ITEM 1. BUSINESS
Overview
MedAssets is headquartered in Alpharetta, Georgia, and was incorporated in 1999. We are a performance improvement company providing technology-enabled products and services (“solutions”) that, together, help mitigate the increasing financial challenges faced by healthcare organizations, including hospitals, health systems, non-acute healthcare providers, payers, other service providers andproduct manufacturers. These challenges include higher costs resulting from increasing complexity in operational approaches and clinical care, the transition of patient care to lower cost care settings,pressure on our clients’ and partners’ revenuestreams and high levels of uncompensated care provided by healthcare providers. The rising complexity of healthcare reimbursement is due to a number of factors, such as the trend of shifting an increasing percentage of Medicare payments into alternative payment and delivery models such as Accountable Care Organizations (“ACOs”), bundled-payment arrangements and other value-based reimbursement methodologies.
According to Standard and Poor’s Ratings Services, the median operating margin for not-for-profit hospitals and health systems declined to 2.1% in 2013 from 2.6% in 2012. The decline is due to the increase in expenses outpacing revenue growth as a result of an increased number of physician practice acquisitions, rising bad debt, and higher employee benefit costs.We believe that hospital and health system operating margins will remain under long-term and continual financial pressure due to shortfalls or reductions in government reimbursement, commercial insurance pricing leverage, continued escalation of operating and supply costs, and increased demand for services at lower reimbursement rates with the implementation of healthcare reform initiatives.
Index to Financial Statements Our solutions are designed to deliver market insight, reduce the total cost of care delivery, enhance operational efficiency, align clinical delivery of physicians and staff to advance care coordination, and improve revenue performance primarily for hospitals and health systems. We believe implementation of our full suite of solutions has the potential to help strategically position healthcare organizations across the continuum of care in the communities they serve, decrease supply costs, improve clinical resource utilization and increase revenue capture and cash flow. The sustainable financial improvements provided by our solutions typically occur in a matter of months and can be quantified and confirmed by our clients. Our solutions integrate with our clients’ existing operations and enterprise software systems, and require minimal upfront costs or capital expenditures for our clients.
Our technology-enabled solutions are delivered primarily through company-hosted software, sometimes referred to as software as a service (“SaaS”) or Web-based applications, supported by implementation, process improvement consulting and outsourced services, as well as enterprise-wide sales and client management support. Our Web-based applications employ cloud computing by using the Internet to virtually deploy our solutions across decentralized health care organizations, providing standardization and compliance to improve operating efficiency and performance. We employ an integrated, client-centric approach to delivering our solutions which, when combined with the ability to deliver measurable financial improvement, has resulted in high retention of our large health system clients, and, in turn, a predictable base of stable, recurring revenue. Our ability to expand the breadth and value of our solutions over time has allowed us to develop strong relationships with our clients’ senior management teams.
Our success in improving our clients’ ability to increase revenue and manage supply expense has driven substantial growth in our client base and has allowed us to expand sales of our products and services to existing clients. These factors have contributed to our compounded annual net revenue growth rate of approximately 16.5% over our last five fiscal years. Our client base currently includes approximately 4,500 acute care hospitals and 123,000 ancillary or non-acute provider locations.
We manage our business through our two business segments, Spend and Clinical Resource Management (“SCM”) and Revenue Cycle Management (“RCM”). Our SCM segment manages approximately $59 billion of annual supply spend by healthcare providers, including more than $30 billion of annual spend through our group purchasing organization (“GPO”), on behalf of approximately 3,400 hospital clients. Our RCM segment currently has more than 2,700 hospital clients and touches over $450 billion in gross patient revenue annually.
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Spend and Clinical Resource Management. Our SCM segment is an industry leader in delivering strategic market insight, performance improvement advisory and cost management capabilities to healthcare providers. We provide a comprehensive suite of cost management services, supply chain analytics and data capabilities that help our clients gain market intelligence, reduce their total cost of care delivery, enhance their operational efficiency and align their clinicians’ delivery of care with advance care coordination. Our solutions lower operating costs through compliance to our strategic sourcing of supplies and purchased services at discounted prices, supply chain outsourcing and procurement services capabilities. We also help to improve care processes and reduce care variations through our clinical and process improvement consulting services, workforce optimization solutions and business analytics and intelligence tools. Based on our analysis of certain clients that have implemented a portion of our products and services, we estimate that implementation of our full suite of SCM solutions has the potential to decrease a typical health system’s supply expenses by 3% to 10%, which equates to an increase in operating margin of 0.5% to 2.0% of revenue.
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Revenue Cycle Management. Our RCM segment is one of the largest providers of revenue cycle management solutions to healthcare providers, primarily hospitals and health systems. We provide SaaS or Web-based software and technology-enabled services designed to improve revenue performance for healthcare organizations - through patient access and financial responsibility, clinical documentation, charge capture and revenue integrity, pricing analysis, claims processing and denials management, payor contract management, extended business office revenue recovery, accounts
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receivable services and outsourcing. Our workflow solutions, together with our analytics tools, leverage proprietary data, reimbursement and payor rules to increase revenue capture and cash collections, reduce accounts receivable balances and increase regulatory compliance. Based on our analysis of certain clients that have implemented a portion of our products and services, we estimate that implementation of our full suite of RCM solutions has the potential to increase a typical health system’s net patient revenue by 1.0% to 3.0%.
We believe that we are well positioned to deliver client-specific solutions to the market as hospitals, health systems and non-acute providers continue to face the financial pressures that are endemic and long-term to the healthcare industry. We have leveraged the scale and scope of our overall business to develop a strong understanding and unique base of content regarding the environment inwhich hospitals and health systems operate. With the benefit of this insight, we develop solutions that are designed to strengthen financial and operational performance across our clients’ organizations.
Industry
According to the U.S. Centers for Medicare & Medicaid Services (“CMS”), spending on healthcare in the United States increased 3.6% to reach $2.9 trillion in 2013, or 17.9% of United States Gross Domestic Product, or GDP. Healthcare spending is projected to reach $5.2 trillion by 2023, or 19.3% of GDP. In 2013, spending on hospital care was estimated to be $936.9 billion, representing the single largest component of healthcare spending. According to the American Hospital Association, the U.S. healthcare market has approximately 5,700 acute care hospitals, of which nearly 3,100 are part of health systems. A health system is a healthcare provider with a range of facilities and services designed to deliver care more efficiently and to compete more effectively to increase market share. The Bureau of Labor Statistics estimates that the non-acute care market consists of nearly 575,000 healthcare facilities and providers, including outpatient medical centers and surgery centers, medical and diagnostic laboratories, imaging and diagnostic centers, home healthcare service providers, long term care providers, and physician practices.
We believe that ongoing strains on government agencies’ ability to pay for healthcare will continue to have the effect of limiting available reimbursement for healthcare providers. Reimbursement by federal programs often does not cover a hospital’s cost of providing care. In 2012, community hospitals had a shortfall of more than $45.9 billion relative to the cost of providing care to Medicare and Medicaid beneficiaries, up 105.8% from $22.3 billion in 2002, according to the American Hospital Association. The growing Medicare- and Medicaid-eligible population, combined with a declining number of workers per Medicare beneficiary, is expected to result in significant federal and state budgetary pressures leading to increasing reimbursement shortfalls for hospitals relative to the cost of providing care.
In order to address rising healthcare costs, employers are pressuring managed care companies to contain healthcare insurance premium increases and reduce the healthcare benefits offered to employees. These ongoing efforts by employers to manage healthcare costs could have the effect of limiting reimbursement for hospitals. In addition, the launch of government-sponsored health insurance exchanges are negatively impacting broader reimbursement trends for healthcare providers.
The introduction of consumer-directed or high-deductible health plans by managed care companies, as well as the overall decline in healthcare coverage by employers, has forced private individuals to assume greater financial responsibility for their healthcare expenditures. Consumer-directed health plans, and their associated high deductibles, increase the complexity and change the nature of billing procedures for hospitals and health systems. As more and more payment responsibility shifts to the consumer, hospitals are less likely to be reimbursed and are required to classify the associated care expenses as bad debt as individuals are unable to pay for services rendered.
Index to Financial Statements Hospital and Health System Reimbursement Complexity
Hospitals typically submit multiple invoices to a large number of different payors, including government agencies, commercial insurance companies and private individuals, in order to collect payment for the care they provide. The delivery of an individual patient’s care depends on the provision of a large number and wide range of different products and services, which are tracked through numerous clinical and financial information systems across various hospital departments, resulting in invoices that are usually highly detailed and complex. For example, a hospital invoice for a common surgical procedure can reflect over 200 unique charges or supply items and other expenses. A fundamental component of a hospital’s ability to bill for these items is the maintenance of an up-to-date, accurate chargemaster file, which can consist of over 40,000 individual charge items.
In addition to requiring intricate operational processes to compile appropriate charges and claims for reimbursement, hospitals must also submit these claims in a manner that adheres to numerous payor claim formats and properly reflects individually contracted payor reimbursement rates. For example, some hospitals rely on accurate billing adjudication and payment from over 50 contracted payors that are linked to thousands of independent insurance plans, inclusive of private individuals, in order to be compensated for the patient care they provide. Upon receipt of the claim from a hospital, a payor proceeds to verify the accuracy and completeness of, or adjudicate, the claim to determine the appropriateness and accuracy of the corresponding payment to the hospital. If a payor denies payment for any or all of the amount of the claim, the hospital must determine the reason for the denial and then amend and/or resubmit the claim to the payor.
As reimbursement models move from fee-for-service to fee-for-value, healthcare providers will need to manage the complexities of both reimbursement structures, as well as understand profitability and utilization under both models. Payor contract modeling and adjudication capabilities must address these complexities.
Unsustainable Hospital and Health System Costs and Supply Expenses
We estimate that the supplies and non-labor services used in conjunction with the delivery of hospital care account for more than 40% of overall hospital costs. These costs include commodity-type medical-surgical supplies, medical devices, branded and generic pharmaceuticals, laboratory supplies, food and nutritional products and purchased services. Hospitals are required to purchase many different types of supplies and services as a result of the wide range of medical care that they administer to patients. For example, it is common for hospitals to maintain supply cost and pricing information on over 35,000 different product types and models in their internal supply record-keeping systems, or master item files.
Hospitals often rely on GPOs, which aggregate hospitals’ purchasing volumes, to help manage supply and service costs.In 2012, GPOs generated $55.2 billion in savings to the healthcare system, and researchers believe this trend will continue.Over the next 10 years, GPOs are positioned to generate additional savings for the healthcare industry. A report released by the Healthcare Supply Chain Association (“HSCA”) and healthcare economists at Dobson DaVanzo& Associates found GPOs could help reduce overall healthcare spending by up to $864.4 billion by 2022. The HSCA also estimated that GPOs save the U.S. healthcare industry over $2 billion in annual human resource costs. GPOs contract with suppliers directly for the benefit of their clients, but they do not take title or possession of the products for which they contract; nor do GPOs make any payments to the vendors for the products purchased by their clients. GPOs primarily derive their revenues from administrative fees earned from vendors based on a percentage of dollars spent by their hospital and health system clients. Vendors discount prices and pay administrative fees to GPOs because GPOs provide access to a large client base, thus reducing sales and marketing costs and overhead associated with managing contract terms with a highly fragmented provider market.
Index to Financial Statements Market Opportunity
We believe that the endemic, persistent and growing healthcare industry pressures provide us substantial opportunities to assist hospitals and health systems to increase net revenue and reduce supply expense. We estimate the total addressable market for our enterprise-wide solutions in the United States to be more than $12 billion, including outsourced or embedded management services.
Reimbursement Complexities and Pressures
Hospitals and health systems are faced with complex and changing reimbursement rules across the government agency and managed care payor categories, as well as the challenge of collecting an increasing percentage of revenue directly from individual patients. Key reimbursement complexities and pressures include:
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Patient Protection and Affordable Care Act. In March 2010, the Patient Protection and Affordable Care Act (“PPACA”) was signed into law. The law focuses, among other things, on reform of the private health insurance market to provide coverage for uninsured individuals and better coverage for those with pre-existing conditions. It was estimated that as many as 25 million uninsured individuals had access to affordable coverage beginning in 2014. According to Obamacarefacts.com, as of mid-January, 2015, 7.1 million previously uninsured individuals were enrolled in an insurance plan through HealthCare.Gov and 2.4 million enrolled through state Marketplaces, as well as 3 million covered as part of Medicaid expansion in certain states.
The law also provides for the commencement of health insurance exchanges as a new market place where individuals and small businesses can compare policies and premiums, and buy insurance with a government subsidy, if eligible. In addition, the PPACA encourages the formation of accountable care organizations (“ACOs”) to promote accountability by healthcare providers and payors for a patient population, and has established various pilot projects to understand the impact and benefits of various bundled reimbursement methodologies. These new reimbursement methodologies will significantly affect providers that are involved in patient care delivery. Instead of each provider being paid separately for the services performed, one bundled payment will cover the total care provided. New competencies will be needed to coordinate care, manage costs and allocate reimbursement.
While coverage of uninsured individuals may mean fewer unpaid hospital bills, the additional insurance coverage provided through expanded Medicaid coverage as well as by state or federally-sponsored health insurance exchanges is often at reimbursement rates below recent historical levels. In the case of Medicaid, reimbursement rates have been below the cost of care delivery. Any short-term benefit for healthcare providers may also be offset by a decrease in funding for uncompensated care, reductions in Medicare and Medicaid payments, penalties for adverse outcomes, and the challenges of supporting increased utilization of healthcare services.
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Government agency reimbursement coding standards. Government-mandated billable coding changes continue to present ever greater complexity in the reimbursement process by requiring hospitals to change their systems and processes in order to submit compliant Medicare invoices required for payment, thereby straining existing information technology. For example, U.S. healthcare providers, payors and clearinghouses were required to be compliant with version 5010 of the Health Insurance Portability and Accountability Act (“HIPAA”) transaction and code set standards for eligibility, claims status, referrals, claims and remittances by June 30, 2012. In addition, healthcare providers are required to transition from the ICD-9 (International Statistical Classification of Diseases and Related Health Problems) system to ICD-10, a much more complex coding scheme for documenting diagnoses and procedures in order to comply with World Health Organization standards as required by the U.S. Department of Health and Human Services (“HHS”) by October 1, 2015. The ICD-10 coding system totals approximately 155,000 different codes, ten times more than the 14,400 codes found in ICD-9. Healthcare providers continue to make investments in technology upgrades, process change and staff training due to this major regulatory change.
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Managed care plans. Employers typically provide medical insurance benefits to their employees through managed care plans that can offer a variety of indemnity, preferred provider organization (“PPO”), health maintenance organization (“HMO”), point-of-service (“POS”), and consumer-directed health plans. Each of these plans has individual network designs and pre-authorization requirements, as well as co-payment, co-insurance and deductible profiles. These varying profiles are difficult to monitor and frequently result in the submission of invoices that do not comply with applicable payor requirements.
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Consumer-directed health plans. According to CMS, consumer out-of-pocket payments for health expenditures increased to $339.4 billion in 2013 from $271.6 billion in 2006. Furthermore, many employer-sponsored plans have benefit designs that require large out-of-pocket expenses for individual employees. Traditionally, hospitals and health systems have developed billing and collection processes to interact with government agency and managed care payors on a high-volume, scheduled basis. The advent of consumer-directed healthcare, or high-deductible health insurance plans, requires hospitals and health systems to invoice patients on an individual basis. We believe many hospitals and health systems do not have the appropriate level of technological infrastructure and/or operational expertise required to successfully manage a high volume of invoices to individuals.
Provider Complexities and Pressures
Hospitals and health systems face increasing cost pressures caused by declining reimbursement, overutilization of services, continued increase of supply prices, technological innovation and complexities inherent in procuring the vast number and quantity of supplies and medical devices required for the delivery of care, as well as the anticipated impact of health insurance reform initiatives. Key complexities and pressures include:
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Increased patient volumes and lower reimbursement from health insurance coverage. While coverage of previously uninsured individuals may mean fewer unpaid hospital bills, much of the care provided to the newly insured is expected to be provided through expanded Medicaid coverage as well as by state or federally-sponsored health insurance exchanges. In addition, it is estimated that approximately 8,000 baby boomers per day are becoming eligible for Medicare. Such care is likely to be covered at reimbursement rates below previous levels, which, in the case of both Medicare and Medicaid, are already below the cost of care delivery.
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Pricing pressure due to technological innovation. Historically, advances in specific therapies and technologies have resulted in higher-priced supplies for hospitals, which have significantly decreased the profitability associated with a number of the medical procedures that hospitals perform. For implantable medical devices in particular, hospitals often have a limited ability to mitigate high unit costs because practicing physicians, who are usually not employed by the hospital, often prefer to choose the specific devices that will be used in the delivery of care. Although hospitals are required to procure and pay for these devices, their ability to manage the costs is limited because the hospitals cannot influence the purchasing decision in the same way they are able to with other medical supplies.
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Supply chain complexities. Despite the use of GPOs to obtain discounts on supplies, hospitals and health systems often do not optimally manage their supply costs due to decentralized purchasing decisions and varying clinical preferences. In addition, hospital supply procurement is highly complex given the vast number of supplies purchased subject to frequently changing contract terms. As a result, supplies are often purchased without a manufacturer contract, or off-contract, which results in higher prices. Furthermore, hospitals often fail to aggregate purchases of commodity-type supplies to take advantage of discounts based on purchase volume or to recognize when they have qualified for these discounts.
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Hospitals focus on quality clinical care. Healthcare organizations have historically devoted the majority of their financial and operational resources to investing in people, technologies and infrastructure that improve the level and quantities of clinical care that they can provide. In part, this
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focus has been driven by healthcare providers’ historical ability to capture higher reimbursement for innovative, more sophisticated medical procedures and therapeutic specialties. In addition, healthcare executives are worried about reducing waste and unwarranted utilization, and managing horizontally across their organizations. Since these organizations’ overall financial and operational resources are limited, investments in higher quality clinical care have often come at the expense of investment in other infrastructure systems, including revenue capture, billing, and materials management. As a result, existing hospital operations and financial and information systems are often ill-suited to manage the increasing complexity and ongoing changes that are inherent in the current and future reimbursement, supply procurement, clinical care and cost management environment.
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Population health management and accountable care organizations (“ACOs”). Population health management uses analytics and care coordination to shepherd groups of patients through a higher-quality, lower-cost care continuum. An ACO is a healthcare organization characterized by a payment and care delivery model that seeks to tie provider reimbursements to quality of care metrics and reductions in the total cost of care for an assigned population of patients. A group of coordinated health care providers forms an ACO, which then provides care to a group of patients. An ACO may use a range of payment models (capitation, fee-for-service with shared savings, etc.), and is accountable to the patients and the third-party payer for the quality, appropriateness and efficiency of the health care provided. These strategies and programs help lower overall healthcare costs and are expected to continue to gain popularity. For example, in January 2015, the HHS Secretary outlined new targets for Medicare payment reform to rapidly accelerate federal use of accountable care, bundled payments and other methods to pay hospitals and physicians.
MedAssets Solutions
Our technology-enabled solutions enable healthcare providers, primarily hospitals and health systems, to mitigate the trend of expenses increasing at a greater rate than revenue. Our SCM solutions reduce expenses through focused or comprehensive supply chain and clinical resource utilization services that use data and analytics, such as master item files and hospital purchasing data, to identify opportunities for savings and process improvement. This enables us to assist our clients in negotiating discounts on specific high-cost physicianpreference items and pharmaceuticals, and allows our clients to optimize purchasing of supplies and services and to engage physicians in the process to reduce the total cost of care. Our RCM solutions increase net revenue collection rates for healthcare providers by analyzing complex information sets, such as chargemasters and payor rules, to facilitate regulatory compliance and payor requirements in order to realize accurate and timely submission and tracking of invoices or claims.
Our Competitive Strengths
Key elements of our competitive strengths include:
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Comprehensive and flexible suite of solutions. Our proprietary applications are primarily delivered through SaaS-based software and are designed to integrate with our clients’ existing systems and work processes, rather than replacing enterprise software systems. As a result, our solutions are scalable and generally require minimal or no upfront investment by our clients. Moreover, we can offer our clients an opportunity to leverage our comprehensive and flexible set of product and service capabilities in order to help transform their operations through fundamental and sustainable process change and to increase cost savings, revenue capture and/or cash flows.
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Leading market position. We believe we are a market leader in each of the two segments in which we operate. This relative market share advantage enables us to invest, at a greater level, in areas of our business to enhance our competitiveness through product innovation and development, sales and client support, as well as employee training and development.
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Long-term and expanding client relationships. We collaborate with our clients throughout the duration of our relationships to ensure anticipated financial improvement is realized and to identify additional
Index to Financial Statements
solutions that can yield incremental financial improvements. Our ability to provide measurable financial improvement and expand the value of our solutions over time has allowed us to develop strong relationships with our clients’ senior management teams. Our collaborative approach and ability to deliver measurable financial improvement has resulted in high retention of our large health system clients and, in turn, a predictable base of stable, recurring revenue.
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Superior proprietary data. Our solutions are supported by proprietary databases compiled by leveraging the breadth of our client base and product and service offerings over a period of years. We believe our databases are the industry’s most comprehensive, including our clinical analytic database of inpatient, outpatient, ambulatory surgery and physician encounters of over two billion charge detail records for over 550 clinical programs. MedAssets is able to provide a detailed service line analysis that includes benchmarks, pricing targets, and utilization targets. Our proprietary master item file contains approximately two million different product types and models, our chargemaster contains over 385,000 distinct charges, and our claims management, contract management and Knowledge Source databases contain governmental and other third-party payor rules and comprehensive pricing data. In addition, we integrate a hospital’s revenue cycle and spend management data sets to help ensure that all chargeable supplies are accurately represented in the hospital’s chargemaster, resulting in increased revenue capture and enhanced regulatory compliance. This content also enables us to provide our clients with spend management decision support and analytical services, including the ability to effectively manage and control their contract portfolios and monitor pricing, tiers and market share. The breadth and scale of our client base and product and service offerings enhances our ability to continually update our proprietary databases, ensuring that our data remains current and comprehensive.
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Experienced and driven sales force & client management team. We employ highly-trained and focused sales and client service teams of approximately 350 people. Our sales and client service teams provide national coverage for establishing and managing client relationships and maintain close relationships with senior management of hospitals and health systems, as well as other operationally-focused executives involved in areas of revenue cycle management and spend and clinical resource management. Our large sales and client service teams allow us to have personnel that focus on enterprise sales, which we define as selling a comprehensive solution to healthcare providers, and on technical sales, which we define as sales of individual products and services. We utilize a highly consultative sales process during which we gather extensive client financial and operating data that we use to demonstrate that our solutions can yield significant near-term financial improvement. Our sales and client service teams’ compensation is designed to drive profitable growth in sales to both current clients and new prospects, and to support client satisfaction and retention efforts. We expect to use our existing highly consultative sales and client service teams and increased scale to drive additional growth across the combined company’s suite of products and solutions to both new and existing clients.
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Proven management team and dynamic culture. Our senior management team has many years of business and healthcare industry experience, and our company has a proven track record of delivering measurable financial improvement for healthcare providers. We believe that our current management team has the expertise and experience to continue to grow our business by executing our strategy without significant additional headcount in senior management positions. Our management team has established a client-driven culture that encourages employees at all levels to focus on identifying and addressing the evolving needs of healthcare providers and has facilitated the integration of acquired companies.
Index to Financial Statements Our Strategy
Our mission is to partner primarily with healthcare providers to enhance their financial strength through improved operating margins and cash flows. Key elements of our strategy include:
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Capitalizing on strong industry fundamentals. Our target market has continued to experience growth due to increasing financial challenges faced by hospitals and health systems. These include the increasing complexity of healthcare reimbursement, rising levels of bad debt and uncompensated care, limited access to capital and significant increases in supply utilization and operating costs. We believe there is tremendous pressure on the United States healthcare system to reduce costs and transform the delivery system. Our comprehensive solutions can help our current and prospective clients simultaneously reduce costs, enhance operational efficiency and improve revenue and cash flow, all of which may improve financial and operational performance.
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Continually improving and expanding our suite of solutions. We intend to continue to deploy our research and development team, proprietary databases and industry knowledge to further integrate our products and services and develop new financial and operational improvement solutions for hospitals and healthcare providers. In addition to our internal research and development, we also will continue to look to expand our portfolio of solutions through strategic partnerships and select acquisitions, if appropriate, that will allow us to offer incremental financial improvement to healthcare providers. Research and development of new products and the successful execution and integration of future acquisitions are integral to our overall strategy as we continue to expand our portfolio of solutions.
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Further penetrating our existing client base. We intend to use our long-standing client relationships, large and experienced sales and client service teams, and expanded breadth of our SCM and RCM capabilities to increase the penetration rate for our comprehensive suite of solutions with our existing clients. We estimate the addressable market for existing clients to be a $4.0 billion revenue opportunity for our existing products and services. Within our large and diverse client base, many of our clients utilize solutions from only one of our segments, and the vast majority of our clients use less than the full suite of our solutions.
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Attracting new clients. We utilize our large and experienced sales team to aggressively seek new clients. We estimate that the addressable market for new clients for our SCM and RCM solutions represents a $4.0 billion revenue opportunity for our existing products and services. We believe that our comprehensive suite of solutions and ability to demonstrate financial improvement opportunities through our highly-consultative sales process will continue to allow us to successfully differentiate our solutions from those of our competitors. The implementation of our advisory and outsourced or embedded SCM and RCM services represents an additional revenue opportunity of more than $4.0 billion.
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Leveraging operating efficiencies and economies of scale and scope. The design, scalability and scope of our solutions enable us to efficiently deploy a client-specific solution principally through web-based SaaS technologies. As we add new solutions to our portfolio and new clients, we expect to leverage our current capabilities to reduce the average cost of providing our solutions. As clients continue to experience cost pressures, they will be challenged to be able to afford the individual investments needed to operate and compete effectively. We believe demand for our solutions will grow as clients look to leverage our economies of scale and national presence.
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Maintaining an internal environment that fosters a strong and dynamic culture. Our management team strives to maintain an organization of individuals who possess a strong work ethic and high integrity, and who are recognized for their dependability and commitment to excellence. We believe that this results in attracting employees who are driven to achieve our long-term mission of being the recognized leader in the markets in which we compete. We believe that dynamic, client-centric thinking will be a catalyst for our continued growth and success.
Index to Financial Statements Business Segments
We manage our business through two business segments, Spend and Clinical Resource Management (“SCM”) and Revenue Cycle Management (“RCM”). Information about our business segments should be read together with Management’s Discussion and Analysis of Financial Condition and Results of Operations and our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K.
Spend and Clinical Resource Management Segment
Our SCM segment helps our clients manage a substantial portion of their high expense categories through a combination of strategic sourcing and group purchasing services, services that include medical device and clinical resource consulting, Lean performance improvement, workforce management, and supply chain outsourcing and procurement, among other capabilities. In addition, we offer sophisticated business intelligence and decision support tools.
Strategic Sourcing
Our SCM segment is the industry leader in cost management capabilities for healthcare providers, managing approximately $51 billion of annual supply spend by healthcare providers. We focus on optimizing supply chain performance by identifying and delivering cost savings opportunities through a combination of technology and strategic contracting services. These solutions encompass the procurement of medical supplies, pharmaceuticals, food and nutrition items, capital equipment, and purchased services. Our strategic sourcing services help clients reduce total supply expense in their major spend areas as well as perform more efficiently and effectively.
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Group purchasing. We are one of the largest healthcare GPOs in the United States. Our national portfolio of over 2,300 contracts with approximately 1,200 manufacturers, distributors and other vendors provides our clients with access to a wide range of products and services, including: medical/surgical supplies; pharmaceuticals; laboratory supplies; capital equipment; information technology; food and nutritional products; and purchased services. We use our aggregate purchasing power to negotiate pricing discounts and improved contract terms with vendors. Contracted vendors pay us administrative fees based on the purchase price of goods and services sold to our healthcare provider clients purchasing under the contracts we have negotiated.
Our contract portfolio is designed to offer our healthcare provider clients with both a flexible solution comprised of multi-sourced supplier contracts, as well as a core group of pre-commitment and/or sole-sourced contracts that offer significant discounts. Our multi-sourced contracts include pricing tiers based on purchase volume and offer multiple sources for many products and services. Our pre-commitment or sole-source supplier contracts require that our clients commit to a high percentage of purchase volume from the specified supplier contracts to access greater savings. We regularly evaluate the depth, breadth and competitiveness of our contract portfolio, and have adopted this evolving, data-driven strategy to better address the varying needs of our clients and the significant number of factors, including overall size, service mix, for-profit versus not-for-profit status, and the degree of integration between hospitals in a health system, that influence and dictate their needs.
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Capital and construction solutions. We offer end-to-end capabilities that help clients lower costs, extend capital equipment life cycle and gain greater fiscal control of the building process - from contracting and subcontracting, to interior design and equipment planning.
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Purchased services. We help clients better manage their spending on non-medical operational and support services through a comprehensive sourcing and consulting approach. Our initiatives are based on client needs and include, for example, evaluating energy consumption and negotiating reduced rates for commodity energy and delivery cost, or lowering the total cost of an organization’s life and disability insurance rates.
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Bulk buy. We gain negotiated, one-time discounts and other beneficial enhancements for our clients through our bulk buy program, a single-sourcing event that aggregates a large quantity of similar medical device items.
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Contract catalog. We offer a Web-based catalog to easily search and view vendor contract details for our complete vendor contract portfolio, including line-item pricing and certain other contract terms and conditions, to help identify savings opportunities.
SCM Services
Our SCM services use a combination of demonstrated best practices, leading-edge technology, analytics, market insight and experienced consultants to provide strategic market insight, reduce clinical and operational costs, increase operational efficiency, and help clinicians and healthcare administrators better align clinical delivery for optimal patient and financial outcomes. The focus of our SCM segment is on delivering significant and sustainable financial and operational improvement in the following areas:
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Strategic market intelligence and consulting. Through our Sg2 business, we help healthcare organizations leverage information by providing insight and guidance to prioritize and execute a strategic plan for future growth and success. Our consulting experts - which include clinicians, strategists, health care executives and statisticians utilize system-wide analytics and future-focused intelligence to provide analysis, actionable plans, and insight into national and local market trends, market position, growth opportunities and strategic priorities. Areas of focus include ambulatory strategy, health exchanges, medical staff planning, service line planning, virtual health strategy and strategic partnerships.
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Clinical resource and utilization management. Our clinical consulting professionals help clients realize savings, improved physician alignment and product utilization through the analysis of supply and device costs against patient outcomes. A large component of product utilization is implantable physician preference items, or “PPI”, the costs of which may represent approximately 40% of the total supply expense of an average hospital. PPI include expensive medical products and implantable devices (e.g., stents, catheters, heart valves, pacemakers, leads, total joint implants, spine implants and bone products) in the areas of cardiology, orthopedics, neurology, and other highly advanced and innovative service lines, as well as branded pharmaceuticals. We assist healthcare providers with PPI cost reduction by providing data and utilization analyses and pricing targets and by facilitating the implementation and request for proposal processes for PPI in the following areas: cardiac rhythm management, cardiovascular surgery, orthopedic surgery, spine surgery, interventional procedures, and clinical pharmacy management.
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Outsourced / embedded management services. We have approximately 530 professionals who oversee the supply chain operations for approximately 200 hospitals through the direct management of the sourcing and contracting, purchasing, materials management and inventory management activities. Our teams of embedded employees work with hospital executives to set defined and measurable cost-reduction goals, leverage the most competitive supply contracts, use automation to streamline supply purchases, create new practices to accelerate distribution, and track performance to enable continuous improvement.
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Procurement solutions. Through our National Procurement Center, we enable hospitals and other non-acute healthcare provider organizationsto purchase supply chain products, consumable goods, purchased services and capital equipment. This highly-scalable service helps our clients increase efficiency and lower procurement-related expenses.
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Workforce management. We help healthcare providers optimize internal and external clinical labor costs without sacrificing quality or service levels. We bring together a combination of our Web-based staff scheduling technology, agency nursing and allied healthcare sourcing, and vendor management services to optimize the staffing process and allow healthcare organizations to spend more time on providing patient care.
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Process improvement consulting. Our teams of process improvement experts combine Lean healthcare, Six Sigma, and other effective methods for implementing operating enhancements in order to increase patient access and generate significant sustainable improvements. These operational efficiency processes, which can be used across all major departments and services in a healthcare organization, including the operating room, emergency department, pharmacy department, and nursing floors, are implemented to increase throughput turnaround time, patient satisfaction, and consistency in care delivery.
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Comprehensive service line improvement. We assist providers in evaluating their service lines and identifying areas for clinical resource improvement through a rigorous process that includes advanced data analysis of utilization, profitability and other operational metrics. Specific areas of our service line expertise include cardiac and vascular surgery, invasive cardiology and rhythm management, medical cardiology, orthopedic surgery, spine and neurology, and general medicine. We assist organizations in reducing the variation in care delivery across locations and physicians within the health system.
Market and Performance Analytics
Our performance analytics and data management tools are an integral part of our SCM solutions. These tools provide transparency into expenses, identify performance deficiencies and areas for operational improvement, and allow for monitoring and measuring results. Key components include:
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Strategic market analytics. Through the Sg2 EDGE®analytics and intelligence platform, we provide valuable insight into national, regional and local trends and forecasts across the full continuum of care provided by healthcare organizations. The EDGE platform helps enable healthcare organizations and other market participants to optimize their system of care in their community and their business results while adapting value-based care models.
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Service line analytics. We offer a Web-based solution, supported by consulting services, for the ongoing control and management of supply costs. Using data from a hospital’s information systems, including clinical, financial and supply-cost data reported by service lines and diagnostic-related groups (“DRGs”), we identify opportunities for cost reduction and develop a management plan to achieve improved operational and financial performance results.
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Cost analytics. These Web-based tools help healthcare organizations improve the management of budgets, costs, third-party payor contracts for both drug purchases and medical/surgical supplies, and help to optimize supply chain contract utilization.
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Spend analytics and strategic information services. These Web-based tools identify savings opportunities by functional category, manufacturer or contract, and also identify identical or similar products available on private or GPO contracts. In addition, we provide our clients with analytical services to help effectively manage pricing and pricing tiers, monitor market share and the ability to identify cost-saving alternatives.
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Procure-to-pay. Our team of experts and information technology platform help to streamline healthcare organizations’ requisition-to-payment process for increased productivity and reduced costs. Our clients gain automation to their back office functions, enhanced visibility into areas of supply spend to help reinforce contract compliance and identify pricing errors at the point of purchase and invoice.
Our e-commerce platform links clients with their suppliers to automate the supply procurement process, as well as e-procurement connectivity to supplier content networks, both of which help to lower transaction costs, increase labor efficiency, and automate and expedite supply requisition processes. Through our National Procurement Center, MedAssets manages and procures more than $4 billion in purchases per year on behalf of over 800 healthcare facilities, making us one of the nation’s largest third-party providers of healthcare supply chain management services.
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Client master item file services. We believe we have one of the most comprehensive, proprietary supply item databases in the industry. We provide master item file services utilizing our proprietary master item file containing approximately two million items, which allows us to quickly identify and standardize client supply data for timely and accurate reporting.
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Decision support services. Our decision support software provides clients with an integrated suite of business intelligence tools designed to facilitate hospital decision-making by combining clinical, financial and operational information into a common data set for accuracy and ease of use across the organization. Key components include budgeting, cost accounting, cost management, contract analytics, clinical analytics and client-defined key performance indicators such as profitability per referring physician and per procedure.
Revenue Cycle Management Segment
Our RCM segment provides comprehensive solutions that span what has traditionally been viewed as the hospital revenue cycle. Our scope of revenue cycle products and services help to enhance the effectiveness of certain clinical and administrative functions performed within hospitals and health systems. We combine our revenue cycle workflow solutions with business intelligence tools to increase financial improvement opportunities and regulatory compliance for our clients. Our suite of solutions provides us with significant flexibility in meeting client needs. Some clients choose to actively manage their revenue cycle using internal resources that are supplemented with our solutions. Other clients have chosen a more comprehensive solution set that utilizes our full suite of products and services spanning the entire revenue cycle workflow. Regardless of the client approach, we create timely, actionable information from the vast amount of data that exists in underlying client information systems. In so doing, we enable financial improvement through successful process improvement, informed decision making, and implementation.
Revenue Cycle Technology
Healthcare providers face unique content, data management, business process and claims processing challenges and can utilize our SaaS or Web-based software applications to address these issues in the following stages of the revenue cycle workflow:
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Patient access and financial responsibility. The initial point of patient contact and data collection during the scheduling and admissions process is critical for efficient and effective claim adjudication. Our patient bill estimation, patient access workflow manager and process improvement tools and services promote accurate information and data capture, facilitate communication across revenue cycle operations and assist clients in identifying a patient’s ability to pay and the subsequent collection of payment.
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Case management, coding and documentation. Many hospitals need tools and processes to ensure accurate documentation and coding that adheres to complex and changing regulatory and payor requirements. For example, payors deploy reimbursement mechanisms that shift length-of-stay cost risk to providers and necessitate tools and processes to help providers manage ongoing payor authorization and concurrent denials management while the patient is being treated. Our solutions help clients negotiate the complexities of documentation and coding and streamline the payor authorization communication channel, improving workflow and management of covered days and length of stay to prevent denied days and reduced reimbursement. In addition, our clinical documentation solution improves the accuracy and completeness of documentation needed for reimbursement.
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Charge capture and revenue integrity. Many hospitals need to have processes that ensure implementation of a defensible pricing strategy and compliance with third-party and government payor rules. Our charge integrity solutions help establish and sustain revenue integrity by identifying missed charges on billed claims. Our chargemaster and pricing solutions and workflow capabilities help hospitals accurately capture services rendered and present those services for billing with appropriate and compliant coding consistent with the hospital’s pricing methodology and payor rules.
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Strategic pricing. We maintain a proprietary charge benchmark database that we estimate covers services resulting in over 95% of a hospital’s departmental gross revenues. Through our tools, hospitals are able to establish defensible pricing based on comparative charging benchmarks as well as hospital-specific costs and payor contracts to increase revenue while providing transparency to pricing strategies.
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Claims processing. Following aggregation of all necessary claim data by a hospital’s patient accounting system, a hospital must deliver claims to payors electronically. Our claims processing tools enhance the process with comprehensive edits and workflow technology to correct non-compliant claims prior to submission. The efficiency that this tool provides expedites processing and, by extension, receipt of cash while reducing the resources required to adjudicate claims.
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Denials management and reimbursement integrity. The collection of reimbursable dollars requires successful payor management and communication, and a proactive approach to managing the accuracy of payor reimbursement of claims. Our contract management and denial management solutions help providers hold payors accountable for contracted terms and rates, and identify all underpayments and denials to recover all net revenue owed to our clients for services rendered. We also target problem areas that affect the bottom line to improve collection of receivables due from payors. Our exception-driven receivables workflow creates customized work lists for hospital staff to flag and prioritize outstanding accounts receivable to minimize the potential for lost reimbursable dollars.
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Prospective and retrospective episode payment solutions. Value-based reimbursement is a key initiative of healthcare reform, and our prospective and retrospective episode payment solutions help healthcare organizations prepare for the significant changes to come in payment structure. Using our proprietary software and consultative knowledge, healthcare payors and providers are able to create new definitions for new patient episodes of care, implement and monitor fee-for-service claims within episode budgets, report on financial and quality metrics, administer payment reconciliation to each provider involved in the patient case, and monitor and track patients care pathway through the episode of care.
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Revenue cycle and supply chain integration. Our Cost-to-Charge analytics solutions (previously named CrossWalk® and CrossWalk for Pharmacy) integrate a hospital’s supply chain and revenue cycle to provide side-by-side visibility into supply charge and cost data and the corresponding charges in the hospital’s chargemaster to ensure that all chargeable supplies are accurately represented in the chargemaster. These tools use our proprietary master item file containing approximately four million different product types and models and our proprietary chargemaster containing over 385,000 distinct charges.
Revenue Cycle Services
We employ our services and consulting expertise to help clients pinpoint the greatest opportunities to achieve operational improvements, and implement our capabilities to deliver measurable and sustainable financial improvements in the following areas:
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Revenue recovery and accounts receivable management. Our solutions help to ensure appropriate payment is received for the services provided. We help manage clients’ accounts receivable balances to accelerate payments and to increase net revenues. Our revenue recovery services collect additional cash by detecting inappropriate discounting and inaccurate payments by payors, including silent PPOs, recovering revenue from denied claims and providing Medicare RAC audit review and appeal services. Our extended business office services focus on appeal and recovery of clinical denials, underpayments and breach of contract.
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Comprehensive and outsourced services. Our revenue cycle consultants manage and drive best-practice process improvement by developing a data-intensive assessment of revenue cycle performance and a detailed plan for redesigning services and solutions. We then implement products and services to
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transform revenue cycle processes to help provide appropriate payment for services and generate improved margins and cash flow through operational efficiency.
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Episode of care consulting. Bundled payments, also known as episode-based payments, relate to the reimbursement of healthcare providers on the basis of expected costs for clinically defined episodes of care. These payments were introduced as part of the recent healthcare reform as a means to improve clinical delivery efficiency, gain insight into a patient’s full episode of care and, ultimately, improve the quality of care. Through our consulting capabilities, we offer expertise to healthcare providers to enable them to reduce costs and achieve success in connection with episode of care reimbursement.
Other Information About the Business
Clients
As of December 31, 2014, our client base included approximately 4,500 acute care hospitals and 123,000 ancillary or non-acute provider locations. Our group purchasing organization has contracts with approximately 1,200 manufacturers, distributors and other vendors that pay us administrative fees based on purchase volume by our healthcare provider clients. The diversity of our large client base ensures that our success is not tied to a single healthcare provider or GPO vendor. Our clients are located primarily throughout the United States and, to a limited extent, Canada.
Strategic Business Alliances
We complement our existing products and services and research and development (“R&D”) activities by entering into strategic business relationships with companies whose products and services complement our solutions. We also have co-marketing arrangements with entities whose products and services complement our solutions, such as products and services related to patients financial eligibility qualification and registration quality that are typically offered as patients are being admitted into the hospital.
In addition to our employed sales force, we maintain business relationships with a number of other group purchasing and marketing affiliates that market or support our products or services. We refer to these individuals and organizations as affiliates or affiliate partners. These affiliate partners, which typically provide a limited number of services on a regional basis, are responsible for the recruitment and direct management of healthcare providers in both the acute care and non-acute care markets. Through our relationship with these affiliate partners, we are able to offer a range of solutions to these providers, including both spend and clinical resource management and revenue cycle management products and services, with minimal investment in additional time and resources. Our affiliate relationships provide a cost-effective way to serve certain markets, such as non-acute healthcare providers.
Competition
The market for our products and services is fragmented, intensely competitive and characterized by the frequent introduction of new products and services, rapidly evolving industry standards, technology and client needs. We have experienced and expect to continue to experience intense competition from a number of companies.
Our revenue cycle management solutions compete with products and services provided by large, well-financed and technologically sophisticated entities, including healthcare information technology providers such as Allscripts Corporation, Epic Systems Corporation, McKesson Corporation and Siemens AG; consulting and outsourcing firms such as Accenture Ltd., Accretive Health, Inc., Deloitte &Touche LLP, Ernst & Young LLP,Huron Consulting, Inc., Navigant Consulting, Inc., PricewaterhouseCoopers LLP, The Advisory Board Company and Truven Healthcare Analytics; and providers of competitive products and services such as Conifer (a subsidiary of Tenet Healthcare), Craneware Inc., Emdeon Inc., Optum (a subsidiary of UnitedHealth Group,
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Inc.), Parallon (a subsidiary of HCA, Inc.), Passport Health Communications (a subsidiary of Experian), RelayHealth (a subsidiary of McKesson Corporation) and The SSI Group, Inc. We also compete with hundreds of smaller niche companies.
Within our SCM segment, in addition to a number of the consulting firms listed above, our primary competitors are GPOs. There are more than 600 GPOs in the United States, the vast majority of which negotiate minor agreements with regional vendors for services. Five GPOs, including us, account for approximately 85 percent of the market. We primarily compete with Amerinet Inc., HealthTrust LLC, Novation LLC and Premier, Inc.
We compete on the basis of several factors, including:
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ability to deliver financial improvement and return on investment through the use of products and services;
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breadth, depth and quality of product and service offerings;
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quality and reliability of services, including client support;
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ease of use and convenience;
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ability to integrate services with existing technology;
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price; and
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brand recognition.
We believe that our ability to deliver measurable financial improvement and the breadth of our full suite of solutions give us a competitive advantage in the marketplace.
Employees
As of December 31, 2014, we had approximately 3,350 full time employees.
Government Regulation
The healthcare industry is highly regulated and is subject to changing political, legislative, regulatory and other influences. Existing and new federal and state laws and regulations affecting the healthcare industry could create unexpected liabilities for us, could cause us or our clients to incur additional costs and could restrict our or our client’s operations. Many healthcare laws are complex and their application to us, our clients or the specific services and relationships we have with our clients are not always clear. In particular, many existing healthcare laws and regulations, when enacted, did not anticipate the comprehensive products and revenue cycle management and spend management solutions that we provide, and these laws and regulations may be applied to our products and services in ways that we do not anticipate. Our failure to accurately anticipate the application of these laws and regulations, or our other failure to comply, could create liability for us, result in adverse publicity and negatively affect our business. See the “Risk Factors” section herein for more information regarding the impact of government regulation on our Company.
Intellectual Property
Our success as a company depends upon our ability to protect our core technology and intellectual property. To accomplish this, we rely on a combination of intellectual property rights, trade secrets, copyrights and trademarks, as well as customary contractual protections.
Index to Financial Statements We generally control access to, and the use of, our proprietary software and other confidential information. This protection is accomplished through a combination of internal and external controls, including protective provisions in contracts with employees, contractors, clients, and partners, and through a combination of U.S. and international copyright laws. We license some of our software pursuant to agreements that impose restrictions on our clients’ ability to use such software, such as prohibiting reverse engineering and limiting the use of copies. We also seek to avoid disclosure of our intellectual property by relying on non-disclosure and assignment of intellectual property agreements with our employees and consultants that acknowledge our exclusive ownership of all intellectual property developed by the individual during the course of his or her work with us. The agreements also require that each person maintain the confidentiality of all proprietary information disclosed to them.
We incorporate a number of third party software programs into certain of our software and information technology platforms pursuant to license agreements. Some of this software is proprietary and some is open source. We use third-party software to, among other things, maintain and enhance content generation and delivery, and support our technology infrastructure. Although we rely on multiple licenses from various third parties, we do not consider such licenses to be individually material to our business given the “off-the-shelf” nature of these licenses and that standard operating procedures and practices utilized by these third parties would generally afford us sufficient time to effectively transition to other readily available sources without long-term impact to our business.
We have registered, or have pending applications for the registration of, certain of our trademarks. We actively manage our trademark portfolio, maintain long-standing trademarks that are in use and file applications for trademark registrations for new brands in all relevant jurisdictions.
Research and Development
Our research and development expenditures primarily consist of our investment in internally developed software. We incurred $73.3 million, $72.0 million and $68.7 million for R&D activities in 2014, 2013 and 2012, respectively, and we capitalized 57.6%, 57.1% and 58.5% of these expenses, respectively. As of December 31, 2014, our software development, product management and quality assurance activities involved approximately 460 employees. We expect to incur significant R&D costs in the future due to our continuing investment in internally developed software as we intend to release new features and functionality, expand our content offerings, upgrade and extend our service offerings, and develop new technologies.
Information Availability
Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”), as amended, are available free of charge on our website (www.medassets.com under the “Investor Relations” caption) as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (the “SEC”). The content on any website referred to in this Annual Report on Form 10-K is not incorporated by reference into this report, unless expressly noted otherwise.
ITEM 1A.
ITEM 1A. RISK FACTORS.
Although it is not possible to predict or identify all risks and uncertainties that could cause actual results to differ materially from those anticipated, projected or implied in any forward-looking statement, you should carefully consider the risk factors discussed below which constitute material risks and uncertainties known to us that we believe could affect our future growth, results of operations, performance and business prospects and opportunities. You should not consider this list to be a complete statement of all the potential risks and
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uncertainties regarding our business and the trading price of our securities. Additional risks not presently known to us, or which we currently consider immaterial, may adversely impact our business and the trading price of our securities.
Risks Related to Our Business
We face intense competition, which could limit our ability to maintain or expand market share within our industry, and if we do not maintain or expand our market share, our business and operating results will be harmed.
The market for our products and services is fragmented, intensely competitive and characterized by the frequent introduction of new products and services and by rapidly evolving industry standards, technology and client needs. Our revenue cycle management products and services compete with products and services provided by large, well-financed and technologically-sophisticated entities, including: information technology providers such as Allscripts Corporation, Epic Systems Corporation, McKesson Corporation and Siemens AG; consulting and outsourcing firms such as Accenture Ltd., Accretive Health, Inc., Deloitte &Touche LLP, Ernst & Young LLP, Huron Consulting, Inc., Navigant Consulting, Inc., PricewaterhouseCoopers LLP, The Advisory Board Company and Truven Healthcare Analytics; and providers of competitive products and services such as Conifer (a subsidiary of Tenet Healthcare), Craneware Inc., Emdeon Inc., Optum (a subsidiary of UnitedHealth Group, Inc.), Parallon (a subsidiary of HCA, Inc.), Passport Health Communications (a subsidiary of Experian), RelayHealth (a subsidiary of McKesson Corporation) and The SSI Group, Inc. We also compete with hundreds of smaller niche companies. The primary competitors to our SCM products and services are other large GPOs, such as Amerinet Inc., HealthTrust LLC, Novation LLC and Premier, Inc., as well as a number of the consulting firms named above.
With respect to both our RCM and SCM products and services, we compete on the basis of several factors, including breadth, depth and quality of product and service offerings, ability to deliver financial improvement through the use of products and services, quality and reliability of services, ease of use and convenience, brand recognition, ability to integrate services with existing technology and price. Many of our competitors are more established, benefit from greater name recognition, have larger client bases and have substantially greater financial, technical and marketing resources. Other of our competitors have proprietary technology that differentiates their product and service offerings from ours. As a result of these competitive advantages, our competitors and potential competitors may be able to respond more quickly to market forces, undertake more extensive marketing campaigns for their brands, products and services and make more attractive offers to clients. In addition, many GPOs are associated with provider-clients of the GPO through equity ownership or other financial interests, which enables our competitors to distinguish themselves on that basis.
We expect that competition will continue to increase as a result of consolidation in both the information technology and healthcare industries. If one or more of our competitors or potential competitors were to merge or partner with another of our competitors, the change in the competitive landscape could also adversely affect our ability to compete effectively and could harm our business. Many healthcare providers are consolidating to create integrated healthcare delivery systems with greater market power and regulatory and economic conditions may encourage additional consolidation. Also, some healthcare systems and insurers are vertically integrating to facilitate tighter coordination of care necessary to deliver differentiated clinical quality. Some large healthcare systems may choose to contract directly with vendors for some supply categories; just as some vendors may seek to contract directly with providers rather than with GPOs. Additionally, providers could choose to create their own GPOs. As the healthcare industry consolidates, competition to provide services to industry participants will become more intense and the importance of existing relationships with industry participants will become greater. We cannot be certain that we will be able to retain our current clients or expand our client base in this competitive environment.
Additionally, as a result of agreements that we have entered into in the recent past with certain of our clients, a larger portion of our revenue is now attributable to a smaller group of clients. Although no single client
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accounted for more than ten percent of our total net revenue as of December 31, 2014, any significant loss of business from these large clients could have a material adverse effect on our business, results of operations and financial condition. Also, in February 2015, we announced the appointment of R. Halsey Wise to the position of Chairman and Chief Executive Officer of the company succeeding John A. Bardis, the company’s founder, who retired. Mr. Bardis will continue to serve the company as a consultant to support client relationships; however, we could experience client losses as a result of this leadership change. If we do not retain current clients or expand our client base, our business and results of operations will be harmed.
We expect to conduct a full assessment of our business which could significantly impact our financial results.
As a result of our appointment of Mr. Wise to the position of Chairman and Chief Executive Officer, we expect to perform a complete assessment of our business. Actions taken following this assessment may involve a change in strategy and operations, which could substantially impact our financial results and may include certain restructuring and other related charges.
We may face pricing pressures that could limit our ability to maintain or increase prices for our products and services.
We may be subject to pricing pressures with respect to our future sales arising from various sources, including, without limitation, competition within the industry, consolidation of healthcare industry participants, practices of managed care organizations, government actions affecting reimbursement and clients who experience significant financial stress. If our competitors are able to offer products and services that result, or that are perceived to result, in client financial improvement that is substantially similar to or better than the financial improvement generated by our products and services, we may be forced to compete on the basis of additional attributes, such as charging lower prices or increasing the revenue share obligation that we pay our GPO provider-clients, to remain competitive. As healthcare providers consolidate to create integrated healthcare delivery systems with greater market power, these providers may try to use their market power to negotiate fee reductions for our products and services. If we cannot demonstrate the ability to increase vendor market share of healthcare provider purchases through our GPO, we may have less negotiating leverage with our contracted vendors which may result in our inability to maintain our client agreements or win new business. Additionally, our clients and the other entities with which we have a business relationship are affected by changes in regulations and limitations in governmental spending for Medicare and Medicaid programs. Government actions could limit government spending for the Medicare and Medicaid programs, limit payments to healthcare providers, and increase emphasis on competition and other programs that could have an adverse effect on our clients and the other entities with which we have a business relationship.
If our pricing experiences significant downward pressure, our business will be less profitable and our results of operations will be adversely affected. In addition, because cash flow from operations funds our working capital requirements, reduced profitability could require us to raise additional capital sooner than we would otherwise need.
If we are not able to offer new and valuable products and services, we may not remain competitive and our revenue and results of operations may suffer.
Our success depends on providing products and services that healthcare providers use to improve financial performance. Our competitors are constantly developing products and services that may become more efficient or appealing to our clients. Our products may become obsolete in light of rapidly evolving industry standards, technology and client needs, including changing regulations and provider reimbursement policies, such as the transition from fee-for-service reimbursement models to value-based payment, bundled payment and episodic care models. Additionally, some healthcare information technology providers have begun to incorporate enhanced revenue cycle management analytical tools and functionality into their core product and service
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offerings used by healthcare providers. These developments may adversely impact the demand for our products and services. We must continue to invest significant resources in research and development in order to enhance our existing products and services, maintain or improve our product category rankings and introduce new high-quality products and services that clients and potential clients will want. Many of our client relationships are nonexclusive or terminable on short notice, or otherwise terminable after a specified term. If our new or modified product and service innovations are not responsive to client preferences or industry or regulatory changes, are not appropriately timed with market opportunity, or are not effectively brought to market, we may lose existing clients and be unable to obtain new clients and our results of operations may suffer.
We may experience significant delays in generating, or an inability to generate, revenues if potential clients take substantial time in evaluating our products and services.
A key element of our strategy is to market our products and services directly to large healthcare providers, such as health systems and acute care hospitals and to increase the number of our products and services utilized by existing clients. The evaluation process is often lengthy and involves significant technical evaluation and commitment of personnel by these organizations. The use of our products and services may also be delayed due to an inability or reluctance to change or modify existing procedures. Additionally, healthcare providers’ resources may be focused on other mission critical initiatives which could delay their evaluation of our products and services. If we are unable to sell additional products and services to existing clients in a timely fashion, our revenue could grow at a slower rate or even decrease.
Unsuccessful implementation of our products and services with our clients may harm our future financial success.
Some of our new-client projects are complex and require lengthy and significant work to implement our products and services. Each client’s situation may be different, and unanticipated difficulties and delays may arise as a result of failure by us or by the client to meet respective implementation responsibilities. If the client implementation process is not executed successfully or if execution is delayed, our relationships with the clients, and our results of operations may be adversely impacted. In addition, cancellation of any implementation of our products and services after it has begun may involve the loss to us of time, effort and resources invested in the cancelled implementation as well as lost opportunity for acquiring other clients over that same period of time. These factors may also contribute to substantial fluctuations in our quarterly operating results.
If we are unable to maintain our strategic alliances or enter into new alliances, we may be unable to grow our current base business.
Our business strategy includes entering into strategic alliances and affiliations with leading healthcare service and information technology providers. We work closely with our strategic partners to either expand our penetration in certain areas or classes of trade, or expand our market capabilities. We may not achieve our objectives through these alliances. Many of these companies have multiple relationships and they may not regard us as significant to their business. These companies may pursue relationships with our competitors or develop or acquire products and services that compete with our products and services. In addition, in many cases, these companies may terminate their relationships with us with little or no notice. If existing alliances are terminated or we are unable to enter into alliances with leading healthcare service and information technology providers, we may be unable to maintain or increase our market presence.
If the protection of our intellectual property is inadequate, our competitors may gain access to our technology or confidential information and we may lose our competitive advantage.
Our success as a company depends in part upon our ability to protect our core technology and intellectual property. To accomplish this, we rely on a combination of intellectual property rights, including trade secrets, copyrights and trademarks, as well as customary contractual protections.
Index to Financial Statements We utilize a combination of internal and external measures to protect our proprietary software and confidential information. Such measures include contractual protections with employees, contractors, clients, and partners, as well as U.S. copyright laws.
We protect the intellectual property in our software pursuant to customary contractual protections in our agreements that impose restrictions on our clients’ ability to use such software, such as prohibiting reverse engineering and limiting the use of copies. We also seek to avoid disclosure of our intellectual property by relying on non-disclosure and intellectual property assignment agreements with our employees and consultants that acknowledge our ownership of all intellectual property developed by the individual during the course of his or her work with us. The agreements also require each person to maintain the confidentiality of all proprietary information disclosed to them. Other parties may not comply with the terms of their agreements with us, and we may not be able to enforce our rights adequately against these parties. The disclosure to, or independent development by, a competitor of any trade secret, know-how or other technology not protected by a patent could materially adversely affect any competitive advantage we may have over any such competitor.
We cannot assure you that the steps we have taken to protect our intellectual property rights will be adequate to deter misappropriation of our rights or that we will be able to detect unauthorized uses of our proprietary products and services and take timely and effective steps to enforce our rights. If unauthorized uses were to occur, we might be required to engage in costly and time-consuming litigation to enforce our rights. We cannot assure you that we would prevail in any such litigation. If others were able to use our intellectual property, our business could be subject to greater pricing pressure.
If we are alleged to have infringed on the rights of others, we could incur unanticipated costs and be prevented from providing our products and services.
We could be subject to intellectual property infringement claims as the number of our competitors grows and our applications’ functionality overlaps with competitor products. While we do not believe that we have infringed or are infringing on any proprietary rights of third parties, we cannot assure you that infringement claims will not be asserted against us or that those claims will be unsuccessful. Any intellectual property rights claim against us or our clients, with or without merit, could be expensive to litigate, cause us to incur substantial costs and divert management resources and attention in defending the claim. Furthermore, a party making a claim against us could secure a judgment awarding substantial damages, as well as injunctive or other equitable relief that could effectively block our ability to provide products or services. In addition, we cannot assure you that licenses for any intellectual property of third parties that might be required for our products or services will be available on commercially reasonable terms, or at all. As a result, we may also be required to develop alternative non-infringing technology, which could require significant effort and expense.
In addition, a number of our contracts with our clients contain indemnity provisions whereby we indemnify them against certain losses that may arise from third-party claims that are brought in connection with the use of our products.
Our exposure to risks associated with the use of intellectual property may be increased as a result of acquisitions, as we have limited visibility into the development process with respect to such technology or the care taken to safeguard against infringement risks. In addition, third parties may make infringement and similar or related claims after we have acquired technology that had not been asserted prior to our acquisition.
Our sources of data might restrict our use of or refuse to license data, which could adversely impact our ability to provide certain products or services.
A portion of the data that we use is either purchased or licensed from third parties or is obtained from our clients for specific client engagements. We also obtain a portion of the data that we use from public records. We believe that we have all rights necessary to use the data that is incorporated into our products and services.
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However, in the future, data providers could withdraw their data from us if: there is a competitive or business reason to do so; if pricing or contractual terms are changed at renewal; if legislation is passed restricting the use of the data; or if judicial interpretations are issued restricting use of the data that we currently use in our products and services. Further, we cannot assure you that our licenses for information will allow us to use that information for all potential or contemplated applications and products. If a substantial number of data providers were to withdraw their data, our ability to provide products and services to our clients could be materially adversely impacted.
Our use of “open source” software could adversely affect our ability to sell our products and subject us to possible litigation.
The products or technologies acquired, licensed or developed by us may incorporate so-called “open source” software, and we may incorporate open source software into other products in the future. Such open source software is generally licensed by its authors or other third parties under open source licenses, including, for example, the GNU General Public License, the GNU Lesser General Public License, “Apache-style” licenses, “Berkeley Software Distribution,” “BSD-style” licenses and other open source licenses. We attempt to monitor our use of open source software in an effort to avoid subjecting our products to conditions we do not intend; however, there can be no assurance that our efforts have been or will be successful. There is little or no legal precedent governing the interpretation of many of the terms of certain of these licenses, and therefore the potential impact of these terms on our business is somewhat unknown and may result in unanticipated obligations regarding our products and technologies. For example, we may be subjected to certain conditions, including requirements that we offer our products that use particular open source software at no cost to the user; that we make available the source code for modifications or derivative works we create based upon, incorporating or using the open source software; and/or that we license such modifications or derivative works under the terms of the particular open source license.
If an author or other party that distributes such open source software were to allege that we had not complied with the conditions of one or more of these licenses, we could be required to incur significant legal costs defending ourselves against such allegations. If our defenses were not successful, we could be subject to significant damages; be enjoined from the distribution of our products that contained the open source software; and be required to comply with the foregoing conditions, which could disrupt the distribution and sale of some of our products. In addition, if we combine our proprietary software with open source software in a certain manner, under some open source licenses we could be required to release the source code of our proprietary software, which could substantially help our competitors develop products that are similar to or better than ours.
Our failure to license and integrate third-party technologies could harm our business.
We depend upon licenses from third-party vendors for some of the technology and data used in our applications, and for some of the technology platforms upon which these applications are built and operate, including Microsoft and Oracle. We also integrate into our proprietary applications and use third-party software to maintain and enhance, among other things, content generation and delivery, and to support our technology infrastructure. Some of this software is proprietary and some is open source. These technologies may not be available to us in the future on commercially reasonable terms or at all and could be difficult to replace once integrated into our own proprietary applications (although we currently believe this risk is remote given the “off-the-shelf” nature of these licenses and that standard operating procedures and practices utilized by these third parties would generally afford us sufficient time to effectively transition to other readily available sources without significant long-term impact to our business). Most of these licenses can be renewed only by mutual consent and may be terminated if we breach the terms of the license and fail to cure the breach within a specified period of time. Our inability to obtain any of these licenses could delay development until equivalent technology can be identified, licensed and integrated, which will harm our business, financial condition and results of operations.
Index to Financial Statements Most of our third-party licenses are non-exclusive and our competitors may obtain the right to use any of the technology covered by these licenses to compete directly with us. Our use of third-party technologies exposes us to increased risks, including, but not limited to, risks associated with the integration of new technology into our solutions, the diversion of our resources from development of our own proprietary technology and our inability to generate revenue from licensed technology sufficient to offset associated acquisition and maintenance costs. In addition, if our vendors choose to discontinue support of the licensed technology in the future, we might not be able to modify or adapt our own solutions.
We intend to continue to pursue acquisition opportunities, which may subject us to considerable business and financial risk.
We have grown through, and anticipate that we will continue to grow through, acquisitions of competitive and complementary businesses. We evaluate potential acquisitions on an ongoing basis and regularly pursue acquisition opportunities. We may not be successful in identifying acquisition opportunities, assessing the value, strengths and weaknesses of these opportunities and consummating acquisitions on acceptable terms. Furthermore, suitable acquisition opportunities may not be made available or known to us. In addition, we may compete for certain acquisition targets with companies having greater financial resources than we do and may expend significant resources in acquisition attempts that prove unsuccessful. We anticipate that we may finance acquisitions through cash provided by operating activities, borrowings under our credit facility, other indebtedness and issuances of equity. Borrowings necessary to finance acquisitions may not be available on terms acceptable to us, or at all. Future acquisitions may also result in potentially dilutive issuances of equity securities. Acquisitions may expose us to particular business and financial risks that include, but are not limited to:
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diverting management’s attention;
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incurring additional indebtedness and assuming liabilities, known and unknown;
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incurring significant additional capital expenditures, transaction and operating expenses and other acquisition-related charges;
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experiencing an adverse impact on our earnings from the amortization of acquired intangible assets, as well as from any future impairment of goodwill and other acquired intangible assets as a result of certain economic, competitive or regulatory changes impacting the fair value of these assets;
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failing to integrate the operations and personnel of the acquired businesses;
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entering new markets with which we are not familiar; and
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failing to retain key personnel, vendors and clients of the acquired businesses.
If we are unable to successfully implement our acquisition strategy or address the risks associated with acquisitions, or if we encounter unforeseen expenses, difficulties, complications or delays frequently encountered in connection with the integration of acquired entities and the expansion of operations, our growth and ability to compete may be impaired, we may fail to achieve anticipated cost-savings and we may be required to focus resources on integration of operations rather than on our primary product and service offerings.
Our indebtedness could adversely affect our financial health and reduce the funds available to us for other purposes.
We have and may continue to have a significant amount of indebtedness. On December 13, 2012, we entered into a credit agreement consisting of a five-year $250 million senior secured term A loan facility (“Term A Facility”), a seven-year $300 million senior secured term B loan facility (“Term B Facility”) and a five-year $200 million senior secured revolving credit facility, including a letter of credit sub-facility of $25 million and a swing line sub-facility of $25 million. On September 8, 2014, the Company entered into a First Increase Joinder
Index to Financial Statements
to the Credit Agreement (the “First Increase Joinder”). The First Increase Joinder increased the revolving commitment amount under the Credit Agreement by $100 million to $300 million. In addition, on November 16, 2010, we issued an aggregate principal amount of $325 million of senior notes due 2018. At December 31, 2014, we had total indebtedness of approximately $881 million.
Our substantial indebtedness could adversely affect our financial health in the following ways:
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a material portion of our cash flow from operations must be dedicated to the payment of interest on and principal of our outstanding indebtedness, thereby reducing the funds available to us for other purposes, including working capital, acquisitions and capital expenditures;
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our substantial degree of leverage could make us more vulnerable in the event of a downturn in general economic conditions or other adverse events in our business or our industry;
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our substantial degree of leverage could impair our ability to obtain additional financing for working capital, capital expenditures, acquisitions or general corporate purposes limiting our ability to maintain the value of our assets and operations; and
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our revolving credit facility matures in December 2017, our Term A Facility matures in December 2017 and our Term B Facility matures in December 2019 (although our Term B Facility will mature on May 15, 2018 if our senior notes have not been repaid or refinanced in full by such date) . If cash flow from operations is less than our debt service responsibilities, we may face financial risk that could increase interest expense and hinder our ability to refinance our debt obligations.
In addition, our credit facilities and the indenture governing our senior notes contain, and agreements governing future indebtedness may contain, financial and other restrictive covenants, ratios and tests that limit our ability to incur additional debt and engage in other activities that may be in our long-term best interests. For example, our credit facilities and indenture include covenants restricting, among other things, our ability to incur indebtedness, create liens on assets, engage in certain lines of business, engage in certain mergers or consolidations, dispose of assets, make certain investments or acquisitions, engage in transactions with affiliates, enter into sale leaseback transactions, enter into negative pledges or pay dividends or make other restricted payments. Our credit facilities also include financial covenants, including requirements that we maintain compliance with a total leverage ratio and an interest coverage ratio.
Our ability to comply with the covenants and ratios contained in our credit facilities and indenture or in the agreements governing our future indebtedness may be affected by events beyond our control, including prevailing economic, financial and industry conditions. Our credit facilities and indenture prohibit us from making dividend payments on our common stock if we are not in compliance with our restricted payment covenants. If we were to experience any future event of default, if not waived or cured, it could result in the acceleration of the maturity of our indebtedness. If we were unable to repay those amounts, the lenders under our credit facilities could proceed against the security granted to them to secure that indebtedness. If the lenders accelerate the payment of our indebtedness, our assets may not be sufficient to repay in full such indebtedness.
We may need to obtain additional financing which may not be available or, if it is available, may result in a reduction in the percentage ownership of our existing stockholders.
We may need to raise additional funds in order to:
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finance unanticipated working capital requirements;
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develop or enhance our technological infrastructure and our existing products and services;
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fund strategic relationships;
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respond to competitive pressures; and
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acquire complementary businesses, technologies, products or services.
Index to Financial Statements Additional financing may not be available on terms favorable to us, or at all. If adequate funds are not available or are not available on acceptable terms, our ability to fund our expansion, take advantage of unanticipated opportunities, develop or enhance technology or services or otherwise respond to competitive pressures would be significantly limited. If we raise additional funds by issuing equity or convertible debt securities, the percentage ownership of our then-existing stockholders may be reduced, and these securities may have rights, preferences or privileges senior to those of our existing stockholders.
If we are required to collect sales and use taxes on the solutions we sell in certain jurisdictions, we may be subject to tax liability for past sales and our future sales may decrease.
Rules and regulations applicable to sales and use tax vary significantly from state to state. In addition, the applicability of these rules given the nature of our products and services is subject to change.
We may lose sales or incur significant costs should various tax jurisdictions be successful in imposing sales and use taxes on a broader range of products and services. A successful assertion by one or more tax jurisdictions that we should collect sales or other taxes on the sale of our solutions could result in substantial tax liabilities for past sales, decrease our ability to compete and otherwise harm our business.
If one or more taxing authorities determines that taxes should have, but have not, been paid with respect to our services, we may be liable for past taxes in addition to taxes going forward. Liability for past taxes may also include substantial interest and penalty charges. If we are required to collect and pay back taxes and the associated interest and penalties and if our clients fail or refuse to reimburse us for all or a portion of these amounts, we will incur unplanned costs that may be substantial. Moreover, imposition of such taxes on our services going forward will effectively increase the cost of such services to our clients and may adversely affect our ability to retain existing clients or to gain new clients in the areas in which such taxes are imposed.
Any significant increase in bad debt in excess of recorded estimates would have a negative impact on our business, financial condition and results of operations.
We initially evaluate the collectability of our accounts receivable based on a number of factors, including a specific client’s ability to meet its financial obligations to us, the length of time the receivables are past due and historical collections experience. Based on these assessments, we record a reserve for specific account balances as well as a general reserve based on our historical experience for bad debt to reduce the related receivables to the amount we expect to collect from clients. Many of our clients are under intense financial pressure and their operations are characterized by declining or negative margins. If circumstances related to specific clients worsen, especially those of our larger clients, as a result of economic conditions or otherwise, such as a limited ability to meet financial obligations due to bankruptcy, or if conditions deteriorate such that our past collection experience is no longer relevant, the amount of accounts receivable that we are able to collect may be less than our previous estimates as we experience bad debt in excess of reserves previously recorded.
Our quarterly results of operations have fluctuated in the past and may continue to fluctuate in the future as a result of certain factors, some of which may be outside of our control.
Certain of our client contracts contain terms that result in revenue that is deferred and cannot be recognized until the occurrence of certain events. For example, accounting principles do not allow us to recognize revenue associated with the implementation of products and services until the implementation has been completed, at which time we begin to recognize revenue over the life of the contract or the estimated client relationship period, whichever is longer. In addition, subscription-based fees generally commence only upon completion of implementation. As a result, the period of time between contract signing and recognition of associated revenue may be lengthy, and we are not able to predict with certainty the period in which implementation will be completed.
Index to Financial Statements Certain of our contracts provide that some portion or all of our fees are at risk and refundable if our products and services do not result in the achievement of certain financial performance targets. To the extent that any revenue is subject to contingency for the non-achievement of a performance target, we only recognize revenue upon client confirmation that the financial performance targets have been achieved. If a client fails to provide such confirmation in a timely manner, our ability to recognize revenue will be delayed. Additionally, certain of our contracts include the potential for performance bonuses, which we may or may not earn when expected or at all.
Our SCM segment relies on participating vendors to provide periodic reports of their sales volumes to our clients and resulting administrative fees to us. If a vendor fails to provide such reporting in a timely and accurate manner, our ability to recognize administrative fee revenue will be delayed or prevented.
Certain of our fees are based on timing and volume of client invoices processed and payments received, which are often dependent upon factors outside of our control.
Other fluctuations in our quarterly results of operations may be due to a number of other factors, some of which are not within our control, including:
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the extent to which our products and services achieve or maintain market acceptance;
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the purchasing and budgeting cycles of our clients;
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the lengthy sales cycles for our products and services;
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the impact of transaction fee and contingency fee arrangements with clients;
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changes in our or our competitors’ pricing policies or sales terms;
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the timing and success of our or our competitors’ new product and service offerings;
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client decisions, especially those involving our larger client relationships, regarding renewal or termination of their contracts;
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the amount and timing of operating costs related to the maintenance and expansion of our business, operations and infrastructure;
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the amount and timing of costs related to the development or acquisition of technologies or businesses;
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the financial condition of our current and potential clients;
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unforeseen legal expenses, including litigation and settlement costs; and
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general economic, industry and market conditions and those circumstances experienced by our healthcare provider-clients such as variations in patient census and seasonal issues.
We base our expense levels in part upon our expectations concerning future revenue, and these expense levels are relatively fixed in the short term. If we have lower revenue than expected, we may not be able to reduce our spending in the short term in response. Any significant shortfall in revenue would have a direct and material adverse impact on our results of operations. We believe that our quarterly results of operations may vary significantly in the future and that period-to-period comparisons of our results of operations may not be meaningful. You should not rely on the results of one quarter as an indication of future performance. If our quarterly results of operations fall below the expectations of securities analysts or investors, the price of our common stock could decline substantially.
If we lose key personnel or if we are unable to attract, hire, integrate and retain key personnel, our business would be harmed.
Our future success depends in part on our ability to attract, hire, integrate and retain key personnel. Our future success also depends on the continued contributions of our executive officers and other key personnel,
Index to Financial Statements
each of whom may be difficult to replace. In February 2015, we announced the appointment of R. Halsey Wise to the position of Chairman and Chief Executive Officer of the company succeeding John A. Bardis, the company’s founder, who retired but will continue to serve the company as a consultant to support client relationships. The loss of services of any of our executive officers or key personnel could have a material adverse effect on our business. The replacement of any of these key individuals would involve significant time and expense and may significantly delay or prevent the achievement of our business objectives.
Risks Related to Our Product and Service Offerings
If our products fail to perform properly due to undetected errors or similar problems, our business could suffer.
Because of the large amount of data that we collect and manage, it is possible that hardware failures or errors in our systems could result in data loss or corruption or cause the information that we collect to be incomplete or contain inaccuracies that our clients regard as significant. Complex software such as ours may contain errors or failures that are not detected until after the software is introduced or updates and new versions are released. We continually introduce new software and updates and enhancements to our software. Despite testing by us, from time to time we have discovered defects or errors in our software, and such defects or errors may be discovered in the future. Defects and errors that are not timely detected and remedied could expose us to risk of liability to clients and the government and could cause delays in the introduction of new products and services, result in increased costs and diversion of development resources, require design modifications, decrease market acceptance or client satisfaction with our products and services or cause harm to our reputation. If any of these events occur, it could materially adversely affect our business, financial condition or results of operations.
Furthermore, our clients might use our software together with products from other companies. As a result, when problems occur, it might be difficult to identify the source of the problem. Even when our software does not cause these problems, the existence of these errors might cause us to incur significant costs, divert the attention of our technical personnel from our product development efforts, impact our reputation and lead to significant client relations problems.
If our products or services fail to provide accurate information, or if our content or any other element of our products or services is associated with incorrect, inaccurate or faulty coding, billing, or claims submissions to Medicare or any other third-party payor, we could be liable to clients or the government which could adversely affect our business.
Our products and content were developed based on the laws, regulations and third-party payor rules in existence at the time such software and content was developed. If we interpret those laws, regulations or rules incorrectly; the laws, regulations or rules materially change at any point after the software and content was developed; we fail to provide up-to-date, accurate information; or our products, or services are otherwise associated with incorrect, inaccurate or faulty coding, billing or claims submissions, then clients could assert claims against us or the government or qui tam relators on behalf of the government could assert claims against us under the Federal False Claims Act or similar state laws. The assertion of such claims and ensuing litigation, regardless of its outcome, could result in substantial costs to us, divert management’s attention from operations, damage our reputation and decrease market acceptance of our services. We attempt to limit by contract our liability to clients for damages. We cannot, however, limit liability the government could seek to impose on us under the False Claims Act. Further, the allocations of responsibility and limitations of liability set forth in our contracts may not be enforceable or otherwise protect us from liability for damages.
Our information technology operations could be interrupted, which may adversely affect our reputation in the marketplace and our business, financial condition and results of operations.
The timely development, implementation and continuous and uninterrupted performance of our hardware, network, applications, the Internet and other systems, including those which may be provided by third parties, are
Index to Financial Statements
important facets in our delivery of products and services to our clients. Our ability to properly manage and protect these processes and systems is a key factor in continuing to offer our clients our full complement of products and services on time in an uninterrupted manner.
Our operations, information technology and infrastructure are vulnerable to interruption or damage from a variety of sources, some of which are not within our control, including without limitation: (1) power loss and telecommunications failures; (2) software and hardware errors, failures or crashes; (3) computer viruses and similar disruptive problems; (4) fire, flood and other natural disasters; and (5) cyber-security attacks on our network or damage to our software and systems carried out by hackers or Internet criminals, despite our security measures employed.
System failures that interrupt our ability to develop applications or provide our products and services could affect our clients’ perception of the value and security of our products and services. Delays or interruptions in the delivery of our products and services could result from many causes including hardware and software defects, insufficient capacity or the failure of our website hosting and telecommunications providers to provide continuous and uninterrupted service. Additionally, we host some of our services and serve our clients through third-party data center hosting facilities. We do not control the operation of these facilities. From time to time, we may need to relocate our data or our clients’ data to alternative locations. Despite precautions taken during such moves, any difficulties experienced may impair the delivery of our services. We also depend on service providers that provide clients with access to our products and services. In addition, computer viruses or other attacks on our network and software may harm our systems causing us to lose data, and the transmission of computer viruses could expose us to litigation. In addition to potential liability, if we supply inaccurate information or experience interruptions in our ability to capture, store and supply information, our reputation could be harmed and we could lose clients. Any significant interruptions in our products and services could damage our reputation in the marketplace and have a negative impact on our business, financial condition and results of operations.
Unauthorized disclosure of confidential information provided to us by our clients or third parties, whether through breach of our secure network by an unauthorized party, employee theft or misuse, or otherwise, could harm our business.
The difficulty of securely transmitting confidential information has been a significant issue when engaging in sensitive communications over the Internet. Our business relies on using the Internet to transmit confidential information. We believe that any well-publicized compromise of Internet security may deter companies from using the Internet for these purposes.
Our services present the potential for embezzlement, identity theft, or other similar illegal behavior by our employees, subcontractors or third parties. If there were a disclosure of confidential information, or if a third party were to gain unauthorized access to the confidential information we possess, our operations could be seriously disrupted, our reputation could be harmed and we could be subject to claims pursuant to our agreements with our clients or other liabilities. In addition, if this were to occur, we could be perceived to have facilitated or participated in illegal misappropriation of funds, documents or data and therefore be subject to civil or criminal liability or regulatory action. While we maintain professional liability insurance coverage in an amount that we believe is sufficient for our business, we cannot assure you that this coverage will prove to be adequate or will continue to be available on acceptable terms, if at all. A claim against us that is uninsured or under-insured could harm our business, financial conditions and results of operations. Even unsuccessful claims could result in substantial costs and diversion of management resources.
Index to Financial Statements Risks Related to Government Regulation
The healthcare industry is highly regulated. Any material changes in the political, economic or regulatory healthcare environment that affect the group purchasing business or the purchasing practices and operations of healthcare organizations, or that lead to consolidation in the healthcare industry, could require us to modify our services or reduce the funds available to providers to purchase our products and services.
Our business, financial condition and results of operations depend upon conditions affecting the healthcare industry generally and hospitals and health systems particularly. Our ability to grow will depend upon the economic environment of the healthcare industry generally as well as our ability to increase the number of programs and services that we sell to our clients. The healthcare industry is highly regulated and is subject to changing political, economic and regulatory influences. Factors such as changes in reimbursement policies for healthcare expenses; consolidation in the healthcare industry; regulation; litigation; and general economic conditions affect the purchasing practices, operations and the financial health of healthcare organizations. In particular, changes in regulations affecting the healthcare industry, such as increased regulation of the purchase and sale of medical products, or restrictions on permissible discounts and other financial arrangements, could require us to make unplanned modifications to our products and services, result in delays or cancellations of orders, or reduce funds and demand for our products and services.
Cash flow and access to credit continue to be problematic for many healthcare delivery organizations. While we believe we are well positioned through our product and service offerings to assist hospitals and health systems who are dealing with intense and increasing financial pressures, it is unclear what long-term effects these conditions will have on the healthcare industry and in turn on our business, financial condition and results of operations.
In February 2009 the United States Congress enacted the Heath Information Technology for Clinical Health Act (“HITECH”) as part of the American Recovery and Reinvestment Act of 2009. Among other things, the HITECH Act provides incentives for certain physicians and hospitals related to the adoption and meaningful use of electronic health records (“EHRs”). The Department of Health and Human Services (“HHS”) continues to issue regulations to implement these requirements in stages. Meeting the requirements for such incentives may require additional investment in clinical information systems. While we believe that increased emphasis on EHRs by hospitals and health systems will also drive demand for SaaS-based tools, such as ours, to help rationalize and standardize patient and clinical data for efficient and accurate use, we cannot be certain of the extent or financial impact from such demand.
In March 2010, President Obama signed into law the Patient Protection and Affordable Care Act (“PPACA”), amended by the Health Care and Education and Reconciliation Act of 2010 (collectively, the “Affordable Care Act”). The Affordable Care Act is a sweeping measure designed to expand access to affordable health insurance, control health care spending, and improve health care quality. The law includes provisions to tie Medicare provider reimbursement to health care quality and incentives; Medicare health care delivery reforms; mandatory compliance programs; enhanced transparency disclosure requirements; increased funding and initiatives to address fraud and abuse; and incentives to state Medicaid programs to promote community-based care as an alternative to institutional long-term care services. In addition, the law provides for the establishment of a national voluntary pilot program to bundle Medicare payments for hospital and post-acute services, which could lead to changes in the delivery of health care services. Likewise, many states have adopted or are considering changes in health care policies in part due to state budgetary shortfalls. While many of the provisions of the Affordable Care Act have begun to be implemented, we do not know what long-term effect the federal Affordable Care Act or other future changes to federal or state laws may have on our business.
The Budget Control Act of 2011, as amended by subsequent legislation, established a budget process known as sequestration that imposes across-the-board federal spending cuts (with certain exceptions) to meet budget targets. Under this process, a two percent reduction to Medicare provider and plan payments has been in effect
Index to Financial Statements
since April 1, 2013, and this reduction will continue through 2024 unless additional Congressional action is taken to achieve alternative budget savings or otherwise modify the terms of sequestration. There can be no assurances that reimbursement reductions under sequestration or alternative federal or state budgetary actions will not have an adverse impact on our clients and in turn our business.
If current or future government regulations are interpreted or enforced in a manner adverse to us or our business, we may be subject to enforcement actions, penalties, and other material limitations on our business.
Most of the products offered through our group purchasing contracts are subject to direct regulation by federal and state governmental agencies. We rely upon vendors who use our services to meet all quality control, packaging, distribution, labeling, hazard and health information notice, record keeping and licensing requirements. In addition, we rely upon the carriers retained by our vendors to comply with regulations regarding the shipment of any hazardous materials.
We cannot guarantee that the vendors are in compliance with applicable laws and regulations. If vendors or the providers with whom we do business have failed, or fail in the future, to adequately comply with relevant laws or regulations, we could become involved in governmental investigations or private lawsuits concerning these regulations. If we were found to be legally responsible in any way for such failure we could be subject to injunctions, penalties or fines which could harm our business. Furthermore, any such investigation or lawsuit could cause us to expend significant resources and divert the attention of our management team, regardless of the outcome, and thus could harm our business.
The group purchasing industry and some of its largest purchasing clients have been reviewed by the Senate Judiciary Subcommittee on Antitrust, Competition Policy and Consumer Rights for possible conflict of interest and restraint of trade violations. As a response to the Senate Subcommittee inquiry, our company joined other GPOs to develop a set of voluntary principles of ethics and business conduct designed to address concerns regarding anti-competitive practices. The voluntary code was presented to the Senate Subcommittee in March 2006. In addition, we maintain our own Standards of Business Conduct that provide guidelines for conducting our business practices in a manner that is consistent with antitrust and restraint of trade laws and regulations. There has not been any further inquiry by the Senate Subcommittee since March 2006. On August 11, 2009, we, and several other GPOs, received a letter from Senators Charles Grassley, Herb Kohl and Bill Nelson requesting information concerning the different relationships between and among our GPO and its clients, distributors, manufacturers and other vendors and suppliers, and requesting certain information about the services the GPO performs and the payments it receives. On September 25, 2009, we and several other GPOs received a request for information from the Government Accountability Office (GAO), also concerning our GPO’s services and relationships with our clients. Subsequently, we, and other GPOs, received follow-up requests for additional information. We fully complied with all of these requests. On September 27, 2010, the GAO released a report titled “Group Purchasing Organizations - Services Provided to Customers and Initiatives Regarding Their Business Practices”. On that same day, the Minority Staff of the Senate Finance Committee released a report titled “Empirical Data Lacking to Support Claims of Savings with Group Purchasing Organizations”. On April 30, 2012, the GAO released another report, titled “Group Purchasing Organizations - Federal Oversight and Self-Regulation”, addressing federal oversight practices with respect to GPOs. On November 24, 2014, the GAO released another report, titled “Group Purchasing Organizations - Funding Structure Has Potential Implications for Medicare Costs,” addressing GPO contracting practices and funding structures and their potential impact on the Medicare program.
Congress, HHS, the Department of Justice, the Federal Trade Commission or another state or federal entity could at any time open a new investigation of the group purchasing industry, or develop new rules, regulations or laws governing the industry, that could adversely impact our ability to negotiate pricing arrangements with vendors, increase reporting and documentation requirements, or otherwise require us to modify our arrangements in a manner that adversely impacts our business and financial results. We may also face private or government
Index to Financial Statements
lawsuits alleging violations arising from the concerns articulated by these governmental actors. We are involved on an ongoing basis in litigation, arising in the ordinary course of business or otherwise, which from time to time may include class actions involving consumers, shareholders, employees or injured persons, and claims relating to commercial, labor, employment, antitrust, securities or environmental matters. The outcome of litigation cannot be predicted with certainty and adverse litigation outcomes could adversely affect our financial results.
Our clients are highly dependent on payments from third-party healthcare payors, including Medicare, Medicaid and other government-sponsored programs, and reductions or changes in third-party reimbursement could adversely affect our clients and consequently our business.
Our clients derive a substantial portion of their revenue from third-party private and governmental payors, including Medicare, Medicaid and other government sponsored programs. Our sales and profitability depend, in part, on the extent to which coverage of and reimbursement for the products our clients purchase or otherwise obtain through us is available from governmental health programs, private health insurers, managed care plans and other third-party payors. These third-party payors exercise significant control over, and increasingly use their enhanced bargaining power to secure, discounted reimbursement rates and impose other requirements that may adversely impact our clients’ ability to obtain adequate reimbursement for products and services they purchase or otherwise obtain through us as a group purchasing member.
If third-party payors do not approve products for reimbursement or fail to reimburse for them adequately, our clients may suffer adverse financial consequences which, in turn, may reduce the demand for and ability to purchase our products or services. In addition, pursuant to the Medicare and Medicaid statutes, pharmaceutical manufacturers are required to report certain pricing data to the Centers for Medicare & Medicaid Services (“CMS”), which is the federal agency responsible for administering the Medicare and Medicaid programs. CMS uses this data to determine manufacturer rebate liabilities and to establish reimbursement limits for certain drugs under Medicare and Medicaid. CMS has issued final rules governing Medicare “average sales price” calculations and has published proposed rules governing Medicaid pricing calculations. Both the final and proposed rules include provisions that allow manufacturers to exclude “bona fide service fees” meeting certain standards from their pricing calculations, and CMS guidance has indicated that administrative fees paid by drug manufacturers to GPOs may qualify as bona fide service fees. There can be no assurance (i) that any pharmaceutical manufacturer will treat GPO fees paid to the Company as bona fide service fees or that CMS or other government agencies will agree with the manufacturer’s treatment of such fees, (ii) that CMS will continue to allow exclusion of GPO administrative fees meeting the bona fide service fee standards from Medicare pricing calculations or will adopt such an exclusion in a Medicaid final rule, or (iii) that, in the absence of any other basis for excluding such fees from government pricing calculations, any reimbursement limitations resulting from manufacturers’ reported pricing data, or other efforts by payors to limit reimbursement, will not have an adverse impact on our business.
If we fail to comply with federal and state laws governing submission of false or fraudulent claims to government healthcare programs and financial relationships among healthcare providers, we may be subject to civil and criminal penalties or loss of eligibility to participate in government healthcare programs.
We are subject to federal and state laws and regulations designed to protect patients, governmental healthcare programs, and private health plans from fraudulent and abusive activities. These laws include anti-kickback restrictions and laws prohibiting the submission of false or fraudulent claims. These laws are complex and their application to our specific products, services and relationships may not be clear and may be applied to our business in ways that we do not anticipate. Federal and state regulatory and law enforcement authorities have recently increased enforcement activities with respect to Medicare and Medicaid fraud and abuse regulations and other reimbursement laws and rules. From time to time we and others in the healthcare industry have received inquiries or subpoenas to produce documents in connection with such activities. We could be required to expend significant time and resources to comply with these requests, and the attention of our management team could be diverted to these efforts. Furthermore, if we are found to be in violation of any federal or state fraud and abuse laws, we could be subject to civil and criminal penalties, and we could be excluded from participating in federal
Index to Financial Statements
and state healthcare programs such as Medicare and Medicaid. The occurrence of any of these events could significantly harm our business and financial condition.
Provisions in Title XI of the Social Security Act, commonly referred to as the federal Anti-Kickback Statute, prohibit the knowing and willful offer, payment, solicitation or receipt of remuneration, directly or indirectly, in return for the referral of patients or arranging for the referral of patients, or in return for the recommendation, arrangement, purchase, lease or order of items or services that are covered, in whole or in part, by a federal healthcare program such as Medicare or Medicaid. The definition of “remuneration” has been broadly interpreted to include anything of value such as gifts, discounts, rebates, waiver of payments or providing anything at less than its fair market value. Many states have adopted similar prohibitions against kickbacks and other practices that are intended to induce referrals which are applicable to all patients regardless of whether the patient is covered under a governmental health program or private health plan. We attempt to scrutinize our business relationships and activities to comply with the federal anti-kickback statute and similar laws; and we attempt to structure our sales and group purchasing arrangements in a manner that is consistent with the requirements of applicable safe harbors to these laws. We cannot assure you, however, that our arrangements will be protected by such safe harbors or that such increased enforcement activities will not directly or indirectly have an adverse effect on our business financial condition or results of operations. Any determination by a state or federal agency that any of our activities or those of our vendors or clients violate any of these laws could subject us to civil or criminal penalties; could require us to change or terminate some portions of or operations or business, or could disqualify us from providing services to healthcare providers doing business with government programs; and, thus could have an adverse effect on our business.
Our business, particularly our Revenue Cycle Management segment, is also subject to numerous federal and state laws that forbid the submission or “causing the submission” of false or fraudulent information or the failure to disclose information in connection with the submission and payment of claims for reimbursement to Medicare, Medicaid, federal healthcare programs or private health plans. These laws and regulations may change rapidly, and it is frequently unclear how they apply to our business. Errors created by our products or consulting services that relate to entry, formatting, preparation or transmission of claim or cost report information may be determined or alleged to be in violation of these laws and regulations. Any failure of our products or services to comply with these laws and regulations could result in substantial civil or criminal liability; could adversely affect demand for our services; could invalidate all or portions of some of our client contracts; could require us to change or terminate some portions of our business; could require us to refund portions of our services fees; could cause us to be disqualified from serving clients doing business with government payors; and could have an adverse effect on our business.
Federal and state privacy and security laws may increase the costs of operation and expose us to civil and criminal sanctions.
We must comply with extensive federal and state requirements regarding the use, disclosure, retention and security of patient healthcare information. The Health Insurance Portability and Accountability Act of 1996 and its implementing regulations, as amended by the regulations promulgated pursuant to the HITECH Act, which we refer to collectively as HIPAA, contain substantial restrictions and requirements with respect to the use and disclosure of individuals’ protected health information. These restrictions and requirements are set forth in the HIPAA Privacy, Security and Breach Notification Rules. The HIPAA Privacy Rule prohibits a covered entity from using or disclosing an individual’s protected health information unless the use or disclosure is subject to the terms of a business associate agreement; is authorized by the individual; or is specifically required or permitted under the Privacy Rule. The Privacy Rule imposes a complex set of requirements on covered entities for complying with this basic standard. Under the HIPAA Security Rule, covered entities must establish administrative, physical and technical safeguards to protect the confidentiality, integrity and availability of electronic protected health information created, received, maintained or transmitted by them or by others on their behalf. The Breach Notification Rule requires covered entities to report breaches of unsecured protected health information to affected individuals, the Secretary of HHS, and, in some circumstances, the media.
Index to Financial Statements Our healthcare provider clients that engage in HIPAA-defined standard electronic transactions, and our own business operations as a healthcare clearinghouse, are directly subject to the HIPAA Privacy, Security and Breach Notification Rules governing “covered entities.” Additionally, because some of our clients are covered entities who disclose protected health information to us so that we may use that information to provide certain consulting or other services to those clients, we are a “business associate” of those clients. In these cases, in order to provide clients with services that involve the use or disclosure of protected health information, the HIPAA Privacy and Security Rules require us to enter into business associate agreements with our clients. Such agreements must, among other things, provide adequate written assurances:
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as to how we will use and disclose the protected health information;
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that we will implement reasonable administrative, physical and technical safeguards to protect such information from misuse;
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that we will enter into agreements with our subcontractors that create, receive, maintain or transmit the information on our behalf that impose the same restrictions and conditions that apply to us with respect to such information;
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that we will report breaches of unsecured protected health information, security incidents and other inappropriate uses or disclosures of the information; and
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that we will assist the covered entity with certain of its duties under the Privacy Rule.
On January 25, 2013, the Office for Civil Rights of HHS published a major final rule modifying the HIPAA Privacy, Security, Breach Notification and Enforcement Rules, including revisions and changes made pursuant to the HITECH Act. Among other things, this rule expanded the security and certain privacy requirements for business associates that create, receive, maintain or transmit protected health information for or on behalf of covered entities, increased penalties for noncompliance, and strengthened requirements for reporting of breaches of unsecured protected health information. The rule also made business associates and their subcontractors directly liable for civil monetary penalties for impermissible uses and disclosures of protected health information. The rule went into effect March 23, 2013, and as a covered entity and business associate we were, with limited exceptions, required to comply with the applicable requirements of this final rule by September 23, 2013.
Any failure or perceived failure of our products or services to meet HIPAA standards and related regulatory requirements could expose us to certain notification, penalty and/or enforcement risks and could adversely affect demand for our products and services, and force us to expend significant capital, research and development and other resources to modify our products or services to address the privacy and security requirements of our clients and HIPAA.
In addition to our obligations under HIPAA, most states have enacted patient confidentiality laws that protect against the disclosure of confidential medical information, and many states have adopted or are considering adopting further legislation in this area, including privacy safeguards, security standards, and data security breach notification requirements. These state laws, if more stringent than HIPAA requirements, are not preempted by the federal requirements, and we are required to comply with them as well.
We are unable to predict what changes to HIPAA or other federal or state laws or regulations might be made in the future or how those changes could affect our business or the associated costs of compliance. For example, the federal Office of the National Coordinator for Health Information Technology (“ONCHIT”) is coordinating the development of national standards for creating an interoperable health information technology infrastructure based on the widespread adoption of EHRs in the healthcare sector. Several organizations, selected as ONCHIT-Authorized Testing and Certification Bodies (“ATCBs”) for EHR certification, test and certify that EHR products are compliant with the standards, implementation specifications, and certification criteria adopted by the Department of Health and Human Services. Certified EHR technologies are eligible to be used for the CMS EHR Incentive Programs. The regulatory standards for these technologies have been evolving. We are yet unable to predict what, if any, impact the development and ongoing refinement of such standards and related ONCHIT activities will have on our products, services or compliance costs.
Index to Financial Statements Failure by us to comply with any of the federal and state standards regarding patient privacy, identity theft prevention and detection, and data security may subject us to penalties, including civil monetary penalties and in some circumstances, criminal penalties. In addition, such failure may injure our reputation and adversely affect our ability to retain clients and attract new clients.
HIPAA and its implementing regulations also mandate format, data content and provider identifier standards that must be used in certain electronic transactions, such as claims, payment advice and eligibility inquiries. Although our systems are fully capable of transmitting transactions that comply with these requirements, some payers and healthcare clearinghouses with which we conduct business may interpret HIPAA transaction requirements differently than we do or may require us to use legacy formats or include legacy identifiers as they make the transition to full compliance. In cases where payers or healthcare clearinghouses require conformity with their interpretations or require us to accommodate legacy transactions or identifiers as a condition of successful transactions, we attempt to comply with their requirements, but may be subject to enforcement actions as a result. In January 2009, CMS published a final rule adopting updated standard code sets for diagnoses and procedures known as ICD-10 code sets. A separate final rule also published by CMS in January 2009 resulted in changes to the formats to be used for electronic transactions subject to the ICD-10 code sets, known as Version 5010. Healthcare providers were required to comply with Version 5010 by January 1, 2012 (although CMS provided a temporary enforcement discretion period ending June 30, 2012). In 2012, the compliance date for ICD-10 was delayed until October 1, 2014 and the Protecting Access to Medicare Act of 2014 prevents the adoption of ICD-10 prior to October 1, 2015. An August 4, 2014 HHS rule establishes the ICD-10 compliance date as October 1, 2015. We are actively working to make the proper modifications in preparation for the implementation of ICD-10. We may not be successful in responding to these changes and any changes in response that we make to our transactions and software may result in errors or otherwise negatively impact our service levels. We may also experience complications in supporting clients that are not fully compliant with the revised requirements as of the applicable compliance date.
If our clients who operate as not-for profit entities lose their tax-exempt status, those clients would suffer significant adverse tax consequences which, in turn, could adversely impact their ability to purchase products or services from us.
State tax authorities have challenged the tax-exempt status of hospitals and other healthcare facilities claiming such status on the basis that they are operating as charitable and/or religious organizations. The outcome of these cases has been mixed with some facilities retaining their tax-exempt status while others have been denied the ability to continue operating as not-for profit, tax-exempt entities under state law. In addition, many states have removed sales tax exemptions previously available to not-for-profit entities, and both the IRS and the United States Congress are investigating the practices of non-for profit hospitals. The Affordable Care Act added new requirements for hospitals operating as charitable organizations, which the IRS has been implementing through regulations. Those facilities denied tax exemptions could be subject to the imposition of tax penalties and assessments which could have a material adverse impact on their cash flow, financial strength and possibly ongoing viability. If the tax exempt status of any of our clients is revoked or compromised by new legislation, regulation, or interpretation of existing legislation or regulation, that client’s financial health could be adversely affected, which could adversely impact our sales and revenue.
Risks Related to Ownership in Our Common Stock
The market price of our common stock may be volatile, and your investment in our common stock could suffer a decline in value.
There has been significant volatility in the market price and trading volume of equity securities, which is often unrelated or disproportionate to the financial performance of the companies issuing the securities. These broad market fluctuations may negatively affect the market price of our common stock. The market price of our
Index to Financial Statements
common stock could fluctuate significantly in response to the factors described above and other factors, many of which are beyond our control, including:
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actual or anticipated changes in our or our competitors’ growth rates;
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the public’s response to our press releases or other public announcements, including our filings with the SEC and announcements of mergers and acquisitions, technological innovations or new products or services by us or by our competitors;
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sales of common stock by our directors and executive officers;
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any major change in our senior management team;
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legal and regulatory factors unrelated to our performance;
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general economic, industry and market conditions and those conditions specific to the healthcare industry;
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changes in stock market analyst recommendations regarding our common stock, other comparable companies or our industry generally; and
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our quarterly results of operations or future financial projections falling below the expectations of securities analysts or investors.
You may not be able to resell your shares at or above the market price you paid to purchase your shares due to fluctuations in the market price of our common stock caused by changes in the market as a whole or our operating performance or prospects.
Provisions in our certificate of incorporation and by-laws or Delaware law might discourage, delay or prevent a change of control of our company or changes in our management and, therefore, depress the trading price of our common stock.
Provisions of our certificate of incorporation and by-laws and Delaware law may discourage, delay or prevent a merger, acquisition or other change in control that stockholders may consider favorable, including transactions in which you might otherwise receive a premium for your shares of our common stock. These provisions may also prevent or frustrate attempts by our stockholders to replace or remove our management.
For example, our amended and restated certificate of incorporation provides for a staggered board of directors, whereby directors serve for three-year terms, with approximately a third of the directors coming up for re-election each year. Having a staggered board could make it more difficult for a third party to acquire us through a proxy contest. Other provisions that may discourage, delay or prevent a change in control or changes in management include:
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limitations on the removal of directors;
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advance notice requirements for stockholder proposals and nominations;
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the inability of stockholders to act by written consent or to call special meetings; and
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the ability of our board of directors to designate the terms of, including voting, dividend and other special rights, and issue new series of preferred stock without stockholder approval.
In addition, Section 203 of the Delaware General Corporation Law prohibits a publicly held Delaware corporation from engaging in a business combination with an interested stockholder, generally a person which together with its affiliates owns, or within the last three years has owned, 15% of our voting stock, for a period of three years from the time such person became an interested stockholder, unless the business combination is approved in a prescribed manner or an exception to such restriction applies.
Index to Financial Statements A change of control may also impact employee benefit arrangements, which could make an acquisition more costly and could prevent it from going forward. For example, our equity compensation plans allow for all or a portion of the equity granted under these plans to vest upon a change of control and subsequent employee termination. Finally, upon any change in control, the lenders under our credit facilities would have the right to require us to repay all of the outstanding obligations under our credit facilities and the noteholders under our indenture would have the right to require that we offer to redeem the notes thereunder at 101% of the principal amount plus accrued interest and all other amounts payable thereunder.
The existence of the foregoing provisions and anti-takeover measures could limit the price that investors might be willing to pay in the future for shares of our common stock. They could also deter potential acquirers of our company, thereby reducing the likelihood that you could receive a premium for your common stock in an acquisition.
We do not currently intend to pay dividends on our common stock and, consequently, your ability to achieve a return on your investment will depend on appreciation in the price of our common stock.
We do not intend to declare or pay any cash dividends on our common stock for the foreseeable future. Therefore, the success of an investment in shares of our common stock will depend upon any future appreciation in its value. There is no guarantee that shares of our common stock will appreciate in value or even maintain the price at which our stockholders have purchased their shares.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
Not Applicable
Index to Financial Statements
ITEM 2.
ITEM 2. PROPERTIES.
Facilities and Property
We do not own any real property and lease our existing facilities. Our principal executive offices are located in leased office space in Alpharetta, Georgia. Our facilities accommodate product development, marketing and sales, information technology, administration, training, graphic services and operations personnel. As of December 31, 2014, we leased office space to support our operations in the following locations:
(1) See “Finance Obligation” in Note 6 to our Consolidated Financial Statements for a discussion of the capital lease treatment of our Cape Girardeau facility, lease term ending July 31, 2017.
As of December 31, 2014, we did not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future significant effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
Legal Proceedings
From time to time, we become involved in legal proceedings arising in the ordinary course of our business. We are not presently involved in any legal proceedings, the outcome of which, if determined adversely to us, would have a material adverse effect on our business, operating results or financial condition.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES.
Not applicable
Index to Financial Statements PART II.
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHODLER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Our common stock is publicly traded on the Nasdaq Global Select Market under the ticker symbol “MDAS.” The following chart sets forth, for the periods indicated, the high and low sales prices of our common stock on the Nasdaq Global Select Market.
Price Range of Common Stock
On February 12, 2015, the last reported sale price for our common stock was $19.63 per share. As of February 12, 2015, there were 72 holders of record of our common stock and approximately 9,285 beneficial holders.
Dividend Policy
We did not pay any dividends during the fiscal years ended December 31, 2014 and 2013. We do not anticipate paying any cash dividends for the foreseeable future. The payment of dividends, if any, is subject to the discretion of our board of directors and will depend on many factors, including our results of operations, financial condition and capital requirements, earnings, general business conditions, restrictions imposed by our current and any future financing arrangements, legal restrictions on the payment of dividends and other factors our board of directors deems relevant. Our current credit facilities and the indenture governing our senior notes include restrictions on our ability to pay dividends.
Index to Financial Statements Equity Compensation Plan Information
The information regarding securities authorized for issuance under the Company’s equity compensation plans is set forth below, as of December 31, 2014:
(1) This amount includes 487,038 common stock options and 1,173,703 stock-settled stock appreciation rights (“SSARs”) issued under our Long Term Performance Incentive Plan (effected in 2008), 2004 Long Term Equity Incentive Plan, and 1999 Stock Incentive Plan.
(2) All securities remaining available for future issuance are issuable under our Long Term Performance Incentive Plan. See Note 9 of the Notes to Consolidated Financial Statements for discussion of the equity plans.
(3) Amount represents SSARs, net of forfeitures, issued pursuant to the MedAssets, Inc. 2010 Special Stock Incentive Plan (the “Plan”). The Plan was adopted by the Company’s Board of Directors on November 23, 2010 in connection with the Broadlane Acquisition pursuant to an exception to the requirement for stockholder approval under NASDAQ rules. No further equity grants will be issued under the Plan.
Repurchase of Common Stock
Stock repurchases during the fiscal year ended December 31, 2014 was as follows:
Issuer Purchases of Equity Securities
(1) On February 26, 2014, we announced that our board of directors had authorized the repurchase of up to $75,000 of our common stock. The share repurchase program expires the earlier of twelve months from the authorization by our board of directors or the repurchase of $75,000 of our common stock.
For additional information regarding our stock repurchase program, see Note 8 of the Notes to Consolidated Financial Statements.
Index to Financial Statements Sales of Unregistered Securities
Set forth below is information regarding shares of common stock granted by us in the period covered by this Annual Report on Form 10-K that were not registered under the Securities Act. Also included is the consideration, if any, received by us for such shares and information relating to the section of the Securities Act, or rule of the SEC, under which exemption from registration was claimed.
For the fiscal years ended December 31, 2014, 2013 and 2012, we issued approximately zero, 71,000 and 63,000 unregistered shares of our common stock in connection with stock option exercises with respect to options issued relating to our acquisition of OSI Systems, Inc. in June 2003. We received approximately $0.2 million and $0.1 million in consideration in connection with these stock option exercises for fiscal years ended December 31, 2013 and 2012, respectively.
The sales of the above shares were deemed to be exempt from registration in reliance on Section 4(2) of the Securities Act or Regulation D promulgated thereunder as transactions by an issuer not involving any public offering or as transactions pursuant to a compensatory benefit plan or a written contract relating to compensation.
Stock Price Performance Graph
The following graph compares the cumulative total stockholder return on the Company’s common stock from December 31, 2009 to December 31, 2014 with the cumulative total return of: (i) the companies traded on the NASDAQ Global Select Market (the “NASDAQ Composite Index”) and (ii) the NASDAQ Computer & Data Processing Index.
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among MedAssets Inc., the NASDAQ Composite Index,
and the NASDAQ Computer & Data Processing Index
* $100 invested on 12/31/09 in stock or index, including reinvestment of dividends. Fiscal year ending December 31.
Fiscal year ending:
Index to Financial Statements ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
Our historical financial data as of and for the fiscal years ended December 31, 2014, 2013 and 2012 have been derived from the audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K, and such data as of and for the fiscal years ended December 31, 2011 and 2010 have been derived from audited consolidated financial statements not included in this Annual Report on Form 10-K.
Historical results of operations are not necessarily indicative of results of operations or financial condition in the future or to be expected in the future. Refer to Management’s Discussion and Analysis of Financial Condition and Results of Operations for a summary of management’s primary metrics to measure the consolidated financial performance of our business, which includes non-GAAP gross fees, non-GAAP revenue share obligation, non-GAAP adjusted EBITDA, non-GAAP adjusted EBITDA margin and non-GAAP diluted adjusted EPS. The summary historical consolidated financial data and notes should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and our consolidated financial statements and the notes to those financial statements included elsewhere in this Annual Report on Form 10-K.
(1) Amounts have been recast to reflect our DSS operating unit within our SCM segment.
Index to Financial Statements
(2) Amounts include the results of operations of Broadlane (as part of the SCM segment) from November 16, 2010, the date of acquisition.
(3) Total share-based compensation expense included in the operating expense captions above for each period presented is as follows:
(1) During 2011, we reversed $6.5 million of previously recorded share-based compensation expense related to certain performance-based SSARs and performance-based restricted stock that were granted under the MedAssets, Inc. Long-Term Performance Incentive Plan in 2008. The share-based compensation expense was reversed due to non-achievement of certain performance criteria.
(4) The amounts were attributable to restructuring, acquisition and integration-related costs including costs such as severance, retention, salaries relating to redundant positions, certain performance-related salary-based compensation, operating infrastructure costs and facility consolidation costs.
(5) The impairment during the fiscal year ended December 31, 2014 consisted of a write-off of goodwill relating to our Revenue Cycle Services operating unit. The impairment during the fiscal year ended December 31, 2010 primarily consisted of: (i) a $44.5 million write-off of goodwill relating to our DSS operating unit; and (ii) $1.3 million relating to an SCM trade name and a customer base intangible asset from prior acquisitions that were deemed to be impaired as part of the product and service offering integration associated with the Broadlane Acquisition.
(6) The amount reflects the loss on debt extinguishment and is comprised of: (i) a $20.0 million write-off of debt issuance costs relating to our previous credit facility; and (ii) an $8.2 million swap termination fee for two forward starting interest rate swaps also relating to our previous credit facility.
(7) For the years ended December 31, 2014, 2012, 2011 and 2010, the effect of dilutive securities has been excluded because the effect is antidilutive as a result of the net loss attributable to common stockholders.
Index to Financial Statements Consolidated Balance Sheet Data:
(1) Our general cash management practice is to reduce interest expense. We have an auto-borrowing plan which causes excess cash on hand to be used to repay any balance on our swing-line credit facility on a daily basis. We may also repay our revolving credit facility on a routine basis when our swing line credit facility is undrawn. As of December 31, 2012, we had a cash and cash equivalents balance as a result of the refinancing on December 13, 2012. As of December 31, 2011, we had a cash and cash equivalents balance in anticipation of the $120.1 million deferred payment associated with the Broadlane Acquisition that was paid in January 2012. As of December 31, 2010, we had a cash and cash equivalents balance due to the cash flows associated with the Broadlane Acquisition and a temporary suspension of our previous cash management practice.
(2) Inclusive of capital lease obligations and long-term notes payable.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following discussion of our financial condition and results of operations should be read in conjunction with this entire Annual Report on Form 10-K, including the “Risk Factors” section and our consolidated financial statements and the notes to those financial statements appearing elsewhere in this report. The discussion and analysis below includes certain forward-looking statements that are subject to risks, uncertainties and other factors described in “Risk Factors” and elsewhere in this report that could cause our actual future growth, results of operations, performance and business prospects and opportunities to differ materially from those expressed in, or implied by, such forward-looking statements. See “Note On Forward-Looking Statements” herein.
Overview
We are a performance improvement company providing technology-enabled solutions which together help mitigate the increasing financial challenges faced by healthcare organizations, including hospitals, health systems, and other non-acute healthcare providers, payers, product manufacturers and other service providers. Our solutions are designed to deliver market insight, reduce the total cost of care delivery, enhance operational efficiency, align clinical delivery of physicians and staff to advance care coordination, and improve revenue performance primarily for hospitals and health systems. We believe implementation of our full suite of solutions has the potential to help strategically position healthcare organizations across the continuum of care in the communities they serve, decrease supply costs and improve clinical resource utilization and increase revenue capture and cash flow. Our operations and clients are primarily located throughout the United States and, to a limited extent, Canada.
Our full-year results included total consolidated net revenue of $720.2 million, a 5.9% increase over 2013. These results were primarily driven by growth in medical device, clinical and performance improvement consulting services, revenue cycle technology tools and revenue cycle services as well as our Sg2 Acquisition. We reported a net loss of $20.4 million, or $0.34 per diluted share. Our non-GAAP adjusted EBITDA was $234.0 million, a 6% increase over last year.
Index to Financial Statements We believe the breadth of our comprehensive solution set, combined with our superior cost and revenue management value proposition, offers our company substantial opportunities to cross-sell additional products and services to current and prospective clients. Overall, we believe that our business model and best-practice, technology-enabled service solutions can provide our client base with the direction and support to manage total costs, optimize revenue, secure reimbursement, reduce waste, and increase cash flow for healthcare providers as the slow economic recovery and impact of health insurance reform continue to impact their financial stability and provision of care.
Management’s primary metrics to measure the consolidated financial performance of the business are net revenue, non-GAAP gross fees, non-GAAP revenue share obligation, non-GAAP adjusted EBITDA, non-GAAP adjusted EBITDA margin and non-GAAP diluted adjusted EPS.
For the fiscal years ended December 31, 2014, 2013 and 2012, our primary results of operations included the following:
(1) These are non-GAAP measures. See “Use of Non-GAAP Financial Measures” section for additional information.
For the fiscal years ended December 31, 2014 and 2013, we generated non-GAAP gross fees of $923.8 million and $863.0 million, respectively, and total net revenue of $720.2 million and $680.4 million, respectively. The increases in non-GAAP gross fees and total net revenue in the fiscal year ended December 31, 2014 compared to the fiscal year ended December 31, 2013 were primarily attributable to:
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growth in our SCM segment primarily from our medical device consulting and strategic sourcing services and our acquisition of Sg2 and to a lesser extent, higher vendor administrative fees. In addition, we had a higher amount of revenue related to the achievement of certain client financial performance targets earned during the fiscal year ended December 31, 2014; and
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growth in our RCM segment from an increase in our subscription services related to our revenue cycle technology tools, an increase in our revenue cycle services and higher performance-related fee revenue.
For the fiscal year ended December 31, 2014, we generated operating income of $46.5 million compared to $90.7 million for the fiscal year ended December 31, 2013. The decrease in operating income compared to the prior year was primarily attributable to:
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an impairment charge of goodwill relating to our revenue cycle services operating unit;
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increased cost of revenue attributable to a higher percentage of net revenue being derived from service-based engagements;
Index to Financial Statements
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higher operating expenses related to increased compensation expense for new and existing personnel, inclusive of share-based compensation expense partially offset by a lower incentive compensation accrual; and
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an increase in depreciation expense from additions of property and equipment including purchased software and internally developed software.
For the fiscal year ending December 31, 2014, the increase in non-GAAP adjusted EBITDA compared to the fiscal year ended December 31, 2013 was primarily attributable to the net revenue increase discussed above.
For the fiscal year ended December 31, 2013, we generated operating income of $90.7 million compared to $85.2 million for the fiscal year ended December 31, 2012. The increase in operating income compared to the prior year was primarily attributable to the net revenue increase discussed above offset by the following:
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increased acquisition and integration-related expenses related to exit costs associated with our facilities consolidation;
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increased cost of revenue attributable to a higher percentage of net revenue being derived from service-based engagements;
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higher operating expenses related to increased compensation expense for new and existing personnel, inclusive of performance-based incentive and share-based compensation expense; and
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an increase in depreciation expense from additions of property and equipment including purchased software and internally developed software.
For the fiscal year ending December 31, 2013, the increase in non-GAAP adjusted EBITDA and non-GAAP adjusted EBITDA margin compared to the fiscal year ended December 31, 2012 was primarily attributable to the net revenue increase discussed above in addition to lower overall expense growth.
Segment Structure and Revenue Streams
We deliver our solutions through two business segments, Spend and Clinical Resource Management (“SCM”) and Revenue Cycle Management (“RCM”). Management’s primary metrics to measure consolidated and segment financial performance are net revenue, non-GAAP gross fees, non-GAAP revenue share obligation, non-GAAP adjusted EBITDA, non-GAAP adjusted EBITDA margin, non-GAAP diluted adjusted EPS and Segment Adjusted EBITDA. All of our revenues are from external clients and inter-segment revenues have been eliminated. See Note 12 of the Notes to Consolidated Financial Statements herein for discussion on Segment Adjusted EBITDA and certain items of our segment results of operations and financial position.
Spend and Clinical Resource Management
Our SCM segment provides a comprehensive suite of technology-enabled services that help our clients manage their expense categories. Our solutions lower supply and medical device pricing and utilization by managing the procurement process through our group purchasing organization (“GPO”) portfolio of contracts, consulting services and business intelligence tools. Our SCM segment revenue consists of the following components:
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Administrative fees and revenue share obligation. We earn administrative fees from manufacturers, distributors and other vendors (collectively referred to as “vendors”) of products and services with whom we have contracts under which our GPO clients may purchase products and services. Administrative fees represent a percentage, which we refer to as our administrative fee ratio, typically ranging from 0.25% to 3.00% of the purchases made by our GPO clients through contracts with our vendors.
Our GPO clients make purchases, and receive shipments, directly from the vendors. Generally on a monthly or quarterly basis, vendors provide us with a report describing the purchases made by our clients through our GPO vendor contracts, including associated administrative fees. We recognize revenue upon the receipt of these reports from vendors.
Index to Financial Statements Some client contracts require that a portion of our administrative fees be contingent upon achieving certain financial improvements, such as lower supply costs, which we refer to as performance targets. Contingent administrative fees are not recognized as revenue until we receive client acceptance on the achievement of those contractual performance targets. Prior to receiving client acceptance of performance targets, we record contingent administrative fees as deferred revenue on our consolidated balance sheets. Often, recognition of this revenue occurs in periods subsequent to the recognition of the associated costs. Should we fail to meet a performance target, we may be contractually obligated to refund some or all of the contingent fees. Additionally, in many cases, we are contractually obligated to pay a portion of the administrative fees to our hospital and health system clients. Typically this amount, which we refer to as our revenue share obligation, is calculated as a percentage of administrative fees earned on a particular client’s purchases from our vendors. Our total net revenue on our consolidated statements of operations is shown net of the revenue share obligation.
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Other service fees. The following items are included as “Other service fees” in our consolidated statement of operations:
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Consulting fees. We consult with our clients regarding the costs and utilization of medical devices and physician preference items (“PPI”) and the efficiency and quality of their key clinical service lines. Our consulting projects are typically fixed fee projects with an average duration of six to nine months, and the related revenues are earned as services are rendered. We generate revenue from consulting contracts that also include performance targets. The performance targets generally relate to committed financial improvement to our clients from the use and implementation of initiatives that result from our consulting services. Performance targets are measured as our strategic initiatives are identified and implemented, and the financial improvement can be quantified by the client. Prior to receiving client acceptance of performance targets, we record contingent consulting fees as deferred revenue on our consolidated balance sheets. Often, recognition of this revenue occurs in periods subsequent to the recognition of the associated costs. Should we fail to meet a performance target, we may be contractually obligated to refund some or all of the contingent fees.
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Subscription fees. We also offer technology-enabled services that provide spend management analytics and data services to improve operational efficiency, reduce supply costs, and increase transparency across spend management processes. We earn fixed subscription fees on a monthly basis for these Company-hosted SaaS-based solutions.
Revenue Cycle Management
Our RCM segment provides a comprehensive suite of products and services spanning the hospital revenue cycle workflow - from patient access and financial responsibility, charge capture and integrity, pricing analysis, claims processing and denials management, payor contract management, revenue recovery and accounts receivable services. Our workflow solutions, together with our data management, compliance and audit tools, increase revenue capture and cash collections, reduce accounts receivable balances and increase regulatory compliance. Our RCM segment revenue is listed under the caption “Other service fees” on our consolidated statements of operations and consists of the following components:
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Subscription and implementation fees. We earn fixed subscription fees on a monthly or annual basis on multi-year contracts for client access to our SaaS-based solutions. We may also charge our clients non-refundable upfront fees for implementation of our SaaS-based services. These non-refundable upfront fees are earned over the subscription period or estimated client relationship period, whichever is longer.
We defer costs related to implementation services and expense these costs in proportion to the revenue earned over the subscription period or client relationship period, as applicable.
In addition, we defer upfront sales commissions related to subscription and implementation fees and expense these costs ratably over the related contract term.
Index to Financial Statements
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Transaction fees. For certain of our revenue cycle management solutions, we earn fees that vary based on the volume of client transactions or enrolled members.
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Service fees. For certain of our RCM solutions, we earn fees based on a percentage of cash remittances collected and fixed-fee consulting arrangements. The related revenues are earned as services are rendered.
Operating Expenses
We classify our operating expenses as follows:
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Cost of revenue. Cost of revenue primarily consists of the direct labor costs incurred to generate our revenue. Direct labor costs consist primarily of salaries, benefits, incentive compensation and other direct costs and share-based compensation expenses related to personnel who provide services to implement our solutions for our clients (indirect labor costs for these personnel are included in general and administrative expenses). As the majority of our services are generated internally, our costs to provide these services are primarily labor-driven. A less significant portion of our cost of revenue consists of costs of third-party products and services and client reimbursed out-of-pocket costs. Cost of revenue does not include certain expenses relating to hosting our services and providing support and related data center capacity (which is included in general and administrative expenses), and allocated amounts for rent, depreciation, amortization or other indirect operating costs because we do not consider the inclusion of these items in cost of revenue relevant to our business. However, cost of revenue does include the amortization for the cost of software to be sold, leased, or otherwise marketed. In addition, any changes in revenue mix between our SCM and RCM segments, including changes in revenue mix towards SaaS-based revenue and consulting services, may cause significant fluctuations in our cost of revenue and have a favorable or unfavorable impact on operating income.
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Product development expenses. Product development expenses primarily consist of the salaries, benefits, incentive compensation and share-based compensation expense of the technology professionals who develop, support and maintain our software-related products and services. Product development expenses are net of capitalized software development costs for both internal and external use.
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Selling and marketing expenses. Selling and marketing expenses consist primarily of costs related to marketing programs (including trade shows and brand messaging), personnel-related expenses for sales and marketing employees (including salaries, benefits, incentive compensation and share-based compensation expense), certain meeting costs and travel-related expenses.
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General and administrative expenses. General and administrative expenses consist primarily of personnel-related expenses for administrative employees and indirect time related to operational service-based employees (including salaries, benefits, incentive compensation and share-based compensation expense) and travel-related expenses, occupancy and other indirect costs, insurance costs, professional fees, and other general overhead expenses.
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Restructuring, acquisition and integration-related expenses. Restructuring, acquisition and integration-related expenses may consist of: (i) costs incurred to complete acquisitions including due diligence, consulting and other related fees; (ii) integration type costs relating to our completed acquisitions; (iii) other management restructuring costs; and (iv) acquisition-related fees associated with unsuccessful acquisition attempts.
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Depreciation. Depreciation expense consists primarily of depreciation of fixed assets and the amortization of software, including capitalized costs of software developed for internal use.
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Amortization of intangibles. Amortization of intangibles includes the amortization of all identified intangible assets (with the exception of software), primarily resulting from acquisitions.
Index to Financial Statements Key Considerations
Certain significant items or events must be considered to better understand differences in our results of operations from period to period. We believe that the following items or events have had a material impact on our results of operations for the periods discussed below or may have a material impact on our results of operations in future periods:
Sg2 Acquisition
On September 22, 2014, we acquired one hundred percent of the issued and outstanding equity interests (the “Membership Interests”) of SG-2, LLC (“Sg2”) for approximately $138 million (subject to certain purchase price adjustments) (the “Sg2 Acquisition”). We funded the Sg2 Acquisition with cash on hand and borrowings under our existing credit facility. The operating results of Sg2 have been included in our consolidated statement of operations within our Spend and Clinical Resource Management (“SCM”) reporting segment since the September 22, 2014 acquisition date.
First Joinder Increase to Credit Agreement
On September 8, 2014, we entered into a First Increase Joinder to Credit Agreement, dated as of September 8, 2014, by and among the Company and its lenders (the “First Increase Joinder”). The First Increase Joinder increased the revolving commitment amount under our credit agreement by $100 million to $300 million. In connection with the First Increase Joinder, we incurred and capitalized approximately $0.6 million of debt issuance costs which will be amortized into interest expense ratably over the remaining term of the revolving credit facility. Refer to Note 6 of the Notes to Consolidated Financial Statements for details.
Impairment of Goodwill
In connection with our 2014 annual impairment testing, we recognized an impairment charge related to the goodwill at our revenue cycle services (“RCS”) operating unit within our RCM reporting segment. As part of our quarterly and annual forecasting process, we expect our future revenue growth to come from lower margin services. As a result, our projected margins within our discounted cash flow model used for impairment testing were therefore reduced, and the resulting business enterprise value could no longer support the amount of goodwill on the consolidated balance sheet related to the RCS operating unit. As a result, during the fourth quarter of 2014 we incurred a goodwill impairment charge within our RCM segment. We recorded a preliminary estimate of $52.5 million related to the goodwill impairment charge. Refer to Note 3 of the Notes to Consolidated Financial Statements for additional information.
Index to Financial Statements Results of Operations
Consolidated Tables
The following tables set forth our consolidated results of operations grouped by segment for the periods shown:
(1) These are non-GAAP measures. See “Use of Non-GAAP Financial Measures” section for additional information.
(2) Represents the expenses of corporate office operations.
(3) Management’s primary metric of segment profit or loss is segment adjusted EBITDA. See Note 12 of the Notes to Consolidated Financial Statements.
(4) Reportable segment adjusted EBITDA margin represents each reportable segment’s adjusted EBITDA as a percentage of each segment’s respective net revenue.
Index to Financial Statements The following table sets forth our consolidated results of operations as a percentage of total net revenue for the periods shown:
(1) These are non-GAAP measures. See “Use of Non-GAAP Financial Measures” section for additional information.
(2) Represents the expenses of corporate office operations.
Comparison of the Fiscal Years Ended December 31, 2014 and 2013
Index to Financial Statements
(1) These are non-GAAP measures. See “Use of Non-GAAP Financial Measures” section for additional information.
Total net revenue. Total net revenue for the fiscal year ended December 31, 2014 was $720.2 million, an increase of approximately $39.8 million, or 5.9%, from total net revenue of $680.4 million for the fiscal year ended December 31, 2013. The increase in total net revenue was comprised of a $21.1 million increase in SCM revenue and an $18.7 million increase in RCM revenue. For the fiscal years ended December 31, 2014 and 2013, performance-related revenue as a percentage of consolidated net revenue amounted to approximately 3.3% and 3.1%, respectively. Revenue may fluctuate significantly from period to period based upon achieving and thereof receiving client acknowledgement of the financial performance targets.
Spend and Clinical Resource Management net revenue. SCM net revenue for the fiscal year ended December 31, 2014 was $445.6 million, an increase of $21.1 million, or 5.0%, from SCM net revenue of $424.5 million for the fiscal year ended December 31, 2013. The increase was the result of an increase in gross administrative fees of $22.8 million, or 4.8% and an increase in other service fees of $19.2 million partially offset by an approximate $20.9 million increase in non-GAAP revenue share obligation.
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Gross administrative fees. Non-GAAP gross administrative fee revenue increased by $22.8 million, or 4.8%, as compared to the prior period, primarily due to higher purchasing volumes by new and existing clients under our group purchasing organization contracts with our manufacturer and distributor vendors. We may have fluctuations in our non-GAAP gross administrative fee revenue in future periods as the timing of vendor reporting and client acknowledgement of achieved performance targets varies.
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Revenue share obligation. Non-GAAP revenue share obligation increased $20.9 million, or 11.5%, as compared to the prior period. We analyze the impact of our non-GAAP revenue share obligation on our results of operations by calculating the ratio of non-GAAP revenue share obligation to non-GAAP gross administrative fees including administrative fees not subject to a variable revenue share obligation (or the “revenue share ratio”). Our revenue share ratio was 41.1% and 38.7% for the fiscal years ended December 31, 2014 and 2013, respectively. We may experience fluctuations in our revenue share ratio based on the mix of clients who are entitled to a higher revenue share percentage due to increased purchasing volume in addition to an increase in the number of fixed-fee arrangements. In addition, we expect our non-GAAP revenue share obligation to generally increase in future periods.
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Other service fees. The $19.2 million, or 14.3%, increase in other service fees primarily related to higher revenues from supply chain consulting, including medical device consulting and strategic sourcing and decision support services as well as our Sg2 Acquisition. The growth in supply chain consulting was mainly due to an increased number of engagements from new and existing clients. In addition, we recorded $5.8 million in revenue associated with our annual client and vendor meeting for the fiscal year ended December 31, 2014 compared to $5.3 million for the fiscal year ended December 31, 2013.
Revenue Cycle Management net revenue. RCM net revenue for the fiscal year ended December 31, 2014 was $274.6 million, an increase of $18.7 million, or 7.3%, from net revenue of $255.9 million for the fiscal year ended December 31, 2013. The increase was attributable to a $10.1 million increase in revenue from our comprehensive revenue cycle service engagements inclusive of performance-related fee revenue; and an $8.6 million increase in revenue from our revenue cycle technology tools. As we engage new clients, renew with existing clients and complete existing contracts, we may experience fluctuations in our revenue cycle services financial performance as the business is characterized by a relatively small number of agreements, which each relate to large amounts of revenue.
Index to Financial Statements Total Operating Expenses
Cost of revenue. Cost of revenue for the fiscal year ended December 31, 2014 was $171.9 million, or 23.9% of total net revenue, an increase of $19.9 million, or 13.1%, from cost of revenue of $152.0 million, or 22.3% of total net revenue, for the fiscal year ended December 31, 2013. The increase was primarily attributable to an increase in service-related engagements in our SCM segment, which resulted in a higher cost of revenue as these engagements are generally more labor intensive. In addition, for our engagements that include achieving financial performance targets, we recognize revenue based on when the financial performance targets are achieved and such achievement is acknowledged by our clients. There are instances during a reporting period where we incur a higher amount of direct costs with no associated revenue for these types of engagements. Also, we may record revenue in a reporting period where the direct costs have been recorded in a previous period. These events may affect period over period comparability.
Product development expenses. Product development expenses for the fiscal year ended December 31, 2014 were approximately $31.1 million, or 4.3% of total net revenue, an increase of $0.2 million, or 0.8%, from product development expenses of $30.9 million, or 4.5% of total net revenue, for the fiscal year ended December 31, 2013. The increase was primarily attributable to a $0.9 million increase in professional services and a $0.3 million increase in share-based compensation partially offset by a $1.0 million decrease in compensation expense relating to new and existing employees. Our product development capitalization rate for the fiscal years ended December 31, 2014 and 2013 was 57.6% and 57.1%, respectively.
We may experience fluctuations in our capitalization rate due to the timing of our product development investments associated with new product features and functionality, new technologies, and upgrades to our service offerings.
Selling and marketing expenses. Selling and marketing expenses for the fiscal year ended December 31, 2014 were $67.4 million, or 9.4% of total net revenue, an increase of $6.0 million, or 9.8%, from selling and marketing expenses of $61.4 million, or 9.0% of total net revenue, for the fiscal year ended December 31, 2013. The increase was primarily attributable to a $5.3 million increase in compensation expense relating to new and
Index to Financial Statements
existing employees; a $0.4 million increase in share-based compensation expense; and a $0.3 million increase in other operating infrastructure expense. Total expenses related to our client and vendor meeting amounted to $6.0 million and $6.5 million for the fiscal year ended December 31, 2014 and 2013, respectively.
General and administrative expenses. General and administrative expenses for the fiscal year ended December 31, 2014 were approximately $237.6 million, or 33.0% of total net revenue, an increase of $5.8 million, or 2.5%, from general and administrative expenses of $231.8 million, or 34.1% of total net revenue, for the fiscal year ended December 31, 2013. The increase was attributable to a $4.5 million increase in telecommunications expense; a $1.2 million increase in property and use taxes; a $1.0 million increase in share-based compensation expense; a $0.9 million increase in rent expense; a $0.3 million increase in professional fees; a $0.3 million increase in legal expense; and a $0.3 million increase in other operating infrastructure expense. The increase was partially offset by a $1.6 million decrease associated with an impairment charge in the prior year related to certain internally developed software products that were no longer being utilized; a $0.7 million decrease in transportation expense; and a $0.4 million decrease in compensation expense to new and existing employees.
Restructuring, acquisition and integration-related expenses. Restructuring, acquisition and integration-related expenses for the fiscal year ended December 31, 2014 were $7.5 million, or 1.0% of total net revenue, a decrease of $2.6 million, or 25.4%, from restructuring, acquisition and integration-related expenses of $10.1 million, or 1.5% of total net revenue, for the fiscal year ended December 31, 2013. In 2014, we incurred approximately $4.2 million in other costs relating to severance, retention and salaries relating to redundant positions and $3.3 million in transaction costs incurred (not related to the financing) to complete the Sg2 Acquisition including due diligence, consulting and other related fees. In 2013, we incurred approximately $10.1 million in costs relating to a $6.8 million charge for exit costs relating to consolidating certain facilities in Plano, Texas in addition to $3.3 million of other costs relating to severance, retention and salaries relating to redundant positions. Refer to Note 5 of the Notes to Consolidated Financial Statements for further details.
Depreciation. Depreciation expense for the fiscal year ended December 31, 2014 was $48.1 million, or 6.7% of total net revenue, an increase of $7.3 million, or 17.9%, from depreciation of $40.8 million, or 6.0% of total net revenue, for the fiscal year ended December 31, 2013. The increase was primarily attributable to depreciation resulting from purchases of property and equipment inclusive of increases to capitalized software development. As a result of our capital investments, we expect our depreciation expense to increase in future periods.
Amortization of intangibles. Amortization of intangibles for the fiscal year ended December 31, 2014 was $57.6 million, or 8.0% of total net revenue, a decrease of $5.1 million, or 8.2%, from amortization of intangibles of $62.7 million, or 9.2% of total net revenue, for the fiscal year ended December 31, 2013. The decrease in amortization expense compared to the prior year was due to certain identified intangible assets that are nearing the end of their useful life under an accelerated method of amortization partially offset by incremental amortization expense associated with acquisitions that occurred during the year.
Impairment of goodwill. The impairment of goodwill for the fiscal year ended December 31, 2014 was $52.5 million compared to zero for the fiscal year ended December 31, 2013. The impairment consisted of a write-off of goodwill relating to our revenue cycle services operating unit within the RCM segment. Refer to Note 3 of the Notes to Consolidated Financial Statements for further details.
Segment Operating Expenses
Spend and Clinical Resource Management expenses. SCM operating expenses for the fiscal year ended December 31, 2014 were $327.9 million, or 45.5% of total net revenue, an increase of $9.9 million, or 3.1%, from approximately $318.0 million, or 46.7% of total net revenue for the fiscal year ended December 31, 2013. As a percentage of SCM segment net revenue, segment expenses were 73.6% and 74.9% for the fiscal years ended December 31, 2014 and 2013, respectively.
Index to Financial Statements The increase was primarily attributable to a $14.1 million increase in cost of revenue in connection with higher direct labor costs; a $5.1 million increase in telecommunications expense; a $2.0 million increase in share-based compensation expense; and a $0.7 million increase in other operating infrastructure expense. The increase was partially offset by a $7.4 million decrease in restructuring, acquisition and integration-related costs including severance, retention, certain performance-related salary-based compensation, and operating infrastructure costs; a $2.5 million decrease in compensation expense with respect to new and existing employees; and a $2.1 million decrease in the amortization of intangibles as certain intangible assets reached the end of their useful life.
Revenue Cycle Management expenses. RCM operating expenses for the fiscal year ended December 31, 2014 were $291.6 million, or 40.5% of total net revenue, an increase of $68.6 million, or 30.7%, from $223.0 million, or 32.8% of total net revenue, for the fiscal year ended December 31, 2013. As a percentage of RCM segment net revenue, segment expenses were 106.2% (87.0% excluding the RCS impairment charge) and 87.1% for the fiscal year ended December 31, 2014 and 2013, respectively.
The increase was primarily attributable to a $52.5 impairment charge consisting of a write-off of goodwill relating to our revenue cycle services operating unit; a $9.1 million increase in compensation expense with respect to new and existing employees; a $5.0 million increase in depreciation expense; a $4.2 million increase in cost of revenue from our revenue cycle services engagements; and a $0.8 million increase in other operating infrastructure expense. The increase was partially offset by a $3.0 million decrease in amortization of intangibles as certain intangible assets reached the end of their useful life.
Corporate expenses. Corporate expenses for the fiscal year ended December 31, 2014 were $54.3 million, an increase of $5.6 million, or 11.6%, from $48.7 million for the fiscal year ended December 31, 2013, or 7.5% and 7.2% of total net revenue, respectively. The increase in corporate expenses was attributable to a $4.0 million increase in restructuring charges inclusive of $3.3 million in transaction costs incurred (not related to the financing) to complete the Sg2 Acquisition including due diligence, consulting and other related fees; a $2.4 million increase in depreciation expense; a $2.2 million increase in share-based compensation expense; and a $0.6 million increase in other operating infrastructure expense. The increase was partially offset by a $3.6 million decrease in compensation expense with respect to new and existing employees.
Non-operating Expenses
Interest expense. Interest expense for the fiscal year ended December 31, 2014 was $45.6 million, a decrease of $1.3 million from interest expense of $46.9 million for the fiscal year ended December 31, 2013. The decrease in interest expense was primarily due to a lower weighted average interest rate on our credit facility. As of December 31, 2014, we had total indebtedness of $881.0 million compared to $764.5 million as of December 31, 2013. As a result of our higher debt balance, we expect interest expense to increase in future periods. See Note 6 of the Notes to our Consolidated Financial Statements herein for more details.
Other income. Other income for the fiscal years ended December 31, 2014 and 2013 was $0.3 million, primarily comprised of rental income.
Income tax expense. Income tax expense for the fiscal year ended December 31, 2014 was $21.6 million, an increase of $4.9 million from an income tax expense of $16.7 million for the fiscal year ended December 31, 2013. Income tax expense recorded during the fiscal year ended December 31, 2014 reflected an effective income tax rate of 1,781.0% (40.2% excluding the RCS impairment charge). Income tax expense recorded during the fiscal year ended December 31, 2013 reflected an effective income tax rate of 37.8%. The increase in our effective tax rate was primarily driven by the impairment in goodwill at our RCS operating unit, credits for research and development expenditures, which were the result of legislation enacted during the three months ended March 31, 2013 for tax years 2012 and 2013 (such legislation has not been enacted for years beginning after December 31, 2013) and increases to our state deferred income tax expense related to state law changes.
Index to Financial Statements In December 2014, we received a draft settlement from the Internal Revenue Service related to the examination of our 2011 and 2012 federal income tax returns. We closed the examination in January 2015 with no material assessments.
Comparison of the Fiscal Years Ended December 31, 2013 and 2012
(1) These are non-GAAP measures. See “Use of Non-GAAP Financial Measures” section for additional information.
Total net revenue. Total net revenue for the fiscal year ended December 31, 2013 was $680.4 million, an increase of approximately $40.3 million, or 6.3%, from total net revenue of $640.1 million for the fiscal year ended December 31, 2012. The increase in total net revenue was comprised of a $30.9 million increase in SCM revenue and a $9.4 million increase in RCM revenue. For the fiscal years ended December 31, 2013 and 2012, performance-related revenue as a percentage of consolidated net revenue amounted to approximately 3.1% and 3.6%, respectively. Revenue may fluctuate significantly from period to period based upon achieving and thereof receiving client acknowledgement of the financial performance targets.
Spend and Clinical Resource Management net revenue. SCM net revenue for the fiscal year ended December 31, 2013 was $424.5 million, an increase of $30.9 million, or 7.8%, from SCM net revenue of $393.6 million for the fiscal year ended December 31, 2012. The increase was the result of an increase in gross administrative fees of $44.4 million, or 10.4% and an increase in other service fees of $8.3 million partially offset by an approximate $21.8 million increase in non-GAAP revenue share obligation.
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Gross administrative fees. Non-GAAP gross administrative fee revenue increased by $44.4 million, or 10.4%, as compared to the prior period, primarily due to higher purchasing volumes by new and existing clients under our group purchasing organization contracts with our manufacturer and distributor vendors as well as an increase in the average administrative fee percentage realized under our manufacturer and distributor contracts.
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Revenue share obligation. Non-GAAP revenue share obligation increased $21.8 million, or 13.6%, as compared to the prior period. We analyze the impact of our non-GAAP revenue share obligation on our results of operations by calculating the ratio of non-GAAP revenue share obligation to non-GAAP gross administrative fees including administrative fees not subject to a variable revenue share obligation (or the “revenue share ratio”). Our revenue share ratio was 38.7% and 37.6% for the fiscal years ended December 31, 2013 and 2012, respectively.
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Other service fees. The $8.3 million, or 6.6%, increase in other service fees primarily related to higher revenues from supply chain consulting, including medical device consulting and strategic sourcing
Index to Financial Statements
services. The growth in supply chain consulting was mainly due to an increased number of engagements from new and existing clients. In addition, we recorded $6.1 million in revenue associated with our annual client and vendor meeting for the fiscal year ended December 31, 2013 compared to $5.7 million for the fiscal year ended December 31, 2012.
Revenue Cycle Management net revenue. RCM net revenue for the fiscal year ended December 31, 2013 was $255.9 million, an increase of $9.4 million, or 3.8%, from net revenue of $246.5 million for the fiscal year ended December 31, 2012. The increase was attributable to a $10.5 million increase in revenue from our revenue cycle technology tools partially offset by a $1.1 million decrease in revenue from our comprehensive revenue cycle service engagements. As we engage new clients, renew with existing clients and complete existing contracts, we may experience fluctuations in our revenue cycle services financial performance as the business is characterized by a relatively small number of agreements, which each relate to large amounts of revenue.
Total Operating Expenses
Cost of revenue. Cost of revenue for the fiscal year ended December 31, 2013 was $151.9 million, or 22.3% of total net revenue, an increase of $13.3 million, or 9.6%, from cost of revenue of $138.6 million, or 21.7% of total net revenue, for the fiscal year ended December 31, 2012. The increase was primarily attributable to an increase in service-related engagements in our SCM segment, which resulted in a higher cost of revenue as these engagements are generally more labor intensive. In addition, for our engagements that include achieving financial performance targets, we recognize revenue based on when the financial performance targets are achieved and such achievement is acknowledged by our clients. There are instances during a reporting period where we incur a higher amount of direct costs with no associated revenue for these types of engagements. Also, we may record revenue in a reporting period where the direct costs have been recorded in a previous period. These events may affect period over period comparability.
Product development expenses. Product development expenses for the fiscal year ended December 31, 2013 were approximately $30.9 million, or 4.5% of total net revenue, an increase of $2.4 million, or 8.4%, from product development expenses of $28.5 million, or 4.4% of total net revenue, for the fiscal year ended
Index to Financial Statements
December 31, 2012. The increase was primarily attributable to a $1.7 million increase in compensation expense relating to new and existing employees; and a $0.5 million increase in share-based compensation. Our product development capitalization rate for the fiscal years ended December 31, 2013 and 2012 was 57.1% and 58.5%, respectively.
Selling and marketing expenses. Selling and marketing expenses for the fiscal year ended December 31, 2013 were $61.4 million, or 9.0% of total net revenue, an increase of $1.0 million, or 1.6%, from selling and marketing expenses of $60.4 million, or 9.4% of total net revenue, for the fiscal year ended December 31, 2012. The increase was attributable to a $0.8 million increase in share-based compensation expense; a $0.5 million increase in compensation expense relating to new and existing employees; and a $0.4 million increase in advertising expense. The increase was partially offset by a $0.4 million decrease in professional fees; a $0.2 million decrease in transportation expense; and a $0.1 million decrease in other operating infrastructure expense. Total expenses related to our client and vendor meeting amounted to $6.5 million and $6.4 million for the fiscal year ended December 31, 2013 and 2012, respectively.
General and administrative expenses. General and administrative expenses for the fiscal year ended December 31, 2013 were approximately $231.8 million, or 34.1% of total net revenue, an increase of $13.6 million, or 6.2%, from general and administrative expenses of $218.2 million, or 34.1% of total net revenue, for the fiscal year ended December 31, 2012. The increase was attributable to a $10.3 million increase in compensation expense to new and existing employees; a $1.6 million increase in share-based compensation expense; a $1.6 million increase in professional fees; a $1.2 million increase in an impairment charge related to certain internally developed software products that were no longer being utilized; a $1.2 million increase in telecommunications expense; and a $0.4 million increase in legal expense. The increase was partially offset by a $1.1 million decrease in transportation expense; a $0.9 million decrease in other operating infrastructure expense; and a $0.7 million decrease in bad debt expense.
Restructuring, acquisition and integration-related expenses. Restructuring, acquisition and integration-related expenses for the fiscal year ended December 31, 2013 were $10.0 million, or 1.5% of total net revenue, an increase of $3.7 million, or 58.6%, from restructuring, acquisition and integration-related expenses of $6.3 million, or 1.0% of total net revenue, for the fiscal year ended December 31, 2012. The increase was attributable to a $6.8 million charge for exit costs relating to consolidating certain facilities in Plano, Texas; partially offset by a $2.5 million decrease in other costs relating to severance, retention and salaries relating to redundant positions; and a $0.6 million decrease in system migration and standardization costs. Refer to Note 5 of the Notes to Consolidated Financial Statements for further details.
Depreciation. Depreciation expense for the fiscal year ended December 31, 2013 was $40.8 million, or 6.0% of total net revenue, an increase of $10.6 million, or 35.2%, from depreciation of $30.2 million, or 4.7% of total net revenue, for the fiscal year ended December 31, 2012. The increase was primarily attributable to depreciation resulting from purchases of property and equipment inclusive of increases to capitalized software development.
Amortization of intangibles. Amortization of intangibles for the fiscal year ended December 31, 2013 was $62.7 million, or 9.2% of total net revenue, a decrease of $9.9 million, or 13.7%, from amortization of intangibles of $72.6 million, or 11.3% of total net revenue, for the fiscal year ended December 31, 2012. The decrease in amortization expense compared to the prior year was due to certain identified intangible assets that are nearing the end of their useful life under an accelerated method of amortization.
Segment Operating Expenses
Spend and Clinical Resource Management expenses. SCM operating expenses for the fiscal year ended December 31, 2013 were $318.0 million, or 46.7% of total net revenue, an increase of $22.5 million, or 7.6%, from approximately $295.5 million, or 46.2% of total net revenue for the fiscal year ended December 31, 2012.
Index to Financial Statements
As a percentage of SCM segment net revenue, segment expenses were 74.9% and 75.1% for the fiscal years ended December 31, 2013 and 2012, respectively.
The increase was primarily attributable to a $15.0 million increase in cost of revenue in connection with higher direct labor costs; a $4.7 million increase in compensation expense with respect to new and existing employees; a $3.7 million increase in integration and restructuring costs including exit costs associated with our facilities consolidation, severance, retention, certain performance-related salary-based compensation, and operating infrastructure costs; a $3.1 million increase in depreciation expense; a $2.3 million increase in share-based compensation expense; a $0.5 million increase in meetings expense; a $0.4 million increase in an impairment charge related to certain internally developed software products that were no longer being utilized; and a $0.3 million increase in advertising expense. The increase was partially offset by a $4.6 million decrease in the amortization of intangibles as certain intangible assets reached the end of their useful life; a $1.3 million decrease in telecommunications expense; a $1.2 million decrease in other operating infrastructure expense; and a $0.4 million decrease in rent expense.
Revenue Cycle Management expenses. RCM operating expenses for the fiscal year ended December 31, 2013 were $223.0 million, or 32.8% of total net revenue, an increase of $8.1 million, or 3.8%, from $214.9 million, or 33.6% of total net revenue, for the fiscal year ended December 31, 2012. As a percentage of RCM segment net revenue, segment expenses were 87.1% and 87.2% for the fiscal year ended December 31, 2013 and 2012, respectively.
The increase was primarily attributable to a $6.8 million increase in depreciation expense; a $4.6 million increase in telecommunications expense; a $3.6 million increase in compensation expense with respect to new and existing employees; a $0.9 million increase in an impairment charge related to certain internally developed software products that were no longer being utilized; a $0.6 million increase in other operating infrastructure expense; a $0.5 million increase in share-based compensation; and a $0.4 million increase in rent expense. The increase was partially offset by a $5.3 million decrease in amortization of intangibles as certain intangible assets reached the end of their useful life; a $3.4 million decrease in cost of revenue driven by lower third party payments and project labor costs associated with our revenue cycle services engagements; and a $0.6 million decrease in bad debt expense.
Corporate expenses. Corporate expenses for the fiscal year ended December 31, 2013 were $48.7 million, an increase of $4.2 million, or 9.4%, from $44.5 million for the fiscal year ended December 31, 2012, or 7.2% and 7.0% of total net revenue, respectively. The increase in corporate expenses was attributable to a $4.1 million increase in compensation expense with respect to new and existing employees; a $1.4 million increase in share-based compensation expense; a $0.7 million increase in depreciation expense; a $0.6 million increase in professional fees; and a $0.4 million increase in legal expense. The increase was partially offset by a $2.1 million decrease in telecommunications expense; a $0.7 million decrease in transportation expense; a $0.2 million decrease in other operating infrastructure expense.
Non-operating Expenses
Interest expense. Interest expense for the fiscal year ended December 31, 2013 was $46.9 million, a decrease of $19.1 million from interest expense of $66.0 million for the fiscal year ended December 31, 2012. The decrease in interest expense was primarily due to a lower level of indebtedness compared to the prior period and a lower weighted average interest rate on our credit facility due to the debt refinancing in 2012. As of December 31, 2013, we had total indebtedness of $764.5 million compared to $885.0 million as of December 31, 2012. See Note 6 of the Notes to our Consolidated Financial Statements herein for more details.
Other income. Other income for the fiscal year ended December 31, 2013 was $0.3 million, primarily comprised of rental income. Other income for the fiscal year ended December 31, 2012 was $0.7 million, primarily comprised of $0.4 million in rental income.
Index to Financial Statements Income tax expense (benefit). Income tax expense for the fiscal year ended December 31, 2013 was $16.7 million, an increase of $18.2 million from an income tax benefit of $1.5 million for the fiscal year ended December 31, 2012. Income tax expense recorded during the fiscal year ended December 31, 2013 reflected an effective income tax rate of 37.8%. Income tax benefit recorded during the fiscal year ended December 31, 2012 reflected an effective income tax rate of 17.7%. The difference in the effective tax rate when comparing 2013 to 2012 was attributable to (i) income before taxes in 2013 as compared to a loss in 2012 (which was primarily due to the $28.2 million loss on debt extinguishment); (ii) income tax benefit for two years of research and development credits in 2013, which was attributable to the American Taxpayer Relief Act of 2012 being enacted on January 2, 2013; and (iii) tax planning related to certain items previously treated as nondeductible.
In August 2013, we were notified by the Internal Revenue Service that our 2011 federal income tax return was under examination. Fieldwork commenced in September 2013. No conclusion or preliminary results have been communicated to us. We do not expect any material assessment to be realized from this examination. We anticipate the examination will be completed in 2015.
Critical Accounting Policy Disclosure
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenue and expenses during the reporting period. We base our estimates and judgments on historical experience and other assumptions that we find reasonable under the circumstances. Actual results may differ from such estimates under different conditions.
Management believes that the following accounting judgments and uncertainties are the most critical to aid in fully understanding and evaluating our reported financial results, as they require management’s most difficult, subjective or complex judgments. Management has reviewed these critical accounting estimates and related disclosures with the audit committee of our board of directors.
Revenue Recognition
In accordance with Staff Accounting Bulletin No. 104, Revenue Recognition, we recognize revenue when (a) there is a persuasive evidence of an arrangement, (b) the fee is fixed or determinable, (c) services have been rendered and payment has been contractually earned, and (d) collectability is reasonably assured.
Inclusive in our revenue recognition policies, we are required to make certain critical judgments that impact the period over which revenue is recognized. These judgments are described below.
Revenue Recognition - Multiple-Deliverable Revenue Arrangements
We may bundle certain of our SCM service and technology offerings into a single service arrangement. We may also bundle certain of our RCM service and technology offerings into a single service arrangement. In addition, we may bundle certain of both of our SCM and RCM service and technology offerings together into a single service arrangement and market them as an enterprise arrangement.
We use a selling price hierarchy for determining the appropriate value of a deliverable. The hierarchy is based on: (a) vendor-specific objective evidence if available (“VSOE”); (b) third-party evidence (“TPE”) if vendor-specific objective evidence is not available; or (c) estimated selling price (“ESP”) if neither VSOE nor TPE is available.
If we are unable to establish selling price using VSOE or TPE, we will establish an ESP. ESP is the estimated price at which we would transact a sale if the product or service were sold on a stand-alone basis. We
Index to Financial Statements
establish a best estimate of ESP considering internal factors relevant to pricing practices such as costs and margin objectives, standalone sales prices of similar services and percentage of the fee charged for a primary service relative to a related service. Additional consideration is also given to market conditions such as competitor pricing strategies and market trends. If available, we regularly review VSOE and TPE for our services in addition to ESP.
Subscription and Implementation Fees
We apply the revenue recognition guidance prescribed by generally accepted accounting principles in the United States of America (“GAAP”) relating to software for our hosted solutions. We provide subscription-based revenue cycle and spend and clinical resource management services through software tools accessed by our clients while the data is hosted and maintained on our servers. In many arrangements, clients are charged set-up fees for implementation and monthly subscription fees for access to these web-based hosted services. Implementation fees are typically billed at the beginning of the arrangement and recognized as revenue over the greater of the subscription period or the estimated client relationship period. We estimate the client relationship period based on historical client retention rates. We currently estimate our client relationship period to be six years for our hosted services. Revenue from monthly hosting arrangements is recognized on a subscription basis over the period in which the client uses the service. Contract subscription periods typically range from two to six years from execution.
We monitor our client relationship periods and as a result, our estimated client relationship period may change due to the changing attrition rates of our clients. We have historically changed our estimates of client relationship periods for certain of our web-hosted clients. These changes in estimated client lives have typically deferred revenue and the associated costs over longer periods.
Goodwill and Intangible Assets
We evaluate goodwill and other intangible assets for impairment annually and whenever events or changes in circumstances indicate the carrying value of the goodwill or other intangible assets may not be recoverable. The Company considers the following to be important factors that could trigger an impairment review and may result in an impairment charge: significant and sustained underperformance relative to historical or projected future operating results; identification of other impaired assets within a reporting unit; significant and sustained adverse changes in business climate or regulations; significant negative changes in senior management; significant changes in the manner of use of the acquired assets or the strategy for the Company’s overall business; significant negative industry or economic trends; and a significant decline in the Company’s stock price for a sustained period.
We complete our impairment evaluation by performing valuation analyses in accordance with GAAP relating to goodwill and other intangibles. This analysis contains uncertainties because it requires us to make market participant assumptions and to apply judgment to estimate industry economic factors and the profitability and growth of future business strategies to determine estimated future cash flows and an appropriate discount rate. When market prices are not available, we estimate the fair value of the reporting unit or asset group using the income approach and/or the market approach. The income approach uses cash flow projections. Inherent in our development of cash flow projections are assumptions and estimates derived from a review of our operating results, approved business plans, expected growth rates, capital expenditures and cost of capital, similar to those a market participant would use to assess fair value. We also make certain assumptions about future economic conditions and other data. Many of the factors used in assessing fair value are outside the control of management, and these assumptions and estimates may change in future periods.
Index to Financial Statements Changes in assumptions or estimates can materially affect the fair value measurement of a reporting unit or asset group, and therefore can affect the amount of the impairment. The following are key assumptions we use in making cash flow projections:
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Business projections. We make assumptions about the demand for our products in the marketplace. These assumptions drive our planning assumptions for volume, mix, and pricing. We also make assumptions about our cost levels. These projections are derived using our internal business plans that are updated at least annually and reviewed by our Board of Directors.
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Long-term growth rate. A growth rate is used to calculate the terminal value of the business, and is added to the present value of the debt-free cash flows. The growth rate is the expected rate at which a business unit’s earnings stream is projected to grow beyond the planning period.
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Discount rate. When measuring possible impairment, future cash flows are discounted at a rate that is consistent with a weighted-average cost of capital that we anticipate a potential market participant would use. Weighted-average cost of capital is an estimate of the overall risk-adjusted after-tax rate of return required by equity and debt holders of a business enterprise.
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Economic projections. Assumptions regarding general economic conditions are included in and affect our assumptions regarding industry sales and pricing estimates. These macro-economic assumptions include, but are not limited to, industry sales volumes and interest rates.
Our estimates of future cash flows used in these valuations could differ materially from actual results. If actual results are not consistent with our estimates or assumptions, we may be exposed to an impairment charge that could be material.
In connection with our 2014 annual impairment testing, we recognized an impairment charge related to the goodwill at our RCS operating unit within our RCM reporting segment. As part of our quarterly and annual forecasting process, we expect our future revenue growth to come from lower margin services. As a result, our projected margins within our discounted cash flow model used for impairment testing were therefore reduced, and the resulting business enterprise value could no longer support the amount of goodwill on the consolidated balance sheet related to the RCS operating unit. As a result, during the fourth quarter of 2014 we incurred a goodwill impairment charge within our RCM segment. We recorded a preliminary estimate of $52.5 million related to the goodwill impairment charge. The goodwill impairment amount is preliminary pending receipt of our final valuation report.
Further, as a result of our impairment testing as of October 1, 2014, the estimated fair value of our SCM segment substantially exceeded its respective carrying value and the estimated fair value of our revenue cycle technology operating unit within our RCM segment exceeded its respective carrying value by more than 10%.
In addition, we make assumptions about the useful lives of our intangible assets. Intangible assets (including our capitalized software) are amortized over their useful lives, which have been derived based on an assessment of such factors as attrition, expected volume and economic benefit. We evaluate the useful lives of our intangible assets on an annual basis. Any changes to our estimated useful lives could cause depreciation and amortization to increase or decrease.
Acquisitions - Purchase Price Allocation
In accordance with GAAP relating to business combinations, we use the purchase method of accounting for acquisitions which prescribes, among other things, how assets and liabilities are recognized in purchase accounting. The guidance also requires the recognition of assets acquired and liabilities assumed arising from contingencies, the capitalization of in-process research and development at fair value, and the expensing of acquisition-related costs as incurred.
Index to Financial Statements Our purchase price allocation methodology requires us to make assumptions and to apply judgment to estimate the fair value of acquired assets and liabilities. We estimate the fair value of assets and liabilities based upon appraised market values, the carrying value of the acquired assets and widely accepted valuation techniques, including discounted cash flows and market multiple analyses. Management determines the fair value of fixed assets and identifiable intangible assets such as developed technology or client relationships, and any other significant assets or liabilities. We adjust the purchase price allocation, as necessary, up to one year after the acquisition closing date as we obtain more information regarding asset valuations and liabilities assumed. Unanticipated events or circumstances may occur which could affect the accuracy of our fair value estimates, including assumptions regarding industry economic factors and business strategies, and result in an impairment or a new allocation of purchase price.
On September 22, 2014, we acquired one hundred percent of the issued and outstanding equity interests (the “Membership Interests”) of SG-2, LLC (“Sg2”) for approximately $138 million (subject to certain purchase price adjustments) (the “Sg2 Acquisition”).
Included in the purchase price allocation are the fair value of acquired identified intangible assets of $65.7 million, the fair value of which was primarily determined by applying the income approach, using several significant unobservable inputs for projected cash flows and a discount rate. These inputs are considered Level 3 inputs under the fair value measurements and disclosure guidance. The purchase price paid for Sg2 and the resulting goodwill of $81.5 million reflects a premium relative to the value of identified assets due to the strategic importance of the transaction to us and because Sg2’s business model does not rely intensively on fixed assets.
The fair value of acquired assets and liabilities assumed is preliminary pending receipt of final valuation reports. Refer to Note 5 of the Notes to Consolidated Financial Statements for additional information.
Given our history of acquisitions, we may allocate part of the purchase price of future acquisitions to contingent consideration as required by GAAP for business combinations. The fair value calculation of contingent consideration will involve a number of assumptions that are subjective in nature and which may differ materially from actual results. We may experience volatility in our earnings to some degree in future reporting periods as a result of these fair value measurements.
Allowance for Doubtful Accounts
In evaluating the collectability of our accounts receivable, we assess a number of factors, including a specific client’s ability to meet its financial obligations to us (which would be affected, for example, if such client declared bankruptcy). Other factors include the length of time the receivables are past due and historical collection experience. Based on these assessments, we record a reserve for specific account balances as well as a general reserve based on our historical experience for bad debt to reduce the related receivables to the amount we expect to collect from clients. Refer to Note 15 of the notes to Consolidated Financial Statements.
We have not made any material changes in the accounting methodology used to estimate the allowance for doubtful accounts. If actual results are inconsistent with our estimates or assumptions, we may experience a higher or lower expense. In addition, if circumstances related to specific clients change, or economic conditions deteriorate such that our past collection experience is no longer relevant, our estimate of the recoverability of our accounts receivable could be further reduced from the levels provided for in the consolidated financial statements.
Client Service Allowance
We maintain a client service allowance based on management’s evaluation of historical experience, current trends, individual client experience and other relevant factors that, in the opinion of management, deserve
Index to Financial Statements
recognition in estimating such allowance. Estimates related to our client service allowance are recorded as a reduction to net revenue in our consolidated statements of operations and as a current liability in our consolidated balance sheets. Refer to Note 15 of the notes to consolidated financial statements.
We have not made any material changes in the accounting methodology used to estimate the client service allowance. If actual results are inconsistent with our estimates or assumptions, we may experience a higher or lower expense.
Income Taxes
We regularly review our deferred tax assets for recoverability and establish a valuation allowance, as needed, based upon historical taxable income, projected future taxable income, the expected timing of the reversals of existing temporary differences and the implementation of tax-planning strategies. Our tax valuation allowance requires us to make assumptions and apply judgment regarding the forecasted amount and timing of future taxable income.
We estimate the company’s effective tax rate based upon the currently enacted tax rates and estimated state apportionment. This rate is determined based upon location of company personnel, location of company assets and determination of sales on a jurisdictional basis. We currently file income tax returns in approximately 56 jurisdictions (inclusive of certain city jurisdictions).
We recognize excess tax benefits associated with stock based compensation directly to stockholders’ equity when realized. When assessing whether a tax benefit relating to share-based compensation has been realized, we follow the tax law ordering method, under which current year share-based compensation deductions are assumed to be utilized before net operating loss carryforwards and other tax attributes such as tax credits. If tax law does not specify the ordering in a particular circumstance, then a pro-rata approach is used.
We account for uncertain tax positions in accordance with GAAP relating to the accounting for uncertainty in income taxes. The guidance prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of uncertain tax positions taken or expected to be taken in a company’s income tax return, and also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. Our policy is to include interest and penalties in our provision for income taxes. The tax years 1999 through 2013 remain open to examination by the Internal Revenue Service and certain state taxing jurisdictions to which we are subject. For years 1999 to 2010, the statute for assessments and refunds has generally expired; however, tax attributes for those years may still be examined, which would impact the tax years 2011 and forward.
Each quarter we assess our uncertain tax positions and adjust our reserve accordingly based on the most recent facts and circumstances. If there is a significant change in the underlying facts and circumstances or applicable tax law modifications, we may be exposed to additional benefits or expense. See Note 10 of the Notes to Consolidated Financial Statements for the impact of uncertain tax positions in 2014.
We expect a significant increase in our cash taxes in future years, primarily attributable to exhausting all of our federal net operating loss carryforwards and most of our other tax attributes such as tax credits.
Liquidity and Capital Resources
Our primary cash requirements involve payment of ordinary expenses, working capital fluctuations, debt service obligations and capital expenditures. Our capital expenditures typically consist of software purchases, internal product development capitalization and computer hardware purchases. Historically, the acquisition of complementary businesses has resulted in a significant use of cash. Our principal sources of funds have primarily been cash provided by operating activities and borrowings under our credit facilities.
Index to Financial Statements We believe we currently have adequate cash flow from operations, capital resources, available credit facilities and liquidity to meet our cash flow requirements including the following near term obligations (next 12 months): (i) our working capital needs; (ii) our debt service obligations; (iii) planned capital expenditures; (iv) our revenue share obligation and rebate payments; and (v) estimated federal and state income tax payments.
On September 8, 2014, we entered into a First Increase Joinder to Credit Agreement, dated as of September 8, 2014, by and among the Company and its lenders (the “First Increase Joinder”). The First Increase Joinder increased the revolving commitment amount under our Credit Agreement by $100 million to $300 million.
Historically, we have utilized federal net operating loss carryforwards (“NOLs”) to reduce both regular and Alternative Minimum Tax (“AMT”) cash payments. Consequently, our federal cash tax payments in past reporting periods have been minimal. During 2014, we paid cash taxes of approximately $27.4 million. We expect our cash tax liability to increase in 2015 and in the future.
We have not historically utilized borrowings available under our credit agreement to fund operations. We implemented an auto-borrowing plan which caused all excess cash on hand to be used to repay our swing-line credit facility on a daily basis. As a result, any excess cash on hand will be used to repay our swing-line balance, if any, on a daily basis. See Note 6 of the Notes to Consolidated Financial Statements for further details.
As of December 31, 2014, we had $152.0 million drawn on our revolving credit facility resulting in $147.0 million of availability under our revolving credit facility inclusive of the swing-line (netted for a $1.0 million letter of credit). We may observe fluctuations in cash flows provided by operations from period to period. Certain events may cause us to draw additional amounts under our swing-line or revolving facility and may include the following:
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changes in working capital due to inconsistent timing of cash receipts and payments for major recurring items such as trade accounts payable, revenue share obligation, incentive compensation, changes in deferred revenue, and other various items;
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transaction and integration related costs;
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acquisitions; and
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unforeseeable events or transactions.
We may continue to pursue other acquisitions or investments in the future. We may also increase our capital expenditures consistent with our anticipated growth in infrastructure, software solutions, and personnel, and as we expand our market presence. Cash provided by operating activities may not be sufficient to fund such expenditures. Accordingly, in addition to the use of our available revolving credit facility, we may need to engage in additional equity or debt financings to secure additional funds for such purposes. Any debt financing obtained by us in the future could involve restrictive covenants relating to our capital raising activities and other financial and operational matters including higher interest costs, which may make it more difficult for us to obtain additional capital and to pursue business opportunities, including potential acquisitions. In addition, we may not be able to obtain additional financing on terms favorable to us, if at all. If we are unable to obtain required financing on terms satisfactory to us, our ability to continue to support our business growth and to respond to business challenges could be limited.
Discussion of Cash Flow
As of December 31, 2014 and 2013, we had cash and cash equivalents totaling $12.1 million and $2.8 million, respectively.
Index to Financial Statements Operating Activities:
The following table summarizes the cash provided by operating activities for the fiscal years ended December 31, 2014 and 2013:
Net (loss) income represents the (loss) income attained during the periods presented and is inclusive of certain non-cash expenses. These non-cash expenses include depreciation for fixed assets, amortization of intangible assets, stock compensation expense, bad debt expense, deferred income tax expense, excess tax benefit from the exercise of stock options, loss on sale of assets, loss on debt extinguishment, amortization of debt issuance costs, impairment of assets and non-cash interest expense. Refer to our Consolidated Statement of Cash Flows for details regarding these non-cash items. The total for these non-cash expenses was $176.4 million and $124.1 million for the fiscal years ended December 31, 2014 and 2013, respectively. The increase in non-cash expenses for the fiscal year ended December 31, 2014 compared to December 31, 2013 was primarily attributable to: (i) an increase in the impairment of assets of $49.0 million; (ii) an $8.3 million increase in depreciation expense; (iii) a $4.1 million increase in the excess tax benefit from exercise of equity awards; and (iv) a $3.4 million increase in share-based compensation. The increase was partially offset by: (i) a $7.6 million decrease in our deferred income tax expense (benefit); and (ii) a $5.1 million decrease in the amortization of intangibles. Refer to our Management Discussion and Analysis for more detail.
Working capital is a measure of our liquid assets. Changes in working capital are included in the determination of cash provided by operating activities. For the fiscal year ended December 31, 2014, the working capital changes resulting in a decrease to cash flow from operations of $18.4 million primarily consisted of the following:
Decrease of cash flow
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an increase in accounts receivable of $40.0 million related to the timing of invoicing and cash collections and our revenue growth;
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an increase in prepaid expenses and other assets of $2.3 million primarily related to an increase in prepaid taxes of $2.9 million and an increase in prepaid insurance of $2.5 million partially offset by a decrease in software and hardware maintenance of $3.7 million; and
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an $11.9 million decrease in accrued payroll and benefits due to payroll cycle timing.
The working capital changes resulting in a decrease to cash flow from operations discussed above were partially offset by the following changes in working capital resulting in increases to cash flow:
Increase of cash flow
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a decrease in other long term assets of $0.5 million primarily related to the timing of cash payments for our deferred sales expenses;
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a $4.0 million working capital increase in trade accounts payable due to the timing of various payment obligations;
Index to Financial Statements
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a $11.3 million increase in accrued revenue share obligation and rebates due to the timing of cash payments and client purchasing volume for our GPO; and
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an increase in deferred revenue of $17.9 million for cash receipts not yet recognized as revenue.
Changes in working capital are included in the determination of cash provided by operating activities. For the fiscal year ended December 31, 2013, the working capital changes resulting in an increase to cash flow from operations of $1.4 million primarily consisted of the following:
Increase of cash flow
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a decrease in accounts receivable of $9.0 million related to the timing of invoicing and cash collections and our revenue growth;
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a $3.1 million increase in accrued revenue share obligation and rebates due to the timing of cash payments and client purchasing volume for our GPO; and
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a $1.5 million increase in accrued payroll and benefits due to payroll cycle timing and higher performance-based compensation expense than the prior period.
The working capital changes resulting in an increase to cash flow from operations discussed above were partially offset by the following changes in working capital resulting in decreases to cash flow:
Decrease of cash flow
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an increase in prepaid expenses and other assets of $2.3 million primarily related to an increase in software and hardware maintenance;
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an increase in other long term assets of $0.4 million primarily related to the timing of cash payments for our deferred sales expenses;
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a $0.4 million working capital decrease in trade accounts payable due to the timing of various payment obligations;
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a decrease in other accrued expenses and long-term liabilities of $1.9 million primarily due to timing of various payment obligations;
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a decrease in deferred revenue of $7.2 million for cash receipts not yet recognized as revenue.
Investing Activities:
Investing activities used $204.5 million of cash for the fiscal year ended December 31, 2014 which included approximately $141.3 million primarily related to the Sg2 Acquisition; $42.2 million for investment in software development and $21.0 million of capital expenditures.
Investing activities used $58.8 million of cash for the fiscal year ended December 31, 2013 which included $41.2 million for investment in software development and $17.6 million of capital expenditures.
We believe that cash used in investing activities will continue to be materially impacted by continued growth in investments in property and equipment and capitalized software. Our property, equipment, and software investments consist primarily of SaaS-based technology infrastructure to provide capacity for expansion of our client base, including computers and related equipment and software purchased or implemented by outside parties. Our software development investments consist primarily of company-managed design, development, testing and deployment of new application functionality. In addition, cash used in investing activities may be materially impacted by future acquisitions.
Index to Financial Statements Financing Activities:
Financing activities provided $74.8 million of cash for the fiscal year ended December 31, 2014. We received $216.1 million from borrowings on our revolving credit facility (inclusive of our swing line borrowings of $34.1 million); $3.6 million from the issuance of common stock; and $2.0 million from the excess tax benefit from the exercise of stock options. This was partially offset by payments made on our Term Loan Facility of $25.5 million consisting of $15.5 million in scheduled principal payments, $10.0 million in voluntary prepayments our Term B Facility, $40.0 million in voluntary payments on our revolving credit facility and payments of $34.1 million on our swing line. We also made payments of $0.7 million on our finance obligation (discussed below). In addition, we paid $0.6 million in debt issuance costs associated with the First Increase Joinder discussed herein. We purchased 1,784,645 shares of common stock under our share repurchase program totaling $42.8 million and settled the tax liability relating to shares surrendered for tax withholdings totaling $3.2 million. As of December 31, 2014, the Credit Agreement requires an assessment of excess cash flow for our fiscal year ended December 31, 2014. Based on the voluntary repayments made during the fiscal year ended December 31, 2014, we expect to make an excess cash flow payment of approximately $8.0 million during the first quarter of 2015.
Financing activities used $105.0 million of cash for the fiscal year ended December 31, 2013. We made payments on our Term Loan Facility of $120.5 million consisting of $15.5 million in scheduled principal payments and $105.0 million voluntary prepayment from free cash flow. In addition, we made payments of $0.7 million that were made on our finance obligation. This was partially offset by $10.1 million received from the issuance of common stock (net of offering costs) and $6.0 million from the excess tax benefit from the exercise of stock options.
Credit Facility and Notes Offering
Credit Facility
On December 13, 2012, we completed a refinancing and entered into a Credit Agreement with the banks and other financial institutions named therein (the “Lenders”), JPMorgan Chase Bank, N.A., acting as administrative agent and collateral agent for the Lenders and letter of credit issuer, and Bank of America, N.A., acting as swing line lender (the “Credit Agreement”). The Credit Agreement consists of a (i) five-year $250.0 million senior secured term A loan facility (the “Term A Facility”), (ii) a seven-year $300.0 million senior secured term B loan facility (the “Term B Facility”; and collectively with the Term A Facility, the “Term Loan Facility”); and (iii) a five-year $200.0 million senior secured revolving credit facility, including a letter of credit sub-facility of $25.0 million and a swing line sub-facility of $25.0 million (the “Revolving Credit Facility”). The borrowings under the Term Loan Facility were made in a single draw on December 13, 2012. Amounts borrowed under the Term Loan Facility that are prepaid may not be reborrowed. Proceeds of borrowing under the Credit Agreement were used to repay all outstanding amounts under our prior credit facility. The Revolving Credit Facility is available for working capital and other general corporate purposes at any time prior to the final maturity thereof. Borrowings under the Revolving Credit Facility are subject to the satisfaction of customary conditions precedent. Amounts repaid under the Revolving Credit Facility may be reborrowed.
The Credit Agreement permits us, subject to the satisfaction of certain conditions and obtaining commitments, to add one or more incremental term loan facilities, increase the commitments under the Term Loan Facility or increase the aggregate commitments under the Revolving Credit Facility in an aggregate amount of up to $200.0 million, which may have the same guarantees, and be secured on a pari passu basis by the same collateral as the Term Facility or Revolving Facility, as applicable.
On September 8, 2014, we entered into a First Increase Joinder to Credit Agreement, dated as of September 8, 2014, by and among the Company and its lenders. The First Increase Joinder increased the revolving commitment amount under our Credit Agreement by $100 million to $300 million. In connection with the First Increase Joinder, we incurred and capitalized approximately $0.6 million of debt issuance costs which
Index to Financial Statements
will be amortized into interest expense ratably over the remaining term of the revolving credit facility. Refer to Note 6 of the Notes to Consolidated Financial Statements for details.
The interest rates per annum applicable to loans (other than swing line loans) under the Credit Agreement are, at our option, equal to either (i) a eurodollar rate for one-, two-, three- six-, or if agreed to by all relevant lenders, nine- or twelve-month interest periods or (ii) an alternate base rate, in each case, plus an applicable margin of (x) with respect to loans under the Term B Facility, (A) 2.75% for eurodollar loans and (B) 1.75% for alternate base rate loans, and (y) with respect to loans under the Term A Facility and Revolving Credit Facility, in each case subject to our leverage ratio, (A) 2.25%-2.50% for eurodollar loans and (B) 1.25%-1.50% for base rate loans. Interest rates per annum applicable to swing line loans are equal to the alternate base rate plus an applicable margin.
The eurodollar rate is determined by reference to the London inter-bank offer rate, which is the settlement rate established for deposits in dollars in the London interbank market for a period equal to the interest period of the loan and the maximum reserve percentages established by the Board of Governors of the United States Federal Reserve to which the lenders are subject. The eurodollar rate includes statutory reserves. The eurodollar rate for loans under the Term B Facility is subject to a floor of 1.25%. The alternate base rate for loans under the Term B Facility is subject to a floor of 2.25%. The alternate base rate is the highest of (i) the prime commercial lender rate published by the Wall Street Journal as the “prime rate”, (ii) the weighted average of rates on overnight Federal funds as published by the Federal Reserve Bank of New York plus one-half of 1% and (iii) the eurodollar rate for a one-month interest period plus 1%. The alternate base rate is subject to a minimum percentage equal to the minimum percentage for the eurodollar rate plus 1%.
See table below for a summary of the pricing tiers for all applicable margin rates. As of December 31, 2014, our applicable margin on our Revolving Credit Facility and Term A Facility was tier 2.
The loans under the Term A Facility amortize in quarterly installments of (i) $3.1 million each during 2013 and 2014, (ii) $4.7 million during 2015, and (iii) $6.3 million during 2016 through September 2017, with the balance payable on the fifth anniversary of December 13, 2012. The loans under the Term B Facility amortize in equal quarterly installments of $0.8 million each, with the balance payable on the seventh anniversary of December 13, 2012. The Term B Facility matures on December 13, 2019; provided that the facility will mature in full on May 15, 2018 if our outstanding senior notes have not been repaid or refinanced in full by such date. No principal payments are due on the revolving loan facility until the revolving facility maturity date. We are also required to prepay our debt obligations based on an excess cash flow calculation for the applicable fiscal year which is determined in accordance with the terms of our credit agreement.
Index to Financial Statements As of December 31, 2014, we had an outstanding balance of $152.0 million on the Revolving Credit Facility resulting in $147.0 million available under the Revolving Credit Facility (after giving effect to $1.0 million of outstanding but undrawn letters of credit on such date). We also had $881.0 million of debt outstanding and a cash balance of $12.1 million as of December 31, 2014.
The Credit Agreement contains certain customary negative covenants, including, but not limited to, limitations on the incurrence of debt, limitations on liens, limitations on fundamental changes, limitations on asset sales and sale leasebacks, limitations on investments, limitations on dividends or distributions on, or redemptions of, equity interests, limitations on prepayments or redemptions of unsecured or subordinated debt, limitations on negative pledge clauses, limitations on transactions with affiliates and limitations on changes to our fiscal year. The Credit Agreement also includes maintenance covenants of maximum ratios of consolidated total indebtedness (subject to certain adjustments) to consolidated EBITDA (subject to certain adjustments) and minimum cash interest coverage ratios. The Credit Agreement contains certain customary representations and warranties, affirmative covenants and events of default, including payment defaults, breaches of representations and warranties, covenant defaults, cross-defaults to certain indebtedness, certain events of insolvency or bankruptcy, material judgments, certain events under ERISA, actual or asserted failures of any guaranty or security document supporting the Credit Agreement to be in full force and effect and changes of control.
For the fiscal quarter ending December 31, 2014, we were required to maintain compliance with a maximum consolidated total debt to consolidated EBITDA leverage ratio of 5.25 to 1.0 (5.00 to 1.0 on a pro forma basis) and a minimum consolidated interest coverage ratio of 2.5 to 1.0. The consolidated total debt to consolidated EBITDA leverage ratio and the consolidated interest coverage ratio thresholds adjust in future periods. The following table shows our future covenant thresholds:
The components that comprise the calculation of the aforementioned covenants are specifically defined in the Credit Agreement and require us to make certain adjustments to derive the amounts used in the calculation of each ratio. Refer to the table in the earlier part of this section for a summary of the pricing tiers and the applicable rates.
The determination of our pricing tier is based on the total leverage ratio that was calculated in the most recent compliance certificate received by our administrative agent. In addition, our loans and other obligations under the credit agreement are guaranteed, subject to specified limitations, by our present and future direct and indirect domestic subsidiaries. As of December 31, 2014, we were not in default of any covenants under our credit agreement.
Notes Offering
The Company has an aggregate principal amount of $325 million of senior notes (the “Notes”) outstanding that have been registered under the Securities Act of 1933, as amended. The Notes are jointly and severally guaranteed on a senior unsecured basis by each of the Company’s existing domestic restricted subsidiaries and
Index to Financial Statements
each of the Company’s future domestic restricted subsidiaries in each case that guarantees the Company’s obligations under the credit agreement. The Notes and the guarantees are senior unsecured obligations of the Company.
The Notes were issued pursuant to an Indenture (the “Indenture”) dated as of November 16, 2010, among the Company, its subsidiary guarantors and Wells Fargo Bank, N.A., as trustee. Pursuant to the Indenture, the Notes will mature on November 15, 2018, and bear 8% annual interest. Interest on the Notes is payable semi-annually in arrears on May 15 and November 15 of each year, beginning on May 15, 2011.
The Indenture contains certain customary negative covenants, including, but not limited to, limitations on: the incurrence of debt; liens; consolidations or mergers; asset sales; certain restricted payments and transactions with affiliates. The Indenture does not contain any significant restrictions on the ability of the parent company to obtain funds from its subsidiaries by dividend or loan. The Indenture also contains customary events of default. As of December 31, 2014, we were not in default of any covenants under the Indenture.
Summary Disclosure Concerning Contractual Obligations and Commercial Commitments
In the ordinary course of business, we enter into contractual obligations to make cash payments to third parties. The Company’s known contractual obligations as of December 31, 2014 are as follows:
(1) Indebtedness under our credit facility bears interest at an annual rate of LIBOR (our credit agreement contains a 1.25% LIBOR floor on the Term B Facility) plus an applicable margin. The applicable weighted average interest rate, inclusive of LIBOR and the applicable margin was 3.0% on our Term Loan Facility at December 31, 2014. We had $152.0 million outstanding under our revolving credit facility at December 31, 2014. See Note 6 of the Notes to Consolidated Financial Statements for additional information regarding our borrowings.
(2) Indebtedness on our bonds bear interest at an 8% annual rate. See Note 6 of the Notes to Consolidated Financial Statements for additional information regarding our bond offering.
(3) Interest on variable rate debt is calculated using the weighted-average interest rate in effect as of December 31, 2014 for all future periods. In addition, our credit agreement requires us to calculate excess cash flow on an annual basis. As discussed elsewhere herein, we will be required to make an excess cash flow payment during the first quarter of 2015.
(4) Relates to certain office space and office equipment under operating leases. Amounts represent future minimum rental payments under operating leases with initial or remaining non-cancelable lease terms of one year or more. See Note 7 of the Notes to Consolidated Financial Statements for more information.
(5) Represents restructuring, acquisition and integration-related costs. See Note 5 of the Notes to Consolidated Financial Statements for additional information.
Index to Financial Statements
(6) Represents a capital lease obligation incurred in a sale and subsequent leaseback transaction of an office building. See Note 6 of the Notes to Consolidated Financial Statements under the subheading “Finance Obligations” for additional information regarding this transaction and the related obligation.
(7) The above amount relates to management’s estimate of uncertain tax positions. As a result of tax attributes (net operating losses and tax credits), we have several tax periods open to examination until the statute of limitations has expired with respect to the year in which these attributes are utilized. As such, we cannot predict the precise timing that this liability will be applied or utilized. Additionally, the liability may increase or decrease if management’s estimate of uncertain tax positions changes when new information arises or changes in circumstances occur.
Indemnification of product users.We provide a limited indemnification to users of our products against any patent, copyright, or trade secret claims brought against them. The duration of the indemnifications vary based upon the life of the specific individual agreements. We have not had a material indemnification claim, and we do not believe we will have a material claim in the future. As such, we have not recorded any liability for these indemnification obligations in our financial statements.
Off-Balance Sheet Arrangements
We have provided a $1.0 million letter of credit to guarantee our performance under the terms of a ten-year lease agreement. The letter of credit is associated with the capital lease of a building located in Cape Girardeau, Missouri under a finance obligation. We do not believe that this letter of credit will be drawn.
We lease office space and equipment under operating leases. Some of these operating leases include rent escalations, rent holidays, and rent concessions and incentives. However, we recognize lease expense on a straight-line basis over the minimum lease term utilizing total future minimum lease payments.
As of December 31, 2014, we did not have any other off-balance sheet arrangements that have or are reasonably likely to have a current or future significant effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Use of Non-GAAP Financial Measures
In order to provide investors with greater insight, promote transparency and allow for a more comprehensive understanding of the information used by management and the Board in its financial and operational decision-making, we supplement our consolidated financial statements presented on a GAAP basis herein with the following non-GAAP financial measures: gross fees, gross administrative fees, revenue share obligation, EBITDA, adjusted EBITDA, adjusted EBITDA margin, adjusted net income and adjusted diluted earnings per share.
These non-GAAP financial measures have limitations as analytical tools and should not be considered in isolation or as a substitute for analysis of our results as reported under GAAP. We compensate for such limitations by relying primarily on our GAAP results and using non-GAAP financial measures only supplementally. We provide reconciliations of non-GAAP measures to their most directly comparable GAAP measures, where possible. Investors are encouraged to carefully review those reconciliations. In addition, because these non-GAAP measures are not measures of financial performance under GAAP and are susceptible to varying calculations, these measures, as defined by us, may differ from and may not be comparable to similarly titled measures used by other companies.
Gross Fees, Gross Administrative Fees and Revenue Share Obligation. Gross fees include all gross administrative fees we receive pursuant to our vendor contracts and all other fees we receive from clients. Our revenue share obligation represents the portion of the gross administrative fees we are contractually obligated to share with certain of our GPO clients. Total net revenue (a GAAP measure) reflects our gross fees net of our
Index to Financial Statements
revenue share obligation. These non-GAAP measures assist management and the Board and may be helpful to investors in analyzing our growth in the SCM segment given that administrative fees constitute a material portion of our revenue and are paid to us by over 1,150 vendors contracted by our GPO, and that our revenue share obligation constitutes a significant outlay to certain of our GPO clients. A reconciliation of these non-GAAP measures to their most directly comparable GAAP measure can be found in the “Overview” and “Results of Operations” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations herein.
EBITDA, adjusted EBITDA and adjusted EBITDA margin. We define: (i) EBITDA, as net income before net interest expense, income tax expense (benefit), depreciation and amortization; (ii) adjusted EBITDA, as net income before net interest expense, income tax expense (benefit), depreciation and amortization and other non-recurring, non-cash or non-operating items; and (iii) adjusted EBITDA margin, as adjusted EBITDA as a percentage of net revenue. We use EBITDA, adjusted EBITDA and adjusted EBITDA margin to facilitate a comparison of our operating performance on a consistent basis from period to period and provide for a more complete understanding of factors and trends affecting our business than GAAP measures alone. These measures assist management and the Board and may be useful to investors in comparing our operating performance consistently over time as it removes the impact of our capital structure (primarily interest charges and amortization of debt issuance costs), asset base (primarily depreciation and amortization) and items outside the control of the management team (taxes), as well as other non-cash (purchase accounting adjustments and imputed rental income) and non-recurring items, from our operational results. Adjusted EBITDA also removes the impact of non-cash share-based compensation expense, goodwill impairment, and certain restructuring, acquisition and integration-related charges.
Our Board and management also use these measures as: i) one of the primary methods for planning and forecasting overall expectations and for evaluating, on at least a quarterly and annual basis, actual results against such expectations; and ii) as a performance evaluation metric in determining achievement of certain executive incentive compensation programs, as well as for incentive compensation plans for employees generally.
Additionally, research analysts, investment bankers and lenders may use these measures to assess our operating performance. For example, our credit agreement requires delivery of compliance reports certifying compliance with financial covenants certain of which are, in part, based on an adjusted EBITDA measurement that is similar to the adjusted EBITDA measurement reviewed by our management and our Board. The principal difference is that the measurement of adjusted EBITDA considered by our lenders under our credit agreement allows for certain adjustments (e.g., inclusion of interest income, franchise taxes and other non-cash expenses, offset by the deduction of our capitalized lease payments for one of our office leases) that result in a higher adjusted EBITDA than the adjusted EBITDA measure reviewed by our Board and management and disclosed in our Annual Report on Form 10-K. Additionally, our credit agreement contains provisions that utilize other measures, such as excess cash flow, to measure liquidity.
EBITDA, adjusted EBITDA and adjusted EBITDA margin are not measures of liquidity under GAAP, or otherwise, and are not alternatives to cash flow from continuing operating activities. Despite the advantages regarding the use and analysis of these measures as mentioned above, EBITDA, adjusted EBITDA and adjusted EBITDA margin, as disclosed herein, have limitations as analytical tools, and you should not consider these measures in isolation, or as a substitute for analysis of our results as reported under GAAP; nor are these measures intended to be measures of liquidity or free cash flow for our discretionary use. Some of the limitations of EBITDA are:
•
EBITDA does not reflect our cash expenditures or future requirements for capital expenditures or contractual commitments;
•
EBITDA does not reflect changes in, or cash requirements for, our working capital needs;
•
EBITDA does not reflect the interest expense, or the cash requirements to service interest or principal payments under our credit agreement;
Index to Financial Statements
•
EBITDA does not reflect income tax payments we are required to make; and
•
Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized often will have to be replaced in the future, and EBITDA does not reflect any cash requirements for such replacements.
Adjusted EBITDA has all the inherent limitations of EBITDA. To properly and prudently evaluate our business, we encourage you to review the GAAP financial statements included elsewhere herein, and not rely on any single financial measure to evaluate our business. We also strongly urge you to review the reconciliation of net income to adjusted EBITDA in this section, along with our consolidated financial statements included elsewhere herein.
The following table sets forth a reconciliation of EBITDA and adjusted EBITDA to net income, a comparable GAAP-based measure. All of the items included in the reconciliation from net income to EBITDA to adjusted EBITDA are either: (i) non-cash items (e.g., depreciation and amortization, impairment of intangibles and share-based compensation expense) or (ii) items that management does not consider in assessing our on-going operating performance (e.g., income taxes, interest expense and expenses related to the cancellation of an interest rate swap and acquisition and integration-related expenses). In the case of the non-cash items, management believes that investors may find it useful to assess our comparative operating performance because the measures without such items are less susceptible to variances in actual performance resulting from depreciation, amortization and other non-cash charges and more reflective of other factors that affect operating performance. In the case of the other non-recurring items, management believes that investors may find it useful to assess our operating performance if the measures are presented without these items because their financial impact does not reflect ongoing operating performance.
The following table reconciles net income to adjusted EBITDA for the fiscal years ended December 31, 2014, 2013 and 2012:
(1) Interest income is included in other income (expense) and is not netted against interest expense in our Consolidated Statement of Operations.
(2) The impairment during the fiscal year ended December 31, 2014 consisted of a write-off of goodwill relating to our revenue cycle services operating unit;
Index to Financial Statements
(3) Represents non-cash share-based compensation to both employees and directors. We believe excluding this non-cash expense allows us to compare our operating performance without regard to the impact of share-based compensation expense, which varies from period to period based on the amount and timing of grants.
(4) The imputed rental income recognized with respect to a capitalized building lease is deducted from net income (loss) due to its non-cash nature. We believe this income is not a useful measure of continuing operating performance. See Note 6 of the Notes to Consolidated Financial Statements herein for further discussion of this rental income.
(5) Represents the effect on revenue of adjusting the acquired deferred revenue balance associated with the Sg2 Acquisition to fair value at the acquisition date.
(6) Represents the amount attributable to restructuring, acquisition and integration-related costs which may include costs such as severance, retention, salaries relating to redundant positions, certain performance-related salary-based compensation, operating infrastructure costs and facility consolidation costs.
(7) The amount reflects the loss on debt extinguishment and is comprised of: (i) a $20.0 million write-off of debt issuance costs relating to our previous credit facility; and (ii) an $8.2 million swap termination fee for two forward starting interest rate swaps also relating to our previous credit facility.
Adjusted Net Income and Diluted Adjusted Earnings Per Share. The Company defines: i) adjusted net income as net income excluding non-cash acquisition-related intangible amortization and depreciation, and non-recurring expense items on a tax-adjusted basis, non-cash share-based compensation and certain restructuring, acquisition and integration-related expenses on a tax-adjusted basis; purchase accounting adjustments on a tax-adjusted basis; and ii) diluted adjusted EPS as earnings per share excluding non-cash acquisition-related intangible amortization and depreciation, and non-recurring expense items, non-cash share-based compensation and certain restructuring, acquisition and integration-related expenses on a tax-adjusted basis. Adjusted net income and diluted adjusted EPS are not measures of liquidity under GAAP, or otherwise, and are not alternatives to cash flow from continuing operating activities. Diluted adjusted EPS growth has been used historically by the Company as the financial performance metric that determines whether certain equity awards granted pursuant to the Company’s LTPIP will vest. Use of these measures allows management and the Board to analyze the Company’s operating performance on a consistent basis by removing the impact of certain non-cash and non-recurring items from our operations and assess organic growth and accretive business transactions. As a significant portion of senior management’s incentive-based compensation historically has been based on the achievement of certain diluted adjusted EPS growth over time, which is intended to reward them for organic growth and accretive business transactions, investors may find such information useful; however, as non-GAAP financial measures, adjusted net income and diluted adjusted EPS are not the sole measures of the Company’s financial performance and may not be the best measures for investors to gauge such performance.
Index to Financial Statements
(1) Given the Company’s net loss, GAAP diluted net loss per share is the same as basic net loss per share. However, the Company uses weighted average shares, diluted in its calculation of non-GAAP adjusted EPS. Amount represents the impact of this change.
(2) Represents the amount and the per share impact, on a pre-tax basis, of non-cash share-based compensation to employees and directors. We believe excluding this non-cash expense allows us to compare our operating performance without regard to the impact of share-based compensation expense, which varies from period to period based on the amount and timing of grants.
(3) Represents the amount and the per share impact, on a pre-tax basis, of restructuring, acquisition and integration-related costs which may include costs such as severance, retention, salaries relating to redundant positions, certain performance-related salary-based compensation, operating infrastructure costs and facility consolidation costs. We consider these charges to be non-operating expenses and unrelated to our underlying results of operations.
(4) Represents the amount and the per share impact, on a pre-tax basis, of the effect on revenue of adjusting the acquired deferred revenue balance associated with the Sg2 Acquisition to fair value at the acquisition date.
(5) Represents the amount and the per share impact, on a pre-tax basis, of loss on debt extinguishment and is comprised of (i) a $20.0 million write-off of debt issuance costs relating to our previous credit facility; and (ii) an $8.2 million swap termination fee for two forward starting interest rate swaps also relating to our previous credit facility.
(6) Represents the amount and per share impact, on a pre-tax basis, of a write-off of goodwill relating to our revenue cycle services operating unit.
(7) Reflects the tax impact on the adjustments used to derive Non-GAAP diluted adjusted EPS. We used a tax rate of 40.0% for the fiscal years ended December 31, 2014, 2013 and 2012 since we believe the 40% will be our normalized long-term tax rate. The effective tax rate for the fiscal years ended December 31, 2014, 2013 and 2012 was 1,781.0% (40.2% excluding the RCS impairment charge), 37.8% and 17.7%, respectively.
(8) As noted above, for the fiscal year ended December 31, 2014, the Company used the weighted average shares - diluted in its calculation of non-GAAP adjusted EPS. Given the Company’s net loss in 2012, basic and diluted weighted average shares are the same for EPS and Non-GAAP diluted adjusted EPS.
Related Party Transactions
For a discussion of our transactions with certain related parties see Note 17 of the Notes to Consolidated Financial Statements.
Index to Financial Statements New Accounting Pronouncements
Going Concern
In August 2014, the Financial Accounting Standards Board (“FASB”) issued an accounting standard update relating to disclosure of uncertainties about an entity’s ability to continue as a going concern. The update provides guidance about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures in the event that there is such substantial doubt. The update will be effective on January 1, 2016.
Share-Based Compensation
In June 2014, the FASB issued an accounting standard update relating to reporting entities that grant their employees share-based payments in which the terms of the award provide that a performance target that affects vesting could be achieved after the requisite service period. This update requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. The update will be effective on January 1, 2016.
Revenue Recognition
In May 2014, the FASB issued an accounting standard update relating to revenue from contracts with customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The update will replace most existing revenue recognition guidance under generally accepted accounting principles when it becomes effective. The update is effective for us on January 1, 2017. Early application is not permitted. The update permits the use of either the retrospective or cumulative effect transition method. We are evaluating the effect that the update will have on our consolidated financial statements and related disclosures. We have not yet selected a transition method nor have we determined the effect of the standard on our ongoing financial reporting.
Discontinued Operations
In April 2014, the FASB issued an accounting standard update which revises what qualifies as a discontinued operation, changes the criteria for determining which disposals can be presented as discontinued operations and modifies related disclosure requirements. This update will be effective for applicable transactions occurring after January 1, 2015.
Income Taxes
In July 2013, the FASB issued an accounting standard update relating to the presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. This update amends existing GAAP that required in certain cases, an unrecognized tax benefit, or portion of an unrecognized tax benefit, to be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward when such items exist in the same taxing jurisdiction. The amendments in this update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The amendments should be applied prospectively to all unrecognized tax benefits that exist at the effective date, and retrospective application is permitted. We adopted this update on January 1, 2014.
Obligations Resulting from Joint and Several Liability Arrangements
In February 2013, the FASB issued guidance for the recognition, measurement and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of the guidance is fixed at the reporting date. Examples of obligations within the scope of this update
Index to Financial Statements
include debt arrangements, other contractual obligations and settled litigation and judicial rulings. The guidance requires an entity to measure such obligations as the sum of the amount that the reporting entity agreed to pay on the basis of its arrangement among its co-obligors plus additional amounts the reporting entity expects to pay on behalf of its co-obligors. The guidance in the update also requires an entity to disclose the nature and amount of the obligation as well as other information about those obligations. The update is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. We adopted this update on January 1, 2014.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Quantitative and Qualitative Disclosures About Market Risk
Foreign currency exchange risk.Certain of our contracts are denominated in Canadian dollars. As our Canadian sales have not historically been significant to our operations, we do not believe that changes in theCanadian dollar relative to the U.S. dollar will have a significant impact on our financial condition, results of operations or cash flows. We currently do not transact any other business in any currency other than the U.S. dollar. As we continue to grow our operations, we may increase the amount of our sales to foreign clients. Although we do not expect foreign currency exchange risk to have a significant impact on our future operations, we will assess the risk on a case-specific basis to determine whether any forward currency hedge instrument would be warranted.
Interest rate risk.We had outstanding borrowings on our Term Loan Facility and Revolving Credit Facility of $556.0 million as of December 31, 2014. The Term A Facility and the Revolving Credit Facility bear interest at LIBOR plus an applicable margin. The Term B Facility bears interest at LIBOR, subject to a floor of 1.25% plus an applicable margin. We also had outstanding an aggregate principal amount of our Notes of $325.0 million as of December 31, 2014, which bears interest at 8% per annum.
To the extent we do not hedge our variable rate debt, interest rates and interest expense could increase significantly.
A hypothetical 100 basis point increase in LIBOR, which would represent potential interest rate change exposure on our outstanding term loans, would have resulted in an approximate $5.6 million increase to our interest expense for the fiscal year ended December 31, 2014.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The information required by this item is included herein beginning on page.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
Not applicable.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES.
Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by us in reports we file or submit 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 our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating disclosure controls and procedures, management recognizes that any control and procedure, no matter how well designed
Index to Financial Statements
and operated, can provide only reasonable assurance of achieving the desired control objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship regarding the potential utilization of certain controls and procedures. In September 2014, we completed our acquisition of Sg2 (see Note 5 to the Consolidated Financial Statements). We are not required to include an assessment of the disclosure controls and procedures of a newly acquired entity in our evaluation of disclosure controls and procedures for MedAssets pursuant to guidance supplied by the SEC to companies regarding the treatment of business combinations. In accordance with our integration efforts, we have initiated the process of incorporating Sg2’s operations into our disclosure controls and procedures program and plan to include them in our formal evaluation process in the future within the time period provided by applicable SEC rules and regulations.
As required by Rule 13a-15(b) under the Exchange Act, our management, with the participation of our chief executive officer and chief financial officer, evaluated the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act). Based on such evaluation, our chief executive officer and chief financial officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective and were operating at a reasonable assurance level.
Management Report on Internal Control Over Financial Reporting
Our 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) to provide reasonable assuranceregarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Management assessed our internal control over financial reporting as of December 31, 2014. In making this assessment, we used the criteria established by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control - Integrated Framework. Management’s assessment included evaluation of elements such as the design and operating effectiveness of key financial reporting controls, process documentation, accounting policies, and our overall control environment. In September 2014, we completed our acquisition of Sg2 (see Note 5 to the Consolidated Financial Statements). In accordance with our integration efforts, we plan to initiate the process of incorporating Sg2’s operations into our internal control over financial reporting program in the future within the time period provided by applicable SEC rules and regulations. As such, management has excluded this acquired business from its assessment.
Based on our assessment, management has concluded that our internal control over financial reporting was effective as of December 31, 2014 to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with U.S. generally accepted accounting principles. The effectiveness of our internal control over financial reporting as of December 31, 2014 has been audited by KPMG LLP, an independent registered public accounting firm, as stated in their report which is included herein.
Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financial reporting for the three months ended December 31, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION.
None.
Index to Financial Statements PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
Information regarding directors, executive officers and corporate governance will be set forth in the proxy statement for our 2015 annual meeting of stockholders and is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
Information regarding executive compensation will be set forth in the proxy statement for our 2015 annual meeting of stockholders and is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
Information regarding security ownership of certain beneficial owners and management and related stockholder matters will be set forth in the proxy statement for our 2015 annual meeting of stockholders and is incorporated herein by reference. Also, see section “Equity Compensation Plan Information” in Item 5 of Part 2 herein.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.
Information regarding certain relationships and related transactions and director independence will be set forth in the proxy statement for our 2015 annual meeting of stockholders and is incorporated herein by reference.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.
Information regarding principal accountant fees and services will be set forth in the proxy statement for our 2015 annual meeting of stockholders and is incorporated herein by reference.
PART IV
ITEM 15.
ITEM 15. Exhibits and Financial Statement Schedules.
a) documents as part of this Report.
(1) The following consolidated financial statements are filed herewith in Item 8 of Part II above.
(i) Report of Independent Registered Public Accounting firm
(ii) Consolidated Balance Sheets
(iii) Consolidated Statements of Operations
(iv) Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income (Loss)
(v) Consolidated Statements of Cash Flows
(vi) Notes to Consolidated Financial Statements
(2) Financial Statement Schedule
All other supplemental schedules are omitted because of the absence of conditions under which they are required.
Index to Financial Statements
(3) Exhibits
Index to Financial Statements
Index to Financial Statements
* Filed herewith
Index to Financial Statements 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 by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Index to Financial Statements INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Index to Financial Statements Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
MedAssets, Inc.:
We have audited the accompanying consolidated balance sheets of MedAssets, Inc. (the Company) as of December 31, 2014 and 2013, and the related consolidated statements of operations, comprehensive (loss) income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2014. We also have audited the Company’s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the Company’s internal control over financial reporting 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 audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of MedAssets, Inc. as of December 31, 2014 and 2013, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2014, in conformity with U.S. generally accepted accounting principles. Also in our opinion, MedAssets, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
The Company acquired Sg2, LLC (Sg2) in 2014, and management excluded from its assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2014, Sg2’s internal control over financial reporting associated with total assets of approximately $169 million and total revenues of approximately $11.7 million included in the consolidated financial statements of the Company as of and for the year ended December 31, 2014. Our audit of internal control over financial reporting of the Company also excluded an evaluation of the internal control over financial reporting of Sg2.
/s/ KPMG LLP
Atlanta, Georgia
March 2, 2015
Index to Financial Statements MedAssets, Inc.
Consolidated Balance Sheets
The accompanying notes are an integral part of these consolidated financial statements.
Index to Financial Statements MedAssets, Inc.
Consolidated Statements of Operations
The accompanying notes are an integral part of these consolidated financial statements.
Index to Financial Statements MedAssets, Inc.
Consolidated Statements of Stockholders’ Equity
Year Ended December 31, 2014
The accompanying notes are an integral part of these consolidated financial statements.
Index to Financial Statements MedAssets, Inc.
Consolidated Statements of Stockholders’ Equity
Year Ended December 31, 2013
The accompanying notes are an integral part of these consolidated financial statements.
Index to Financial Statements MedAssets, Inc.
Consolidated Statements of Stockholders’ Equity
Year Ended December 31, 2012
The accompanying notes are an integral part of these consolidated financial statements.
Index to Financial Statements MedAssets, Inc.
Consolidated Statements of Cash Flows
The accompanying notes are an integral part of these consolidated financial statements.
Index to Financial Statements MedAssets, Inc.
Notes to Consolidated Financial Statements
(in thousands, except share and per share amounts)
1. DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
We provide technology-enabled products and services that, together, deliver solutions designed to reduce total cost of care, enhance operational efficiency, align clinical delivery with advance care coordination and improve revenue performance for hospitals, health systems and other ancillary healthcare providers. Our client-specific solutions are designed to efficiently analyze detailed information across the spectrum of cost, operations, clinical delivery and reimbursement. Our solutions integrate with existing operations and enterprise software systems of our clients and provide financial improvement with minimal upfront costs or capital expenditures. Our operations and clients are primarily located throughout the United States and to a limited extent, Canada.
Basis of Presentation
The consolidated financial statements include the accounts of MedAssets, Inc. and our wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. We have prepared the accompanying consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”).
Use of Estimates
The preparation of the financial statements and related disclosures in conformity with GAAP and pursuant to the rules and regulations of the SEC, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ materially from those estimates. We believe that the estimates, assumptions and judgments involved in revenue recognition, allowances for doubtful accounts and returns, product development costs, share-based payments, business combinations, impairment of goodwill, intangible assets and long-lived assets, and accounting for income taxes have the greatest potential impact on our consolidated financial statements.
Cash and Cash Equivalents
All of our highly liquid investments with original maturities of three months or less at the date of purchase are carried at cost which approximates fair value and are considered to be cash equivalents. Currently, our excess cash is voluntarily used to repay our swing-line credit facility, if any, on a daily basis and applied against our revolving credit facility on a routine basis when our swing-line credit facility is undrawn. In addition, we may periodically make voluntary repayments on our term loans. Cash and cash equivalents were $12,100 and $2,790 as of December 31, 2014 and December 31, 2013, respectively, and our swing-line balance was zero during those reporting periods. We had $152,000 and $10,000 outstanding on our revolving credit facility as of December 31, 2014 and 2013, respectively. In the event our cash balance is zero at the end of a period, any outstanding checks are recorded as accrued expenses. See Note 6 for immediately available cash under our revolving credit facility.
Additionally, we have a concentration of credit risk arising from cash deposits held in excess of federally insured amounts totaling $11,600 as of December 31, 2014.
Accounts Receivables and Allowance
Our trade accounts receivables are recorded at invoiced amounts and do not bear interest. We record an allowance for doubtful accounts against our trade receivables to reflect the balance at net realizable value on our consolidated balance sheets.
Index to Financial Statements MedAssets, Inc.
Notes to Consolidated Financial Statements - (Continued)
(in thousands, except share and per share amounts)
An allowance for doubtful accounts is established for accounts receivable estimated to be uncollectible due to client credit worthiness and is adjusted periodically based upon management’s evaluation of current economic conditions, historical experience and other relevant factors that, in the opinion of management, deserve recognition in estimating such allowance. Estimates related to our allowance for doubtful accounts are recorded as bad debt expense in our consolidated statement of operations. We review our allowance for doubtful accounts based upon the credit risk of specific clients, historical experience and other information.
Client Service Allowance
We maintain a client service allowance based on management’s evaluation of historical experience, current trends, individual client experience and other relevant factors that, in the opinion of management, deserve recognition in estimating such allowance. Estimates related to our client service allowance are recorded as a reduction to net revenue in our consolidated statements of operations and as a current liability in our consolidated balance sheets.
Financial Instruments
The carrying amount reported on the balance sheet for trade accounts receivable, trade accounts payable, accrued revenue share obligations and rebates, accrued payroll and benefits, and other accrued expenses approximate fair values due to the short maturities of the financial instruments.
We believe the carrying amount of notes payable approximates fair value since they bear interest at variable rates, and interest expense is accrued on notes outstanding. The current portion of notes payable represents the portion of notes payable due within one year of the period end.
The fair value of the bonds payable is calculated based on quoted market prices for the same or similar issues or on rates currently offered to the Company for similar debt instruments.
Revenue Recognition
Net revenue consists primarily of: (a) administrative fees reported under contracts with manufacturers and distributors and (b) other service fee revenue that is comprised of: (i) consulting revenues received under fixed-fee or contingent-based service contracts; (ii) subscription and implementation fees received under our software as a service (“SaaS”) agreements; and (iii) transaction and contingent fees received under service contracts. Revenue is earned primarily in the United States and to a limited extent, Canada.
Revenue is recognized when: 1) there is persuasive evidence of an arrangement; 2) the fee is fixed or determinable; 3) services have been rendered and payment has been contractually earned, and 4) collectability is reasonably assured.
Administrative Fees
Administrative fees are generated under contracted purchasing agreements with manufacturers and distributors of healthcare products and services (“vendors”). Vendors pay administrative fees to us in return for the provision of aggregated sales volumes from hospitals and health systems that purchase products qualified under our contracts. The administrative fees paid to us represent a percentage of the purchase volume of our hospitals and healthcare system clients.
Index to Financial Statements MedAssets, Inc.
Notes to Consolidated Financial Statements - (Continued)
(in thousands, except share and per share amounts)
We earn administrative fees in the quarter in which the respective vendors report client purchasing data to us, usually a month or a quarter in arrears of actual client purchase activity. The majority of our vendor contracts disallow netting product returns from the vendors’ administrative fee calculations in periods subsequent to their reporting dates. For those contracts that allow for netting of product returns, vendors supply us with sufficient purchase and return data needed for us to estimate and record an allowance for sales returns.
Revenue is recognized upon the receipt of vendor reports as this reporting proves that the delivery of the product or service has occurred, the administrative fees are fixed and determinable based on reported purchasing volume, and collectability is reasonably assured. Our client and vendor contracts substantiate persuasive evidence of an arrangement.
Certain hospital and healthcare system clients receive a revenue share obligation. This obligation is recognized according to the clients’ contractual agreements with our group purchasing organization (“GPO”) as the related administrative fee revenue is recognized. In accordance with GAAP relating to principal agent considerations under revenue recognition, this obligation is netted against the related gross administrative fees, and is presented on the accompanying consolidated statements of operations as a reduction to arrive at total net revenue on our consolidated statements of operations.
Net administrative fees shown on our consolidated statements of operations reflect our gross administrative fees net of our revenue share obligation. Gross administrative fees include all administrative fees we receive pursuant to our GPO vendor contracts. Our revenue share obligation represents the portion of the administrative fees we are contractually obligated to share with certain of our GPO clients. The following shows the details of net administrative fee revenues for the years ended December 31, 2014, 2013 and 2012:
Other Service Fees
Consulting Fees
We generate revenue from fixed-fee consulting contracts. Revenue under these fixed-fee arrangements is recognized based on a proportional performance method as services are performed and deliverables are provided, as long as all other elements of SAB 104 are met.
Consulting Fees with Performance Targets
We generate revenue from consulting contracts that also include performance targets. The performance targets generally relate to committed financial improvement to our clients from the use and implementation of initiatives that result from our consulting services. Performance targets are measured as our strategic initiatives are identified and implemented, and the financial improvement can be quantified by the client. In the event the performance targets are not achieved, we are obligated to refund or reduce a portion of our fees.
Under these arrangements, all revenue is deferred and recognized as the performance target is achieved and the applicable contingency is released as evidenced by client acceptance. All revenues are fixed and determinable and
Index to Financial Statements MedAssets, Inc.
Notes to Consolidated Financial Statements - (Continued)
(in thousands, except share and per share amounts)
the applicable service is rendered prior to recognition in the financial statements in accordance with SAB 104. One-time or non-recurring performance fees are recognized proportionately over the contract term in the period in which they are earned. We do not defer any related costs under these types of arrangements.
Subscription and Implementation Fees
We follow GAAP for revenue recognition relating to arrangements that include the right to use software stored on another entity’s hardware for our SaaS-based solutions. Our clients are typically charged upfront non-refundable fees for implementation and recurring host subscription fees for access to web-based services. Our clients have access to our software applications while the data is hosted and maintained on our servers. Our clients cannot take physical possession of the software applications. Revenue from monthly hosting arrangements and services is recognized on a subscription basis over the period in which our clients have access to the product. Implementation fees are typically billed at the beginning of the arrangement and recognized as revenue over the greater of the subscription period or the estimated client relationship period beginning at client acceptance. We currently estimate the client relationship period at six years for our SaaS-based Revenue Cycle Management solutions. Contract subscription periods generally range from two to six years from execution.
Transaction Fees and Contingent Service Fees
We generate revenue from transactional-based service contracts and contingency-fee based service contracts. Provided all other elements of revenue recognition are met, revenue under these arrangements is recognized as services are performed, deliverables are provided and related contingencies are removed. All related direct costs are recorded as period costs when incurred.
Other
Other fees are primarily earned for our annual client and vendor meeting. Fees for our annual client and vendor meeting are recognized when the meeting is held and related obligations are performed.
Revenue Recognition - Multiple-Deliverable Revenue Arrangements
Effective January 1, 2011, we adopted the FASB’s accounting standards update for multiple-deliverable arrangements on a prospective basis. The guidance establishes a selling price hierarchy for determining the appropriate value of a deliverable. The hierarchy is based on: (a) vendor-specific objective evidence, if available (“VSOE”); (b) third-party evidence (“TPE”) if vendor-specific objective evidence is not available; or (c) estimated selling price (“ESP”) if neither VSOE nor TPE is available. The guidance also eliminates the residual method of allocation of contract consideration to elements in the arrangement and requires that arrangement consideration be allocated to all elements at the inception of the arrangement using the relative selling price method.
Based on the selling price hierarchy established by the update, if we are unable to establish selling price using VSOE or TPE, we will establish an ESP. ESP is the estimated price at which we would transact a sale if the product or service were sold on a stand-alone basis. We establish a best estimate of ESP considering internal factors relevant to pricing practices such as costs and margin objectives, standalone sales prices of similar services and percentage of the fee charged for a primary service relative to a related service. Additional consideration is also given to market conditions such as competitor pricing strategies and other factors such as market size, the number of facilities, and the number of beds in a facility. If available, we regularly review VSOE and TPE for our services in addition to ESP.
Index to Financial Statements MedAssets, Inc.
Notes to Consolidated Financial Statements - (Continued)
(in thousands, except share and per share amounts)
Our revenue recognition policy for multiple-deliverable revenue arrangements is as follows:
We may bundle certain of our SCM service and technology offerings into a single service arrangement. We may also bundle certain of our RCM service and technology offerings into a single service arrangement. In addition, we may bundle certain of both of our SCM and RCM service and technology offerings together into a single service arrangement and market them as an enterprise arrangement.
Service arrangements generally include multiple deliverables or elements such as group purchasing services, consulting services, and SaaS-based subscription and implementation services. Provided that the total arrangement consideration is fixed and determinable at the inception of the arrangement, we allocate the total arrangement consideration to the individual elements within the arrangement based on their relative selling price using VSOE, TPE, or ESP for each element of the arrangement. We establish VSOE, TPE, or ESP for each element of a service arrangement based on the price charged for a particular element when it is sold separately in a stand-alone arrangement. Revenue is then recognized for each element according to the following revenue recognition methodology: (i) group purchasing service revenue is recognized as administrative fees are reported to us (generally approximates ratable recognition over the contractual term); (ii) consulting revenue is recognized on a proportional performance method as services are performed and deliverables are provided or once performance targets are accepted by our clients; and (iii) SaaS-based subscription revenue is recognized ratably over the subscription period (upfront non-refundable fees on our SaaS-based subscription services are recognized over the longer of the subscription period or the estimated client relationship period) beginning with the period in which the SaaS-based services are accepted by the client.
The majority of our multi-element service arrangements that include group purchasing services are not fixed and determinable at the inception of the arrangement because the fees for such arrangements are earned as administrative fees are reported. Administrative fees are not fixed and determinable until the receipt of vendor reports. For these multi-element service arrangements, we recognize each element as such element is delivered and as administrative fees are reported to us which generally approximates ratable recognition over the contract term.
In addition, certain of our arrangements include performance targets or other contingent fees that are not fixed and determinable at the inception of the arrangement. If the total arrangement consideration is not fixed and determinable at the inception of the arrangement, we allocate only that portion of the arrangement that is fixed and determinable to each element. As additional consideration becomes fixed, it is similarly allocated based on VSOE, TPE or ESP to each element in the arrangement and recognized in accordance with each element’s revenue recognition policy.
Performance targets generally relate to committed financial improvement to our clients from the use of our services. Revenue is only recognized if there are no refund rights and the fees earned are fixed and determinable. We obtain client acceptance as performance targets are achieved. In the event the performance targets are not achieved, we may be obligated to refund or reduce a portion of our fees and as such do not consider these fees fixed and determinable until we receive client acceptance.
In multi-element service arrangements that involve performance targets, the amount of revenue recognized on a particular delivered element is limited to the amount of revenue earned based on: (i) the proportionate performance of the individual element compared with all elements in the arrangement using the relative selling price method; and (ii) the proportional performance of that individual element. In all cases, revenue recognition is deferred on each element until the contingency on the performance target has been removed and the related revenue is fixed and determinable.
Index to Financial Statements MedAssets, Inc.
Notes to Consolidated Financial Statements - (Continued)
(in thousands, except share and per share amounts)
Deferred Costs
We capitalize direct costs incurred during the implementation of our SaaS-based solutions. Deferred implementation costs are amortized into cost of revenue in proportion to the revenue earned over the client relationship period. In addition, we defer upfront sales commissions primarily related to subscription and implementation fees and expense these costs ratably over the contract term. The current and long term portions of deferred costs are included in “Prepaid expense and other current assets” and “Other assets,” respectively in the accompanying consolidated balance sheets.
Property and Equipment
Property and equipment are stated at cost and include the capitalized portion of internal use product development costs. Depreciation of property and equipment (which includes amortization of capitalized internal use software) is computed on the straight-line method over the estimated useful lives of the assets which are as follows:
We evaluate the impairment or disposal of our property and equipment in accordance with GAAP. We evaluate the recoverability of property and equipment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable, or whenever management has committed to an asset disposal plan. Whenever these indicators occur, recoverability is determined by comparing the net carrying value of an asset to its total undiscounted cash flows.
Product Development Costs
Our product development costs include costs incurred: (i) prior to the application development stage; (ii) prior to technological feasibility being reached; and (iii) in the post-development or maintenance stage. The majority of our software development costs relate to internal-use software development costs which are capitalized in accordance with relevant GAAP and classified as property and equipment. We have a small amount of external-use software development costs which are capitalized when the technological feasibility of a software product has been established in accordance with GAAP relating to research and development costs of computer software and are included in “Other” within Other long term assets in the accompanying consolidated balance sheets. Capitalized software costs are amortized on a straight-line basis over the estimated useful lives of the related software applications of up to five years. We periodically evaluate the useful lives of our capitalized software costs.
Goodwill and Intangible Assets - Indefinite Life
For identified intangible assets acquired in business combinations, we allocate purchase consideration based on the fair value of intangible assets acquired in accordance with GAAP relating to business combinations.
As of December 31, 2014 and 2013, intangible assets with indefinite lives consist of goodwill. See Note 3 for further details.
Index to Financial Statements MedAssets, Inc.
Notes to Consolidated Financial Statements - (Continued)
(in thousands, except share and per share amounts)
We account for our intangible assets in accordance with GAAP relating to intangible assets, which states that goodwill or intangible assets with indefinite lives are not amortized. Our annual impairment testing date is October 1. We perform an impairment test of these assets on at least an annual basis and whenever events or changes in circumstances indicate that the carrying value of these assets may not be recoverable. To determine the fair values, we use the income approach based on estimated discounted future cash flows and the market approach based on comparable publicly traded companies in similar lines of business, and to a lesser extent, guideline public companies. Our cash flow assumptions consider historical and forecasted revenue, operating costs and other relevant factors. If the carrying value of the assets is deemed to be impaired, the amount of the impairment recognized in the financial statements is determined by estimating the fair value of the assets and recording a loss for the amount that the carrying value exceeds the estimated fair value.
We consider the following to be important factors that could trigger an impairment review: significant continued underperformance relative to historical or projected future operating results; identification of other impaired assets within a reporting unit; the more-likely-than not expectation that a reporting unit or a significant portion of a reporting unit will be sold; significant adverse changes in business climate or regulations; significant changes in senior management; significant changes in the manner of use of the acquired assets or the strategy for the Company’s overall business; significant negative industry or economic trends; a significant decline in the Company’s stock price for a sustained period or a significant unforeseen decline in the Company’s credit rating.
In connection with our 2014 annual impairment testing, we recognized an impairment charge of $52,539 on the goodwill relating to our revenue cycle services operating unit which is part of our Revenue Cycle Management reporting segment. We did not recognize any goodwill or indefinite-lived intangible asset impairments during the fiscal years ended December 31, 2013 and 2012.
Intangible Assets - Definite Life
The intangible assets with definite lives are comprised of our customer base, developed technology, non-compete agreements and certain trade name assets. See Note 4 for further details.
Intangible assets with definite lives are amortized over their estimated useful lives which have been derived based on an assessment of such factors as attrition, expected volume and price changes. We evaluate the useful lives of our intangible assets with definite lives on an annual basis. Costs related to our customer base are amortized over the period and pattern of economic benefit that is expected from the client relationship based on the expected benefit of discounted cash flows. Customer base intangibles have estimated useful lives that range from seven to fourteen years. Costs related to developed technology are amortized on a straight-line basis over a useful life of three to seven years. Costs related to non-compete agreements are amortized on a straight-line basis over the life of the respective agreements. Costs associated with definite-lived trade names are amortized over the period of expected benefit of two to three years.
We evaluate indefinite-lived intangibles for impairment when events or changes in circumstances indicate that the carrying value of such assets may not be recoverable.
Business Combinations
We account for acquisitions in accordance with GAAP relating to business combinations. The guidance requires recognition of assets acquired, liabilities assumed, and contingent consideration at their fair value on theacquisition date with subsequent changes recognized in earnings; requires acquisition related expenses and restructuring costs to be recognized separately from the business combination and expensed as incurred; requires in-process research and
Index to Financial Statements MedAssets, Inc.
Notes to Consolidated Financial Statements - (Continued)
(in thousands, except share and per share amounts)
development to be capitalized at fair value as an indefinite-lived intangible asset until completion or abandonment; and requires that changes in accounting for deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period be recognized as a component of provision for taxes. While we use our best estimates and assumptions as a part of the purchase price allocation process to accurately value assets acquired and liabilities assumed as of the business combination date, our estimates and assumptions are inherently uncertain and subject to refinement. As a result, during the preliminary purchase price measurement period, which may be up to one year from the business combination date, we record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. After the preliminary purchase price measurement period, we record adjustments to assets acquired or liabilities assumed subsequent to the purchase price measurement period in our operating results in the period in which the adjustments were determined.
Restructuring, Acquisition and Integration - Related Expenses
Restructuring, acquisition and integration-related expenses may consist of: (i) transaction costs incurred to complete acquisitions including due diligence, consulting and other advisory related fees; (ii) integration-related costs related to third party consulting and other employee-related costs associated with the integration of an acquired business into our business; (iii) acquisition-related fees associated with unsuccessful acquisition attempts; and (iv) restructuring-related costs. Our restructuring-related costs are comprised primarily of employee termination costs related to headcount reductions. A liability for costs associated with an exit or disposal activity is recognized and measured initially at fair value only when the liability is incurred. Our restructuring charges also include accruals for estimated losses related to our excess facilities, based on our contractual obligations, net of estimated sublease income. We reassess the liability periodically based on market conditions. Refer to Note 5 for additional details of restructuring activities.
Deferred Revenue
Deferred revenue consists of unrecognized revenue related to advanced client invoicing or client payments received prior to revenue being realized and earned. Substantially all deferred revenue consists of: (i) deferred administrative fees; (ii) deferred service fees; (iii) deferred software and implementation fees; and (iv) other deferred fees, including receipts for our annual client and vendor meeting prior to the event.
Deferred administrative fees arise when cash is received from vendors prior to the receipt of vendor reports. Vendor reports provide details about a client’s purchases and provide evidence that delivery of product or service occurred. Administrative fees are also deferred when reported fees are contingent upon meeting a performance target that has not yet been achieved.
Deferred service fees arise when cash is received from clients or upon advanced client invoicing, prior to delivery of service. When the fees are contingent upon meeting a performance target that has not yet been achieved, the service fees are either not invoiced or are deferred on our balance sheet.
Deferred software and implementation fees primarily include: (i) implementation fees that are received at the beginning of a subscription contract. These fees are deferred and amortized over the expected period of benefit, which is the greater of the contracted subscription period or the client relationship period; and to a lesser extent, (ii) software support fees which represent client payments made in advance for annual software support contracts. Software and implementation fees are also deferred when the fees are contingent upon meeting a performance target that has not yet been achieved.
For the years ended December 31, 2014 and 2013, deferred revenues recorded that are contingent upon meeting performance targets were $8,441 and $6,516, respectively.
Index to Financial Statements MedAssets, Inc.
Notes to Consolidated Financial Statements - (Continued)
(in thousands, except share and per share amounts)
The following table summarizes the deferred revenue categories and balances as of:
Revenue Share Obligation and Rebates
We accrue revenue share obligation and rebates for certain clients according to our: (i) revenue share program and (ii) vendor rebate program.
Under our revenue share program, certain hospital and health system clients receive revenue share payments. This obligation is accrued according to contractual agreements between our GPO and the hospital and healthcare clients as the related administrative fee revenue is recognized. See description of this accounting treatment under “Administrative Fees” in the “Revenue Recognition” section.
We receive rebates pursuant to the provisions of certain vendor agreements. The rebates are earned by our hospitals and health system clients based on the volume of their purchases. We collect, process, and pay the rebates as a service to our clients. Substantially all the vendor rebates are excluded from revenue. The vendor rebates are accrued for active clients when we receive cash payments from vendors.
Advertising Costs
Advertising costs are expensed as incurred. Advertising expense for the years ended December 31, 2014, 2013 and 2012 was $2,598, $3,196 and $2,750, respectively.
Defined Contribution Plan
We sponsor a defined contribution plan for eligible employees. Under the terms of the plan, employees have the option of contributing a portion of their annual salary to the plan. We make matching contributions of 50 cents for each dollar contributed by employees up to the first six percent of compensation contributed. For the years ended December 31, 2014, 2013 and 2012, our plan contributions amounted to $6,535, $6,062 and $5,175, respectively.
Share-Based Compensation
Share-based payment transactions (as fully discussed in Note 9) are accounted for in accordance with GAAP relating to stock compensation. The guidance requires companies to recognize the cost (expense) of all share-based payment transactions in the financial statements. We expense employee share-based compensation using fair value-based measurement over an appropriate requisite service period primarily on an accelerated basis.
Index to Financial Statements MedAssets, Inc.
Notes to Consolidated Financial Statements - (Continued)
(in thousands, except share and per share amounts)
Derivative Financial Instruments
Derivative instruments are accounted for in accordance with GAAP relating to derivatives and hedging. The guidance requires companies to recognize derivative instruments as either assets or liabilities on the balance sheet at fair value. See Note 13 for further discussion regarding our derivative financial instruments.
Income Taxes
In accordance with GAAP relating to income taxes, we recognize deferred income taxes based on the expected future tax consequences of differences between the financial statement basis and the tax basis of assets and liabilities, calculated using enacted tax rates in effect for the tax year in which the differences are expected to be reflected in the tax return.
The carrying value of our net deferred tax assets assumes that we will be able to generate sufficient future taxable income in applicable tax jurisdictions to realize the value of these assets. If we are unable to generate sufficient future taxable income in these jurisdictions, a valuation allowance is recorded when it is more likely than not that the value of the deferred tax assets is not realizable. Management evaluates the realizability of deferred tax assets and assesses the need for any valuation allowance adjustment. It is our policy to provide for uncertain tax positions and the related interest and penalties based upon management’s assessment of whether a tax benefit is more likely than not to be sustained upon examination by tax authorities. To the extent that the tax outcome of these uncertain tax positions falls below more likely than not, the change in estimate will impact the income tax provision in the period in which such determination is made. At December 31, 2014, we believe we have appropriately accounted for any unrecognized tax benefits. To the extent we prevail in matters for which a liability for an unrecognized tax benefit is established or we are required to pay amounts in excess of the liability, our effective tax rate in a given financial statement period may be affected. See Note 10 for further information.
Sales Taxes
In accordance with GAAP relating to principal agent considerations under revenue recognition, we record any tax assessed by a governmental authority that is directly imposed on a revenue-producing transaction between a seller and a client on a net basis (excluded from revenues).
Basic and Diluted Net Income and Loss Per Share
Basic net income or (loss) per share (“EPS”) is calculated in accordance with GAAP relating to earnings per share. Diluted EPS assumes the conversion, exercise or issuance of all potential common stock equivalents, unless the effect of inclusion would result in the reduction of a loss or the increase in income per share. For purposes of this calculation, our stock options, stock warrants, non-vested restricted stock, stock-settled stock appreciation rights and shares that were purchasable pursuant to our employee stock purchase plan are considered to be potential common shares and are only included in the calculation of diluted EPS when the effect is dilutive.
The shares used to calculate basic and diluted EPS represent the weighted-average common shares outstanding. Diluted net (loss) per share is the same as basic net (loss) per share for the fiscal years ended December 31, 2014 and 2012 since the effect of any potentially dilutive securities was excluded (as they were anti-dilutive due to our net loss).
Index to Financial Statements MedAssets, Inc.
Notes to Consolidated Financial Statements - (Continued)
(in thousands, except share and per share amounts)
Comprehensive Income
Comprehensive income reflects the change in equity during the periods presented and is comprised of all components of net income and all components of other comprehensive income.
Recent Accounting Pronouncements
Going Concern
In August 2014, the Financial Accounting Standards Board (“FASB”) issued an accounting standard update relating to disclosure of uncertainties about an entity’s ability to continue as a going concern. The update provides guidance about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures in the event that there is such substantial doubt. The update will be effective on January 1, 2016.
Share-Based Compensation
In June 2014, the FASB issued an accounting standard update relating to reporting entities that grant their employees share-based payments in which the terms of the award provide that a performance target that affects vesting could be achieved after the requisite service period. This update requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. The update will be effective on January 1, 2016.
Revenue Recognition
In May 2014, the FASB issued an accounting standard update relating to revenue from contracts with customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The update will replace most existing revenue recognition guidance under GAAP when it becomes effective. The update is effective for us on January 1, 2017. Early application is not permitted. The update permits the use of either the retrospective or cumulative effect transition method. We are evaluating the effect that the update will have on our consolidated financial statements and related disclosures. We have not yet selected a transition method nor have we determined the effect of the standard on our ongoing financial reporting.
Discontinued Operations
In April 2014, the FASB issued an accounting standard update which revises what qualifies as a discontinued operation, changes the criteria for determining which disposals can be presented as discontinued operations and modifies related disclosure requirements. This update will be effective for applicable transactions occurring after January 1, 2015.
Income Taxes
In July 2013, the FASB issued an accounting standard update relating to the presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. This update amends existing GAAP that required in certain cases, an unrecognized tax benefit, or portion of an unrecognized tax benefit, to be presented in the financial statements as a reduction to a deferred tax asset for a
Index to Financial Statements MedAssets, Inc.
Notes to Consolidated Financial Statements - (Continued)
(in thousands, except share and per share amounts)
net operating loss carryforward, a similar tax loss, or a tax credit carryforward when such items exist in the same taxing jurisdiction. The amendments in this update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The amendments should be applied prospectively to all unrecognized tax benefits that exist at the effective date, and retrospective application is permitted. We adopted this update on January 1, 2014.
Obligations Resulting from Joint and Several Liability Arrangements
In February 2013, the FASB issued guidance for the recognition, measurement and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of the guidance is fixed at the reporting date. Examples of obligations within the scope of this update include debt arrangements, other contractual obligations and settled litigation and judicial rulings. The guidance requires an entity to measure such obligations as the sum of the amount that the reporting entity agreed to pay on the basis of its arrangement among its co-obligors plus additional amounts the reporting entity expects to pay on behalf of its co-obligors. The guidance in the update also requires an entity to disclose the nature and amount of the obligation as well as other information about those obligations. The update is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. We adopted this update on January 1, 2014.
2. PROPERTY AND EQUIPMENT
Property and equipment consists of the following as of:
We received a tenant allowance related to an operating lease entered into on March 1, 2013 amounting to $10,378 which was recorded as a leasehold improvement on our consolidated balance sheet. The leasehold improvement is being depreciated on a straight line basis over the term of the lease of fifteen years. We had approximately $9,110 and $9,802 included in property and equipment on our consolidated balance sheet as of December 31, 2014 and 2013, respectively.
During the year ended December 31, 2014 and 2012, we had no impairment charges related to property and equipment.
During the year ended December 31, 2013, we had impairment charges related to property and equipment of approximately $3,551.
Index to Financial Statements MedAssets, Inc.
Notes to Consolidated Financial Statements - (Continued)
(in thousands, except share and per share amounts)
Software - Internal Use
We classify capitalized costs of software developed for internal use in property and equipment. Costs capitalized for software to be sold, leased or otherwise marketed are classified as other assets. Software acquired in a business combination is classified as a developed technology intangible asset. Additions of capitalized costs of software developed for internal use during the years ended December 31, 2014 and 2013 amounted to $38,092 and $38,944, respectively. Accumulated amortization related to capitalized costs of software developed for internal use was $85,555 and $57,823 at December 31, 2014 and 2013, respectively.
Software - External Use
Capitalized costs of software developed for external use are classified as other assets on our consolidated balance sheet. Additions of capitalized costs of software developed for external use during the years ended December 31, 2014 and 2013 amounted to $3,429 and $4,399, respectively. Gross carrying value related to capitalized costs of software developed for external use was $23,263 and $19,834 at December 31, 2014 and 2013, respectively. Accumulated amortization related to capitalized costs of software developed for external use was $13,845 and $10,714 at December 31, 2014 and 2013, respectively.
During the years ended December 31, 2014, 2013 and 2012, we recognized $3,131, $2,157 and $1,859, respectively, in cost of revenue related to amortization of software developed for external use.
3. GOODWILL
Goodwill consists of the following as of:
The changes in goodwill are summarized as follows, consolidated and by segment, for the years ended December 31, 2014 and 2013:
In connection with our 2014 annual impairment testing, we recognized an impairment charge related to the goodwill at our revenue cycle services (“RCS”) operating unit within our RCM reporting segment. As part of our quarterly and annual forecasting process, we expect our future revenue growth to come from lower margin services. As a result, our projected margins within our discounted cash flow model used for impairment testing were therefore reduced, and the resulting business enterprise value could no longer support the amount of goodwill on the consolidated balance sheet related to the RCS operating unit. As a result, during the fourth quarter of 2014 we incurred a goodwill impairment charge within our RCM segment. We recorded a preliminary estimate of $52,539 related to the goodwill impairment charge. The goodwill impairment amount is preliminary pending receipt of our final valuation report.
Index to Financial Statements MedAssets, Inc.
Notes to Consolidated Financial Statements - (Continued)
(in thousands, except share and per share amounts)
Further, as a result of our annual impairment test as of October 1, 2014, the estimated fair value of our SCM segment substantially exceeded its respective carrying value and the estimated fair value of our revenue cycle technology operating unit within our RCM segment exceeded its respective carrying value by more than 10%.
4. OTHER INTANGIBLE ASSETS
Intangible assets with definite lives consist of the following:
(1) The period represents the weighted average amortization period remaining in total and for each asset class.
(1) The period represents the weighted average amortization period remaining in total and for each asset class.
In 2014, we reduced the gross carrying amount and the related accumulated amortization of our intangible assets by approximately $14,200 relating to a fully amortized customer base asset within our RCM segment.
In 2013, we reduced the gross carrying amount and the related accumulated amortization of our intangible assets by the following: (i) approximately $23,200 relating to fully amortized developed technology assets within our RCM segment; and (ii) approximately $4,300 relating to a fully amortized trade name within our SCM segment.
During the years ended December 31, 2014, 2013 and 2012, we recognized $57,593, $62,723 and $73,209, respectively in amortization expense, inclusive of ($0, $0 and $557) charged to cost of revenue for amortization
Index to Financial Statements MedAssets, Inc.
Notes to Consolidated Financial Statements - (Continued)
(in thousands, except share and per share amounts)
of external-use acquired developed technology related to definite-lived intangible assets. Future amortization expense of definite-lived intangibles as of December 31, 2014, is as follows:
5. RESTRUCTURING, ACQUISITION AND INTEGRATION-RELATED EXPENSES
Restructuring Activities
Restructuring charges consist of exit costs and other costs associated with the reorganization of our operations, including employee termination costs, lease contract termination costs, impairment of assets, and any other qualifying exit costs. Costs associated with exit or disposal activities are generally recorded when the liability is incurred.
In 2014, our management approved and initiated a plan to restructure our operations resulting in certain workforce changes within the Company that resulted in costs of approximately $4,207. During the fiscal years ended December 31, 2014, 2013 and 2012, we expensed restructuring and exit and integration-related costs of $4,207, $10,070 and $6,348, respectively. These costs are included within the restructuring, acquisition and integration-related expenses line on the accompanying consolidated statements of operations. As of December 31, 2014, cash payments were made of approximately $2,909 and we had approximately $1,918 included in current liabilities for these employee-related costs that we expect to pay over the next twelve months.
Acquisition Activities
Sg2 Acquisition
On September 22, 2014, we acquired one hundred percent of the issued and outstanding equity interests (the “Membership Interests”) of SG-2, LLC (“Sg2”) for approximately $138,201 (subject to certain purchase price adjustments) (the “Sg2 Acquisition”). We funded the Sg2 Acquisition with cash on hand and borrowings under our existing credit facility. In December 2014, we reached an agreement on the final purchase price with the sellers of Sg2 to reflect the final working capital adjustment as defined by the purchase agreement. As a result, we recorded a decrease to the purchase price of approximately $32.
Sg2 is a leading provider of healthcare market intelligence, strategic analytics and clinical consulting services to more than 1,500 hospitals and health systems, as well as pharmaceutical and medical device companies, understand current and future market dynamics in order to capitalize on growth and performance improvement opportunities.
The purchase price paid for Sg2 and the resulting goodwill of $81,476 reflects a premium relative to the value of identified assets due to the strategic importance of the transaction to us and because Sg2’s business model does not rely intensively on fixed assets.
Index to Financial Statements MedAssets, Inc.
Notes to Consolidated Financial Statements - (Continued)
(in thousands, except share and per share amounts)
We expect that all of the goodwill and identified intangible assets will be deductible for income tax purposes.
Sg2 Purchase Price Allocation
The following table summarizes the consideration paid for Sg2 and the preliminary amounts of the assets acquired and liabilities assumed recognized at the acquisition date:
The fair value of current assets acquired includes trade accounts receivable due under agreements with customers with a fair value of approximately $9,198. The gross amount due under customer contracts is $9,598, of which $400 is expected to be uncollectible.
Included in the purchase price allocation are the fair value of acquired identified intangible assets of $65,700, the fair value of which was primarily determined by applying the income approach, using several significant unobservable inputs for projected cash flows and a discount rate. These inputs are considered Level 3 inputs under the fair value measurements and disclosure guidance. The fair value of acquired identified intangible assets of $65,700 is preliminary pending receipt of final valuations for those assets. Our preliminary fair value estimates are as follows:
Also included in the purchase price allocation is the estimated fair value of the service obligation related to our commitment to provide continued SaaS-based software for Sg2 customer relationships that existed prior to the Sg2 Acquisition where the requisite service period has not yet expired. The estimated fair value of the obligation and other future services was determined utilizing a top-down approach. The top-down approach relies on market indicators of expected revenue for any obligation yet to be delivered with appropriate adjustments. Conceptually, we start with the amount we would expect to receive in a transaction, less primarily the estimated
Index to Financial Statements MedAssets, Inc.
Notes to Consolidated Financial Statements - (Continued)
(in thousands, except share and per share amounts)
selling effort, which has already been performed, including an estimated profit margin on that selling effort. As a result of allocating the acquisition purchase price, we recorded an adjustment to reduce the carrying value of Sg2’s September 22, 2014 deferred revenue by $1,923 down to $17,901, an amount representing our estimate of the fair value of the service obligation assumed.
The fair value of long-term liabilities relates to our determination that the terms of the acquired lease arrangement between Sg2 and the lessor were unfavorable relative to market prices. As a result, we valued and recorded an unfavorable lease obligation of approximately $995 (the short-term portion of approximately $220 is included in current liabilities).
In connection with the Sg2 Acquisition, we incurred approximately $3,305 of costs primarily related to legal, financial, and accounting professional advisors. These costs were expensed as incurred and are included in the restructuring, acquisition and integration-related line item on the accompanying consolidated statement of operations.
The operating results of Sg2 have been included in our consolidated statement of operations within our Spend and Clinical Resource Management (“SCM”) reporting segment since the September 22, 2014 acquisition date. Sg2 contributed revenues of $11,730 and a net loss of $2,408 from the date of acquisition through December 31, 2014.
Unaudited Pro Forma Financial Information
The unaudited financial information in the table below summarizes the combined results of operations of MedAssets and Sg2 on a pro forma basis. The pro forma information is presented as if the companies had been combined on January 1, 2013. The 2014 and 2013 pro forma results include the following non-recurring pro forma adjustments that were directly attributable to the Sg2 Acquisition:
•
adjustments to reduce net revenue by approximately $2,019 during the fiscal year ended December 31, 2013, respectively, related to purchase accounting adjustments that reflect the fair value of the deferred revenue acquired;
•
adjustments to exclude approximately $3,661 during the fiscal year ended December 31, 2014 of certain non-recurring expenses related to one-time special employee bonuses paid by Sg2 in connection with the Sg2 Acquisition. The supplemental pro forma earnings for the fiscal year ended December 31, 2013 were adjusted to include this charge; and
•
adjustments to exclude approximately $3,305 during the fiscal year ended December 31, 2014 of certain non-recurring expenses in connection with the Sg2 Acquisition primarily related to legal, financial, and accounting professional advisors. The supplemental pro forma earnings for the fiscal year ended December 31, 2013 were adjusted to include these charges.
Index to Financial Statements MedAssets, Inc.
Notes to Consolidated Financial Statements - (Continued)
(in thousands, except share and per share amounts)
The following pro forma financial information is presented for informational purposes only and is not indicative of the results of operations that would have been achieved if the Sg2 Acquisition had taken place at the beginning of each period:
Other Acquisition-Related Activities
During the fiscal year ended December 31, 2014, our SCM segment acquired certain assets associated with hospital and physician consultative solutions for $3,055. The acquired assets consisted of current assets of $565, a customer base valued at $480 with a three-year weighted-average useful life, a non-compete intangible asset valued at $380 with a three-year weighted-average useful life and goodwill of $1,630, all of which will be deductible for income tax purposes.
6. NOTES AND BONDS PAYABLE
Our notes and bonds payable are summarized as follows as of:
Notes Payable
As of December 31, 2014, our long-term notes payable consists of a Term A Facility, a Term B Facility and a revolving credit facility under a credit agreement with JP Morgan Chase Bank, N.A and other financial institutions named therein, dated December 13, 2012 (as amended from time to time, the “Credit Agreement”), each with an outstanding balance of $225,000, $179,000 and $152,000, respectively. We have classified the $152,000 outstanding balance on our revolving credit facility as a long term liability given the maturity date of December 13, 2017. No amounts were drawn on our swing line loan, which resulted in $147,000 of availability under our revolving credit facility (after giving effect to $1,000 of outstanding but undrawn letters of credit on
Index to Financial Statements MedAssets, Inc.
Notes to Consolidated Financial Statements - (Continued)
(in thousands, except share and per share amounts)
such date and the increase in the revolving credit facility as discussed below) as of December 31, 2014. During the fiscal year ended December 31, 2014, we made scheduled principal payments of $15,500 on our Term A Facility and Term B Facility in addition to $10,000 voluntary prepayment on our Term B Facility and $40,000 in voluntary payments on our revolving credit facility. The applicable weighted average interest rates (inclusive of the applicable bank margin) on our Term A Facility, Term B Facility and Revolving Credit Facility at December 31, 2014 were 2.49%, 4.00% and 2.48%, respectively. On September 8, 2014, the Company entered into a First Increase Joinder to the Credit Agreement (the “First Increase Joinder”). The First Increase Joinder increased the revolving commitment amount under the Credit Agreement by $100,000 to $300,000. In connection with the First Increase Joinder, we incurred and capitalized approximately $615 of debt issuance costs which will be amortized into interest expense ratably over the remaining term of the revolving credit facility.
The Credit Agreement contains certain customary negative covenants, including but not limited to, limitations on the incurrence of debt, limitations on liens, limitations on fundamental changes, limitations on asset sales and sale leasebacks, limitations on investments, limitations on dividends or distributions on, or redemptions of, equity interests, limitations on prepayments or redemptions of unsecured or subordinated debt, limitations on negative pledge clauses, limitations on transactions with affiliates and limitations on changes to the Company’s fiscal year. The Credit Agreement also includes maintenance covenants of maximum ratios of consolidated total indebtedness (subject to certain adjustments) to consolidated EBITDA (subject to certain adjustments) and minimum cash interest coverage ratios. The Credit Agreement contains certain customary representations and warranties, affirmative covenants and events of default, including but not limited to, payment defaults, breaches of representations and warranties, covenant defaults, cross-defaults to certain indebtedness, certain events of insolvency or bankruptcy, material judgments, certain events under ERISA, actual or asserted failures of any guaranty or security document supporting the credit agreement to be in full force and effect and changes of control. The Company was in compliance with these covenants as of December 31, 2014. We are also required to prepay our debt obligations based on an excess cash flow calculation for the applicable fiscal year which is determined in accordance with the terms of the Credit Agreement. Our current portion of notes payable includes approximately $7,833 with respect to our 2014 required excess cash flow payment which will be paid within the first quarter of 2015.
All of the Company’s obligations under the Credit Agreement are unconditionally guaranteed by each of the Company’s existing and subsequently acquired or organized wholly-owned restricted subsidiaries, except that the following subsidiaries do not and will not provide guarantees: (a) unrestricted subsidiaries, (b) subsidiaries with tangible assets and revenues each having a value of less than 2.5% of the consolidated tangible assets and consolidated revenues of the Company (provided that all such immaterial subsidiaries, on a consolidated basis, shall not account for more than 5.0% of the consolidated EBITDA of the Company), (c) any subsidiary prohibited by applicable law, rule or regulation from providing a guarantee or which would require governmental (including regulatory) consent or approval or which would result in adverse tax consequences and (d) not-for-profit subsidiaries.
All of the Company’s obligations under the Credit Agreement are secured by substantially all of the Company’s assets and the assets of each guarantor (subject to certain exceptions), including but not limited to, (1) a perfected pledge of all of the equity securities of each direct wholly owned restricted subsidiary of the Company and of each subsidiary guarantor (which pledge, in the case of any foreign subsidiary, is limited to 65% of the equity securities of such foreign subsidiary) and (2) perfected security interests in, and mortgages on, substantially all tangible and intangible personal property and material fee-owned real property of the Company and each subsidiary guarantor (including but not limited to, accounts receivable, inventory, equipment, general intangibles (including contract rights), investment property, intellectual property, material intercompany notes and proceeds of the foregoing).
Index to Financial Statements MedAssets, Inc.
Notes to Consolidated Financial Statements - (Continued)
(in thousands, except share and per share amounts)
Loans under the Credit Agreement must be prepaid under certain circumstances, including with proceeds from certain future debt issuances, asset sales and a portion of excess cash flow for the applicable fiscal year. Loans under the Credit Agreement may be voluntarily prepaid at any time, subject to customary LIBOR breakage costs.
Bonds Payable
The Company has an aggregate principal amount of $325,000 of Notes outstanding that have been registered under the Securities Act of 1933, as amended. The Notes are guaranteed on a senior unsecured basis by each of our existing domestic subsidiaries and each of our future domestic restricted subsidiaries in each case that guarantees our obligations under the Credit Agreement. Each of the subsidiary guarantors is 100% owned by us. The guarantees by the subsidiary guarantors are full and unconditional. The guarantees by the subsidiary guarantors are joint and several. We have no independent assets or operations, and any subsidiaries of ours other than the subsidiary guarantors are minor. The Notes and the guarantees are senior unsecured obligations of the Company and the subsidiary guarantors, respectively.
The Notes were issued pursuant to an indenture dated as of November 16, 2010 (the “Indenture”) among the Company, its subsidiary guarantors and Wells Fargo Bank, N.A., as trustee. Pursuant to the Indenture, the Notes will mature on November 15, 2018 and bear 8% annual interest. Interest on the Notes is payable semi-annually in arrears on May 15 and November 15 of each year, beginning on May 15, 2011.
The Indenture contains certain customary negative covenants, including but not limited to, limitations on the incurrence of debt, limitations on liens, limitations on consolidations or mergers, limitations on asset sales, limitations on certain restricted payments and limitations on transactions with affiliates. The Indenture does not contain any significant restrictions on the ability of the Company or any subsidiary guarantor to obtain funds from the Company or any other subsidiary guarantor by dividend or loan. The Indenture also contains customary events of default. The Company was in compliance with these covenants as of December 31, 2014.
The Company has the option to redeem all or a part of the Notes, at the following redemption prices:
The Notes also contain a redemption feature that would require the repurchase of 101% of the aggregate principal amount plus accrued and unpaid interest at the option of the holders upon a change in control.
As of December 31, 2014, the Company’s 8% senior notes due 2018 were trading at 103.0% of par value (Level 1).
Debt Issuance Costs
As of December 31, 2014, we had approximately $14,075 of debt issuance costs related to our Credit Agreement and Notes which will be amortized into interest expense generally using the effective interest method until the applicable maturity date. For the fiscal year ended December 31, 2014, we recognized $3,805 in interest expense related to the amortization of debt issuance costs. For the fiscal year ended December 31, 2013, we recognized $3,807 in interest expense related to the amortization of debt issuance costs.
Index to Financial Statements MedAssets, Inc.
Notes to Consolidated Financial Statements - (Continued)
(in thousands, except share and per share amounts)
Debt Maturity Table
The following table summarizes our stated debt maturities and scheduled principal repayments as of December 31, 2014:
(1) Includes mandatory 2014 excess flow payment of $7,833 payable during the first quarter of 2015.
(2) The Term B Facility matures on December 13, 2019; however, the facility will mature in full on May 15, 2018 if our outstanding senior notes have not been repaid or refinanced in full by such date.
Total interest paid (net of amounts capitalized) on our notes and bonds payable during the fiscal years ended December 31, 2014 and 2013 was approximately $41,464 and $45,185, respectively.
Finance Obligation
We are a party to a lease agreement for a certain office building in Cape Girardeau, Missouri (the “Lease Agreement”) in which we have continuing involvement as defined by GAAP relating to leases and as such recorded the transaction as a financing obligation.
The lease payments on the office building are charged to interest expense in the periods they are due. The lease payments included as interest expense in the accompanying statement of operations for the years ended December 31, 2014, 2013 and 2012 were $676. The amount of the financial obligation decretion for the years ended December 31, 2014 and 2013 was $267 and $243, respectively.
Rental income and additional interest expense is imputed under the Lease Agreement and amounts to approximately $438 annually. Both the income and the expense are included in “Other income (expense)” in the accompanying consolidated statement of operations for each of the years ended December 31, 2014, 2013 and 2012 with no effect to net income.
When we have no further continuing involvement with the building as defined under GAAP relating to leases, we will remove the net book value of the office building, adjoining retail space, and the related finance obligation and account for the remainder of our payments under the Lease Agreement as an operating lease. Under the Lease Agreement, we will not obtain title to the office building and retail space. Our future commitment is limited to the payments required by the Lease Agreement. At December 31, 2014, the future undiscounted payments under the Lease Agreement aggregate to $1,746.
Index to Financial Statements MedAssets, Inc.
Notes to Consolidated Financial Statements - (Continued)
(in thousands, except share and per share amounts)
Future payments of the finance obligation as of December 31, 2014 are as follows:
7. COMMITMENTS AND CONTINGENCIES
We lease certain office space and office equipment under operating leases. Some of our operating leases include rent escalations, rent holidays, and rent concessions and incentives. However, we recognize lease expense on a straight-line basis over the related minimum lease term utilizing total future minimum lease payments. Future minimum rental payments under operating leases with initial or remaining non-cancelable lease terms of one year or more as of December 31, 2014 are as follows:
Rent expense for the years ended December 31, 2014, 2013 and 2012, was approximately $11,685, $16,635 and $11,060, respectively. Rent expense for the year ended December 31, 2013 included approximately $5,341 of lease termination fees related to the exit of certain facility leases. These lease termination fees are included in the restructuring, acquisition and integration-related expenses line item of the accompanying consolidated statements of operations.
Performance Targets
In the ordinary course of contracting with our clients, we may agree to make some or all of our fees contingent upon the client’s achievement of financial improvement targets from the use of our services and software. These contingent fees are not recognized as revenue until the client confirms achievement of the performance targets. We generally receive client acceptance as and when the performance targets are achieved. Prior to client confirmation that a performance target has been achieved, we record invoiced contingent fees as deferred revenue on our consolidated balance sheet. Often, recognition of this revenue occurs in periods subsequent to the recognition of the associated costs.
Index to Financial Statements MedAssets, Inc.
Notes to Consolidated Financial Statements - (Continued)
(in thousands, except share and per share amounts)
Legal Proceedings
As of December 31, 2014, we are not presently involved in any legal proceedings, the outcome of which, if determined adversely to us, would have a material adverse effect on our business, operating results or financial condition.
8. STOCKHOLDERS’ EQUITY
Preferred Stock
In connection with our initial public offering we amended and restated our Certificate of Incorporation authorizing us to issue 50,000,000 shares of undesignated preferred stock, par value $0.01 per share. The preferred stock may be issued from time to time in one or more series, each series of which would have distinctive designation or title and such number of shares as was fixed by the Board prior to the issuance of any shares thereof. Each such series of preferred stock would have voting powers, full or limited, or no voting powers, and such preferences and relative, participating optional or other special rights and such qualifications, limitations or restrictions thereof, as stated and expressed in the resolution or resolutions providing for the issue of such series of preferred stock. We had no preferred stock issued or outstanding as of December 31, 2014 or 2013.
Common Stock
During 2014, 2013 and 2012, we issued shares of common stock in connection with employee share-based payment arrangements. See Note 9 for further information.
Common Stock Warrants
During the fiscal year ended December 31, 2013, approximately 13,000 shares of common stock were issued in connection with an exercise of warrants. As a result, as of December 31, 2014 and 2013, we had no warrants outstanding.
Repurchase of Common Stock
On February 26, 2014, our Board of Directors authorized a share repurchase program of up to $75,000 of our common stock. The table below shows the amount and cost of shares of common stock we repurchased for the fiscal year ended December 31, 2014 under the share repurchase program. The repurchased shares have not been retired and constitute authorized but unissued shares.
On August 23, 2011, our Board of Directors authorized a share repurchase program of up to $25,000 of our common stock. The table below shows the amount and cost of shares of common stock we repurchased for the fiscal year ended December 31, 2012 under the share repurchase program. The repurchased shares have not been retired and constitute authorized but unissued shares. The share repurchase program expired in August 2012.
Index to Financial Statements MedAssets, Inc.
Notes to Consolidated Financial Statements - (Continued)
(in thousands, except share and per share amounts)
9. SHARE-BASED COMPENSATION
As of December 31, 2014, we had restricted common stock, restricted stock units (“RSUs”), stock-settled stock appreciation rights (or “SSARs”) and common stock option equity awards outstanding under three share-based compensation plans.
The share-based compensation cost related to equity awards that has been charged against income was $17,849, $14,496 and $10,291 for the fiscal years ended December 31, 2014, 2013 and 2012, respectively. The total income tax benefit recognized in the income statement for share based compensation arrangements related to equity awards was $6,665, $5,365 and $3,853 for the fiscal years ended December 31, 2014, 2013 and 2012, respectively. There were no capitalized share-based compensation costs as of December 31, 2014, 2013 or 2012.
Total share-based compensation expense (inclusive of restricted common stock, RSUs, common stock options, and SSARs) for the fiscal years ended December 31, 2014, 2013 and 2012 is reflected in our consolidated statements of operations as noted below:
Employee Stock Purchase Plan
In 2010, the Company established the MedAssets, Inc. Employee Stock Purchase Plan (the “ESPP Plan”). Under the ESPP Plan, eligible employees may purchase shares of our common stock at a discounted price through payroll deductions. The price per share of the common stock sold to participating employees will be 95% of the fair market value of such share on the applicable purchase date. The ESPP Plan requires that all stock purchases be held by participants for a period of 18 months from the purchase date. A total of 500,000 shares of our common stock are authorized for purchase under the ESPP Plan. For the fiscal year ended December 31, 2014, we purchased approximately 22,000 shares of our common stock under the ESPP Plan which amounted to approximately $494. For the fiscal year ended December 31, 2013, we purchased approximately 24,700 shares of our common stock under the ESPP Plan which amounted to approximately $482. The ESPP Plan is non-compensatory and, as a result, no compensation expense is recorded in our consolidated statement of operations for the fiscal years ended December 31, 2014, 2013 and 2012.
Equity Incentive Plans
In 2008, the Board approved and the Company’s stockholders adopted the MedAssets Inc. Long-Term Performance Incentive Plan (the “2008 Plan”). The 2008 Plan provides for the grant of non-qualified stock options, incentive stock options, restricted stock awards, restricted stock unit awards, performance awards, stock appreciation rights and other stock-based awards. As of December 31, 2014, we had approximately 5,263,000 shares remaining under our 2008 Plan available for grant.
Equity awards issued under the 2008 Plan generally vest over five years of continuous service and have seven-year contractual terms. Service-based share awards generally vest over one to five years. Performance-
Index to Financial Statements MedAssets, Inc.
Notes to Consolidated Financial Statements - (Continued)
(in thousands, except share and per share amounts)
based awards vest upon the attainment of one or more performance objectives over a specified period. We have outstanding stock option awards that were issued under previous plans that generally vest over three to five years of continuous service and have ten-year contractual terms.
2014 Equity Award Grants
In February 2014, the Compensation Committee of our Board of Directors (the “Compensation Committee”) approved an equity grant for certain eligible employees consisting of service-based and performance-based restricted stock units (“RSUs”). The purpose of the equity grant is to assist the Company in attracting, retaining, motivating, and rewarding certain individuals of the Company. The equity grant is intended to promote the creation of long-term value for stockholders of the Company by closely aligning the interests of such individuals with those of the stockholders. The total approved equity grant amounted to 1,218,826 RSUs with a grant date fair value of $25.06 per award and was comprised of: (i) 63,355 service-based RSUs that vest ratably each month through December 31, 2014; (ii) 469,011 service-based RSUs that vest annually over three years of continuous service with the first annual vest date beginning on March 1, 2015; (iii) 343,230 performance-based RSUs using a net revenue performance metric that vest annually over three years of continuous service with the first annual vest date beginning on March 1, 2015 provided the performance metric is achieved; and (iv) 343,230 performance-based RSUs using an adjusted EBITDA performance metric that vest annually over three years of continuous service with the first annual vest date beginning on March 1, 2015 provided the performance metric is achieved.
In May 2014, the Compensation Committee approved an equity grant for certain eligible employees consisting of service-based and performance-based RSUs. The total approved equity grant amounted to 8,982 RSUs with a grant date fair value of $23.54 per award and was comprised of: (i) 6,179 service-based RSUs that vest ratably each month through December 31, 2014; (ii) 2,107 service-based RSUs that vest annually over three years of continuous service with the first annual vest date beginning on March 1, 2015; (iii) 348 performance-based RSUs using a net revenue performance metric that vest annually over three years of continuous service with the first annual vest date beginning on March 1, 2015 provided the performance metric is achieved; and (iv) 348 performance-based RSUs using an adjusted EBITDA performance metric that vest annually over three years of continuous service with the first annual vest date beginning on March 1, 2015 provided the performance metric is achieved.
The measurement period for the net revenue performance-based awards is from January 1, 2014 through December 31, 2014. The net revenue performance metric is based on the achievement of an established net revenue target. The Company must achieve a minimum threshold of net revenue before any performance-based RSUs begin vesting. The equity award holders have an opportunity to earn between 50% and 100% of the performance-based equity awards once the minimum threshold has been met. If the minimum threshold is not met, the equity award holders will forfeit those awards.
The measurement period for the adjusted EBITDA performance-based awards is from January 1, 2014 through December 31, 2014. The adjusted EBITDA performance metric is based on the achievement of an established adjusted EBITDA target. The Company must achieve a minimum threshold of adjusted EBITDA before any performance-based RSUs begin vesting. The equity award holders have an opportunity to earn between 50% and 100% of the performance-based equity awards once the minimum threshold has been met. If the minimum threshold is not met, the equity award holders will forfeit those awards.
In May 2014, the Compensation Committee also approved an equity grant consisting of 100,000 performance-based RSUs using a net revenue performance metric that is a cliff-vesting award and is based on the achievement of a target cumulative annual growth rate over a three-year performance period. Depending on the
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cumulative revenue growth rate achieved, up to 200,000 RSUs can be earned. The RSUs have a grant date fair value of $23.54 per award and the measurement period is from January 1, 2014 through December 31, 2016. A certain minimum cumulative revenue growth rate must be achieved before any RSUs will vest on March 1, 2017. If the minimum threshold is not met, the equity award holder will forfeit the awards.
In August 2014, the Compensation Committee approved an equity grant for certain eligible employees consisting of service-based RSUs. The total approved equity grant amounted to 6,328 RSUs with a grant date fair value of $21.97 per award that will primarily vest annually over three years of continuous service with the first annual vest date beginning on September 1, 2015.
In September 2014, and in connection with the Sg2 Acquisition, the Compensation Committee approved an equity grant for certain eligible employees consisting of service-based and performance-based RSUs. The total approved equity grant amounted to 100,786 RSUs with a grant date fair value of $21.26 per award and was comprised of: (i) 30,095 service-based RSUs that vest annually over three years of continuous service with the first annual vest date beginning on March 1, 2016; and (ii) 70,691 performance-based RSUs using a Sg2 revenue performance metric based on the achievement of a target revenue amount over a three-year performance period. Depending on the Sg2 revenue achieved, up to 200,000 RSUs can be earned. A certain minimum Sg2 revenue amount must be achieved before any RSUs will vest beginning on March 1, 2015. If the minimum threshold is not met, the equity award holder will forfeit the awards.
In November 2014, the Compensation Committee approved an equity grant for certain eligible employees consisting of service-based RSUs. The total approved equity grant amounted to 15,910 RSUs with a grant date fair value of $20.72 per award that will primarily vest annually over three years of continuous service with the first annual vest date beginning on December 1, 2015.
Under all plans, our policy is to grant equity awards with an exercise price (or base price in the case of SSARs) equal to the fair market price of our stock on the date of grant.
Equity Award Valuation
Under generally accepted accounting principles for stock compensation for SSARs and stock options, we calculate the grant-date estimated fair value of share-based awards using a Black-Scholes valuation model. Determining the estimated fair value of share-based awards is judgmental in nature and involves the use of significant estimates and assumptions, including the expected term of the share-based awards, risk-free interest rates over the vesting period, expected dividend rates, the price volatility of the Company’s shares and forfeiture rates of the awards. The guidance requires forfeitures to be estimated at the time of grant and adjusted, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The forfeiture rate is estimated based on historical and expected experience. We base fair value estimates on assumptions we believe to be reasonable but that are inherently uncertain. Actual future results may differ materially from those estimates.
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The fair value of each equity award has been estimated as of the date of grant using the Black-Scholes option-pricing model with the following assumptions for the fiscal years ended December 31, 2014, 2013 and 2012:
Historically, it has not been practicable for us to estimate the expected volatility of our share price required by existing accounting requirements based solely on our own historical stock price volatility (i.e., trading history), given our limited history as a publicly traded company. Beginning in 2013, we had sufficient history as a public company and will estimate the expected volatility of our share price, which may impact our future share-based compensation. In accordance with generally accepted accounting principles for stock compensation, for certain grants awarded prior to January 1, 2013, we estimated the grant-date fair value of our shares using a combination of our own trading history and a volatility calculated (“calculated volatility”) from an appropriate industry sector index of comparable entities and using the “simplified method” as prescribed in Staff Accounting Bulletin No. 110, Share-based Payment, to calculate expected term. Dividend payments were not assumed, as we did not anticipate paying a dividend at the dates in which the various option grants occurred during the year. The risk-free rate of return reflects the interest rate offered for zero coupon treasury bonds over the expected term of the options. The expected term of the awards represents the period of time that options granted are expected to be outstanding.
Equity Award Expense Attribution
In general, for equity awards with graded-vesting, compensation cost is recognized using an accelerated method over the vesting or service period and is net of estimated forfeitures. In general, for equity awards with cliff-vesting, compensation cost is recognized using a straight-line method over the vesting or service period and is net of estimated forfeitures. For performance-based equity awards, compensation cost is adjusted each reporting period in which a change in performance achievement is determined and is net of estimated forfeitures. We evaluate the probability of performance achievement each reporting period and, if necessary, adjust share-based compensation expense based on expected performance achievement.
Restricted Stock Units and Restricted Common Stock Awards
We have issued restricted stock units and restricted common stock awards to employees, our Board and our senior advisory board. During 2014, 2013 and 2012, we issued approximately 1,451,000 units, 1,211,000 shares and 438,000 shares, respectively. During 2014, 2013 and 2012, the weighted-average grant date fair value of each restricted stock unit and restricted common stock share was $24.62, $18.44 and $14.00, respectively. The fair value of shares vested during the fiscal years ended December 31, 2014, 2013 and 2012 was $11,118, $5,732 and $10,584, respectively.
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A summary of changes in restricted units and shares during the fiscal year ended December 31, 2014 is as follows:
(1) Service-based shares are inclusive of certain restricted stock awards issued pursuant to the MedAssets, Inc. 2010 Special Stock Incentive Plan (the “Plan”). The Plan was adopted by the Company’s Board of Directors on November 23, 2010 in connection with the Broadlane Acquisition pursuant to an exception to the requirement for stockholder approval under NASDAQ rules.
(2) During the year, approximately 135,000 restricted shares were surrendered from equity award holders to settle their associated tax liability. The tax liability was paid by the Company on their behalf and amounted to approximately $3,197.
As of December 31, 2014, there was $17,905 of total unrecognized compensation cost related to unvested restricted common stock awards and restricted stock units that will be recognized over a weighted average period of 1.5 years.
SSARs
We have issued SSARs to employees, our Board and our senior advisory board. During 2013 and 2012, we issued approximately 3,000 and 653,000 SSARs, respectively. During 2013 and 2012 the weighted-average grant date fair value of each SSAR was $7.15 and $6.07, respectively. The fair value of SSARs vested during the fiscal years ended December 31, 2014, 2013 and 2012 was $1,842, $3,529 and $4,291, respectively.
A summary of changes in SSARs during the fiscal year ended December 31, 2014 is as follows:
(1) During the year, equity award holders surrendered SSARs to settle their associated tax liability. The tax liability was paid by the Company on their behalf and amounted to approximately $219.
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During the fiscal year ended December 31, 2014, we issued approximately 106,000 shares of common stock in connection with exercises of 388,000 SSARs.
During the fiscal year ended December 31, 2013, we issued approximately 267,000 shares of common stock in connection with exercises of 1,340,000 SSARs.
During the fiscal year ended December 31, 2012, we issued approximately 19,000 shares of common stock in connection with exercises of 173,000 SSARs.
As of December 31, 2014, there was $877 of total unrecognized compensation cost related to unvested SSARs that will be recognized over a weighted average period of 1.3 years.
Common Stock Option Awards
During the fiscal years ended December 31, 2014, 2013 and 2012, no service-based stock options were issued. The exercise price of all stock options described below was equal to the market price of our common stock on the date of grant (or “common stock grant-date fair value”), and therefore the intrinsic value of each option grant was zero.
A summary of changes in outstanding options during the fiscal year ended December 31, 2014 is as follows:
The total fair value of stock options vested during the fiscal years ended December 31, 2014, 2013 and 2012 was $201, $737 and $2,246, respectively.
During the fiscal years ended December 31, 2014, 2013 and 2012, we issued approximately 306,000, 1,364,000 and 1,336,000 shares of common stock, respectively, in connection with employee stock option exercises for aggregate exercise proceeds of $3,829, $14,808 and $10,618, respectively.
The total intrinsic value of stock options exercised during the fiscal years ended December 31, 2014, 2013 and 2012 was $3,370, $14,180 and $10,606, respectively. Our policy for issuing shares upon stock option exercise is to issue new shares of common stock.
As of December 31, 2014, there was $2 of total unrecognized compensation cost related to outstanding stock option awards that will be recognized over a weighted average period of 1 year.
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The following table summarizes the exercise price range, weighted average exercise price, and remaining contractual lives for the number of stock options outstanding as of December 31, 2014, 2013 and 2012:
10. INCOME TAXES
The provision for income tax expense (benefit) is as follows for the years ended December 31:
A reconciliation between reported income tax expense (benefit) and the amount computed by applying the statutory federal income tax rate of 35 percent is as follows at December 31, 2014, 2013 and 2012:
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Deferred income taxes reflect the net effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s deferred tax assets and liabilities are as follows at December 31:
We have historically maintained a valuation allowance on certain deferred tax assets, such as capital losses and various state net operating losses. In assessing the ongoing need for a valuation allowance, we consider recent operating results, the expected scheduled reversal of deferred tax liabilities, projected future taxable
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benefits and tax planning strategies. As a result of this assessment, we recorded a $1,016 decrease to our valuation allowance for the expiration of our capital loss carryforward and a $25 decrease to our valuation allowance on our state net operating losses for the year ended December 31, 2014.
As of December 31, 2014, we have state net operating losses of $107,854 (expiring 2020 - 2034). As of December 31, 2014 we have federal credits of $55 (expiring 2019-2024).
Cash paid for income taxes amounted to $27,438 and $7,660 for the years ended December 31, 2014 and 2013, respectively.
We reversed net interest expense and penalties of $153 related to changes in estimates concerning settlement of certain state income tax examination and recorded net interest expense and penalties of $47 for the fiscal years ended December 31, 2014 and December 31, 2013, respectively. As of December 31, 2014, the total amount of interest and penalties included on our consolidated balance sheet was $279.
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
Included in our unrecognized tax benefits are $579 of uncertain positions that would impact our effective rate if recognized. We anticipate releasing $520 of unrecognized tax benefits in 2015.
Our consolidated U.S. federal income tax returns for tax years 1999 to 2013 remain subject to examination by the Internal Revenue Service (or “IRS”) for net operating loss carryforward and credit carryforward purposes. For years 1999 to 2010, the statute for assessments and refunds has generally expired; however, tax attributes for those years may still be examined, which would impact the tax years 2011 and forward.
11. EARNINGS (LOSS) PER SHARE
We calculate earnings per share (or “EPS”) in accordance with the GAAP relating to earnings per share. Basic EPS is calculated by dividing reported net loss by the weighted-average number of common shares outstanding for the reported period following the two-class method. Diluted EPS reflects the potential dilution that could occur if our stock options, stock settled stock appreciation rights, unvested restricted stock, stock warrants and shares that were purchasable pursuant to our employee stock purchase plan were exercised and converted into our common shares during the reporting periods.
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The following table is a reconciliation of the denominator for basic and diluted loss per share for the years ended December 31, 2014, 2013 and 2012.
During the fiscal years ended December 31, 2014 and 2012, basic and diluted EPS are the same because potentially dilutive securities have been excluded from the calculation of diluted EPS given our net loss for each year. In addition, the effect of certain dilutive securities have been excluded because the impact is anti-dilutive as a result of certain securities being “out of the money” with strike prices greater than the average market price during the period presented. The following table provides a summary of those potentially dilutive securities that have been excluded from the above calculation of diluted EPS:
12. SEGMENT INFORMATION
We deliver our solutions and manage our business through two reportable business segments, Spend and Clinical Resource Management (or “SCM”) and Revenue Cycle Management (or “RCM”).
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Spend and Clinical Resource Management. Our SCM segment provides a comprehensive suite of technology-enabled services that help our clients manage their expense categories. Our solutions lower supply and medical device pricing and utilization by managing the procurement process through our group purchasing organization (“GPO”) portfolio of contracts, consulting services and business intelligence tools.
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Revenue Cycle Management. Our RCM segment provides a comprehensive suite of products and services spanning the hospital revenue cycle workflow-from patient access and financial responsibility, charge capture and integrity, pricing analysis, claims processing and denials management, payor contract management, revenue recovery and accounts receivable services. Our workflow solutions, together with our data management, compliance and audit tools, increase revenue capture and cash collections, reduce accounts receivable balances and increase regulatory compliance.
GAAP relating to segment reporting, defines reportable segments as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing financial performance. The guidance indicates that financial information about segments should be reported on the same basis as that which is used by the chief operating decision maker in the analysis of performance and allocation of resources. Management of the Company, including our chief operating decision maker, uses what we refer to as Segment Adjusted EBITDA as its primary measure of profit or loss to assess segment performance and to determine the allocation of resources. We define Segment Adjusted EBITDA as segment net income (loss) before net interest expense, income tax expense (benefit), depreciation and amortization (“EBITDA”) as adjusted for other non-recurring, non-cash or non-operating items. Our chief operating decision maker uses Segment Adjusted EBITDA to facilitate a comparison of our operating performance on a consistent basis from period to period. Segment Adjusted EBITDA includes expenses associated with sales and marketing, general and administrative and product development activities specific to the operation of the segment. General and administrative corporate expenses that are not specific to the segments are not included in the calculation of Segment Adjusted EBITDA. These expenses include the costs to manage our corporate offices, interest expense on our credit facilities and expenses related to being a publicly-held company. All reportable segment revenues are presented net of inter-segment eliminations and represent revenues from external clients.
The following tables present Segment Adjusted EBITDA and financial position information as utilized by our chief operating decision maker. A reconciliation of Segment Adjusted EBITDA to consolidated net income is included. General corporate expenses are included in the “Corporate” line item. “RCM” represents the Revenue Cycle Management segment and “SCM” represents the Spend and Clinical Resource Management segment. Other assets and liabilities are included to provide a reconciliation to total assets and total liabilities.
The following tables represent our results of operations, by segment, for the fiscal years ended December 31, 2014, 2013 and 2012:
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(1) These are non-GAAP measures. See “Use of Non-GAAP Financial Measures” section for additional information.
(2) Other service fees primarily consists of consulting, services and technology fees.
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(1) Capital expenditures consist of purchases of property and equipment and capitalized software development costs (internal and external use).
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GAAP relating to segment reporting requires that the total of the reportable segments’ measures of profit or loss be reconciled to the Company’s consolidated operating results. The following table reconciles Segment Adjusted EBITDA to consolidated net (loss) income for each of the fiscal years ended December 31, 2014, 2013 and 2012:
(1) Interest income is included in other income (expense) and is not netted against interest expense in our consolidated statements of operations.
(2) The impairment during the fiscal year ended December 31, 2014 consisted of the write-off of goodwill relating to our revenue cycle services operating unit.
(3) Represents non-cash share-based compensation to both employees and directors. We believe excluding this non-cash expense allows us to compare our operating performance without regard to the impact of share-based compensation, which varies from period to period based on amount and timing of grants.
(4) Represents the effect on revenue of adjusting the acquired deferred revenue balance associated with the Sg2 Acquisition to fair value at the acquisition date.
(5) Represents the amount attributable to restructuring, acquisition and integration-related costs which include costs such as severance, retention, salaries relating to redundant positions, certain performance-related salary-based compensation, operating infrastructure costs and facility consolidation costs.
13. DERIVATIVE FINANCIAL INSTRUMENTS
On December 13, 2012, we terminated our two floating-to-fixed rate LIBOR-based forward starting interest rate swaps, originally entered into on May 5, 2011. The swaps were originally scheduled to fully terminate by February 2015. Such early termination was deemed to be a termination of all future obligations between us and each counterparty. In consideration of the early termination, we paid a total of $8,209 to the counterparties on December 17, 2012. Prior to the termination, the fair values of the swaps were recorded in other long-term liabilities and accumulated other comprehensive loss on our balance sheet. The termination of the swaps resulted
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in the payment of such liability and the reclassification of the related accumulated other comprehensive loss to current period expense. The result was a charge to expense for the fiscal year ended December 31, 2012 of $8,209 ($5,227 net of tax). We have no assets or liabilities remaining on our Consolidated Balance Sheet with respect to these interest rate swaps as of December 31, 2013.
The effects of derivative instruments designated as cash flow hedges on income and AOCI are summarized below:
14. FAIR VALUE MEASUREMENTS
We measure fair value for financial instruments, such as derivatives and non-financial assets, when a valuation is necessary, such as for impairment of long-lived and indefinite-lived assets when indicators of impairment exist in accordance with GAAP for fair value measurements and disclosures. This defines fair value, establishes a framework for measuring fair value and enhances disclosures about fair value measures required under other accounting pronouncements, but does not change existing guidance as to whether or not an instrument is carried at fair value.
Refer to Note 13 for information and fair values of our derivative instruments measured on a recurring basis under GAAP for fair value measurements and disclosures.
In estimating our fair value disclosures for financial instruments, we use the following methods and assumptions:
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Cash and cash equivalents. The carrying value reported in the consolidated balance sheets for these items approximates fair value due to the high credit standing of the financial institutions holding these items and their liquid nature;
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Accounts receivable, net. The carrying value reported in the consolidated balance sheets is net of allowances for doubtful accounts which includes a degree of counterparty non-performance risk;
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Accounts payable and current liabilities. The carrying value reported in the consolidated balance sheets for these items approximates fair value, which is the likely amount for which the liability with short settlement periods would be transferred to a market participant with a similar credit standing as the Company;
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Notes payable. The carrying value of our long-term notes payable reported in the consolidated balance sheets approximates fair value since they bear interest at variable rates. Refer to Note 6 for further information; and
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Bonds payable. The carrying value of our long-term bonds payable reported in the consolidated balance sheets approximates fair value. Refer to Note 6 for further information.
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15. VALUATION AND QUALIFYING ACCOUNTS
We maintain an allowance for doubtful accounts that is recorded as a contra asset to our accounts receivable balance; a sales return reserve and client allowance that is recorded as a contra revenue account; and, a self-insurance accrual related to the medical and dental insurance provided to our employees. The following table sets forth the change in each of those reserves for the years ended December 31, 2014, 2013, and 2012.
Valuation and Qualifying Accounts
(1) Additions to the allowance account through the normal course of business are charged to expense.
(2) Write-offs reduce the balance of accounts receivable and the related allowance for doubtful accounts indicating management’s belief that specific balances are not recoverable.
(1) Includes client service allowance and sales returns. Additions to the allowance through the normal course of business reduce net revenue.
(2) Write-offs reduce the balance of the client allowance and return reserve.
(1) We have a self-insurance policy to cover our employees’ medical and dental insurance.
(2) Estimates of insurance claims expected to be incurred through the normal course of business are charged to expense.
(3) Actual insurance claims payments reduce the self-insurance accrual.
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16. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Unaudited summarized financial data by quarter for the years ended December 31, 2014 and 2013 is as follows:
17. RELATED PARTY TRANSACTION
We had an agreement with John Bardis, formerly our chief executive officer, for the use of an airplane owned by JJB Aviation, LLC, a limited liability company, owned by Mr. Bardis. We paid Mr. Bardis at market-based rates for the use of the airplane for business purposes. The audit committee of the board of directors reviews such usage of the airplane annually. During the fiscal years ended December 31, 2014, 2013 and 2012, we incurred charges of $1,621, $2,250 and $1,861, respectively, related to transactions with Mr. Bardis. On February 17, 2015, the Company entered into a Transition and Consulting Agreement (the “Transition Agreement”) with Mr. Bardis in connection with Mr. Bardis’s resignation from his positions with the Company. Pursuant to the Transition Agreement, the Company’s agreement to use the airplane owned by JJB Aviation, LLC was terminated effective as of January 1, 2015.
18. SUBSEQUENT EVENTS
We have evaluated subsequent events for recognition or disclosure in the consolidated financial statements filed on Form 10-K with the SEC and no events have occurred that require disclosure, except for the following:
In January 2015, our management approved and initiated a plan to restructure our operations which included certain management changes within our SCM and RCM segments. We expect to incur approximately $1,600 in restructuring costs.
In February 2015, our Board of Directors authorized an extension to our existing share repurchase program until February 29, 2016 and increased the total dollar amount available for the repurchase of shares of our common stock to $100,000 subject to certain restrictions under our Credit Agreement and Indenture.
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On February 17, 2015, Mr. Bardis resigned as the chairman of the Company’s board of directors (the “Board”) and chief executive officer for personal reasons, effective immediately. In connection with Mr. Bardis’s resignation, the Company entered into the Transition Agreement with Mr. Bardis, pursuant to which Mr. Bardis will transition to a consulting role with the Company for a term of three years (the “Term”) to provide consulting, business development and similar services of a non-operating nature for an annual consulting fee of $650. Mr. Bardis will remain a member of the Board until the Company’s 2015 Annual Meeting of Stockholders, following which he will have the title of Non-Executive Chairman Emeritus during the Term. Following Mr. Bardis’s resignation, the Board appointed Mr. R. Halsey Wise as Chairman and chief executive officer of the Company, effective immediately. The Company filed an 8-K on February 17, 2015 disclosing the specific terms of the resignation, Transition Agreement and new appointment of its chairman and chief executive officer.