method over their useful lives, which generally range from 3 to 15 years. The goodwill recorded by the Company in acquisitions relates to intangible assets that do not qualify for separate recognition, such as the assembled workforce and anticipated synergies. The Company recorded $60,000 and $2.3 million of tax deductible goodwill related to the 2014 and 2015 acquisitions, respectively.
The following table summarizes the estimated aggregate fair value of the assets acquired and liabilities assumed in connection with the 2015 acquisitions (in thousands):
Pro-forma information (unaudited)
The accompanying consolidated financial statements include the results of operations of the acquisitions from the date acquired through December 31, 2015. The 2014 acquisitions contributed approximately $4.8 million of revenue and approximately $0.4 million of net income for the year ended December 31, 2014. The 2014 and 2015 acquisitions contributed approximately $20.6 million of revenue and approximately $3.6 million of net income for the year ended December 31, 2015.
The following unaudited pro forma information presents the consolidated results of the Company’s operations and the results of the 2014 and 2015 acquisitions for the years ended December 31, 2014 and 2015, after giving effect to amortization, depreciation, interest, income tax, and the reduced level of certain specific operating expenses (primarily compensation and related expenses attributable to former owners) as if the acquisitions had been consummated on January 1, 2014. Such unaudited pro forma information is based on historical unaudited financial information with respect to the 2014 and 2015 acquisitions and does not include operational or other changes which might have been effected by the Company. The unaudited pro forma information for the years ended December 31, 2014 and 2015 presented below is for illustrative purposes only and is not necessarily indicative of results which would have been achieved or results which may be achieved in the future (in thousands):
Contingent Consideration
In connection with certain of its acquisitions, the Company has agreed to pay additional consideration in future periods based upon the attainment of stipulated levels of operating results by each of the acquired entities, as defined in their respective agreements.
For acquisitions completed prior to January 1, 2009, the Company did not accrue contingent consideration obligations prior to the attainment of the objectives and the amount owed becomes fixed and determinable. The Company paid consideration under contingent notes related to acquisitions completed prior to January 1, 2009 of $3.4 million for the year ended December 31, 2013. For the years ended December 31, 2014 and 2015, the Company made no payments of contingent notes for acquisitions prior to January 1, 2009. As of December 31, 2015, there were no remaining outstanding contingent notes for acquisitions prior to January 1, 2009.
In connection with one of the acquisitions completed prior to January 1, 2009, in April 2014 the sellers repaid to the Company $1.2 million in final settlement of the contingent note. The $1.2 million repayment related to an acquisition for which the full balance of goodwill had been previously written off during 2012. The Company also assumed approximately $0.1 million of liabilities and recorded a $1.1 million gain as part of the change in fair value of contingent consideration in its consolidated statement of operations for the year ended December 31, 2014.
As of December 31, 2015, assuming the practices achieve the maximum level of stipulated operating results, the maximum principal amount of contingent consideration payable over the next six years is $21.8 million. A lesser amount will be paid if the performance criteria fall below the maximum levels or no payments will be made if the practices do not achieve the minimum level of performance criteria as outlined in their respective agreements. For the years ended December 31, 2013, 2014 and 2015, the Company paid consideration under contingent notes related to acquisitions completed subsequent to January 1, 2009 of $18.1 million, $5.8 million and $4.5 million, respectively. Future payments for acquisitions completed subsequent to January 1, 2009 will be reflected in the change in the fair value of the contingent consideration. The total fair value of the contingent consideration reflected in the accompanying consolidated balance sheets as of December 31, 2014 and 2015 is $9.1 million and $13.1 million, respectively.
Note 3.
Accounts Receivable
Accounts receivable consisted of the following as of December 31, 2014 and 2015 (in thousands):
Note 4.
Property and Equipment
Property and equipment, including assets acquired under capital leases, as of December 31, 2014 and 2015 consisted of the following (in thousands):
Depreciation expense, inclusive of amortization of capital leases, was $4.5 million, $4.5 million and $4.2 million for the years ended December 31, 2013, 2014 and 2015, respectively.
Note 5.
Goodwill and Intangible Assets
The following table presents adjustments to goodwill during the years ended December 31, 2014 and 2015 (in thousands):
For the years ended December 31, 2013, 2014 and 2015, the Company recorded expense for the amortization of intangible assets of $18.6 million, $18.1 million and $19.0 million, respectively related to its continuing operations. The Company’s balances for intangible assets as of December 31, 2014 and 2015 and the related accumulated amortization are set forth in the table below (in thousands):
As of December 31, 2015, estimated future amortization expense is as follows (in thousands):
Impairment of Goodwill and Other Intangible Assets
For purposes of testing goodwill for impairment, with the exception of four practices for which operations have been combined into two reporting units, each of the Company’s acquired practices is considered a separate reporting unit. To estimate the fair value of the reporting units, the Company utilizes a discounted cash flow model as the primary approach to value, supported by a market approach guideline public company method (the “GPC Method”) which is used as a reasonableness test. The results of the discounted cash flow provide reasonable estimates of the fair value of the reporting units because this approach is based on each respective unit’s actual results and reasonable estimates of future performance, and because it also takes into consideration a number of other factors deemed relevant by management, including but not limited to, expected future market revenue growth and operating profit margins. The Company has consistently used these approaches in determining the value of goodwill. The Company considers the GPC Method as an adequate reasonableness test which utilizes market multiples of industry participants to corroborate the discounted cash flow analysis. The Company believes this methodology is consistent with the approach that any strategic market participant would utilize if they were to value one of the Company’s reporting units.
2013 Impairment Testing
As of November 30, 2013, the Company tested goodwill at all of its reporting units for impairment and recorded a non-cash impairment charge of $52.9 million to write down the carrying value of goodwill. The write-down of the goodwill related to seven reporting units. Regarding these reporting units, the Company believes the reductions in the reimbursement rates under the 2014 Medicare Physician Fee Schedule, as issued by CMS on November 27, 2013, resulted in a reduction in the fair value of goodwill below its carrying value.
The following assumptions were made by management in determining the fair value of the reporting units and related intangibles as of November 30, 2013: (a) the discount rates ranged between 13.9 percent and 16.9 percent, based on relative size and perceived risk of the reporting unit; and (b) an average compound annual growth rate (CAGR) of 2.2 percent during the five year forecast period. These assumptions are based on both the actual historical performance of the reporting units and management’s estimates of future performance of the reporting units.
In connection with the Company’s testing of goodwill as of November 30, 2013, the reporting units for which testing indicated there was no impairment, their calculated fair values exceeded their carrying values by a weighted average 29.0 percent. Three of the unimpaired reporting units were calculated to have fair values that were 1.7 percent, 3.6 percent and 6.4 percent in excess of their carrying values. As of November 30, 2013, the Company had goodwill of $13.6 million, $11.0 million and $18.8 million, respectively, recorded for these three reporting units. As noted above, assumptions were made regarding the revenue, operating expense, and anticipated economic and market conditions related to these reporting units as part of the impairment analysis.
As of November 30, 2013, the Company tested certain of its intangible assets for impairment and recorded a non-cash impairment charge of $1.0 million to write down the carrying value of intangible assets at one of its reporting units.
2014 Impairment Testing
As of November 30, 2014, the Company performed qualitative analyses to assess the likelihood of impairment of goodwill at its reporting units. The Company’s assessment considered various factors, including the results of the impairment analyses performed as of November 30, 2013, changes in the carrying amount of net assets since November 30, 2013, management’s expectations of future performance, historical financial results and trends, changes in interest rates and other market conditions and other factors affecting reporting unit fair values. The Company also considered each reporting unit’s performance in relation to previous projections, the economic outlook for the healthcare services industry and various other factors during the testing process, including hospital and physician contract changes, local market developments, changes in third party payor payments, and other publicly available information. Based on its assessment, the Company determined it was more likely than not that the fair value exceeded the carrying value for five of its seventeen reporting units with recorded goodwill. For these five reporting units, the Company did not perform the two-step impairment testing.
As of November 30, 2014, the Company tested goodwill for impairment and recorded a non-cash impairment charge of $27.3 million to write down the carrying value of goodwill. The write-down of the goodwill related to five reporting units. Regarding these reporting units, the Company believes the gradual reduction in volume due to attrition in the client base resulted in a reduction in the fair value of the reporting unit below its carrying value.
The following assumptions were made by management in determining the fair value of the reporting units and related intangibles as of November 30, 2014: (a) the discount rates ranged between 13.9 percent and 17.0 percent, based on relative size and perceived risk of the reporting unit; and (b) an average compound annual growth rate (CAGR) of 2.6 percent during the five year forecast period. These assumptions are based on both the actual historical performance of the reporting units and management’s estimates of future performance of the reporting units.
In connection with the Company’s testing of goodwill as of November 30, 2014, the reporting units for which testing indicated there was no impairment, their calculated fair values exceeded their carrying values by a weighted average 25.0 percent. Two of the unimpaired reporting units were calculated to have fair values that were 1.9 percent and 4.0 percent in excess of their carrying values. As of November 30, 2014, the Company had goodwill of $9.8 million and $18.8 million, respectively, recorded for these two reporting units. As noted above, assumptions were made regarding the revenue, operating expense, and anticipated economic and market conditions related to these reporting units as part of the impairment analysis. Assumptions made regarding future operations involve significant uncertainty, particularly with regard to anticipated economic and market conditions that are beyond the control of the Company’s management. Potential events or circumstances that could negatively impact future performance include, but are not limited to, losses of customers, changes in regulations or reimbursement rates and increased internalization of diagnostic testing by clients.
As of November 30, 2014, the Company tested certain of its intangible assets for impairment and recorded a non-cash impairment charge of $0.2 million to write down the carrying value of intangible assets at two of its reporting units.
2015 Impairment Testing
As of June 30, 2015, the Company identified indications of impairment at two of its reporting units. One of the reporting units exhibited lower margins and both of the reporting units experienced lower volume as a result of competition to such an extent as to indicate potential impairment. Regarding these reporting units, the Company believes the reduction in volume due to attrition in the client base resulted in reductions in the fair values of the reporting units below their carrying values. As of June 30, 2015, the Company tested goodwill for impairment at these two reporting units and recorded non-cash impairment charges of $39.6 million to write down the carrying value of goodwill.
The following assumptions were made by management in determining the fair value of the reporting units and related intangibles as of June 30, 2015: (a) the discount rates were 14.1 percent and 15.3 percent, based on relative size and perceived risk of the reporting unit; and (b) an average compound annual growth rate (CAGR) of 1.6 percent and 2.0 percent during the five year forecast period. These assumptions are based on both the actual historical performance of the reporting units and management’s estimates of future performance of the reporting units.
As noted above, assumptions were made regarding the revenue, operating expense, and anticipated economic and market conditions related to these reporting units as part of the impairment analysis. Assumptions made regarding future operations involve significant uncertainty, particularly with regard to anticipated economic and market conditions that are beyond the control of the Company’s management. Potential events or circumstances that could negatively impact future performance include, but are not limited to, losses of customers, changes in regulations or reimbursement rates and increased internalization of diagnostic testing by clients.
As of November 30, 2015, the Company performed qualitative analyses to assess the likelihood of impairment of goodwill at its reporting units. The Company’s assessment considered various factors, including the results of the impairment analyses performed as of November 30, 2014 and June 30, 2015, changes in the carrying amount of net assets since November 30, 2014, management’s expectations of future performance, historical financial results and trends, changes in interest rates and other market conditions and other factors affecting reporting unit fair values. The Company also considered each reporting unit’s performance in relation to previous projections, the economic outlook for the healthcare services industry and various other factors during the testing process, including hospital and physician contract changes, local market developments, changes in third party payor payments, and other publicly available information. Based on its assessment, the Company determined it was more likely than not that the fair value exceeded the carrying value for eight of its nineteen reporting units with recorded goodwill. For these eight reporting units, the Company did not perform the two-step impairment testing.
As of November 30, 2015, the Company tested goodwill for impairment and recorded a non-cash impairment charge of $17.1 million to write down the carrying value of goodwill. The write-down of the goodwill related to three reporting units. Regarding these reporting units, the Company believes various factors, including the expected loss of a significant client, higher projected costs and reductions in projected private insurance reimbursement rates resulted in a reduction in the fair value of the reporting unit below its carrying value. As of December 31, 2014 and 2015, the Company had accumulated impairment charges related to goodwill of $247.9 million and $304.6 million, respectively.
The following assumptions were made by management in determining the fair value of the reporting units and related intangibles as of November 30, 2015: (a) the discount rates ranged between 15.8 percent and 21.3 percent, based on relative size and perceived risk of the reporting unit; and (b) an average compound annual growth rate (CAGR) of 3.1 percent during the five year forecast period. These assumptions are based on both the actual historical performance of the reporting units and management’s estimates of future performance of the reporting units.
In connection with the Company’s testing of goodwill as of November 30, 2015, with respect to the reporting units for which testing indicated there was no impairment, their calculated fair values exceeded their carrying values by a weighted average 23.5 percent. Two of the unimpaired reporting units were calculated to have fair values that were 4.5 percent and 9.1 percent in excess of their carrying values. As of November 30, 2015, the Company had goodwill of $2.3 million and $7.5 million, respectively, recorded for these two reporting units. As noted above, assumptions were made regarding the revenue, operating expense, and anticipated economic and market conditions related to these reporting units as part of the impairment analysis. Assumptions regarding future operations involve significant uncertainty, particularly with regard to anticipated economic and market conditions that are beyond the control of the Company’s management. Potential events or circumstances that could negatively impact future performance include, but are not limited to, losses of customers, changes in regulations or reimbursement rates and increased internalization of diagnostic testing by clients.
Note 6.
Accounts Payable, Accrued Expenses and Other Current Liabilities
Accounts payable, accrued expenses and other current liabilities as of December 31, 2014 and 2015 consisted of the following (in thousands):
Note 7.
Long-Term Debt
On December 20, 2010, the Company issued $200.0 million in unsecured Senior Notes that mature on January 15, 2018. The Senior Notes bear interest at an annual rate of 10.75%, which is payable each January 15th and July 15th. In accordance with the indenture governing our Senior Notes, the Company is subject to certain limitations on issuing additional debt and is required to submit quarterly and annual financial reports. As of December 31, 2015, the Senior Notes were redeemable at the Company’s option at 105.375 percent of par, plus accrued interest. The redemption price decreased to 102.688 percent of par on January 15, 2016 and will further decrease to 100 percent of par on January 15, 2017. The Senior Notes rank equally in right of repayment with all of the Company’s other senior indebtedness, but are subordinated to the Company’s secured indebtedness to the extent of the value of the assets securing that indebtedness.
On May 26, 2010, the Company entered into a $335.0 million credit facility with Barclays Bank PLC and certain other lenders. This credit facility, which was collateralized by substantially all of the Company’s assets and guaranteed by the Company’s subsidiaries, included a $225.0 million senior secured first lien term loan facility that was scheduled to mature in May 2016. The credit facility also included a $110.0 million senior secured first lien revolving credit facility, which was reduced to $60.0 million on October 26, 2012, that was scheduled to mature in May 2015.
On July 31, 2014, the Company entered into a new $220.0 million credit facility with Cerberus Business Finance, LLC, which is referred to as the New Credit Facility. The New Credit Facility consists of a $165.0 million initial term loan, $30.0 million revolving credit line and $25.0 million delayed draw term loan. Prior to the amendments discussed below, the delayed draw term loan facility was available through July 31, 2015 to pay the consideration for acquisitions, as permitted under the New Credit Facility, including acquisition related fees and expenses. Each of the term loan, revolving credit line and delayed draw term loan under the New Credit Facility has a maturity of five years but is subject to a maturity date of October 14, 2017 if the Company’s existing Senior Notes are not refinanced or their maturity is not extended prior to such date. Under the outstanding term loans, quarterly principal repayments of $0.5 million became due commencing on September 30, 2015 and continuing through December 31, 2016. Quarterly principal repayments increase to $0.9 million on March 31, 2017 through June 30, 2018 and to $1.3 million on September 30, 2018 and each quarter end thereafter, with the balance due at maturity. Prior to the second amendment on April 10, 2015 discussed below, at the Company’s option, interest under the New Credit Facility was either LIBOR, with a 1.25% floor, plus 7%, or at a base rate, with a 2.25% floor, plus 6%. The New Senior Secured Credit Facility is subject to a 2.25% per annum fee on the undrawn amount thereof, payable quarterly in arrears. The New Credit Facility is secured by essentially all of the Company’s assets and unconditionally guaranteed by the Company and certain of the Company’s existing and subsequently acquired or organized domestic subsidiaries and is subject to certain financial covenants.
The Company used $145.6 million of the $165.0 million proceeds from the New Credit Facility to retire the Barclays revolving credit facility due May 2015 and term loan facility due May 2016, including accrued interest and fees. The proceeds under the New Credit Facility were reduced by discounts of $5.1 million. Additionally, the Company used $3.9 million of the proceeds to pay issuance costs in connection with the New Credit Facility. The remaining $10.4 million balance of the proceeds under the New Credit Facility initial term loan and the funds available under the $30.0 million revolving credit line are available to execute future acquisitions and for the Company’s general working capital and operational needs. In connection with the retirement of its previous credit facility, the Company recorded a non-cash charge of $1.6 million to write off the unamortized balance of deferred issuance costs and a non-cash loss on extinguishment of debt of $0.8 million for the related original issue discount.
On April 10, 2015, the Company entered into a second amendment to the New Credit Facility. The second amendment to the New Credit Facility added a $40 million delayed draw term loan B facility which is available through April 10, 2016 to pay consideration for acquisitions, as permitted under the New Credit Facility, including acquisition related fees and expenses. The second amendment also increased the interest rate under the New Credit Facility to LIBOR, with a 1.25% floor, plus 7.125%, or to the base rate, with a 2.25% floor, plus 6.125%.
In connection with the acquisition consummated by the Company on July 15, 2015, the Company borrowed the remaining $15.3 million available under the delayed draw term loan. The amount borrowed exceeded the total paid by the Company for eligible acquisitions, inclusive of related expenses, by $5.4 million. The Company entered into third and fourth amendments to its New Credit Facility that extended the period that the Company was able to use the remaining $5.4 million availability under the $25.0 million delayed draw term loan from July 31, 2015, to October 31, 2015. The Company used the remaining $5.4 million for an acquisition completed on October 29, 2015.
As of December 31, 2015, the balance outstanding under the term loan facility was $164.0 million and the balance outstanding under the delayed draw term loan facility was $25.0 million. As of December 31, 2015, no amounts were outstanding and $30.0 million was available under the revolving credit facility and $40 million was available under its delayed draw term loan B facility. As of December 31, 2015, the Company was in compliance with all financial loan covenants.
Generally, the Company is permitted to make voluntary prepayments under the New Credit Facility and to reduce the existing revolving loan commitments at any time. However, subject to certain exceptions, prepayments and commitment reductions are subject to a premium equal to 3.0% of the term loans prepaid and revolving credit commitments reduced through July 31, 2016. The premium is reduced to 2.0% effective August 1, 2016, further reduced to 1.0% effective August 1, 2017 and eliminated entirely after July 31, 2018.
Subject to certain exceptions, the Company is required to prepay borrowings under the New Credit Facility as follows: (i) with 100% of the net cash proceeds the Company or any of its subsidiaries receives from the incurrence of debt obligations other than debt obligations otherwise permitted under the financing agreement, (ii) with 100% of the net cash proceeds in excess of $1 million in the aggregate in any fiscal year the Company or any of its subsidiaries receives from specified non-ordinary course asset sales or as a result of casualty or condemnation events, subject to reinvestment provisions, (iii) with 50% of excess cash flow of the Company for each fiscal year ended December 31, 2015 or later and (iv) 100% of the net cash proceeds from the exercise of any “equity cure” with respect to the financial covenants contained in the financing agreement.
The New Credit Facility requires the Company to maintain a maximum leverage ratio (based upon the ratio of total funded debt to consolidated EBITDA, net of agreed cash amounts) and a minimum interest coverage ratio (based upon the ratio of consolidated EBITDA to net cash interest expense), each quarter based on the last four fiscal quarters. The maximum leverage ratio as of December 31, 2015 was 10.2:1.0 and becomes more restrictive each quarter to 8.2:1.0 at June 30, 2019. The minimum interest coverage ratio is 1.00:1.00 as of December 31, 2015 through September 30, 2017, increases to 1.05:1.00 on December 31, 2017, and further increases to 1.10:1.00 on December 31, 2018. In addition, the Company is required to maintain liquidity (defined as availability under the revolving credit facility plus amounts in bank accounts that are subject to the agent’s perfected first priority liens) of at least $5.0 million at any time and $10.0 million on the last business day of each month. The Company’s compliance with the maximum leverage ratio and the minimum interest coverage ratio is subject to customary “equity cure” rights.
The New Credit Facility specifies maximum limits for the Company’s consolidated capital expenditures on an annual basis and includes negative covenants restricting or limiting the Company’s ability to, among other things, incur, assume or permit to exist additional indebtedness or guarantees; incur liens and engage in sale leaseback transactions; make loans and investments; declare dividends, make payments or redeem or repurchase capital stock; engage in mergers, acquisitions and other business combinations; prepay, redeem or purchase certain indebtedness; amend or otherwise alter terms of its indebtedness; sell assets; enter into transactions with affiliates and alter the business it conducts without prior approval of the lenders. The New Credit Facility also contains customary default provisions that include material adverse events, as defined therein. The Company has determined that the risk of subjective acceleration under the material adverse events clause is remote and therefore has classified the outstanding principal in long-term debt based on scheduled repayments.
In connection with the final settlement of one of its contingent notes, effective June 26, 2013, the Company agreed to pay $2.0 million in 24 equal monthly installments, plus 8 percent interest on the unpaid balance, through June 2015. The principal balance under this subordinated note was $0.5 million as of December 31, 2014 and the note was fully repaid as of June 30, 2015.
Long-term debt consists of the following as of December 31, 2014 and 2015 (in thousands):
As of December 31, 2015, future debt principal payments are as follows (in thousands):
*
The estimated future debt principal payments in 2019 reflect the maturity of the Company’s New Credit Facility which is subject to a maturity date of October 14, 2017 and would be repaid in 2017 if the Company’s Senior Notes are not refinanced or their maturity is not extended prior to October 14, 2017.
Note 8.
Related Party Transactions
Acquisition Target Consulting Agreement
The Company has a professional services agreement with an entity owned by two of the Company’s members. Under this agreement, the entity provides certain acquisition target identification consulting services to the Company. In exchange for these services the Company pays the entity a monthly retainer of $12,000, plus reimbursable expenses, as well as a success fee of $65,000 for each identified acquisition consummated by the Company. The entity also will be paid a fee of 8 percent of revenue for certain new business development efforts as outlined in the agreement. During the years ended December 31, 2013, 2014 and 2015, a total of approximately $0.2 million, $0.4 million and $0.3 million, respectively, was paid to the entity. As of December 31, 2014 the Company owed the entity $13,000. The Company owed the entity nothing as of December 31, 2015.
Management and Financial Advisory Agreement
The Company, through its wholly-owned subsidiary, has a management services agreement with two of the Company’s members. The management services agreement calls for the members and their affiliates to provide certain financial and management advisory services in connection with the general business planning and forecasting and acquisition and divestiture strategies of the Company. In exchange for the services, the Company pays the members management fees equal to 1.0 percent of revenues, plus expenses.
In connection with the third amendment to the Company’s previous credit facility in April 2013, the Company agreed to not make any payments of management or similar fees until payment in full of all loans under the credit facility, provided that such management fees shall continue to accrue. Management fees to the Company’s members up to 1 percent of net revenue are permitted under the New Credit Facility and the Company continues to accrue management fees. However, the Company expects to pay no management fees through December 31, 2016. As of December 31, 2014 and 2015, $6.0 million and $8.6 million, respectively, of these management fees are reflected in long-term liabilities in the accompanying consolidated balance sheets. The consolidated statements of operations includes management fees, related parties of $2.5 million, $2.5 million and $2.6 million for the years ended December 31, 2013, 2014 and 2015, respectively. During the years ended December 31, 2013, 2014 and 2015, the Company paid expenses of $66,000, $40,000 and $39,000 respectively, but paid no management fees.
Facilities Lease Agreements
The Company leases certain of its facilities from entities owned by physician employees or affiliated physicians who are also former owners of the acquired practices. The Company currently leases six of its facilities from affiliated physicians or entities. One of these six leases is on a month to month basis and the others terminate in April 2017, January 2018, December 2019, October 2020 and June 2022. In aggregate, the six leases provide for monthly aggregate base payments of approximately $85,000. Rent paid to the related entities was $1.0 million, $0.9 million and $1.0 million for the years ended December 31, 2013, 2014 and 2015, respectively.
Executive Management Agreement
On March 12, 2013, Mr. Daniel D. Crowley was appointed as the Chief Executive Officer and President of the Company. In connection with the appointment of Mr. Crowley, the Company entered into an agreement with Dynamic Healthcare Solutions (“DHS”), of which Mr. Crowley is the founder and a principal. Pursuant to the agreement, the Company pays DHS a monthly fee of $100,000, plus reasonable out of pocket expenses and hourly fees for DHS staff (other than Mr. Crowley) that provide services under the agreement. The agreement may be terminated by the Company with thirty days notice, subject to the payment of termination fees in certain circumstances as prescribed in the agreement. In addition, the agreement requires the Company to pay DHS a success fee in the event that a change of control of the Company occurs at any time during the term of the agreement or the one-year period following the termination of the agreement. The amount of the success fee would be based on the valuation of the Company at the time of the change of control. Other than the agreement with DHS, Mr. Crowley does not receive any direct or indirect compensation or benefits from the Company. During the years ended December 31, 2013, 2014 and 2015, the Company paid $1.8 million, $2.6 million and $3.1 million, respectively, to DHS. The payments in the year ended December 31, 2013 included a retainer of $0.2 million, which is included in deposits and other non-current assets as of December 31, 2014 and 2015.
Healthcare Administration Services
Effective December 1, 2013 the Company entered into an agreement with HealthSmart Benefit Solutions, Inc. (“HBS”), of which Mr. Crowley served as the Executive Chairman and President through July 2014. Pursuant to the agreement, the Company paid fees to HBS of approximately $20,000 per month to process claims under its self-insured health benefits plan and to perform other health plan related services. Premiums for the Company’s stop loss coverage were collected by HBS and remitted to the coverage provider. Effective June 1, 2015, the Company transitioned the administration of its health plan benefits to another provider, however HBS will continue to process claims through May 31, 2016, for dates of service prior to June 1, 2015. During the years ended December 31, 2014 and 2015, the Company paid $0.8 million and $1.2 million, respectively, inclusive of the stop loss premiums, to HBS. No balance was owed by the Company to HBS as of December 31, 2014 or December 31, 2015.
Acquisition Consulting Services
Since September 2013, the Company has engaged Crowley Corporate Legal Strategy (“CCLS”), on an as needed basis, to provide acquisition consulting services. Matthew Crowley is a principal of CCLS and son of Daniel D. Crowley, the Company’s Chief Executive Officer. During the years ended December 31, 2013, 2014 and 2015, the Company paid $4,000, $0.1 million and $0.1 million, respectively, to CCLS.
Executive Consulting Agreement
The Company has a consulting agreement with Mr. James New, a current Board member and owner of the Company’s member units and former CEO of the Company. Pursuant to the consulting agreement, Mr. New provides consulting services as requested by the Company for a fee of $12,500 per month. During each of the years ended December 31, 2014 and 2015, the Company paid $0.2 million to Mr. New. No balance was owed by the Company to Mr. New as of December 31, 2014 or December 31, 2015.
Note 9.
Equity-Based Compensation
On July 6, 2011, the Company adopted the Aurora Diagnostics Holdings, LLC 2011 Equity Incentive Plan for the grant of options to purchase units of Aurora Diagnostics Holdings, LLC to employees, officers, managers, consultants and advisors of the Company and its affiliates. As of December 31, 2015, the Company has authorized the grant of up to 1,931,129 options and reserved the equivalent number of units for issuance upon the future exercise of awards pursuant to the plan.
The Company uses the Black-Scholes method to value its options. The Company considered the volatility for comparable companies in deriving estimates of volatility. The expected term is estimated based upon the vesting period and contractual life of the option. The risk free interest rate is estimated using rates for United States Treasury securities with maturities closest to the estimated life of the option.
During the year ended December 31, 2015 the Company’s Board granted options to purchase 115,000 of the Company’s common units at an exercise price of $2.00. These options were granted to employees and will vest, contingent upon continued employment, in five equal annual installments through 2020. The Company valued the options using the Black-Scholes method. In the absence of publicly traded information, the Company considered its best estimates of future operating performance, its capitalization and market multiples for publicly traded laboratory companies in calculating the Company’s enterprise value. The following table shows the weighted average grant date fair values of options and the weighted average assumptions that the Company used to develop the fair value estimates for the years ended December 31, 2013, 2014 and 2015:
On August 1, 2013, the Company’s Board approved the change in the exercise price of all previously granted and then outstanding options to $2.00. Due to the estimated de minimis fair value of the Company’s common units, the Company recognized no incremental equity compensation costs in connection with the change in the exercise price for the previously granted options.
The options, which have a contractual term of 10 years, vest annually on each anniversary of the grant date. Equity compensation expense is recognized only for those options expected to vest, with forfeitures estimated based on the Company’s historical employee turnover experience and future expectations. The grant date fair value of options expected to vest is being amortized over the vesting periods. Equity compensation costs, which are included in selling, general and administrative expenses, were $0.3 million, $0.5 million and $0.2 million for the years ended December 31, 2013, 2014 and 2015, respectively. As of December 31, 2015, the remaining unamortized equity compensation cost was approximately $0.2 million and the weighted average period over which the non-vested options are expected to be recognized was 1.4 years.
The following table summarizes the option activity for the years ended December 31, 2014 and 2015.
Note 10.
Commitments and Contingencies
During the ordinary course of business, the Company has become and may in the future become subject to pending and threatened legal actions and proceedings. The Company may have liability with respect to its employees and its pathologists. Medical malpractice claims are generally covered by insurance. While the Company believes the outcome of any such pending legal actions and proceedings, individually or in the aggregate, will not have a materially adverse effect on the Company’s financial condition, results of operations or liquidity, if the Company is ultimately found liable under any medical malpractice claims, there can be no assurance the Company’s medical malpractice insurance coverage will be adequate to cover any such liability. The Company may also, from time to time, be involved with legal actions related to the acquisition of and affiliation with physician practices, the prior conduct of such practices, or the employment (and restriction on competition) of its physicians. There can be no assurance that any costs or liabilities for which the Company becomes responsible in connection with such claims or actions will not be material or will not exceed the limitations of any applicable indemnification provisions or the financial resources of the indemnifying parties. As described in Note 6, the Company had accrued $3.2 million and $2.2 million as of December 31, 2014 and 2015, respectively, for medical malpractice claims.
In January 2016, the Company relocated one of its laboratories, vacating one of its leased facilities. The Company has not reached a settlement with the landlord of the leased facility and expects to record a non-cash charge of approximately $1.0 million in the first quarter of 2016 for the abandoned leasehold improvements and to accrue the present value of the future lease payments stipulated under the lease agreement.
In August 2015, the Company received a notice of non-compliance for payroll tax withholding related to a reorganization of two of its subsidiaries during 2011. The Company believes its Form 941 filings for these subsidiaries in 2011 were appropriate and formally appealed approximately $0.5 million of additional taxes, interest and penalties accessed by the IRS in November 2015. The Company cannot currently determine whether or not its appeal will be successful. If the Company’s appeal is unsuccessful, it may incur a charge of approximately $0.5 million for the additional taxes, interest and penalties.
During 2011, the Company received claims of overpayments from the U.S. Veterans Administration, or VA, for a total of $1.6 million. In August 2015, the Company and the VA entered into a final settlement, under which the Company will pay $1.2 million to the VA in twelve monthly installments of $100,000. As of December 31, 2014 and 2015 the Company had recorded an accrued liability for the settlement of $1.2 million and $0.8 million, respectively.
Contingent Notes
As discussed in Note 2, in connection with certain of its acquisitions, the Company agreed to pay additional consideration in future periods based upon the attainment of stipulated levels of operating results by each of the acquired entities, as defined in their respective agreements. The computation of the annual operating results is subject to review and approval by sellers prior to payment. In the event there is a dispute, the Company will pay the undisputed amount and then take reasonable efforts to resolve the dispute with the sellers. If the sellers are successful in asserting their dispute, the Company could be required to make additional payments in future periods.
The Company is in discussions with certain sellers regarding additional contingent note payment amounts. These sellers have asserted the Company owes an aggregate of $2.7 million in excess of its calculations as of December 31, 2015. The Company’s management believes its calculations are correct, but at this time cannot estimate what additional amount, if any, will ultimately be paid in connection with these contingent notes.
Under a settlement agreement with the sellers of one of our acquired labs, the Company committed to extend payments for two additional years under the contingent notes and stipulated minimum operating results to be used in the calculation of the amounts to be paid through the maturity of the notes in 2018. In connection with the settlement the Company recognized a charge of approximately $5.4 million for the change in fair value of contingent consideration for the year ended December 31, 2014 and had recorded a $7.2 million liability as of December 31, 2014 for the estimated fair value of the projected future payments of $9.2 million under the related contingent notes. The minimum operating results stipulated under the settlement agreement will cease to apply when and if the sellers voluntarily terminate their employment by the Company.
As of December 31, 2015, the maximum total future payments for contingent consideration issued in acquisitions was $21.8 million. Lesser amounts will be paid for earnings below the maximum level of performance criteria as prescribed in their respective agreements. Any future payments of contingent consideration will be reflected in the change in the fair value of the contingent consideration. As of December 31, 2015, the fair value of contingent consideration related to acquisitions was $13.1 million, representing the present value of approximately $18.7 million in estimated future payments through 2021.
Purchase Obligation
The Company has entered into non-cancelable commitments to purchase reagents and other laboratory supplies. Under these agreements, the Company must purchase minimum amounts of reagents and other laboratory supplies through 2020.
At December 31, 2015, the remaining minimum purchase commitments are as follows (in thousands):
In connection with these commitments, the Company received lab testing equipment, to which the Company has either received title, or will receive title upon fulfillment of its purchase obligations under the respective commitment. The Company recorded the obligation under purchase commitment for the fair value of the equipment, reduced by the cash paid. The remaining obligations under purchase commitments included in other liabilities in the accompanying consolidated balance sheets were $1.5 million and $1.6 million as of December 31, 2014 and 2015, respectively.
Employment agreements
The Company has employment agreements with its executive officers and certain physician employees. Such agreements provide for minimum salary levels that may be adjusted annually for cost-of-living changes and may contain incentive bonuses that are payable if specified goals are attained. Under certain of the agreements, in the event employment is terminated (other than voluntarily by the employee, by the Company for cause, or upon the death of the employee), the Company is committed to pay certain benefits, including specified monthly severance for periods from six months to one year from the date of termination.
Self-insured health benefits
The Company provides health care benefits to the majority of its employees through a partially self-insured plan. The Company records its estimate of the ultimate cost of, and reserves for, health care benefits based on computations using the Company’s loss history as well as industry statistics. In determining its reserves, the Company includes reserves for estimated claims incurred but not reported. The amount reserved for estimated claims was $1.0 million and $0.7 million as of December 31, 2014 and 2015, respectively. The ultimate cost of health care benefits will depend on actual costs incurred to settle the claims and may differ from the amounts reserved by the Company for those claims.
Operating leases
The Company leases various office and medical laboratory facilities and equipment under non-cancelable lease agreements with varying terms through February 2026. The terms of some of the facility leases require the Company to pay for certain taxes or common utility charges. Rent expense, including these taxes and common utility charges, was $4.7 million, $4.9 million, and $5.1 million for the years ended December 31, 2013, 2014, and 2015, respectively. Rent expense associated with operating leases that include scheduled rent increases and tenant incentives are recorded on a straight-line basis over the term of the lease. Aggregate future minimum annual rentals under the lease agreements as of December 31, 2015 are as follows (in thousands):
Note 11.
Fair Value of Financial Instruments
Fair value is defined as the exchange price that would be received for 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 on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. A fair value hierarchy has been established based on three levels of inputs, of which the first two are considered observable and the last unobservable.
Level 1:
Quoted prices in active markets for identical assets or liabilities. These are typically obtained from real-time quotes for transactions in active exchange markets involving identical assets.
Level 2:
Inputs, other than quoted prices included within Level 1, which are observable for the asset or liability, either directly or indirectly. These are typically obtained from readily-available pricing sources for comparable instruments.
Level 3:
Unobservable inputs, where there is little or no market activity for the asset or liability. These inputs reflect the reporting entity’s own assumptions of the data that market participants would use in pricing the asset or liability, based on the best information available in the circumstances.
Recurring Fair Value Measurements
As of December 31, 2014 and 2015, the fair value of contingent consideration related to acquisitions since January 1, 2009 was $9.1 million and $13.1 million, respectively. The fair value of contingent consideration is derived using valuation techniques that incorporate unobservable inputs and are considered Level 3 items. The Company uses a present value of estimated future payments approach to estimate the fair value of the contingent consideration. Estimates for fair value of contingent consideration primarily involve two inputs, which are (i) the projections of the financial performance of the acquired practices that are used to calculate the amount of the payments and (ii) the discount rates used to calculate the present value of future payments. Changes in either of these inputs will impact the estimated fair value of contingent consideration. At December 31, 2014, the discount rates ranged from 15.8 percent to 20.5 percent, and at December 31, 2015, the discount rates ranged from 15.8 percent to 20.1 percent.
The Company had no transfers of fair value instruments between Level 2 and Level 3 during 2014 or 2015. The following is a summary of the Company’s fair value instruments categorized by their fair value input level as of December 31, 2014 (in thousands):
The following is a summary of the Company’s fair value instruments categorized by their fair value input level as of December 31, 2015 (in thousands):
The following is a roll-forward of the Company’s Level 3 fair value instruments for the years ended December 31, 2014 and 2015 (in thousands):
Non-Recurring Fair Value Measurements
Certain assets that are measured at fair value on a non-recurring basis, including property and equipment and intangible assets, are adjusted to fair value only when the carrying values are greater than their fair values. As described in Note 5, Goodwill and Intangible Assets, the Company completed its annual impairment evaluations as of November 30, 2014, June 30, 2015 and November 30, 2015, and recorded write-offs of goodwill and intangibles to reflect the current estimated fair value of the impaired reporting units and intangible assets. The fair value was derived with fair value models utilizing unobservable inputs that therefore are considered Level 3 items. The following table presents the non-recurring fair value measurements and related impairment charges recognized for the years ended December 31, 2014 and 2015 (in thousands):
As of December 31, 2014 and 2015, the carrying amounts of cash, accounts receivable, accounts payable, accrued interest and accrued expenses approximate fair value based on the short maturity of these instruments. As of December 31, 2014 and 2015, the fair value of the Company’s long-term debt was $349.3 million and $332.1 million, respectively. The Company uses quoted market prices and yields for the same or similar types of borrowings in active markets when available to determine the fair value of the Company’s debt. These fair values are considered Level 2 items.
Note 12.
Defined Contribution Plan
The Company sponsors a salary deferral plan under Section 401(k) of the Internal Revenue Code. The plan allows eligible employees to defer up to 100 percent of their compensation in accordance with IRS guidelines. Such deferrals accumulate on a tax deferred basis until the employee withdraws the funds. The Company is required to match a portion of the employees’ contribution. For 2013, 2014 and 2015, the rate of the Company’s match was 25 percent, up to $1,000 per participating employee. Total expense recorded for the Company’s match was $0.3 million, $0.4 million and $0.5 million for of the years ended December 31, 2013, 2014 and 2015, respectively.
Note 13.
Income Taxes
The benefit for federal and state taxes was $3.9 million, $4.1 million and $0.9 million for the years ended December 31, 2013, 2014 and 2015, respectively.
The provision for income taxes for certain of the Company’s subsidiaries structured as corporations and states that tax partnerships for the years ended December 31, 2013, 2014 and 2015 consist of the following (in thousands):
A reconciliation of the provision for income taxes with amounts determined by applying the statutory U.S. federal income tax rate of 34 percent to actual income taxes, primarily for the Company’s subsidiaries structured as corporations for the years ended December 31, 2013, 2014 and 2015 was as follows (in thousands):
The following is a summary of the Company’s deferred tax assets and liabilities as of December 31, 2014 and 2015, respectively (in thousands):
The Company recognizes the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following a tax audit. For tax positions meeting the more likely than not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority. The Company has no material unrecognized tax benefits and has accrued no interest or penalties related to uncertain tax positions for the years ended December 31, 2014 and 2015. As of December 31, 2015, tax years 2011 through 2015 are subject to examination by the tax authorities.
The Company has $8.8 million of Federal net operating loss carryforwards which begin to expire in 2032 and $9.6 million of combined net operating loss carryforwards in various states which begin to expire in 2022. The Company has recorded a partial valuation allowance against the deferred tax assets related to the Federal and state net operating losses.
Deferred income taxes should be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax assets will not be realized. On a periodic basis, management evaluates and determines the amount of the valuation allowance required and adjusts such valuation allowance accordingly. For the years ended December 31, 2014 and 2015, the Company has recorded a valuation allowance of $6.1 million and $6.5 million, respectively, related to the deferred tax assets of two of the Company’s corporate subsidiaries. The valuation allowance increased by $0.3 million during the year ended December 31, 2015.
Note 14.
Guarantor Subsidiaries
The following information is presented as required by regulations of the Securities and Exchange Commission in connection with the Company’s 10.75% Senior Notes due 2018. This information is not routinely prepared for use by management. The operating and investing activities of the separate legal entities included in the Company’s consolidated financial statements are fully interdependent and integrated. Accordingly, consolidating the operating results of those separate legal entities is not representative of what the actual operating results of those entities would be on a stand-alone basis. Operating expenses of those separate legal entities include intercompany charges for management fees and other services. Certain expense items that are applicable to the Company’s subsidiaries are typically recorded in the books and records of Aurora Diagnostics Holdings, LLC. For purposes of this footnote disclosure, such balances and amounts have been “pushed down” to the respective subsidiaries either on a specific identification basis or, when such items cannot be specifically attributed to an individual subsidiary, have been allocated on an incremental or proportional cost basis to Aurora Diagnostics Holdings, LLC and the Company’s subsidiaries.
The following tables present consolidating financial information as of December 31, 2014, and 2015 and for the years ended December 31, 2013, 2014 and 2015 for (i) Aurora Diagnostics Holdings, LLC, (ii) on a combined basis, the subsidiaries of the Company that are guarantors of the Company’s Senior Notes (the “Subsidiary Guarantors”) and (iii) on a combined basis, the subsidiaries of the Company that are not guarantors of the Company’s Senior Notes (the “Non-Guarantor Subsidiaries”). For presentation in the following tables, Subsidiary Guarantors includes revenue and expenses and assets and liabilities for those subsidiaries directly or indirectly 100 percent owned by the Company, including those entities that have contractual arrangements with affiliated physician groups. Essentially, all property and equipment reflected in the accompanying consolidated balance sheets collateralize the Company’s debt. As such, as of December 31, 2014 and 2015, $2.4 million and $2.2 million, respectively, of property and equipment held by Non-Guarantor Subsidiaries are reflected under Subsidiary Guarantors in the following tables.
Consolidating Balance Sheets (in thousands):
Consolidating Statements of Operations (in thousands):
Consolidating Statements of Cash Flows (in thousands):
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
The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
As of the end of the period covered by this report, the Company’s management carried out an evaluation, under the supervision and with the participation of its principal executive officer and principal financial officer, of the effectiveness of the Company’s disclosure controls and procedures. Based upon that evaluation, the Company’s principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures, as defined by Rule 15d-15(e) under the Exchange Act, were effective as of December 31, 2015.
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 Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Internal control over financial reporting is a process designed by, and under the supervision of, our principal executive officer and principal financial officer and effected by management and our Board of Directors to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP. Internal control over financial reporting includes those policies and procedures that:
·
Pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of assets of the Company.
·
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP and that receipts and expenditures of the Company are being made in accordance with authorization of our management and our Board of Directors.
·
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on our consolidated financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect all misstatements. Also, projections of any evaluation of the effectiveness of our internal control over financial reporting 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, with the participation of our principal executive officer and principal financial officer, has evaluated the effectiveness of the Company’s internal control over financial reporting as of December 31, 2015. In making its evaluation, management has used the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on its assessment, management concluded that the Company’s internal control over financial reporting was effective as of December 31, 2015.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting during the fourth quarter ended December 31, 2015 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
This report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting because the Securities and Exchange Commission’s rules regarding such attestations do not apply to non-accelerated filers.
ITEM 9B.
ITEM 9B.
OTHER INFORMATION.
None.
PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
The following table sets forth the name, age and position of each of our executive officers and managers as of March 21, 2016.
Daniel D. Crowley
Chief Executive Officer,
President, Chairman of the Board of Managers
Mr. Crowley has served on our Board of Managers as the Chairman since February 24, 2015 and as our Chief Executive Officer and President since March 12, 2013. He is the founder and principal of Dynamic Healthcare Solutions, a firm that provides executive management principally to healthcare companies, which he formed in 1997. Mr. Crowley has significant experience as a healthcare executive, senior management and board advisor and advisor to private investment firms.
Bruce C. Walton
Chief Operating Officer and Executive Vice President
Mr. Walton has served as our Chief Operating Officer since January 2015 and as Executive Vice President, Operations since March 2013. Mr. Walton joined Aurora Diagnostics as Regional Vice President of Operations in October 2009.
Michael J. Null
President, Aurora Research Institute
Mr. Null has served as our President of the Aurora Research Institute since June 1, 2015. Prior to his current position, Mr. Null was Vice President, Sales & Marketing since April 2007 and received the additional title of Executive Vice President in March 2012.
Michael C. Grattendick
Vice President, Finance, Controller and Treasurer
Mr. Grattendick has served as our Vice President of Finance, Controller and Treasurer since May 2013. Mr. Grattendick joined Aurora Diagnostics as our Director of Finance in September 2006. Mr. Grattendick has over 15 years of experience in the health care industry.
Anthony D. Bobos
Chief Information Officer and Vice President
Mr. Bobos has served as our Chief Information Officer since joining Aurora Diagnostics in December 2014. Prior to joining Aurora Diagnostics, he was the Chief Technology Officer for BloodCenter of Wisconsin, where he was responsible for overseeing the technology for their five service lines. Mr. Bobos has over 12 years of experience in technology in the healthcare industry.
James C. New
Manager
Mr. New has served as one of our managers since 2006. He also served as our Chief Executive Officer and President from 2006 until his retirement on September 1, 2011. Since his retirement, he has served as Special Advisor to our Board of Managers and Chief Executive Officer. The Board has concluded that Mr. New should serve as a manager because of his extensive experience in managing anatomic pathology companies, including his experience as our former Chairman, Chief Executive Officer and President.
Thomas S. Roberts
Manager
Mr. Roberts has served as one of our managers since 2006 and currently serves as a Managing Director of Summit Partners, a growth equity firm. Mr. Roberts joined Summit Partners in 1989. Mr. Roberts also served in the past as the Chairman and Director of AmeriPath, an anatomic pathology laboratory company. The Board has concluded that Mr. Roberts should serve as a director because of his significant executive experience as well as the fact that his relationship with Summit Partners, which has a substantial ownership interest in us, aligns his interests with those of our other stakeholders.
Christopher Dean
Manager
Mr. Dean has served as one of our managers since 2006 and currently serves as a Managing Director of Summit Partners, a growth equity firm. Mr. Dean joined Summit Partners in 2001. The Board has concluded that Mr. Dean should serve as a director because of his significant executive experience as well as the fact that his relationship with Summit Partners, which has a substantial ownership interest in us, aligns his interests with those of our other stakeholders.
Steven Neumann
Manager
Mr. Neumann has served as one of our managers since August 2012 and is a Managing Director of KRG Capital Partners, a private equity investment firm. Mr. Neumann joined KRG Capital Partners in 1998. The Board has concluded that Mr. Neumann should serve as a manager because of his significant executive experience as well as the fact that his relationship with KRG Capital Partners, which has a substantial ownership interest in us, aligns his interests with those of our other stakeholders.
Blair Tikker
Manager
Mr. Tikker has served as one of our managers since June 2009 and is a Managing Director of KRG Capital Partners, a private equity investment firm. Mr. Tikker joined KRG Capital Partners in 2007. The Board has concluded that Mr. Tikker should serve as a director because of his significant executive experience as well as the fact that his relationship with KRG Capital Partners, which has a substantial ownership interest in us, aligns his interests with those of our other stakeholders.
Bennett R. Thompson
Manager
Mr. Thompson has served as one of our managers since August 2011 and has been a regular board observer since June 2009. Mr. Thompson is a Managing Director of KRG Capital Partners, a private equity investment firm. Mr. Thompson joined KRG Capital Partners in 2007. Mr. Thompson also serves on the board of directors of Square Two Financial. The Board has concluded that Mr. Thompson should serve as a manager because of his significant executive experience as well as the fact that his relationship with KRG Capital Partners, which has a substantial ownership interest in us, aligns his interests with those of our other stakeholders.
James Emanuel
Manager
Mr. Emanuel has served as one of our managers since June 2011. Mr. Emanuel has engaged in consulting and private investment activities since his retirement from Lincare, Inc., a national provider of respiratory therapy services for patients with pulmonary disorders, where he served as Chief Financial Officer from January 1984 to June 1997. Mr. Emanuel served as a director of SRI/Surgical Express Inc. from 1996 to 2012, in addition to serving on private company boards. The Board has concluded that Mr. Emanuel should serve as a manager because of his significant executive experience.
Pursuant to the terms of the LLC Agreement, Messrs. Roberts and Dean were designated to serve on our Board by Summit Partners, and Messrs. Neumann, Tikker and Thompson were designated to serve on our Board by KRG Capital Partners.
Board Committees
Our audit committee’s responsibilities include selecting, engaging and evaluating the qualifications, independence and performance of our independent registered public accountant; reviewing, overseeing and monitoring the integrity of our financial statements and our compliance with legal and regulatory requirements as they relate to financial statements or accounting matters; and reviewing and discussing with management and our independent registered public accountant the results of our annual audit and the review of our quarterly unaudited financial statements.
In addition, our audit committee is responsible for reviewing the design, implementation, adequacy and effectiveness of our internal controls over financial reporting, our disclosure controls and procedures and our critical accounting policies; approving the audit and non-audit services to be performed by our independent registered public accountant; establishing procedures for the receipt and retention of accounting related complaints and concerns; and reviewing and approving any related person transactions.
Our audit committee is comprised of Messrs. Emanuel, Roberts and Thompson. Mr. Emanuel is the chairperson of the audit committee. Mr. Emanuel has been designated as the audit committee financial expert, as defined in Item 407(d) of Regulation S-K under the Securities Act.
Other than our audit committee, we have not established any other board committees at this time.
Code of Conduct and Ethics
Our Board of Managers has adopted a code of conduct and ethics applicable to our officers, managers and employees, including our principal executive officer, principal financial officer and principal accounting officer. The Company will provide to any person without charge, upon request, a copy of the code of conduct and ethics. Such requests shall be made in writing to the Company at 11025 RCA Center Drive, Suite 300, Palm Beach Gardens, FL 33410, Attention: Investor Relations.
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION.
SUMMARY OF COMPENSATION PROGRAMS
In the paragraphs that follow, we provide an overview of our compensation program and policies, the material compensation decisions we have made under those programs and policies with respect to our named executive officers, and the material factors that we considered in making those decisions. Following this summary, you will find a series of tables containing specific data about the compensation earned or paid to the following individuals, whom we refer to as our named executive officers:
·
Daniel D. Crowley, our Chief Executive Officer, President and Chairman;
·
Bruce C. Walton, our Chief Operating Officer; and
·
Michael J. Null, our President, Aurora Research Institute.
Objectives of Our Compensation Program; How We Set Compensation
Our compensation objectives as a privately-held company have been to recruit and retain a talented team of employees to grow and develop our business and to reward those employees for accomplishments related to our growth and development.
Historically, we have not had a compensation committee and our Board of Managers has determined the compensation for our Chief Executive Officer and, based on the recommendations of our Chief Executive Officer, the rest of our management team. In setting compensation, our Chief Executive Officer and our Board of Managers did not seek to allocate long-term and current compensation, or cash and non-cash compensation, in any particular percentage. Instead, they reviewed each element of compensation independently and determined the appropriate amount for each element, as discussed below. Neither management nor our Board of Managers engaged a compensation consultant during fiscal year 2015. We believe our historical compensation-setting processes have been effective for a privately-held company.
Compensation for Chief Executive Officer
On March 12, 2013, Mr. Daniel D. Crowley was appointed as our Chief Executive Officer and President. In connection with the appointment of Mr. Crowley, we entered into an agreement with Dynamic Healthcare Solutions (“DHS”), of which Mr. Crowley is the founder and a principal. Pursuant to the agreement, we pay DHS a monthly fee of $100,000, plus reasonable out of pocket expenses and hourly fees for DHS staff (other than Mr. Crowley) that provide services under the agreement. We can terminate the agreement with thirty days notice, subject to the payment of termination fees in certain circumstances as prescribed in the agreement. In addition, the agreement requires us to pay DHS a success fee in a change of control event that occurs at any time during the term of the agreement or the one-year period following the termination of the agreement. The amount of the success fee would be based on our valuation at the time of the change of control. Other than the agreement with DHS, we do not pay any direct or indirect compensation or provide any other benefits to Mr. Crowley. For each of the years ended December 31, 2015 and 2014, we paid $1,250,000 and $1,150,000, respectively, to DHS for the services of Mr. Crowley. Payments in 2013 included a retainer of $200,000, which is included in deposits and other non-current assets as of December 31, 2014 and 2015.
2015 Elements of Compensation for Messrs. Null and Walton
The key elements of compensation for Messrs. Walton and Null in fiscal year 2015 were base salary and annual cash bonuses. Set forth below is a summary of the salary and bonus program for Messrs. Null and Walton. The Board did not grant equity awards to our named executive officers during 2015.
Base Salaries. We intend for base salaries to reward core competence in the executive role relative to skill, experience and contributions to us. We negotiated the initial base salaries individually with each executive, with a focus on the executive’s experience in his respective field and expected contribution to us. In general, we adjust base salaries in connection with performance reviews and/or changes to the scope of an executive officer’s responsibilities.
Effective January 1, 2015, the Board increased Mr. Null’s salary from $294,882 to $315,000 and Mr. Walton’s salary from $350,000 to $380,000 in recognition of their performance. Effective June 1, 2015, the Board increased Mr. Null’s salary from $315,000 to $350,000 in connection with promotion to President of the Aurora Research Institute.
Annual Cash Bonuses. Annual bonuses reward our executive officers for their contribution to our financial goals and focus our executive officers on both short- and long-term objectives. Annual bonuses are earned based on the achievement of certain pre-determined performance goals. On an annual basis, or at the commencement of an executive officer’s employment with us, our Board of Managers sets a target level of bonus compensation that is structured as a percentage of such executive officer’s annual base salary. For 2015, the target bonuses for Mr. Walton and Mr. Null were 50 percent of base salary. Our Board of Managers set such target bonuses after consideration of our Chief Executive Officer’s recommendation and the expected role of each of our executives. The actual amount of the bonus is based on the extent to which we and the executive meet or exceed predetermined financial goals and individual performance goals established for each executive. These goals are set by our Board of Managers prior to the beginning of the performance year and adjusted from time to time to take into consideration the impact of acquisitions completed during the year.
For 2015, annual cash incentive bonus opportunities for each of Messrs. Walton and Null were based on the achievement of a Company financial goal and individual performance goals. The Company financial component of the 2015 bonus opportunities was based on EBITDA, as adjusted for financial reporting. We selected EBITDA to focus the executive on supporting, improving and growing our business.
The Company’s financial goal sets the potential maximum amount of bonuses that could be paid out under the management incentive plan. The maximum amount of bonuses that could be paid out under the management incentive plan for the year ended December 31, 2015 was set at $3.5 million. For the year ended December 31, 2015 the financial goal for EBITDA, as adjusted, to achieve the maximum bonus was set at $60.0 million and no bonuses would be earned for EBITDA, as adjusted, of $48.0 million or less.
In addition to the Company financial goal, each executive must achieve their individual performance goals to receive their bonus. Therefore, for an executive to receive 100 percent of their target bonus, they must achieve 100 percent of their individual performance goals and the Company must attain 100 percent of the EBITDA goal of $60.0 million. Linear interpolation is used to determine payouts between the ranges. Individual performance goals are specific to each executive’s role and responsibilities and are assessed by our Board of Managers and Chief Executive Officer. Additional amounts may be added to the individual performance bonus at the discretion of our Board of Managers and Chief Executive Officer.
Actual 2015 EBITDA, as adjusted, for the Company was within the range of $48.0 million to $60.0 million for 2015. Based on achievement against this financial goal and, after considering their individual performance over the course of 2015, the Board approved bonuses for 2015 of $145,000 for Mr. Walton and $100,000 for Mr. Null.
Other Benefits. Our named executive officers participate in various health and welfare programs that are generally made available to all salaried employees. Our named executive officers also participate in our executive-level life insurance program.
Changes to Compensation Program for 2016
Effective January 1, 2016, we increased Mr. Walton’s salary from $380,000 to $400,000.
Summary Compensation
The following table sets forth the cash and other compensation that we paid to our named executive officers, or that was otherwise earned by our named executive officers, for their services in all capacities during 2015 and 2014.
Summary Compensation Table
(1)
In connection with the Executive Management Agreement effective March 12, 2013, we paid a total of $1,250,000 in 2015 and $1,150,000 in 2014 to Dynamic Health Solutions for Mr. Crowley’s services as our CEO and President. Of the $1,200,000 in fees earned by Mr. Crowley for 2014, $50,000 was paid in 2015. Other than the agreement with DHS, Mr. Crowley does not receive any direct or indirect compensation or benefits from the Company.
(2)
Reflects the annual cash bonuses approved by the Company’s Board of Managers based on the Company’s financial results and the executive’s individual performance during 2015 and 2014, paid in 2016 and 2015, respectively.
(3)
The following items are included in the All Other Compensation column. For 2015: (i) for each of Messrs. Walton and Null, $1,000 in matching contributions under our 401(k) plan; and (ii) Company paid executive level life insurance premiums of $593 for Mr. Walton and $591 for Mr. Null.
Employment Agreements. We maintain employment agreements with each of Messrs. Walton and Null, the term of which will continue until terminated by the executive or us. Pursuant to the agreements, the initial annual base salaries are subject to increases from time to time in the sole discretion of our Board of Managers, and the executives have the opportunity to earn performance bonuses on an annual basis as determined by our Board of Managers. The executives are also entitled to participate in any employee benefit plans that we may from time to time have in effect for our executive-level personnel. In addition, the employment agreements provide certain benefits to the executives upon their termination of employment by us without cause, by the executive for good reason, or by reason of their death or disability. For a description of such benefits, see “- Potential Payments Upon Termination of Employment” below.
Outstanding Equity Awards at 2015 Fiscal Year-End
The following table shows, for each of the named executive officers, all equity awards that were outstanding as of December 31, 2015.
(1)
The options vested in five equal annual installments beginning on the date of grant.
(2)
The options vest in five equal annual installments beginning on the first anniversary of the date of grant.
Summary of Potential Payments upon Termination of Employment or Change in Control
As noted above, during 2015, we maintained employment agreements with Mr. Walton and Mr. Null.
Payments Made Upon Any Termination of Employment. Regardless of the manner in which an executive officer’s employment terminates, he is entitled to receive amounts earned during his term of employment including accrued but unpaid base salary through the date of termination, accrued but unpaid annual bonus, unreimbursed employment-related expenses owed to the executive officer under our policies and accrued but unpaid vacation pay. The executive is also entitled to all accrued benefits under any of our employee benefit programs (in accordance with the terms of such programs). These payments do not differ from payments made upon termination to all employees.
Payments Made Upon Termination Without Cause or Good Reason. Each of the employment agreements provides that if the executive is terminated without Cause, or the executive terminates his employment with us for Good Reason, the executive will be entitled to receive his base salary for 12 months and any unpaid bonus for the previous fiscal year and a pro rata portion of his bonus for the then-current fiscal year.
Cause generally means the executive’s (i) conviction or plea of no contest for or indictment on a felony or a crime involving moral turpitude or the commission of any other act or omission involving dishonesty or fraud, which involves a material matter, with respect to us or any of our customers or suppliers, (ii) substantial and repeated failure to perform his duties, (iii) gross negligence or willful misconduct that is harmful to us, (iv) conduct tending to bring us into substantial public disgrace or disrepute and (v) breach of the restrictive covenants in the employment agreement.
Good Reason generally means, without the executive’s prior written consent, (i) a reduction in, or failure to pay when due, the executive’s base salary, (ii) a material diminution in the executive’s titles or duties inconsistent with his position, (iii) failure to pay any annual bonus when due, (iv) a material reduction in the employee benefits offered to the executive that is not also applicable to our other executive employees and (v) a change in the executive’s principal office to a location more than 50 miles from Palm Beach Gardens, Florida.
Restrictive Covenants. Each of the agreements contains confidentiality and customer and employee nonsolicitation covenants that apply during the executive’s employment with us and for a period of 12 months after his termination of employment.
Change in Control. Upon the occurrence of a sale of the Company, all outstanding options will become fully vested and exercisable.
2015 Director Compensation
We compensate for service as managers only the members of our Board of Managers that are independent from the Company. Mr. Emanuel was the only independent manager during 2015.
(1)
Consists of $150,000 in the aggregate for consulting fees, of $12,500 per month and $11,108 for Company paid expenses. See below for a description of Mr. New’s consulting agreement with the Company.
(2)
Reflects fees received for service on our Board of Managers and Audit Committee.
(3)
As of December 31, 2015, Mr. Emanuel had 20,000 outstanding options to purchase member units.
Consulting Agreement with Mr. New. In connection with Mr. New’s retirement as Chief Executive Officer and President, effective September 1, 2011, we entered into a consulting agreement with Mr. New, pursuant to which he provides consulting services as requested by the Company. Pursuant to the agreement, Mr. New remains subject to confidentiality provisions and the non-compete and non-solicitation obligations set forth in his prior employment agreement through December 31, 2014. On March 1, 2013, the Company and Mr. New amended the agreement to extend the term for an additional three years and increased the consulting fee to $12,500 per month in lieu of any final consulting payment that would have otherwise been due under the agreement.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
The following table sets forth information with respect to the beneficial ownership of outstanding membership interest units of the Company as of March 21, 2016 by (a) any person or group who beneficially owns more than five percent of such units, (b) each of our managers and executive officers and (c) all managers and executive officers as a group. On March 21, 2016, there were 23,549,812 units outstanding and 790,166 additional units issuable upon the exercise of vested options.
An asterisk (*) in the Percent of Class column indicates beneficial ownership of less than 1 percent.
(1)
Unless otherwise specified, the address of each beneficial owner listed in the table below is c/o Aurora Diagnostics, Inc. 11025 RCA Center Drive, Suite 300, Palm Beach Gardens, FL 33410.
(2)
Beneficial ownership is determined in accordance with Rule 13d-3 of the Exchange Act and generally includes voting and investment power with respect to securities, subject to community property laws, where applicable.
(3)
Represents 4,290,810 units held by Summit Ventures VI-A, L.P.; 1,789,329 units held by SV VI-B Aurora Holdings, L.P.; 137,061 units held by Summit VI Entrepreneurs Fund, L.P.; 89,255 units held by Summit VI Advisors Fund, L.P.; 48,088 units held by Summit Investors VI, L.P.; 3,939,915 units held by Summit Partners Private Equity Fund VII-A, L.P.; 2,366,540 units held by SPPE VII-B Aurora Holdings, L.P. Summit Partners, L.P. is the managing member of Summit Partners VI (GP), LLC, which is the general partner of Summit Partners VI (GP), L.P., which is the general partner of each of Summit Ventures VI-A, L.P., Summit Ventures VI-B, L.P., Summit VI Advisors Fund, L.P., Summit VI Entrepreneurs Fund, L.P. and Summit Investors VI, L.P. Summit Partners, L.P. is also the managing member of Summit Partners PE VII, LLC, which is the general partner of Summit Partners PE VII, L.P., which is the general partner of each of Summit Partners Private Equity Fund VII-A, L.P. and Summit Partners Private Equity Fund VII-B, L.P. Summit Partners, L.P., through an investment committee currently composed of Peter Y. Chung and Martin J. Mannion, has voting and dispositive authority over the shares held by each of these entities and therefore beneficially owns such shares. Each of the Summit Entities, Mr. Chung and Mr. Mannion disclaim beneficial ownership of the shares, except, in each case, to the extent of each such Reporting Person’s pecuniary interest therein. The address of each of the Summit Partners entities is 222 Berkeley Street, 18th Floor, Boston, MA 02116.
(4)
KRG Capital Management, L.P. is the general partner of each of KRG Capital Fund IV, L.P., KRG Capital Fund IV-A, L.P., KRG Capital Fund IV (PA), L.P. and KRG Capital Fund IV (FF), L.P., each of which is a stockholder of KRG Aurora Blocker, Inc. KRG Capital Management, L.P., as the general partner of the KRG fund entities, through an eight person investment committee with respect to the Class IV series of funds, including Steven Neumann and Blair J. Tikker, has voting and dispositive authority over the shares held by KRG Aurora Blocker, Inc. and, therefore, beneficially owns such shares. Decisions of the investment committee are made by a vote of the majority of its members and no individual member of the investment committee has voting or dispositive authority over the shares. Steven Neumann, Blair J. Tikker and Bennett Thompson are members of KRG Capital, LLC with respect to the Class IV series of funds, which is the general partner of KRG Capital Management, L.P., and each disclaims beneficial ownership of the shares held by KRG Capital Management, L.P. The address of each of the KRG Capital Partners entities is 1800 Larimer St., Suite 2200, Denver 80202.
(5)
Includes 30,144 units held by Mr. Null individually. Also includes options exercisable within 60 days to purchase 172,440 units by Mr. Walton and 188,881 units by Mr. Null.
(6)
Represents units held by Summit Partners.
(7)
Represents units held by KRG Capital Partners.
(8)
Includes exercisable options to purchase 19,000 units.
Equity Compensation Plan Information
The following table provides information as of December 31, 2014 regarding compensation plans under which the Company’s equity securities are authorized for issuance.
(1)
Consists of our 2011 Incentive Plan.
(2)
Consists of outstanding options to purchase Aurora Holdings Units granted under our 2011 Incentive Plan.
(3)
Weighted average exercise price of outstanding options to purchase Aurora Holdings Units.
(4)
The Company does not maintain any equity compensation plans that have not been approved by the Company’s security holders.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE.
Review, Approval or Ratification of Transactions with Related Persons
Our Board has adopted written policies and procedures for the review and approval or ratification of transactions involving us and related persons, which include our managers, executive officers, persons owning five percent or greater of our equity securities, their immediate family members and other related persons required to be reported under Item 404 of Regulation S-K. The policy governs all transactions between us and a related person in which the amount involved exceeds $10,000 and in which the related person has a direct or indirect material interest.
Related person transactions must be approved in advance by our audit committee whenever possible or ratified as promptly as possible thereafter. Each proposed transaction with a related person must be submitted to our audit committee, together with the facts and circumstances of the proposed transaction, including (i) the related person’s relationship to the Company and interest in the transaction, (ii) the material facts of the proposed transaction, (iii) the benefits to the Company of the proposed transaction, (iv) the availability of other sources of comparable products or services, and (v) an assessment of whether the transaction is on terms comparable to terms available to an unrelated third party or to employees generally.
The audit committee shall consider all relevant facts and circumstances available to it and shall approve or ratify only those related person transactions that are in, or not inconsistent with, the best interests of the Company and its members, as the audit committee determines in good faith, in accordance with our policies and procedures.
Second Amended and Restated Limited Liability Company Agreement of Aurora Holdings
The members and managers of Aurora Holdings have entered into a Second Amended and Restated Limited Liability Company Agreement, dated as of July 6, 2011, which we refer to as the LLC Agreement. Pursuant to the LLC Agreement, a board of managers of Aurora Holdings oversees the operations of Aurora Holdings and, subject to certain exceptions set forth below, manages the business and affairs of Aurora Holdings and exercises all rights and powers of Aurora Holdings.
The board of managers of Aurora Holdings currently consists of eight managers. The LLC Agreement provides for the appointment of at least eight managers, which are appointed as follows:
·
KRG Capital Partners has the right to appoint up to three managers, subject to the conditions provided in the LLC Agreement;
·
the Chief Executive Officer of our subsidiary Aurora Diagnostics, LLC is a manager;
·
Summit Partners and KRG Capital Partners have the right to appoint mutually one independent manager; and
·
Summit Partners has the right to appoint the other managers (which, as of the date hereof, consists of up to three managers).
In addition, the Board has the authority to increase its size and fill additional positions, and the board has appointed Mr. New, our former Chief Executive Officer, as an additional manager.
The LLC Agreement provides that, so long as KRG Capital Partners and Summit Partners are each entitled to appoint an equal number of managers, the number and composition of the board of managers (or similar governing body) of each subsidiary of Aurora Holdings is to consist of an equal number of managers appointed by KRG Capital Partners and Summit Partners. The Chief Executive Officer of Aurora Diagnostics, LLC is also to be a manager on the board of managers (or similar governing body) of each subsidiary of Aurora Holdings.
Under the LLC Agreement, certain transactions between Aurora Holdings and its affiliates require the approval of a majority of the disinterested managers on the board of managers of Aurora Holdings. In addition, the following actions require the approval of both Summit Partners and KRG Capital Partners:
·
the dissolution or liquidation of Aurora Holdings or Aurora Diagnostics, LLC, except in connection with corporate conversions and reorganizations or a sale of the enterprise described below;
·
the sale of Aurora Holdings or Aurora Diagnostics, LLC, unless the transaction results in specified returns on investment for Summit Partners and KRG Capital Partners;
·
the acquisition, by Aurora Holdings or any subsidiary, of any business for consideration in excess of $20 million or any businesses for aggregate consideration in excess of $60 million;
·
the issuance of any equity except (i) for issuances pursuant to an equity incentive plan, (ii) in connection with a public offering of equity otherwise permitted by the LLC Agreement and (iii) for issuances to acquisition targets (or their equityholders) in connection with or related to acquisitions;
·
the incurrence, by Aurora Holdings or any subsidiary, of any new indebtedness or the refinancing of any existing indebtedness, except (i) for amounts of less than $5 million in the aggregate and (ii) to acquisition targets (or their equityholders) in connection with or related to acquisitions;
·
the sale, transfer, termination, assignment, or other disposal of, by Aurora Holdings or any subsidiary of any (i) equity interest of any subsidiary, or (ii) right to vote the equity interests of any affiliated physician-owned professional organization, except in connection with an initial public offering of equity or a sale of the enterprise described above;
·
the hiring, firing, material reduction of the employment responsibilities of, or taking of any other action that could give rise to a termination for “Good Reason” or other similar term under any employment agreement or equity agreement between Aurora Holdings and its Chief Executive Officer, Chief Operating Officer or Chief Financial Officer;
·
the increase of the number of managers serving on the board of managers of Aurora Holdings at any time when KRG Capital Partners has a right to appoint three managers to the board of managers of Aurora Holdings; or
·
the development or implementation of any strategic plan that would materially affect Aurora Holdings’ or Aurora Diagnostics, LLC’s business and business activities ancillary thereto, or materially alter Aurora Holdings’ or Aurora Diagnostics, LLC’s business tactics.
Further, subject to the approval requirements in connection with a sale of the enterprise described above, each of Summit Partners and KRG Capital Partners has a right to force a sale of Aurora Holdings or Aurora Diagnostics, LLC. The LLC Agreement requires Aurora Holdings to make certain tax distributions to its members each year, which distributions are designed to approximate and offset the tax liability resulting from membership in Aurora Holdings for the preceding fiscal year.
The LLC Agreement also contains customary transfer restrictions with respect to the Aurora Holdings Units, including rights of first refusal in favor of Aurora Holdings and certain equityholders. In addition, the LLC Agreement grants certain customary preemptive rights on new issuances of Aurora Holdings Units and customary tag-along or co-sale rights on certain transfers of Aurora Holdings Units.
Registration Rights Agreement
We are party to a Registration Rights Agreement with certain of our members. Under our Registration Rights Agreement, we have granted certain of our members demand, shelf and piggy-back registration rights subject to customary terms, conditions and limitations.
Management Services Agreement
We, through a wholly-owned subsidiary of Aurora Holdings, and two members of Aurora Holdings, Summit Partners and KRG Capital Partners, are party to a Management Services Agreement pursuant to which Summit Partners and KRG Capital Partners provide certain financial and management advisory services to us in connection with the general business planning and forecasting and acquisition and divestiture strategies. In exchange for the services, we pay an annual fee equal to 1.0 percent of the revenue of Aurora Holdings, plus expenses. In connection with the third amendment to the Company’s previous credit facility in April 2013, the Company agreed not make any payments of management or similar fees until payment in full of all loans under the credit facility, provided that such management or similar fees shall continue to accrue. The Company continues to accrue management fees under its new credit facility, but expects to pay no management fees through December 31, 2016. As of December 31, 2014 and 2015, $6.0 million and $8.6 million, respectively, of management fees under the Management Services Agreement are reflected in accrued management fees, related parties, in the accompanying consolidated balance sheets. The consolidated statement of operations includes management fees of $2.5 million, $2.5 million and $2.6 million for the respective years ended December 31, 2013, 2014 and 2015. During the years ended December 31, 2013, 2014 and 2015, the Company paid expenses of $66,000, $40,000 and $39,000, respectively, but paid no management fees.
Other Related Party Transactions
In connection with Mr. New’s retirement as the Company’s Chief Executive Officer effective September 1, 2011, the Company entered into a consulting agreement with Mr. New. For a description of the terms of his consulting agreement, see the narrative following the Director Compensation table in Part III, Item 11 of this Annual Report.
Effective December 1, 2013 the Company entered into an agreement with HealthSmart Benefit Solutions, Inc. (“HBS”), of which Mr. Crowley served as the Executive Chairman and President through July 2014. Pursuant to the agreement, the Company pays fees to HBS of approximately $20,000 per month to process claims under its self-insured health benefits plan and to perform other health plan related services. Premiums for the Company’s stop loss coverage are collected by HBS and remitted to the coverage provider. During the years ended December 31, 2014 and 2015, the Company paid $0.8 million and $1.2 million, respectively, inclusive of the stop loss premiums, to HBS. No amounts were due from the Company to HBS as of December 31, 2014 or December 31, 2015.
Since September 2013, the Company has engaged Crowley Corporate Legal Strategy (“CCLS”), on an as needed basis, to provide acquisition consulting services. Matthew Crowley is a principal of CCLS and son of Daniel D. Crowley, the Company’s Chief Executive Officer. During the years ended December 31, 2014 and 2015, the Company paid $106,000 and $112,000, respectively, to CCLS.
Board Independence
Of our eight managers, only Mr. Emanuel is independent (with independence being determined in accordance with the definition of independence under the NASDAQ Global Market standards, as if they applied to us), meaning that he does not have, and has never had, a relationship that would interfere with the exercise of independent judgment in carrying out his responsibilities as a manager. None of our other current managers are independent.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES.
Audit Fees and Services
Crowe Horwath LLP served as the Company’s independent registered public accounting firm for the years ended December 31, 2014 and 2015. The following table presents estimated fees for professional audit services rendered by Crowe Horwath LLP for the audit of the Company’s annual financial statements for the years ended December 31, 2014 and 2015.
(1)
Audit Fees consisted of professional services performed for the audit of the Company’s annual financial statements.
Pre-approval Policies and Procedures
Our audit committee has adopted a policy requiring the pre-approval by the audit committee of all audit services, whether such services are to be provided by our principal independent auditor or other accounting firms. The policy also requires pre-approval by the audit committee of all other services (review, attest and non-audit) to be provided by our independent auditor; provided, however, that de minimis non-audit services may instead be approved in accordance with applicable SEC rules, although no non-audit services were approved pursuant to this exception in 2014 or 2015.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a)
Documents Filed as Part of this Report. The following documents are filed as part of this Annual Report:
(1) Consolidated Financial Statements. Included in Part II, Item 8 are the consolidated financial statements, the notes thereto and the report of the Independent Registered Public Accounting Firm.
(2) Financial Statement Schedules. Schedule II - Valuation and Qualifying Accounts is filed as a part hereof. All other schedules have been omitted because the information required to be set forth therein is not applicable or is included in the consolidated financial statements or notes thereto.
Aurora Diagnostics Holdings, LLC
Schedule II-Valuation and Qualifying Accounts
Years Ended December 31, 2013, 2014 and 2015 (in thousands):
(3) Exhibits. The exhibits listed in the accompanying Exhibit Index are incorporated by reference as part of this Annual Report.
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.
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.
Name
Title
Date
/s/ Daniel D. Crowley
Daniel D. Crowley
Chief Executive Officer, President and Chairman of the Board of Managers (principal
executive officer)
March 21, 2016
/s/ Michael C. Grattendick
Michael C. Grattendick
Vice President, Controller and Treasurer (principal financial and accounting officer)
March 21, 2016
/s/ Thomas S. Roberts
Thomas S. Roberts
Manager
March 21, 2016
/s/ Christopher Dean
Christopher Dean
Manager
March 21, 2016
/s/ Bennett Thompson
Bennett Thompson
Manager
March 21, 2016
/s/ Steven Neumann
Steven Neumann
Manager
March 21, 2016
/s/ Blair Tikker
Blair Tikker
Manager
March 21, 2016
/s/ James C. New
James C. New
Manager
March 21, 2016
/s/ James Emanuel
James Emanuel
Manager
March 21, 2016
EXHIBIT INDEX
Exhibit
Number
Description
3.1
Certificate of Formation of Aurora Diagnostics Holdings, LLC (filed as Exhibit 3.1 to the Company’s Registration Statement on Form S-4, No. 333-176790, and incorporated herein by reference)
3.2
Second Amended and Restated Limited Liability Company Agreement of Aurora Diagnostics Holdings, LLC (filed as Exhibit 3.2 to the Company’s Registration Statement on Form S-4, No. 333-176790, and incorporated herein by reference)
3.3
First Amendment to the Second Amended and Restated Limited Liability Company Agreement of Aurora Diagnostics Holdings, LLC (filed as Exhibit 3.3 to the Company’s Annual Report on Form 10-K filed on March 25, 2014 and incorporated herein by reference)
3.4
Second Amendment to the Second Amended and Restated Limited Liability Company Agreement of Aurora Diagnostics Holdings, LLC (filed as Exhibit 3.4 to the Company’s Annual Report on Form 10-K filed on June 4, 2015 and incorporated herein by reference)
4.1
Indenture, dated December 20, 2010, by and among Aurora Diagnostics Holdings, LLC, Aurora Diagnostics Financing, Inc., the guarantors named therein and U.S. Bank National Association (filed as Exhibit 4.1 to the Company’s Registration Statement on Form S-4, No. 333-176790, and incorporated herein by reference)
4.2
First Supplemental Indenture, dated December 31, 2011, by and among Aurora Diagnostics Holdings, LLC, Aurora Diagnostics Financing, Inc., the guarantors named therein and U.S. Bank National Association (filed as Exhibit 4.2 to the Company’s Registration Statement on Form S-4, No. 333-176790, and incorporated herein by reference)
4.3
Second Supplemental Indenture, dated December 31, 2011, by and among Aurora Diagnostics Holdings, LLC, Aurora Diagnostics Financing, Inc., the guarantors named therein and U.S. Bank National Association (filed as Exhibit 4.3 to the Company’s Registration Statement on Form S-4, No. 333-176790, and incorporated herein by reference)
4.4
Third Supplemental Indenture, dated June 2, 2011, by and among Aurora Diagnostics Holdings, LLC, Aurora Diagnostics Financing, Inc., the guarantors named therein and U.S. Bank National Association (filed as Exhibit 4.4 to the Company’s Registration Statement on Form S-4, No. 333-176790, and incorporated herein by reference)
4.5
Fourth Supplemental Indenture, dated August 12, 2011, by and among Aurora Diagnostics Holdings, LLC, Aurora Diagnostics Financing, Inc., the guarantors named therein and U.S. Bank National Association (filed as Exhibit 4.5 to the Company’s Registration Statement on Form S-4, No. 333-176790, and incorporated herein by reference)
4.6
Fifth Supplemental Indenture, dated July 31, 2014, by and among Aurora Diagnostics Holdings, LLC, Aurora Diagnostics Financing, Inc., the guarantors named therein and U.S. Bank National Association (filed as Exhibit 4.6 to the Company’s Annual Report on Form 10-K filed on June 4, 2015 and incorporated herein by reference)
4.7
Sixth Supplemental Indenture, dated October 10, 2014, by and among Aurora Diagnostics Holdings, LLC, Aurora Diagnostics Financing, Inc., the guarantors named therein and U.S. Bank National Association (filed as Exhibit 4.7 to the Company’s Annual Report on Form 10-K filed on June 4, 2015 and incorporated herein by reference)
4.8
Seventh Supplemental Indenture, dated November 10, 2014, by and among Aurora Diagnostics Holdings, LLC, Aurora Diagnostics Financing, Inc., the guarantors named therein and U.S. Bank National Association (filed as Exhibit 4.8 to the Company’s Annual Report on Form 10-K filed on June 4, 2015 and incorporated herein by reference)
4.9
Eighth Supplemental Indenture, dated November 11, 2015, by and among Aurora Diagnostics Holdings, LLC, Aurora Diagnostics Financing, Inc., the guarantors named therein and U.S. Bank National Association
4.10
Form of 10.750% senior notes due 2018 (Included as Exhibit A to Exhibit 4.1 to the Company’s Registration Statement on Form S-4, No. 333-176790, and incorporated herein by reference)
4.11
Amended and Restated Registration Rights Agreement, dated June 12, 2009, by and among Aurora Diagnostics Holdings, LLC and each of the signatories thereto (filed as Exhibit 4.8 to the Company’s Registration Statement on Form S-4, No. 333-176790, and incorporated herein by reference)
Exhibit
Number
Description
10.1
Financing Agreement, Dated as of July 31, 2014, by and among Aurora Diagnostics, LLC, as Borrower, Aurora Diagnostics Holdings, LLC and each subsidiary of Aurora Diagnostics, LLC listed as a guarantor on the signature pages thereto, as Guarantors, the Lenders from time to time party thereto, as Lenders, and Cerberus Business Finance, LLC, as Administrative Agent and as Collateral Agent (filed as Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed on August 12, 2014 and incorporated herein by reference).
10.2
Senior Management Agreement, dated April 2007, by and among Aurora Diagnostics Holdings, LLC, Aurora Diagnostics, LLC, James C. New and Michael Null* (filed as Exhibit 10.9 to the Company’s Registration Statement on Form S-4, No. 333-176790, and incorporated herein by reference)
10.3
Aurora Diagnostics Holdings, LLC 2011 Equity Incentive Plan* (filed as Exhibit 10.11 to the Company’s Registration Statement on Form S-4, No. 333-176790, and incorporated herein by reference)
10.4
First Amendment to the Aurora Diagnostics Holdings, LLC 2011 Equity Incentive Plan* (filed as Exhibit 10.12 to the Company’s Registration Statement on Form S-4, No. 333-176790, and incorporated herein by reference)
10.5
Form of Unit Option Award Certificate under the Aurora Diagnostics Holdings, LLC 2011 Equity Incentive Plan* (filed as Exhibit 10.13 to the Company’s Registration Statement on Form S-4, No. 333-176790, and incorporated herein by reference)
10.6
Consulting Agreement, dated July 6, 2011, by and between Aurora Diagnostics, LLC and James C. New* (filed as Exhibit 10.14 to the Company’s Registration Statement on Form S-4, No. 333-176790, and incorporated herein by reference)
10.7
First Amendment to Consulting Agreement, dated March 1, 2013, by and between Aurora Diagnostics, LLC and James C. New * (filed as Exhibit 10.23 to the Company’s Annual Report on Form 10-K filed on March 25, 2013 and incorporated herein by reference)
10.8
Management Consulting Agreement, dated March 15, 2013, between Dynamic Healthcare Solutions, LLC and Aurora Diagnostics Holdings, LLC * (filed as Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q filed on May 15, 2013 and incorporated herein by reference)
10.9
Employment Agreement, dated October 9, 2009, between Aurora Diagnostics, LLC and Bruce Walton* (filed as Exhibit 10.9 to the Company’s Annual Report on Form 10-K filed on June 4, 2015 and incorporated herein by reference)
10.10
Purchase Agreement, dated December 14, 2010, by and among Aurora Diagnostics Holdings, LLC, Aurora Diagnostics Financing, Inc., the Guarantors party thereto, Morgan Stanley & Co. Incorporated, Barclays Capital, Inc. and UBS Securities LLC (filed as Exhibit 10.15 to the Company’s Registration Statement on Form S-4, No. 333-176790, and incorporated herein by reference)
10.11
Management Rights Agreement, dated June 2, 2006, by and among Aurora Diagnostics Holdings, LLC and each of the signatories thereto (filed as Exhibit 10.16 to the Company’s Registration Statement on Form S-4, No. 333-176790, and incorporated herein by reference)
10.12
Management Rights Agreement, dated June 12, 2009, by and among KRG Capital Partners, L.L.C., KRG Aurora Blocker, Inc. and Aurora Diagnostics Holdings, LLC (filed as Exhibit 10.17 to the Company’s Registration Statement on Form S-4, No. 333-176790, and incorporated herein by reference)
10.13
Amended and Restated Management Services Agreement, dated June 12, 2009, by and among Summit Partners, L.P., KRG Capital Management, L.P., and Aurora Diagnostics, LLC (filed as Exhibit 10.18 to the Company’s Registration Statement on Form S-4, No. 333-176790, and incorporated herein by reference)
10.14
First Amendment to Amended and Restated Management Services Agreement, dated May 20, 2010, by and among Summit Partners, L.P., KRG Capital Management, L.P., and Aurora Diagnostics, LLC (filed as Exhibit 10.19 to the Company’s Registration Statement on Form S-4, No. 333-176790, and incorporated herein by reference)
10.15
Second Amendment to Aurora Diagnostics, LLC Amended and Restated Management Services Agreement, dated July 31, 2014, by and among Summit Partners, L.P., KRG Capital Management, L.P., and Aurora Diagnostics, LLC (filed as Exhibit 10.15 to the Company’s Annual Report on Form 10-K filed on June 4, 2015 and incorporated herein by reference)
10.16
Form of Management Agreement by and between Aurora Diagnostics, LLC and certain of its affiliated practice subsidiaries (filed as Exhibit 10.20 to the Company’s Registration Statement on Form S-4, No. 333-176790, and incorporated herein by reference)
Exhibit
Number
Description
10.17
Form of Nominee Agreement by and between Aurora Diagnostics, LLC and certain of its affiliated practice subsidiaries (filed as Exhibit 10.21 to the Company’s Registration Statement on Form S-4, No. 333-176790, and incorporated herein by reference)
10.18
Form of Non-Alienation Agreement by and between Aurora Diagnostics, LLC and certain of its affiliated practice subsidiaries (filed as Exhibit 10.22 to the Company’s Registration Statement on Form S-4, No. 333-176790, and incorporated herein by reference)
10.19
Form of Services Agreement by and between Aurora Diagnostics, LLC and certain of its affiliated practice subsidiaries (filed as Exhibit 10.23 to the Company’s Registration Statement on Form S-4, No. 333-176790, and incorporated herein by reference)
10.20
Waiver to Financing Agreement dated as of March 31, 2015, by and among Aurora Diagnostics, LLC, as borrower, Aurora Diagnostics Holdings, LLC, and certain subsidiaries of Aurora Diagnostics, LLC, as guarantors, various lenders from time to time party thereto, as lenders, and Cerberus Business Finance, LLC, as administrative agent and collateral agent (filed as Exhibit 10.2 to the Company’s Form 8-K filed on April 2, 2015 and incorporated herein by reference)
10.21
First Amendment to Financing Agreement, dated as of March 4, 2015, by and among Aurora Diagnostics, LLC, as borrower, Aurora Diagnostics Holdings, LLC, and certain subsidiaries of Aurora Diagnostics, LLC, as guarantors, various lenders from time to time party thereto, as lenders, and Cerberus Business Finance, LLC, as administrative agent and collateral agent (filed as Exhibit 10.15 to the Company’s Annual Report on Form 10-K filed on June 4, 2015 and incorporated herein by reference)
10.22
Second Amendment to Financing Agreement, dated as of April 10, 2015, by and among Aurora Diagnostics, LLC, as borrower, Aurora Diagnostics Holdings, LLC, and certain subsidiaries of Aurora Diagnostics, LLC, as guarantors, various lenders from time to time party thereto, as lenders, and Cerberus Business Finance, LLC, as administrative agent and collateral agent (filed as Exhibit 10.2 to the Company’s Form 8-K filed on April 15, 2015 and incorporated herein by reference)
10.23
Third Amendment to Financing Agreement, dated as of July 14, 2015, by and among Aurora Diagnostics, LLC, as borrower, Aurora Diagnostics Holdings, LLC, and certain subsidiaries of Aurora Diagnostics, LLC, as guarantors, various lenders from time to time party thereto, as lenders, and Cerberus Business Finance, LLC, as administrative agent and collateral agent (filed as Exhibit 10.2 to the Company’s Form 8-K filed on July 20, 2015 and incorporated herein by reference)
10.24
Fourth Amendment to Financing Agreement, dated as of September 18, 2015, by and among Aurora Diagnostics, LLC, as borrower, Aurora Diagnostics Holdings, LLC, and certain subsidiaries of Aurora Diagnostics, LLC, as guarantors, various lenders from time to time party thereto, as lenders, and Cerberus Business Finance, LLC, as administrative agent and collateral agent (filed as Exhibit 10.2 to the Company’s Form 8-K filed on September 21, 2015 and incorporated herein by reference)
21.1
List of subsidiaries of Aurora Diagnostics Holdings, LLC
31.1
Certification of the Principal Executive Officer, pursuant Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
Certification of the Principal Financial Officer, pursuant Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1
Certification of the Principal Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2
Certification of the Principal Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS
XBRL Instance Document
101.SCH
XBRL Taxonomy Extension Schema Document
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document
*
Indicates management contracts and compensatory plans and arrangements