Item 1. Business
Our company was formed in 1992 for the purpose of developing, acquiring and operating practice-based ambulatory surgery centers, or ASCs, in partnership with physician practice groups throughout the United States. An AmSurg surgery center is typically located adjacent to or in close proximity to the specialty medical practice of a physician group partner’s office. Each of our surgery centers provides a narrow range of high volume, lower-risk surgical procedures, generally in a single specialty, and has been designed with a cost structure that enables us to charge fees which we believe are generally less than those charged by hospitals and freestanding multi-specialty outpatient surgery centers for similar services performed on an outpatient basis. As of December 31, 2006, we owned a majority interest in 156 surgery centers in 32 states and the District of Columbia and had five centers under development. In addition, we acquired a majority interest in seven surgery centers as of January 1, 2007.
Our principal executive offices are located at 20 Burton Hills Boulevard, Nashville, Tennessee 37215, and our telephone number is 615-665-1283.
Industry Overview
For many years, government programs, private insurance companies, managed care organizations and self-insured employers have implemented various cost-containment measures to limit the growth of healthcare expenditures. These cost-containment measures, together with technological advances, have resulted in a significant shift in the delivery of healthcare services away from traditional inpatient hospitals to more cost-effective sites, including ASCs.
According to Verispan’s Freestanding Outpatient Surgery Center Market Report (2006 Edition), there were 5,349 freestanding ASCs in the United States as of November 2006. We believe that approximately 1,000 of these surgery centers are single-specialty centers. Approximately 29% of all ASCs are owned by multi-facility healthcare providers, while approximately 71% are independently owned.
We believe that the following factors have contributed to the growth of ambulatory surgery:
Cost-Effective Alternative. Ambulatory surgery is generally less expensive than hospital-based surgery. We believe that surgery performed at a practice-based ASC is generally less expensive than hospital-based ambulatory surgery for a number of reasons, including lower facility development costs, more efficient staffing and space utilization and a specialized operating environment focused on cost containment.
Physician and Patient Preference. We believe that many physicians prefer practice-based ASCs because these centers enhance physicians’ productivity by providing them with greater scheduling flexibility, more consistent nurse staffing and faster turnaround time between cases, allowing them to perform more surgeries in a defined period of time. In contrast, hospitals and freestanding multi-specialty ASCs generally serve a broader group of physicians, including those involved with emergency procedures, resulting in postponed or delayed surgeries. Additionally, many physicians choose to perform surgery in a practice-based ASC because their patients prefer the simplified admissions and discharge procedures and the less institutional atmosphere.
New Technology. New technology and advances in anesthesia, which have been increasingly accepted by physicians, have significantly expanded the types of surgical procedures that are being performed in ASCs. Lasers, enhanced endoscopic techniques and fiber optics have reduced the trauma and recovery time associated with many surgical procedures. Improved anesthesia has shortened recovery time by minimizing post-operative side effects such as nausea and drowsiness, thereby avoiding, in some cases, overnight hospitalization.
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Strategy
We believe we are a leader in the acquisition, development and operation of practice-based ASCs. The key components of our strategy are to:
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selectively acquire practice-based ASCs with substantial minority physician ownership;
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develop, in partnership with physicians, new practice-based ASCs; and
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grow revenues and profitability at our existing surgery centers.
Ninety-two percent of our centers specialize in gastroenterology or ophthalmology procedures. These specialties have a higher concentration of older patients than other specialties, such as orthopedic or enterology. We believe the aging demographics of the U.S. population will be a source of procedure growth for these specialties.
Acquisition and Development of Surgery Centers
Our practice-based ASCs are outpatient surgery centers generally equipped and staffed for a single medical specialty and are typically located in or adjacent to a physician group practice. We have targeted ownership in centers that perform gastrointestinal endoscopy, ophthalmology, orthopedic and otolaryngology (ear, nose and throat) procedures. We target these medical specialties because they generally involve a high volume of lower-risk procedures that can be performed in an outpatient setting on a safe and cost-effective basis. The focus at each center on a single specialty results in significantly lower capital and operating costs than the costs of hospitals and freestanding ASCs that must be designed to provide more intensive services for a broader array of surgical specialties. In addition, our practice-based surgery centers typically provide a more convenient setting for the patient and the physician performing the procedure.
Our development staff identify existing centers that are potential acquisition candidates and identify physician practices that are potential partners for new center development in the medical specialties which we have targeted. These candidates are then evaluated against our project criteria, which include the quality of the physicians and their growth opportunities in their market, the number of procedures currently being performed by the practice, competition from and the fees being charged by other surgical providers, relative competitive market position of the physician practice under consideration, ability to contract with payors in the market and state certificate of need, or CON, requirements for the development of a new center.
We begin our acquisition process with a due diligence review of the target center and its market. We use experienced teams of operations and financial personnel to conduct a thorough review of all aspects of the center’s operations, including the following:
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market position of the center and the physicians affiliated with the center;
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payor and case mix;
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growth opportunities;
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staffing and supply review; and
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equipment assessment.
In presenting the advantages to physicians of developing a new practice-based ASC in partnership with us, our development staff emphasizes the proximity of a practice-based surgery center to a physician’s office, the simplified administrative procedures, the ability to schedule consecutive cases without preemption by inpatient or emergency procedures, the rapid turnaround time between cases, the high technical competency of the center’s clinical staff that performs only a limited number of specialized procedures and the state-of-the-art surgical equipment. We also focus on our expertise in developing and operating centers. In addition, as part of our role as the manager of our surgery center limited partnerships and limited liability companies, we market the centers to third-party payors.
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In a development project, we provide, among other things, the following services:
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financial feasibility pro forma analysis;
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assistance in the state CON approval process, if needed;
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site selection;
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assistance in space analysis and schematic floor plan design;
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analysis of local, state and federal building codes;
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financing for equipment and buildout;
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equipment budgeting, specification, bidding and purchasing;
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construction financing;
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architectural oversight;
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contractor bidding;
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construction management; and
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assistance with licensing, Medicare certification and contracting with third-party payors.
In addition, capital contributed by the physicians and AmSurg plus debt financing provides the funds necessary to construct and equip a new surgery center and to provide initial working capital.
As part of each acquisition or development transaction, we enter into a limited partnership agreement or, in the case of a limited liability company, an operating agreement with our physician group partner. Under these agreements, we receive a percentage of the net income and cash distributions of the entity equal to our percentage ownership interest in the entity and have the right to the same percentage of the proceeds of a sale or liquidation of the entity. In the limited partnership structure, as the sole general partner, we are generally liable for the debts of the limited partnership. However, the limited partnership agreement requires the physician partners to guarantee their pro rata share of any indebtedness or lease agreements to which the limited partnership is a party in proportion to their ownership interest in the limited partnership. We generally own 51% of the limited partnerships or limited liability companies.
We manage each limited partnership and limited liability company and oversee the business office, marketing, financial reporting, accreditation and administrative operations of the surgery center. The physician group partner provides the center with a medical director and performance improvement chairman and may provide certain other specified services such as billing and collections, transcription and accounts payable processing.
In addition, the limited partnership or limited liability company may lease certain non-physician personnel from the physician practice, who will provide services at the center. The cost of the salary and benefits of these personnel are reimbursed to the practice by the limited partnership or limited liability company. Certain significant aspects of the limited partnership’s or limited liability company’s governance are overseen by an operating board, which is comprised of equal representation by AmSurg and our physician partners. Because the physicians have a minority ownership interest in the center, we work closely with the physicians throughout the process to increase the likelihood of a successful partnership with them in the surgery centers.
Substantially all of the limited partnership and operating agreements provide that, if certain regulatory changes take place, we will be obligated to purchase some or all of the minority interests of the physicians affiliated with us in the limited partnerships or limited liability companies that own and operate our surgery centers. The regulatory changes that could trigger such obligations include changes that: (i) make the referral of Medicare and other patients to our surgery centers by physicians affiliated with us illegal; (ii) create the substantial likelihood that cash distributions from the limited partnership or limited liability company to the affiliated physicians will be illegal; or (iii) cause the ownership by the physicians of interests in the limited partnerships or limited liability companies to be illegal. There can be no assurance that our existing capital resources would be sufficient for us to meet the obligations, if they arise, to purchase these minority interests held by physicians. The determination of whether a triggering event has occurred generally would be made by the concurrence of our legal counsel and counsel for the physician partners or, in the absence of such concurrence, by independent counsel having an expertise in healthcare law and whom both parties choose. Such determination therefore would not be within our control. The triggering of these obligations could have a material adverse effect on our financial condition and results of operations. See “- Government Regulation.”
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Growth in Revenues at Existing Facilities
We grow revenues in our existing facilities primarily through increasing procedure volume. We grow our procedure volume through:
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growth in the number of physicians performing procedures at our centers;
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obtaining new or more favorable managed care contracts for our centers;
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marketing our centers to referring physicians, payors and patients; and
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achieving efficiencies in center operations.
Growth in the number of physicians performing procedures. The most effective way to increase procedure volume and revenues at our ASCs is to increase the number of physicians that use the center through:
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advising the physician practices affiliated with the ASCs in recruiting new physicians to their practices;
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identifying additional physicians or physician practices to join the partnerships that own the ASCs; and
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recruiting non-partner physicians in the same or other specialties to use excess capacity at the ASCs.
We also work with our partners to plan for the retirement or departure of physicians that utilize our ASCs.
Obtaining new or more favorable managed care contracts. Maintaining access to physicians and patients through third-party payor contracts is important to the successful operation of our ASCs. We have a dedicated business development team that is responsible for negotiating contracts with third-party payors. They are responsible for obtaining new contracts for our ASCs with payors that do not currently contract with us and negotiating increased reimbursement rates pursuant to existing contracts.
Marketing our centers to referring physicians, payors and patients. We seek to increase procedure volume at our ASCs by:
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marketing our ASCs to referring physicians emphasizing the quality and high patient satisfaction and lower cost at our ASCs;
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increasing awareness of the benefits of our ASCs with employers and patients through health fairs and screening programs, including local marketing programs designed to educate employers and patients as to the health and cost benefits of detecting colon cancer in its early stages through routine endoscopy procedures; and
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communicating with existing patients regarding follow-up procedures through care coordination programs.
Achieving efficiencies in center operations. We have dedicated teams with business and clinical expertise that are responsible for implementing best practices within our centers. The implementation of these best practices allows the ASCs to improve operating efficiencies through:
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physician scheduling enhancements;
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specially trained clinical staff focused on improved patient flow; and
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improved operating room turnover.
The information we gather and collect from our ASCs and team members allows us to develop best practices and identify those ASCs that could most benefit from improved operating efficiency techniques.
Surgery Center Operations
The size of our typical ASC is approximately 3,000 to 5,000 square feet, and the center is located adjacent to or in close proximity to our physician partners’ offices. Each center we develop typically has two to three operating or procedure rooms with areas for reception, preparation, recovery and administration. Each surgery center is specifically tailored to meet the needs of its related physician practice and typically performs 3,000 to 6,000 procedures per year. Our cost of developing a typical surgery center is approximately $2.0 million. Constructing, equipping and licensing a surgery center generally takes 12 to 15 months. As of December 31, 2006, 104 of our centers performed gastrointestinal endoscopy procedures, 39 centers performed ophthalmology surgery procedures, five centers performed orthopedic
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procedures and eight centers performed procedures in more than one specialty. The procedures performed at our centers generally do not require an extended recovery period. Our centers are staffed with approximately 10 to 15 clinical professionals and administrative personnel, some of whom may be shared with the physician practice group. The clinical staff includes nurses and surgical technicians.
The types of procedures performed at each center depend on the specialty of the practicing physicians. The procedures most commonly performed at our surgery centers are:
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gastroenterology - colonoscopy and other endoscopy procedures;
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ophthalmology - cataracts and retinal laser surgery; and
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orthopedic - knee arthroscopy and carpal tunnel repair.
We market our surgery centers directly to patients, referring physicians and third-party payors, including health maintenance organizations, or HMOs, preferred provider organizations, or PPOs, other managed care organizations, and employers. Marketing activities conducted by our management and center administrators emphasize the high quality of care, cost advantages and convenience of our surgery centers and are focused on making each center an approved provider under local managed care plans.
Accreditation
Many managed care organizations will only contract with a facility that is accredited by either the Joint Commission for the Accreditation of Healthcare Organizations, or JCAHO, or the Accreditation Association for Ambulatory Health Care, or AAAHC. In these markets, we generally seek and obtain these accreditations. Currently, 31% of our surgery centers are accredited by JCAHO or AAAHC, and ten of our surgery centers are scheduled for initial accreditation surveys during 2007. All of the accredited centers have received three-year certifications.
Surgery Center Locations
The following table sets forth certain information relating to surgery centers in operation as of December 31, 2006:
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Our limited partnerships and limited liability companies generally lease the real property in which our surgery centers operate, either from the physician partners or from unaffiliated parties.
Revenues
Substantially all of our revenues are derived from facility fees charged for surgical procedures performed in our surgery centers. These fees vary depending on the procedure, but usually include all charges for operating room usage, special equipment usage, supplies, recovery room usage, nursing staff and medications and, in limited instances, billing for anesthesia services. Facility fees do not include the charges of the patient’s surgeon, anesthesiologist or other attending physicians, which are billed directly by the physicians. Revenue is recorded at the time of the patient encounter and billings for such procedures are made on or about that same date. At the majority of our centers, it is our policy to collect patient co-payments and deductibles at the time the surgery is performed. Our revenues are recorded net of estimated contractual adjustments from third-party medical service payors. Our billing and accounting systems provide us historical trends of the surgery centers’ cash collections and contractual write-offs, accounts receivable agings and established fee adjustments from third-party payors. These estimates are recorded and monitored monthly for each of our surgery centers as additional revenue is recognized. Our ability to accurately estimate contractual adjustments is dependent upon and supported by the fact that our surgery centers perform and bill for limited types of procedures, the range of reimbursement for those procedures within each surgery center specialty is very narrow and payments are typically received within 15 to 45 days of billing. These estimates are not, however, established from billing system generated contractual adjustments based on fee schedules for the patient’s insurance plan for each patient encounter.
Practice-based ASCs, such as those in which we own a majority interest, depend upon third-party reimbursement programs, including governmental and private insurance programs, to pay for services rendered to patients. We derived approximately 35%, 35% and 37% of our revenues in the years ended December 31, 2006, 2005 and 2004, respectively, from governmental healthcare programs, primarily Medicare. The Medicare program currently pays ASCs and physicians in accordance with predetermined fee schedules. Our surgery centers are not required to file cost reports and, accordingly, we have no unsettled amounts from third party payors.
On February 8, 2006, the President signed into law the Deficit Reduction Act of 2005, which includes a provision that limits Medicare reimbursement for certain procedures performed at ASCs to the amounts paid to hospital outpatient departments under the Medicare hospital outpatient department fee schedule for those procedures beginning in 2007. This act negatively impacts the reimbursement of after-cataract laser surgery procedures performed at our ophthalmology centers, the result of which will be an approximately $0.03 reduction in our net earnings per diluted share for the 2007 fiscal year. We believe the after-cataract laser surgery procedure is the only procedure performed in
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significant numbers in our centers for which the current reimbursement rate exceeds the Medicare hospital outpatient department fee schedule amount.
On August 8, 2006, the Centers for Medicare and Medicaid Services, or CMS, announced a proposed rule to revise the payment system for services provided in ASCs. The key points of the proposed rule as it relates to us are:
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CMS’s estimate that the revised ASC rates would be 62% of the corresponding rates of the hospital outpatient prospective payment system;
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a scheduled phase in of the revised rates beginning January 1, 2008 and fully effective on January 1, 2009;
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an annual increase in the ASC rates beginning in 2010 based on the consumer price index for urban consumers; and
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an expansion of the list of procedures that can be performed in an ASC.
CMS has accepted comments on the proposed rule and has stated that it expects to finalize the rule in the spring of 2007, with an expected implementation date of January 1, 2008.
The proposed rule, as written, would result in a significant reduction in the reimbursement rates for gastroenterology procedures, which make up approximately 75% of the procedures performed by our surgery centers, and certain ophthalmology and pain procedures. Based on our 2006 procedure mix, payor mix and volume, we estimate the proposed rule would reduce our net earnings per diluted share in 2008 by approximately $0.15 and our net earnings per diluted share in 2009 by approximately $0.26.
In addition to payment from governmental programs, ASCs derive a significant portion of their revenues from private healthcare insurance plans. These plans include both standard indemnity insurance programs as well as managed care programs, such as PPOs and HMOs. The strengthening of managed care systems nationally has resulted in substantial competition among providers of surgery center services that contract with these systems. Some of our competitors have greater financial resources and market penetration than we do. We believe that all payors, both governmental and private, will continue their efforts over the next several years to reduce healthcare costs and that their efforts will generally result in a less stable market for healthcare services. While no assurances can be given concerning the ultimate success of our efforts to contract with healthcare payors, we believe that our position as a low-cost alternative for certain surgical procedures should enable our surgery centers to compete effectively in the evolving healthcare marketplace.
Competition
We encounter competition in three separate areas: competition with other companies for acquisitions of existing centers, competition for joint venture development of practice-based centers and competition with other providers for physicians to utilize our centers, patients and managed care contracts in each of our markets.
Competition for Center Acquisitions. There are several public and private companies that may compete with us for the acquisition of existing practice-based ASCs. These competitors may have greater resources than we have. The principal competitive factors that affect our and our competitors’ ability to acquire surgery centers are price, experience and reputation, and access to capital.
Competition for Joint Venture Development of Practice-Based Centers. We believe that we do not have a direct corporate competitor in the development of practice-based ASCs across the specialties of gastroenterology, ophthalmology and orthopedics surgery. There are, however, several publicly held companies, divisions or subsidiaries of publicly held companies and several private companies that develop freestanding multispecialty surgery centers, and these companies may compete with us in the development of centers. Further, an increasing number of physician groups are developing surgery centers without a corporate partner, utilizing consultants who typically perform these services for a fee and who take a small equity interest or no equity interest in the ongoing operations of the center.
Competition for Physicians to Utilize our Centers, Patients and Managed Care Contracts. We compete with hospitals and freestanding surgery centers in recruiting physicians to utilize our surgery centers, for patients and for the opportunity to contract with payors to be a provider in their networks of healthcare providers. In some of the markets
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in which we operate, there are shortages of physicians in certain specialties, including gastroenterology. We believe that our surgery centers can provide lower-cost, high quality surgery in a more comfortable environment for the patient in comparison to hospitals and to freestanding surgery centers with which we compete. Exclusion from participation in a managed care network could result in material reductions in patient volume and revenue.
Government Regulation
The healthcare industry is subject to extensive regulation by a number of governmental entities at the federal, state and local level. Government regulation affects our business activities by controlling our growth, requiring licensure and certification for our facilities, regulating the use of our properties and controlling reimbursement to us for the services we provide.
CONs and State Licensing. CON statutes and regulations control the development of ASCs in certain states. CON statutes and regulations generally provide that, prior to the expansion of existing centers, the construction of new centers, the acquisition of major items of equipment or the introduction of certain new services, approval must be obtained from the designated state health planning agency. In giving approval, a designated state health planning agency must determine that a need exists for expanded or additional facilities or services. Our development of ASCs focuses on states that do not require CONs. Acquisitions of existing surgery centers usually do not require CON approval.
State licensing of ASCs is generally a prerequisite to the operation of each center and to participation in federally funded programs, such as Medicare and Medicaid. Once a center becomes licensed and operational, it must continue to comply with federal, state and local licensing and certification requirements, as well as local building and safety codes. In addition, every state imposes licensing requirements on individual physicians and facilities and services operated and owned by physicians. Physician practices are also subject to federal, state and local laws dealing with issues such as occupational safety, employment, medical leave, insurance regulations, civil rights and discrimination and medical waste and other environmental issues.
Corporate Practice of Medicine. The laws of several states in which we operate or may operate in the future do not permit business corporations to practice medicine, exercise control over physicians who practice medicine or engage in various business practices, such as fee-splitting with physicians. The interpretation and enforcement of these laws vary significantly from state to state. We are not required to obtain a license to practice medicine in any jurisdiction in which we own and operate an ASC because the surgery centers are not engaged in the practice of medicine. The physicians who perform procedures at the surgery centers are individually licensed to practice medicine. In most instances, the physicians and physician group practices are not affiliated with us other than through the physicians’ ownership in the limited partnerships and limited liability companies that own the surgery centers and through the service agreements we have with some physicians. The laws in most states regarding the corporate practice of medicine have been subjected to limited judicial and regulatory interpretation. We cannot provide assurances that our activities, if challenged, will be found to be in compliance with these laws.
Certification. We depend on third-party programs, including governmental and private health insurance programs, to reimburse us for services rendered to patients in our ASCs. In order to receive Medicare reimbursement, each surgery center must meet the applicable conditions of participation set forth by the Department of Health and Human Services, or DHHS, relating to the type of facility, its equipment, personnel and standard of medical care, as well as compliance with state and local laws and regulations, all of which are subject to change from time to time. ASCs undergo periodic on-site Medicare certification surveys. Each of our existing centers is certified as a Medicare provider. Although we intend for our centers to participate in Medicare and other government reimbursement programs, there can be no assurance that these centers will continue to qualify for participation.
Medicare-Medicaid Fraud and Abuse Provisions. The federal anti-kickback statute prohibits healthcare providers and others from soliciting, receiving, offering or paying, directly or indirectly, any remuneration (including any kickback, bribe or rebate) with the intent of generating referrals or orders for services or items covered by a federal healthcare program. The anti-kickback statute is very broad in scope and many of its provisions have not been uniformly or definitively interpreted by case law or regulations. Violations may result in criminal penalties or fines of up to $25,000 or imprisonment for up to five years, or both. Violations of the anti-kickback statute may also result in substantial civil penalties, including penalties of up to $50,000 for each violation, plus three times the amount
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claimed and exclusion from participation in the Medicare and Medicaid programs. Exclusion from these programs would result in significant reductions in revenue and would have a material adverse effect on our business. DHHS has published final safe harbor regulations that outline categories of activities that are deemed protected from prosecution under the anti-kickback statute. Two of the safe harbor regulations relate to investment interests in general: the first concerning investment interests in large publicly traded companies ($50,000,000 in net tangible assets) and the second for investments in smaller entities. The safe harbor regulations also include safe harbors for investments in certain types of ASCs. The limited partnerships and limited liability companies that own our surgery centers do not meet all of the criteria of either of the investment interests safe harbors or the surgery center safe harbor. Thus, they do not qualify for safe harbor protection from government review or prosecution under the anti-kickback statute. However, a business arrangement that does not substantially comply with a safe harbor is not necessarily illegal under the anti-kickback statute.
The Office of Inspector General, or OIG, is authorized to issue advisory opinions regarding the interpretation and applicability of the federal anti-kickback statute, including whether an activity constitutes grounds for the imposition of civil or criminal sanctions. We have not sought such an opinion regarding any of our arrangements. However, in February 2003, the OIG issued an advisory opinion on a proposed multi-specialty ASC joint venture involving a hospital and a multi-specialty group practice. The OIG concluded that because the group practice was comprised of a large number of physicians who were not surgeons and therefore were not in a position to personally perform the procedures referred to the surgery center, the proposed arrangement could potentially violate the federal anti-kickback statute.
Although the advisory opinion is not binding on any entity other than the parties who submitted the request, we believe that this advisory opinion provides us with some guidance as to how the OIG would analyze joint ventures involving surgeons such as our physician partners. Substantially all of our joint ventures are distinguishable from the joint venture described in the advisory opinion because, among other things, our physician investors are generally surgeons who not only refer their patients to the surgery centers but also personally perform the surgical procedures.
While several federal court decisions have aggressively applied the restrictions of the anti-kickback statute, they provide little guidance as to the application of the anti-kickback statute to our limited partnerships and limited liability companies. We believe that we are in compliance with the current requirements of applicable federal and state law because among other factors:
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the limited partnerships and limited liability companies exist to effect legitimate business purposes, including the ownership, operation and continued improvement of high quality, cost-effective and efficient services to the patients served;
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the limited partnerships and limited liability companies function as an extension of the group practices of physicians who are affiliated with the surgery centers and the surgical procedures are performed personally by these physicians without referring the patients outside of their practice;
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our physician partners have a substantial investment at risk in the limited partnerships and limited liability companies;
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terms of the investment do not take into account volume of the physician partners’ past or anticipated future services provided to patients of the centers;
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the physician partners are not required or encouraged as a condition of the investment to treat Medicare or Medicaid patients at the centers or to influence others to refer such patients to the centers for treatment;
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the limited partnerships, the limited liability companies, our subsidiaries and our affiliates will not loan any funds to or guarantee any debt on behalf of the physician partners with respect to their investment; and
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distributions by the limited partnerships and limited liability companies are allocated uniformly in proportion to ownership interests.
The safe harbor regulations also set forth a safe harbor for personal services and management contracts. Certain of our limited partnerships and limited liability companies have entered into ancillary services agreements with our physician partners’ group practices, pursuant to which the practice may provide the center with billing and collections, transcription, payables processing, payroll and other ancillary services. The consideration payable by a limited partnership or limited liability company for certain of these services may be based on the volume of services provided by the practice, which is measured by the limited partnership’s or limited liability company’s revenues.
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Although these relationships do not meet all of the criteria of the personal services and management contracts safe harbor, we believe that the ancillary services agreements are in compliance with the current requirements of applicable federal and state law because, among other factors, the fees payable to the physician practices are equal to the fair market value of the services provided thereunder.
Many of the states in which we operate also have adopted laws that prohibit payments to physicians in exchange for referrals similar to the federal anti-kickback statute, some of which apply regardless of the source of payment for care. These statutes typically provide criminal and civil penalties as well as loss of licensure.
Notwithstanding our belief that the relationship of physician partners to our surgery centers should not constitute illegal remuneration under the federal anti-kickback statute or similar laws, we cannot assure you that a federal or state agency charged with enforcement of the anti-kickback statute and similar laws might not assert a contrary position or that new federal or state laws might not be enacted that would cause the physician partners’ ownership interests in our centers to become illegal, or result in the imposition of penalties on us or certain of our facilities. Even the assertion of a violation could have a material adverse effect upon us.
In addition to the anti-kickback statute, the Health Insurance Portability and Accountability Act of 1996, or HIPAA, provides for criminal penalties for healthcare fraud offenses that apply to all health benefit programs, including the payment of inducements to Medicare and Medicaid beneficiaries in order to influence those beneficiaries to order or receive services from a particular provider or practitioner. Federal enforcement officials have numerous enforcement mechanisms to combat fraud and abuse, including the Medicare Integrity Program and an incentive program under which individuals can receive up to $1,000 for providing information on Medicare fraud and abuse that leads to the recovery of at least $100 of Medicare funds. In addition, federal enforcement officials have the ability to exclude from Medicare and Medicaid any investors, officers and managing employees associated with business entities that have committed healthcare fraud.
Evolving interpretations of current, or the adoption of new, federal or state laws or regulations could affect many of our arrangements. Law enforcement authorities, including the OIG, the courts and Congress, are increasing their scrutiny of arrangements between healthcare providers and potential referral sources to ensure that the arrangements are not designed as a mechanism to exchange remuneration for patient care referrals and opportunities. Investigators also have demonstrated a willingness to look behind the formalities of a business transaction to determine the underlying purposes of payments between healthcare providers and potential referral sources.
Prohibition on Physician Ownership of Healthcare Facilities and Certain Self-Referrals. The federal physician self-referral law, commonly referred to as the Stark Law, prohibits a physician from making a referral for a designated health service to an entity if the physician or a member of the physician’s immediate family has a financial relationship with the entity. Sanctions for violating the Stark Law include civil money penalties of up to $15,000 per prohibited service provided and exclusion from the federal healthcare programs. The Stark Law applies to referrals involving the following services under the definition of “designated health services”: clinical laboratory services; physical therapy services; occupational therapy services; radiology and imaging services; radiation therapy services and supplies; durable medical equipment and supplies; parenteral and enteral nutrients, equipment and supplies; prosthetics, orthotics and prosthetic devices and supplies; home health services; outpatient prescription drugs; and inpatient and outpatient hospital services.
On January 4, 2002 and July 26, 2004, final regulations issued under phase one and phase two, respectively, of the Stark Law rulemaking process became effective. DHHS has stated that it intends to issue proposed regulations under phase three of the Stark Law rulemaking process during 2007. Under both the phase one and phase two regulations, services that would otherwise constitute a designated health service, but that are paid by Medicare as a part of the surgery center payment rate, are not a designated health service for purposes of the Stark Law. In addition, the Stark Law contains an exception covering implants, prosthetics, implanted prosthetic devices and implanted durable medical equipment provided in a surgery center setting under certain circumstances. Therefore, we believe the Stark Law does not prohibit physician ownership or investment interests in our surgery centers to which they refer patients. While the phase one and phase two rules help clarify the requirements of the exceptions to the Stark Law, it is difficult to determine the full effect of the regulations.
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In addition, several states in which we operate have self-referral statutes similar to the Stark Law. We believe that physician ownership of surgery centers is not prohibited by these state self-referral statutes. However, the Stark Law and similar state statutes are subject to different interpretations. Violations of these self-referral laws may result in substantial civil or criminal penalties, including large civil monetary penalties and exclusion from participation in the Medicare and Medicaid programs. Exclusion of our surgery centers from these programs could result in significant loss of revenues and could have a material adverse effect on us. We can give you no assurances that further judicial or agency interpretations of existing laws or further legislative restrictions on physician ownership or investment in health care entities will not be issued that could have a material adverse effect on us.
The Federal False Claims Act and Similar Federal and State Laws. We are subject to state and federal laws that govern the submission of claims for reimbursement. These laws generally prohibit an individual or entity from knowingly and willfully presenting a claim (or causing a claim to be presented) for payment from Medicare, Medicaid or other third-party payors that is false or fraudulent. The standard for “knowing and willful” often includes conduct that amounts to a reckless disregard for whether accurate information is presented by claims processors. Penalties under these statutes include substantial civil and criminal fines, exclusion from the Medicare program, and imprisonment. One of the most prominent of these laws is the federal False Claims Act, which may be enforced by the federal government directly, or by a qui tam plaintiff on the government’s behalf. Under the False Claims Act, both the government and the private plaintiff, if successful, are permitted to recover substantial monetary penalties, as well as an amount equal to three times actual damages. In some cases, qui tam plaintiffs and the federal government have taken the position that violations of the anti-kickback statute and the Stark Law should also be prosecuted as violations of the federal False Claims Act. We believe that we have procedures in place to ensure the accurate completion of claims forms and requests for payment. However, the laws and regulations defining proper Medicare or Medicaid billing are frequently unclear and have not been subjected to extensive judicial or agency interpretation. Billing errors can occur despite our best efforts to prevent or correct them, and we cannot assure you that the government will regard such errors as inadvertent and not in violation of the False Claims Act or related statutes. We are currently not aware of any actions against us under the False Claims Act.
A number of states, including states in which we operate, have adopted their own false claims provisions as well as their own qui tam provisions whereby a private party may file a civil lawsuit in state court. We are currently not aware of any actions against us under any state laws.
Healthcare Industry Investigations. Both federal and state government agencies have heightened and coordinated civil and criminal enforcement efforts as part of numerous ongoing investigations of healthcare companies, as well as their executives and managers. These investigations relate to a wide variety of topics, including referral and billing practices.
From time to time, the OIG and the Department of Justice have established national enforcement initiatives that focus on specific billing practices or other suspected areas of abuse. Some of our activities could become the subject of governmental investigations or inquiries. For example, we have significant Medicare billings and we have joint venture arrangements involving physician investors. In addition, our executives and managers, many of whom have worked at other healthcare companies that are or may become the subject of federal and state investigations and private litigation, could be included in governmental investigations or named as defendants in private litigation. We are not aware of any governmental investigations involving any of our facilities, our executives or our managers. A future adverse investigation of us, our executives or our managers could result in significant expense to us, as well as adverse publicity.
Privacy Requirements and Administrative Simplification. There are currently numerous legislative and regulatory initiatives at the state and federal levels addressing patient privacy concerns. DHHS has issued health privacy regulations implementing portions of the Administrative Simplification Provisions of HIPAA that extensively regulate the use and disclosure of individually identifiable health-related information. In addition, DHHS has released security regulations that require healthcare providers to implement administrative, physical and technical practices to protect the security of individually identifiable health-related information that is electronically maintained or transmitted. Further, as required by HIPAA, DHHS has adopted regulations establishing electronic data transmission standards that all healthcare providers must use when submitting or receiving certain healthcare transactions electronically. If we fail to comply with these regulations, we could suffer civil penalties up to $25,000
Item 1. Business - (continued)
per calendar year for each provision violated and criminal penalties with fines of up to $250,000 per violation. In addition, our facilities will continue to remain subject to any state laws that are more restrictive than the privacy regulations issued under HIPAA. These statutes vary by state and could impose additional penalties.
Obligations to Buy Out Physician Partners. Under many of our agreements with physician partners, we are obligated to purchase the interests of the physicians at an amount as determined by a predefined formula, as specified in the limited partnership and operating agreements, in the event that their continued ownership of interests in the limited partnerships and limited liability companies becomes prohibited by the statutes or regulations described above. The determination of such a prohibition generally is required to be made by our counsel in concurrence with counsel of the physician partners or, if they cannot concur, by a nationally recognized law firm with an expertise in healthcare law jointly selected by us and the physician partners. The interest we are required to purchase will not exceed the minimum interest required as a result of the change in the law or regulation causing such prohibition.
Employees
As of December 31, 2006, we and our affiliated entities employed approximately 2,000 persons, approximately 1,300 of whom were full-time employees and 700 of whom were part-time employees. Of our employees, 213 were employed at our headquarters in Nashville, Tennessee. In addition, we lease approximately 660 full-time employees and 500 part-time employees from our associated physician practices. None of these employees are represented by a union. We believe our relationships with our employees to be good.
Legal Proceedings and Insurance
From time to time, we may be named a party to legal claims and proceedings in the ordinary course of business. We are not aware of any claims or proceedings against us or our limited partnerships and limited liability companies that we believe will have a material financial impact on us.
Each of our surgery centers maintains separate medical malpractice insurance in amounts deemed adequate for its business. We also maintain insurance for general liability, director and officer liability and property. Certain policies are subject to deductibles.
Available Information
We file reports with the Securities and Exchange Commission, or SEC, including annual reports on Form 10-K, quarterly reports on Form 10-Q and other reports from time to time. The public may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F. Street, N.E., Room 1580, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. We are an electronic filer and the SEC maintains an Internet site at http://www.sec.gov that contains the reports, proxy and information statements and other information filed electronically. Our website address is: http://www.amsurg.com. We make available free of charge through our website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. The information provided on our website is not part of this report, and is therefore not incorporated by reference unless such information is otherwise specifically referenced elsewhere in this report.
Item 1A.
Item 1A. Risk Factors
The following factors affect our business and the industry in which we operate. The risks and uncertainties described below are not the only ones facing our company. Additional risks and uncertainties not presently known to us or that we currently consider immaterial may also have an adverse effect on us. If any of the matters discussed in the following risk factors were to occur, our business, financial condition, results of operations, cash flows or prospects could be materially adversely affected.
Item 1A. Risk Factors - (continued)
Our results of operations may be adversely affected by proposed changes in the reimbursement system for outpatient surgical procedures under the Medicare program. The Medicare program pays for ASC services using a fee schedule. On August 8, 2006, CMS announced a proposed rule to revise the payment system for services provided in ASCs. The key points of the proposed rule as it relates to us are:
•
CMS’s estimate that the revised ASC rates would be 62% of the corresponding rates of the hospital outpatient prospective payment system;
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a scheduled phase in of the revised rates beginning January 1, 2008 and fully effective on January 1, 2009;
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an annual increase in the ASC rates beginning in 2010 based on the consumer price index for urban consumers; and
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an expansion of the list of procedures that can be performed in an ASC.
CMS has accepted comments on the proposed rule and has stated that it expects to finalize the rule in the spring of 2007, with an expected implementation date of January 1, 2008.
The proposed rule, as written, would result in a significant reduction in the reimbursement rates for gastroenterology procedures, which make up approximately 75% of the procedures performed by our surgery centers, and certain ophthalmology and pain procedures. Based on our 2006 procedure mix, payer mix and volume, we estimate the proposed rule would reduce our net earnings per diluted share in 2008 by approximately $0.15 and our net earnings per diluted share in 2009 by approximately $0.26. However, we can give no assurances that the final rule would not contain provisions that may further impact our net earnings per diluted share.
We depend on payments from third-party payors, including government healthcare programs. If these payments decrease or do not increase as our costs increase, our operating margins and profitability would be adversely affected. We depend on private and governmental third-party sources of payment for the services provided to patients in our surgery centers. The amount our surgery centers receive for their services may be adversely affected by market and cost factors as well as other factors over which we have no control, including Medicare and Medicaid regulations and the cost containment and utilization decisions of third-party payors. We derived approximately 35% of our revenues in 2006 from U.S. government healthcare programs, primarily Medicare. Managed care plans have increased their market share in some areas in which we operate, which has resulted in substantial competition among healthcare providers for inclusion in managed care contracting and may limit the ability of healthcare providers to negotiate favorable payment rates. We can give you no assurances that cost containment measures by private third-party payors, including fixed fee schedules and capitated payment arrangements, changes in reimbursement rates by government healthcare programs or other factors affecting payments for healthcare services will not adversely affect our revenues, operating margins or profitability.
Our business would be adversely affected if we fail to maintain good relationships with the physician partners who use our surgery centers. Our business depends on, among other things, the efforts and success of the physician partners who perform procedures at our surgery centers and the strength of our relationship with these physicians. Our physician partners perform procedures at other facilities or hospitals, are not required to use our surgery centers and may choose not to perform procedures at our surgery centers. In addition, from time to time we may have disputes with physicians who use or own interests in our surgery centers. Our revenues and profitability could be adversely affected if a key physician or group of physicians stopped using or reduced their use of our surgery centers. In addition, if the physicians who use our surgery centers do not provide quality medical care or follow required professional guidelines at our facilities or there is damage to the reputation of a key physician or group of physicians who use our surgery centers, our business and reputation could be damaged.
If we fail to acquire and develop additional surgery centers on favorable terms, our future growth and operating results could be adversely affected. Our growth strategy includes increasing our revenues and earnings by acquiring existing surgery centers and developing new surgery centers. Our efforts to execute our acquisition and development strategy may be affected by our ability to identify suitable acquisition and development opportunities and negotiate and close transactions in a timely manner and on favorable terms. The surgery centers we develop typically incur losses during the initial months of operation. We can give you no assurances that we will be successful in acquiring and developing additional surgery centers, that the surgery centers we acquire and develop will achieve satisfactory operating results or that newly developed centers will not incur greater than anticipated operating losses.
Item 1A. Risk Factors - (continued)
If we are unable to grow revenues at our existing centers, our operating margins and profitability could be adversely affected. Our growth strategy includes increasing our revenues and earnings by increasing the number of procedures at our surgery centers. Because we expect the amount of the payments we receive from third-party payors to remain fairly consistent, our operating margins will be adversely affected if we do not increase the revenues and procedure volume of our surgery centers to offset increases in our operating costs. We seek to increase procedure volume and revenues at our surgery centers by increasing the number of physicians performing procedures at our centers, obtaining new or more favorable managed care contracts, improving patient flow at our centers, promoting screening programs, increasing patient and physician awareness of our centers and achieving operating efficiencies. We can give you no assurances that we will be successful at increasing or maintaining revenues and operating margins at our centers.
If we are unable to manage the growth in our business, our operating results could be adversely affected. To accommodate our past and anticipated future growth, we will need to continue to implement and improve our management, operational and financial information systems and to expand, train, manage and motivate our workforce. We can give you no assurances that our personnel, systems, procedures or controls will be adequate to support our operations in the future or that the costs and management attention related to the expansion of our operations will not adversely affect our results of operations.
If we do not have sufficient capital resources to complete acquisitions and develop new surgery centers, our growth and results of operations could be adversely affected. We will need capital to acquire, develop, integrate, operate and expand surgery centers. We may finance future acquisition and development projects through debt or equity financings. To the extent that we undertake these financings, our shareholders may experience ownership dilution. To the extent we incur debt, we may have significant interest expense and may be subject to covenants in the related debt agreements that affect the conduct of our business. If we do not have sufficient capital resources, our growth could be limited and our results of operations could be adversely impacted. Our credit facility requires that we comply with financial covenants and may not permit additional borrowing or other sources of debt financing if we are not in compliance. We can give you no assurances that we will be able to obtain financing necessary for our acquisition and development strategy or that, if available, the financing will be available on terms acceptable to us.
If we are unable to effectively compete for physician partners, managed care contracts, patients and strategic relationships, our business would be adversely affected. The healthcare business is highly competitive. We compete with other healthcare providers, primarily hospitals and other surgery centers, in recruiting physicians to utilize our surgery centers, for patients and in contracting with managed care payors. In some of the markets in which we operate, there are shortages of physicians in certain specialties, including gastroenterology. Some of our competitors may have greater resources than we do, including financial, marketing, staff and capital resources, and may have or may develop new technologies or services that are attractive to physicians or patients. In each of our markets there are hospitals and other healthcare providers with established relationships with physicians and payors. Exclusion from participation in a managed care contract in a specific location could result in material reductions in patient volume and revenues to our surgery centers.
There are several large, publicly held companies, divisions or subsidiaries of large publicly held companies, and several private companies that develop and acquire freestanding multi-specialty surgery centers, and these companies may compete with us in the development and acquisition of centers. Further, many physician groups develop surgery centers without a corporate partner, utilizing consultants who typically perform these services for a fee and who take a small or no equity interest in the ongoing operations of the center. We can give you no assurances that we can compete effectively in any of these areas.
We operate a significant number of surgery centers in Florida, which makes us sensitive to weather and other factors in Florida. At December 31, 2006, 30 of the 156 surgery centers we operated were located in the State of Florida. This concentration makes us particularly sensitive to adverse weather conditions and other factors that affect the State of Florida. In prior years, the results of operations of our surgery centers in Florida have been adversely impacted by hurricanes, which caused disruption of patient scheduling, displacement of our patients, employees and physician partners and forced certain of our surgery centers temporarily to close. Our future financial and operating results may be adversely affected by weather and other factors affecting the State of Florida, as well as other geographic regions in which we operate.
Item 1A. Risk Factors - (continued)
If we fail to comply with applicable laws and regulations, we could suffer penalties or be required to make significant changes to our operations. We are subject to many laws and regulations at the federal, state and local government levels in the jurisdictions in which we operate. These laws and regulations require that our surgery centers and our operations meet various licensing, certification and other requirements, including those relating to:
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physician ownership of our surgery centers;
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CON approvals and other regulations affecting the construction or acquisition of centers, capital expenditures or the addition of services;
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the adequacy of medical care, equipment, personnel, and operating policies and procedures;
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qualifications of medical and support personnel;
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maintenance and protection of records;
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billing for services by healthcare providers;
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privacy and security of individually identifiable health information; and
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environmental protection.
If we fail to comply with applicable laws and regulations, we could suffer civil or criminal penalties, including the loss of our licenses to operate and our ability to participate in Medicare, Medicaid and other government sponsored and third-party healthcare programs. In addition, a number of states have adopted or are considering legislation or regulations imposing additional restrictions on or otherwise affecting free-standing ASCs, including expansion of CON requirements, restrictions on ownership, taxes on gross receipts, data reporting requirements and restrictions on the enforceability of covenants not to compete affecting physicians. In the future, different interpretations or enforcement of existing or new laws and regulations could subject our current practices to allegations of impropriety or illegality, or require us to make changes in our operations, facilities, equipment, personnel, services, capital expenditure programs or operating expenses. We can give you no assurances that current or future legislative initiatives or government regulation will not have a material adverse effect on us or reduce the demand for our services.
If a federal or state agency asserts a different position or enacts new laws or regulations regarding illegal remuneration or other forms of fraud and abuse, we could suffer penalties or be required to make significant changes to our operations. A federal law, referred to as the anti-kickback statute, prohibits healthcare providers and others from soliciting, receiving, offering or paying, directly or indirectly, any remuneration with the intent of generating referrals or orders for services or items covered by a federal healthcare program. The anti-kickback statute is very broad in scope and many of its provisions have not been uniformly or definitively interpreted by case law or regulations. Violations of the anti-kickback statute may result in substantial civil or criminal penalties and exclusion from participation in the Medicare and Medicaid programs. Exclusion from these programs would result in significant reductions in revenue and would have a material adverse effect on our business.
DHHS has published regulations that outline categories of activities that are deemed protected from prosecution under the anti-kickback statute. Three of the safe harbors apply to business arrangements similar to those used in connection with our surgery centers: the “surgery centers,” “investment interest” and “personal services and management contracts” safe harbors. The structure of the limited partnerships and limited liability companies operating our surgery centers, as well as our various business arrangements involving physician group practices, do not satisfy all of the requirements of any safe harbor. Nevertheless, a business arrangement that does not substantially comply with a safe harbor is not necessarily illegal under the anti-kickback statute. In addition, many of the states in which we operate also have adopted laws, similar to the anti-kickback statute, that prohibit payments to physicians in exchange for referrals, some of which apply regardless of the source of payment for care. These statutes typically impose criminal and civil penalties as well as loss of license.
In addition to the anti-kickback statute, HIPAA provides for criminal penalties for healthcare fraud offenses that apply to all health benefit programs, including the payment of inducements to Medicare and Medicaid beneficiaries in order to influence those beneficiaries to order or receive services from a particular provider or practitioner. Federal enforcement officials have numerous enforcement mechanisms to combat fraud and abuse, including the Medicare Integrity Program and an incentive program under which individuals can receive up to $1,000 for providing information on Medicare fraud and abuse that leads to the recovery of at least $100 of Medicare funds. In addition, federal enforcement officials have the ability to exclude from Medicare and Medicaid any investors, officers and managing employees associated with business entities that have committed healthcare fraud.
Item 1A. Risk Factors - (continued)
Providers in the healthcare industry have been the subject of federal and state investigations, and we may become subject to investigations in the future. Both federal and state government agencies have heightened and coordinated civil and criminal enforcement efforts as part of numerous ongoing investigations of healthcare companies, as well as their executives and managers. These investigations relate to a wide variety of topics, including referral and billing practices. Further, the federal False Claims Act permits private parties to bring “qui tam” whistleblower lawsuits against companies. Some states have adopted similar state whistleblower and false claims provisions.
From time to time, the OIG and the Department of Justice have established national enforcement initiatives that focus on specific billing practices or other suspected areas of abuse. Some of our activities could become the subject of governmental investigations or inquiries. For example, we have significant Medicare billings and we have joint venture arrangements involving physician investors. In addition, our executives and managers, some of whom have worked at other healthcare companies that are or may become the subject of federal and state investigations and private litigation, could be included in governmental investigations or named as defendants in private litigation. We are not aware of any governmental investigations involving any of our facilities, our executives or our managers. A future investigation of us, our executives or our managers could result in significant expense to us, as well as adverse publicity.
If regulations or regulatory interpretations change, we may be obligated to buy out interests of physicians who are minority owners of the surgery centers. Substantially all of the limited partnership and operating agreements for the limited partnerships and limited liability companies through which we own our surgery centers provide that if certain regulations or regulatory interpretations change, we will be obligated to purchase some or all of the minority interests of the physician entities affiliated with us in the limited partnerships and limited liability companies that own and operate our surgery centers. The regulatory changes that could trigger such obligations include changes that:
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make the referral of Medicare and other patients to our surgery centers by physicians affiliated with us illegal;
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create the substantial likelihood that cash distributions from the limited partnership or limited liability company to the affiliated physicians will be illegal; or
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cause the ownership by the physicians of interests in the limited partnerships or limited liability companies to be illegal.
The cost of repurchasing these minority interests would be substantial if a triggering event were to result in simultaneous purchase obligations at each of our surgery centers. The purchase price to be paid in such event would be determined by a predefined formula, as specified in each of the limited partnership and operating agreements, which also provide for the payment terms, generally over four years. There can be no assurance, however, that our existing capital resources would be sufficient for us to meet the obligations, if they arise, to purchase these minority interests held by physicians. The determination of whether a triggering event has occurred generally would be made by the concurrence of our legal counsel and counsel for the physician partners or, in the absence of such concurrence, by a nationally recognized law firm having an expertise in healthcare law jointly selected by both parties. Such determinations therefore would not be within our control. The triggering of these obligations could have a material adverse effect on our financial condition and results of operations. While we believe physician ownership of ASCs as structured within our limited partnerships and limited liability companies is in compliance with applicable law, we can give no assurances that legislative or regulatory changes would not have an adverse impact on us. The issue of physician ownership in ASCs is also being considered by some state legislatures.
We are liable for the debts and other obligations of the limited partnerships that own and operate certain of our surgery centers. In the limited partnerships in which we are the general partner, we are liable for 100% of the debts and other obligations of the limited partnership; however, the limited partnership agreement generally requires the physician partners to guarantee their pro rata share of any indebtedness or lease agreements to which the limited partnership is a party in proportion to their ownership interest in the limited partnership. We also have primary liability for the bank debt that may be incurred for the benefit of the limited liability companies, and in turn, lend funds to these limited liability companies, although the physician members also guarantee this debt. There can be no assurance that a third-party lender or lessor would seek performance of the guarantees rather than seek repayment from us of any obligation of the limited partnership or limited liability company if there is a default, or that the physician partners or members would have sufficient assets to satisfy their guarantee obligations.
Item 1A. Risk Factors - (continued)
We have a legal responsibility to the minority owners of the entities through which we own our surgery centers, which may conflict with our interests and prevent us from acting solely in our own best interests. As the owner of majority interests in the limited partnerships and limited liability companies that own our surgery centers, we owe a fiduciary duty to the minority interest holders in these entities and may encounter conflicts between our interests and that of the minority holders. In these cases, our representatives on the governing board of each joint venture are obligated to exercise reasonable, good faith judgment to resolve the conflicts and may not be free to act solely in our own best interests. In our role as manager of the limited partnership or limited liability company, we generally exercise our discretion in managing the business of the surgery center. Disputes may arise between us and the physician partners regarding a particular business decision or the interpretation of the provisions of the limited partnership agreement or limited liability company operating agreement. The agreements provide for arbitration as a dispute resolution process in some circumstances. We cannot assure you that any dispute will be resolved or that any dispute resolution will be on terms satisfactory to us.
We may write-off intangible assets, such as goodwill. As a result of purchase accounting for our various acquisition transactions, our balance sheet at December 31, 2006 contained an intangible asset designated as goodwill totaling $397.1 million. Additional purchases of interests in practice-based surgery centers that result in the recognition of additional intangible assets would cause an increase in these intangible assets. On an ongoing basis, we evaluate whether facts and circumstances indicate any impairment of value of intangible assets. As circumstances change, we cannot assure you that the value of these intangible assets will be realized by us. If we determine that a significant impairment has occurred, we will be required to write-off the impaired portion of intangible assets, which could have a material adverse effect on our results of operations in the period in which the write-off occurs.
The IRS may challenge tax deductions for certain acquired goodwill. For federal income tax purposes, goodwill and other intangibles acquired as part of the purchase of a business after August 10, 1993 are deductible over a 15-year period. We have been claiming and continue to take tax deductions for goodwill obtained in our acquisition of assets of practice-based ASCs. In 1997, the IRS published proposed regulations that applied “anti-churning” rules to call into question the deductibility of goodwill purchased in transactions structured similarly to some of our acquisitions. The anti-churning rules are designed to prevent taxpayers from converting existing goodwill for which a deduction would not have been allowable prior to 1993 into an asset that could be deducted over 15 years, such as by selling a business some of the value of which arose prior to 1993 to a related party. On January 25, 2000, the IRS issued final regulations that continue to call into question the deductibility of goodwill purchased in transactions structured similarly to some of our acquisitions. This uncertainty applies only to goodwill that arose in part prior to 1993, so the tax deductions we have taken with respect to interests acquired in surgery centers that were formed after August 10, 1993 are not affected. In response to these final regulations, in 2000 we changed our methods of acquiring interests in practice-based ASCs so as to comply with guidance found in the final regulations. There is a risk that the IRS could challenge tax deductions for pre-1993 goodwill in acquisitions we completed prior to changing our approach. Loss of these tax deductions would increase the amount of our tax payments and could subject us to interest and penalties.
Item 1B.
Item 1B. Unresolved Staff Comments
Not applicable.
Item 2.
Item 2. Properties
Our principal executive offices are located in Nashville, Tennessee and contain an aggregate of approximately 44,000 square feet of office space, which we lease from a third party pursuant to an agreement that expires in 2014. We have the option to renew our lease for two additional terms of five years following the expiration of the current term. We also lease office space for our regional offices in Coral Gables, Florida, Tempe, Arizona, Tampa, Florida and Berwyn, Pennsylvania. AmSurg limited partnerships and limited liability companies generally lease space for their surgery centers. Of the centers in operation at December 31, 2006, 154 leased space ranging from 1,000 to 13,000 square feet, with expected remaining lease terms ranging from one to twenty-five years. Two centers in operation at December 31, 2006 are located in buildings owned by our limited partnership or limited liability company that operates the surgery center.
Item 3.
Item 3. Legal Proceedings
Not applicable.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information regarding the persons serving as executive officers of AmSurg as of December 31, 2006. Executive officers of AmSurg serve at the pleasure of the Board of Directors.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock trades under the symbol “AMSG” on the Nasdaq Global Select Market. The following table sets forth the high and low sales prices per share for the common stock for each of the quarters in 2005 and 2006, as reported on the Nasdaq Global Select Market.
At February 23, 2007, there were approximately 5,150 holders of our common stock, including 244 shareholders of record. We have never declared or paid a cash dividend on our common stock. We intend to retain our earnings to finance the growth and development of our business and do not expect to declare or pay any cash dividends in the foreseeable future. The declaration of dividends is within the discretion of our Board of Directors. Presently, the declaration of dividends is prohibited by a covenant in our credit facility.
Item 6.
Item 6. Selected Financial Data
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
This report contains certain forward-looking statements (all statements other than with respect to historical fact) within the meaning of the federal securities laws, which are intended to be covered by the safe harbors created thereby. Investors are cautioned that all forward-looking statements involve known and unknown risks and uncertainties including, without limitation, those described in “Risk Factors,” some of which are beyond our control. Although we believe that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate. Therefore, there can be no assurance that the forward-looking statements included in this report will prove to be accurate. Actual results could differ materially and adversely from those contemplated by any forward-looking statement. In light of the significant risks and uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives and plans will be achieved. We undertake no obligation to publicly release any revisions to any forward-looking statements in this discussion to reflect events and circumstances occurring after the date hereof or to reflect unanticipated events. Forward-looking statements and our liquidity, financial condition and results of operations may be affected by the risks set forth in “Risk Factors” or by other unknown risks and uncertainties.
Overview
We develop, acquire and operate practice-based ambulatory surgery centers, or ASCs, in partnership with physician practice groups. As of December 31, 2006, we owned a majority interest (51% or greater) in 156 surgery centers. We acquired a majority interest in seven additional ASCs as of January 1, 2007. See “- Liquidity and Capital Resources.” The following table presents the changes in the number of surgery centers in operation, under development and under letter of intent for the years ended December 31, 2006, 2005 and 2004. A center is deemed to be under development when a limited partnership or limited liability company has been formed with the physician group partner to develop the center.
Of the continuing surgery centers in operation at December 31, 2006, 104 centers performed gastrointestinal endoscopy procedures, 39 centers performed ophthalmology surgery procedures, five centers performed orthopedic procedures and eight centers performed procedures in more than one specialty. The other partner or member in each limited partnership or limited liability company is generally an entity owned by physicians who perform procedures at the center. We intend to expand primarily through the acquisition and development of additional practice-based ASCs in targeted surgical specialties and through future same-center growth. Our growth targets for 2007 include the acquisition or development of 18 to 20 surgery centers (including the seven surgery centers acquired as of January 1, 2007) and the achievement of annual same-center revenue growth of 3% to 4%.
While we generally own 51% of the entities that own the surgery centers, our consolidated statements of earnings include 100% of the results of operations of the entities, reduced by the minority partners’ share of the net earnings or loss of the surgery center entities.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - (continued)
Sources of Revenues
Substantially all of our revenues are derived from facility fees charged for surgical procedures performed in our surgery centers. This fee varies depending on the procedure, but usually includes all charges for operating room usage, special equipment usage, supplies, recovery room usage, nursing staff and medications and, in limited instances, billing for anesthesia services. Facility fees do not include the charges of the patient’s surgeon, anesthesiologist or other attending physicians, which are billed directly by the physicians. Our revenues are recorded net of estimated contractual adjustments from third-party medical service payors.
Practice-based ASCs, such as those in which we own a majority interest, depend upon third-party reimbursement programs, including governmental and private insurance programs, to pay for services rendered to patients. The amount of payment a surgery center receives for its services may be adversely affected by market and cost factors, as well as other factors over which we have no control, including Medicare and Medicaid regulations and the cost containment and utilization decisions of third-party payors. We derived approximately 35%, 35% and 37% of our revenues in the years ended December 31, 2006, 2005 and 2004, respectively, from governmental healthcare programs, primarily Medicare, and the remainder from a wide mix of commercial payors and patient co-pays and deductibles. The Medicare program currently pays ASCs in accordance with predetermined fee schedules.
On February 8, 2006, the President signed into law the Deficit Reduction Act of 2005, which includes a provision that limits Medicare reimbursement for certain procedures performed at ASCs to the amounts paid to hospital outpatient departments under the Medicare hospital outpatient department fee schedule for those procedures beginning in 2007. This act negatively impacts the reimbursement of after-cataract laser surgery procedures performed at our ophthalmology ASCs, the result of which will be an approximate $0.03 reduction in our net earnings per diluted share for 2007. We believe the after-cataract laser surgery procedure is the only procedure performed in significant numbers in our centers for which the current reimbursement rate exceeds the Medicare hospital outpatient development fee schedule amount.
On August 8, 2006, the Centers for Medicare and Medicaid Services, or CMS, announced a proposed rule to revise the payment system for services provided in ASCs. The key points of the proposed rule as it relates to us are:
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CMS’s estimate that the revised ASC rates would be 62% of the corresponding rates of the hospital outpatient prospective payment system;
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a scheduled phase in of the revised rates over two years, beginning January 1, 2008;
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an annual increase in the ASC rates beginning in 2010 based on the consumer price index; and
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an expansion of the list of procedures that can be performed in an ASC.
CMS accepted comments on the proposed rule through November 6, 2006 and has stated that it expects to finalize the rule in the spring of 2007, with an expected implementation date of January 1, 2008.
The proposed rule, as written, would result in a significant reduction in the reimbursement rates for gastroenterology procedures, which make up approximately 75% of the procedures performed by our surgery centers, and certain ophthalmology and pain procedures. Based on our 2006 procedure mix, payer mix and volume, we estimate the proposed rule would reduce our net earnings per diluted share in 2008 by approximately $0.15 and our net earnings per diluted share in 2009 by approximately $0.26.
Critical Accounting Policies
Our accounting policies are described in note 1 of the consolidated financial statements. We prepare our consolidated financial statements in conformity with accounting principles generally accepted in the United States, which require us to make estimates and assumptions that affect the reported amounts of assets and liabilities and related disclosures at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. We consider the following policies to be most critical in understanding the judgments that are involved in preparing our financial statements and the uncertainties that could impact our results of operations, financial condition and cash flows.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - (continued)
Principles of Consolidation. The consolidated financial statements include the accounts of AmSurg and our subsidiaries and the majority owned limited partnerships and limited liability companies in which our wholly owned subsidiaries are the general partner or majority member. Consolidation of such limited partnerships and limited liability companies is necessary, as our wholly owned subsidiaries have 51% or more of the financial interest, are the general partner or majority member with all the duties, rights and responsibilities thereof, are responsible for the day-to-day management of the limited partnership or limited liability company and have control of the entities. The responsibilities of our minority partners are to supervise the delivery of medical services, with their rights being restricted to those that protect their financial interests, such as approval of the acquisition of significant assets or the incurrence of debt that they are required to guarantee on a pro rata basis based upon their respective ownership interests. Intercompany profits, transactions and balances have been eliminated.
Surgery center profits are allocated to our minority partners in proportion to their individual ownership percentages and reflected in the aggregate as minority interest. The minority partners of our surgery center limited partnerships and limited liability companies typically are organized as general partnerships, limited partnerships or limited liability companies that are not subject to federal income tax. Each minority partner shares in the pre-tax earnings of the surgery center in which it holds minority ownership. Accordingly, the minority interest in each of our limited partnerships and limited liability companies is determined on a pre-tax basis and presented before earnings before income taxes in order to present that amount of earnings on which we must determine our tax expense. In addition, distributions from our limited partnerships and limited liability companies are made both to our subsidiary general partners and majority members and to our minority partners on a pre-tax basis.
As described above, we are a holding company and our ability to service corporate debt is dependent upon distributions from our limited partnerships and limited liability companies. Positive operating cash flows of individual centers are the sole source of cash used to make distributions to our subsidiary general partners and majority members as well as to our minority partners, which we are obligated to make on a monthly basis in accordance with each limited partnership’s and limited liability company’s partnership or operating agreement. Accordingly, distributions to our minority partners are included in our financial statements as a component of our cash flows from operating activities.
We operate in one reportable business segment, the ownership and operation of ASCs.
Revenue Recognition. Center revenues consist of billing for the use of the centers’ facilities, or facility fees, directly to the patient or third-party payor, and in limited instances, billing for anesthesia services. Such revenues are recognized when the related surgical procedures are performed. Revenues exclude any amounts billed for physicians’ surgical services, which are billed separately by the physicians to the patient or third-party payor.
Allowance for Contractual Adjustments and Bad Debt Expense. Our revenues are recorded net of estimated contractual adjustments from third-party medical service payors, which we estimate based on historical trends of the surgery centers’ cash collections and contractual write-offs, accounts receivable agings, established fee schedules, contracts with payors and procedure statistics. In addition, we must estimate allowances for bad debt expense using similar information and analysis. These estimates are recorded and monitored monthly for each of our surgery centers as additional revenue is recognized. Our ability to accurately estimate contractual adjustments is dependent upon and supported by the fact that our surgery centers perform and bill for limited types of procedures, that the range of reimbursement for those procedures within each surgery center specialty is very narrow and that payments are typically received within 15 to 45 days of billing. In addition, our surgery centers are not required to file cost reports, and therefore, we have no risk of unsettled amounts from third-party payors. These estimates are not, however, established from billing system-generated contractual adjustments based on fee schedules for the patient’s insurance plan for each patient encounter. While we believe that our allowances for contractual adjustments and bad debt expense are adequate, if the actual contractual adjustments and write-offs are in excess of our estimates, our results of operations may be overstated. During the years ended December 31, 2006, 2005 and 2004, we had no significant adjustments to our allowances for contractual adjustments and bad debt expense related to prior periods. At December 31, 2006 and 2005, net accounts receivable reflected allowances for contractual adjustments of $63.7 million and $52.9 million, respectively, and allowances for bad debt expense of $6.6 million and $6.2 million, respectively. The increase in our contractual allowance is primarily related to allowances established for new centers acquired during 2006. At December 31, 2006 and 2005, we had 40 and 37 days, respectively, outstanding reflected in our gross accounts receivable. The increase in our days outstanding is due to the average days outstanding at certain centers acquired in 2006.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - (continued)
Purchase Price Allocation. We allocate the respective purchase price of our acquisitions in accordance with Statement of Financial Accounting Standards, or SFAS, No. 141, “Business Combinations.” The allocation of purchase price involves first determining the fair value of net tangible and identifiable intangible assets acquired. Secondly, the excess amount of purchase price is to be allocated to unidentifiable intangible assets (goodwill). A significant portion of each surgery center’s purchase price historically has been allocated to goodwill due to the nature of the businesses acquired, the pricing and structure of our acquisitions and the absence of other factors indicating any significant value that could be attributable to separately identifiable intangible assets.
Goodwill. We apply the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets,” which require that goodwill be evaluated for impairment at least on an annual basis. Impairment of carrying value will be evaluated more frequently if certain indicators are encountered. SFAS No. 142 requires that goodwill be tested at the reporting unit level, defined as an operating segment or one level below an operating segment (referred to as a component), with the fair value of the reporting unit being compared to its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is not considered to be impaired. We have determined that we have one operating, as well as one reportable, segment. For impairment testing purposes, our centers each qualify as components of that operating segment. Because they have similar economic characteristics, they are aggregated and deemed a single reporting unit. We completed our annual impairment test as required by SFAS No. 142 as of December 31, 2006, and have determined that it is not necessary to recognize impairment in our goodwill.
Results of Operations
Our revenues are directly related to the number of procedures performed at our surgery centers. Our overall growth in procedure volume is impacted directly by the increase in the number of surgery centers in operation and the growth in procedure volume at existing centers. We increase our number of surgery centers through both acquisitions and developments. Procedure growth at any existing center may result from additional contracts entered into with third-party payors, increased market share of the associated medical practice of our physician partners, additional physicians utilizing the center and/or scheduling and operating efficiencies gained at the surgery center. A significant measurement of how much our revenues grow from year to year for existing centers is our same-center revenue percentage. We define our same-center group each year as those centers that contain full year-to-date operations in both comparable reporting periods, including the expansion of the number of operating centers within a limited partnership or limited liability company. Our 2006 same-center group, comprised of 126 centers, had revenue growth of 5%. Our same-center group in 2007 will be comprised of 147 centers, which constitutes approximately 90% of our total base of centers. We expect our same-center revenue growth to be 3% to 4% in 2007.
Expenses directly and indirectly related to procedures performed at our surgery centers include clinical and administrative salaries and benefits, supply cost and other operating expenses such as linen cost, repair and maintenance of equipment, billing fees and bad debt expense. The majority of our corporate salary and benefits cost is associated directly with the number of centers we own and manage and tends to grow in proportion to the growth of our centers in operation. Our centers and corporate offices also incur costs that are more fixed in nature, such as lease expense, legal fees, property taxes, utilities and depreciation and amortization.
Surgery center profits are allocated to our minority partners in proportion to their individual ownership percentages and reflected in the aggregate as minority interest. The minority partners of our surgery center limited partnerships and limited liability companies typically are organized as limited partnerships or limited liability companies that are not subject to federal income tax. Each minority partner shares in the pre-tax earnings of the surgery center of which it is a minority partner. Accordingly, the minority interest in each of our surgery center limited partnerships and limited liability companies is determined on a pre-tax basis and presented before earnings before income taxes in order to present that amount of earnings on which we must determine our tax expense.
Our interest expense results primarily from our borrowings used to fund acquisition and development activity, as well as interest incurred on capital leases.
We file a consolidated federal income tax return and numerous state income tax returns with varying tax rates. Our income tax expense reflects the blending of these rates.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - (continued)
The following table shows certain statement of earnings items expressed as a percentage of revenues for the years ended December 31, 2006, 2005 and 2004:
Year Ended December 31, 2006 Compared to Year Ended December 31, 2005
Revenues increased $76.8 million, or 20%, to $464.6 million in 2006 from $387.8 million in 2005. The additional revenues resulted primarily from:
Our procedures increased by 117,259, or 16%, to 851,328 in 2006 from 734,069 in 2005. The difference between our revenue growth and our procedure growth was primarily the result of an increase in our average revenue per procedure because of the increase in the number of orthopedic, eye and multi-specialty centers in operation in 2006 and a change in the mix of procedures in our same-center group.
Staff at newly acquired and developed centers, as well as the additional staffing required at existing centers due to increased volume, resulted in a 19% increase in salaries and benefits at our surgery centers in 2006. We experienced a 60% increase in salaries and benefits at our corporate offices during 2006 over 2005. The increase in corporate office salaries and benefits was primarily due to share-based compensation expense of approximately $7.0 million related to the adoption of SFAS, No. 123R, “Share-Based Payment (Revised 2004),” effective January 1, 2006 (see
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - (continued)
“- Recent Accounting Pronouncements”), increased employee incentive compensation expense for our corporate employees and expense associated with additional corporate employees needed to manage our additional centers in operation during 2006. Salaries and benefits increased in total by 25% to $137.9 million in 2006 from $110.0 million in 2005. Salaries and benefits as a percentage of revenues increased in 2006 over 2005 due to the impact of share-based compensation expense.
Supply cost was $54.3 million in 2006, an increase of $10.5 million, or 24%, over supply cost in 2005. This increase was primarily the result of additional procedure volume. In addition, our average supply cost per procedure increased to $64 in 2006 from $60 in 2005. During 2006 certain surgery centers performed cataract procedures that included a reimbursable presbyopia correcting lens, which has a higher cost and increased our average cost per procedure during 2006 as compared to 2005, during which these type of cataract procedures were not performed. In addition, the increase in the number of orthopedic and multi-specialty centers in operation since 2005 resulted in an increase in supply cost per procedure due to the higher supply cost incurred at these types of centers.
Other operating expenses increased $15.4 million, or 20%, to $91.9 million in 2006 from 2005. The additional expense in the 2006 period resulted primarily from:
Depreciation and amortization expense increased $2.1 million, or 14%, in 2006 from 2005, primarily as a result of centers acquired since 2005 and the newly developed surgery centers in operation, which have an initially higher level of depreciation expense due to their construction costs.
We anticipate further increases in operating expenses in 2007, primarily due to additional acquired centers and additional start-up centers expected to be placed in operation. Typically, a start-up center will incur start-up losses while under development and during its initial months of operation and will experience lower revenues and operating margins than an established center. This typically continues until the case load at the center grows to a more normal operating level, which generally is expected to occur within 12 months after the center opens. At December 31, 2006, we had five centers under development and three centers that had been open for less than one year.
Minority interest in earnings from continuing operations before income taxes in 2006 increased $14.7 million, or 19%, from 2005, primarily as a result of minority partners’ interest in earnings at surgery centers recently added to operations. As a percentage of revenues, minority interest remained reasonably consistent between the 2006 and 2005 periods.
Interest expense increased $3.6 million in 2006, or 86%, from 2005, primarily due to additional long-term debt outstanding during 2006 resulting from acquisition activity, as well as an increase in interest rates. See “- Liquidity and Capital Resources.”
We recognized income tax expense from continuing operations of $24.2 million in 2006 compared to $23.4 million in 2005. Our effective tax rate in 2006 and 2005 was 38.8% and 39.2%, respectively, of earnings from continuing operations before income taxes, and differed from the federal statutory income tax rate of 35%, primarily due to the impact of state income taxes. During 2007, we anticipate that our effective tax rate will be approximately 39.2%. Because we deduct goodwill amortization for tax purposes only, approximately 20% of our overall income tax expense is deferred, which results in a continuing increase in our deferred tax liability, which would only be due in part or in whole upon the disposition of a portion or all of our surgery centers. While we continue to recognize this increase in deferred tax liability, beginning in 2006 deferred tax assets established as a result of expensing share-based compensation began to reduce the overall net increase in deferred taxes and net deferred tax liabilities.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - (continued)
During 2006, we sold our interests in four surgery centers. In 2005, we sold our interests in two surgery centers, and one center was rendered non-operational by Hurricane Katrina and was abandoned. These centers’ results of operations and gains and losses associated with their dispositions have been classified as discontinued operations in all periods presented. We recognized an after tax loss for the disposition of discontinued interests in surgery centers of $463,000 and $986,000 during 2006 and 2005, respectively. The net earnings derived from the operations of the discontinued surgery centers for 2006 were $92,000 and the net loss derived from the operations of the discontinued surgery centers for 2005 was $190,000.
Year Ended December 31, 2005 Compared to Year Ended December 31, 2004
Revenues increased $61.1 million, or 19%, to $387.8 million in 2005 from $326.7 million in 2004. The additional revenues resulted primarily from:
Our procedures increased by 130,810, or 22%, to 734,069 in 2005 from 603,259 in 2004. The difference between our procedure growth and revenue growth was the result of an increased number of gastroenterology procedures over other types of procedures, primarily as a result of the addition of new gastroenterology centers. Gastroenterology procedures receive a lower average reimbursement per procedure than our average reimbursement per procedure in 2004.
Staff at newly acquired and developed centers, as well as the additional staffing required at existing centers due to increased volume, resulted in a 25% increase in salaries and benefits at our surgery centers in 2005. We experienced a 29% increase in salaries and benefits at our corporate offices during 2005 over 2004. The increase in corporate office salaries and benefits in 2005 over 2004 was primarily due to additional corporate employees hired to manage our additional centers in operation and an increase in corporate incentive compensation due to the large number of acquisitions and developments closed in 2005. Salaries and benefits increased in total by 26% to $110.0 million in 2005 from $87.5 million in 2004. Salaries and benefits as a percentage of revenues increased in 2005 over 2004 because of increases in wages and benefits in excess of revenue growth.
Supply cost was $43.8 million in 2005, an increase of $7.2 million, or 20%, over supply cost in 2004. This increase was the result of additional procedure volume. Our average supply cost per procedure in 2005 was $60 compared to $61 in 2004. The decrease in cost per procedure in 2005 resulted primarily from an increased percentage of gastroenterology procedures, which have a lower cost per procedure than ophthalmology procedures.
Other operating expenses increased $11.7 million, or 18%, to $76.5 million in 2005 from 2004. This increase was net of a $1.1 million non-cash loss on a long-term receivable recognized in 2004 due to the establishment of a reserve for the estimated uncollectible portion. The note receivable originated from the sale of a physician practice in 1998 in connection with our exit from that line of business. The additional expense in the 2005 period resulted primarily from:
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - (continued)
Depreciation and amortization expense increased $2.4 million, or 19%, in 2005 from 2004, primarily as a result of the newly developed surgery centers in operation, which have an initially higher level of depreciation expense due to their construction costs.
Minority interest in earnings from continuing operations before income taxes in 2005 increased $10.4 million, or 15%, from 2004, primarily as a result of minority partners’ interest in earnings at surgery centers recently added to operations. As a percentage of revenues, minority interest decreased to 20.2% in 2005 from 20.8% in 2004, as a result of our minority partners sharing in reduced center profit margins caused by lower same-center revenue growth and new-center development activity.
Interest expense increased $2.2 million in 2005, or 112%, from 2004, primarily due to additional long-term debt outstanding during 2005 resulting from acquisition activity and stock repurchase programs completed in 2004 as well as an increase in interest rates. See “- Liquidity and Capital Resources.”
We recognized income tax expense from continuing operations of $23.4 million in 2005 compared to $21.8 million in 2004. Our effective tax rate in 2005 and 2004 was 39.2 % and 39.6%, respectively, of earnings from continuing operations before income taxes, and differed from the federal statutory income tax rate of 35%, primarily due to the impact of state income taxes.
During 2005, we sold our interests in two surgery centers. In addition, one center was rendered non-operational by Hurricane Katrina in August 2005 and was abandoned. In three separate transactions in 2004, we sold our interests in four surgery centers. These centers’ results of operations and gains and losses associated with their dispositions have been classified as discontinued operations in all periods presented. Loss from discontinued operations, including loss from operations and disposition, was approximately $1.2 million in 2005, attributable primarily to the center affected by the hurricane. Earnings from discontinued operations, including earnings from operations and gain on dispositions, was $6.5 million in 2004.
Liquidity and Capital Resources
At December 31, 2006, we had working capital of $66.6 million compared to $61.1 million at December 31, 2005. Operating activities for 2006 generated $72.0 million in cash flow from operations compared to $63.4 million in 2005. The increase in operating cash flow activity resulted primarily from higher net earnings in 2006, excluding non-cash share-based compensation expense, compared to the 2005 period. Cash and cash equivalents at December 31, 2006 and 2005 were $20.1 million and $20.5 million, respectively.
The principal source of our operating cash flow is the collection of accounts receivable from governmental payors, commercial payors and individuals. Each of our surgery centers bills for services as delivered, either electronically or in paper form, usually within several days following the delivery of the procedure. Generally, unpaid amounts that are 30 days past due are rebilled based on a standard set of procedures. If amounts remain uncollected after 60 days, our surgery centers proceed with a series of late-notice notifications until amounts are either collected, contractually written-off in accordance with contracted rates or determined to be uncollectible, typically after 90 to 120 days. Receivables determined to be uncollectible are written off and such amounts are applied to our estimate of allowance for bad debts as previously established in accordance with our policy for allowance for bad debt expense (see “ - Critical Accounting Policies - Allowance for Contractual Adjustments and Bad Debt Expense”). The amount of actual write-offs of account balances for each of our surgery centers is continuously compared to established allowances for bad debt to ensure that such allowances are adequate. At December 31, 2006 and 2005, our accounts receivable represented 40 and 37 days of revenue outstanding, respectively. The increase in our days outstanding is due to the average days outstanding at certain centers acquired in 2006.
During 2006, we had total capital expenditures of $75.5 million, which included:
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - (continued)
Our cash flow from operations was sufficient to fund approximately 95% of our cash obligations for our acquisition and development activity, and we received approximately $177,000 from capital contributions of our minority partners to fund their proportionate share of development activity. Borrowings under long-term debt were used to fund the remaining portion of our obligations. At December 31, 2006, we had unfunded construction and equipment purchase commitments for centers under development or under renovation of approximately $1.7 million, which we intend to fund through additional borrowings of long-term debt, operating cash flow and capital contributions by minority partners.
During 2006, we received approximately $1.1 million from the sale of our interests in four surgery centers. During 2006, notes receivable decreased by $2.6 million, primarily due to payments on a note receivable related to the sale of a surgery center in 2004. The note is secured by a pledge of a 51% ownership interest in the center, is guaranteed by the physician partners at the center and is due in installments through 2009. The balance of this note at December 31, 2006 was $6.7 million.
During 2006, we had net repayments on long-term debt of $4.5 million, and at December 31, 2006, we had $114.0 million outstanding under our revolving credit facility. In July 2006, we amended our credit facility to permit us to borrow up to $200 million to, among other things, finance our acquisition and development projects and any future stock repurchase programs at a rate equal to, at our option, the prime rate, LIBOR plus 0.50% to 1.50% or a combination thereof. The loan agreement provides for a fee of 0.15% to 0.30% of unused commitments, prohibits the payment of dividends and contains covenants relating to the ratio of debt to net worth, operating performance and minimum net worth. We were in compliance with all covenants at December 31, 2006. Borrowings under the revolving credit facility are due in July 2011 and are secured primarily by a pledge of the stock of our subsidiaries that serve as the general partners of our limited partnerships and our partnership and membership interests in the limited partnerships and limited liability companies. We incurred approximately $420,000 in deferred financing fees during 2006, primarily associated with the amendment to our credit facility.
During 2006, we received approximately $3.0 million from the exercise of options and issuance of common stock under our employee stock option plans. The tax benefit received from the exercise of those options was approximately $1.1 million.
At December 31, 2006, we had contingent purchase price obligations relating to two of our 2006 acquisitions dependent upon final rulemaking by CMS related to a change in the rate setting methodology, payment rates, payment policies and the list of covered surgical procedures for ASCs (see “- Sources of Revenues”). Until the final rules are effective, we will make bi-annual installment payments beginning July 2008 through December 2013 of a maximum aggregate amount of approximately $870,000. We intend to fund these obligations through additional borrowings of long-term debt. These contingent liabilities are not reflected as liabilities in our consolidated balance sheet as of December 31, 2006 and are described in note 2 to the consolidated financial statements.
Subsequent to December 31, 2006, we, through two wholly owned subsidiaries and in six separate transactions, acquired majority interests in seven physician practice-based surgery centers for an aggregate purchase price of approximately $41.8 million, which was funded by borrowings under our credit facility.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - (continued)
The following schedule summarizes all of our contractual obligations by period as of December 31, 2006 (in thousands):
(1)
Our long-term debt may increase based on acquisition activity expected to occur in the future. We may use our operating cash flow to repay existing long-term debt under our credit facility prior to its maturity date.
(2)
Other long-term obligations consist of purchase price commitments that are contingent upon certain events.
In addition, as of February 26, 2007, we had available under our revolving credit facility $55.0 million for acquisition borrowings.
Based upon our current operations and anticipated growth, we believe our operating cash flow and borrowing capacity will be adequate to meet our working capital and capital expenditure requirements for the next 12 to 18 months. In addition to acquiring and developing ASCs, we may from time to time consider other acquisitions or strategic joint ventures. Such acquisitions, joint ventures or other opportunities may require additional external financing.
Recent Accounting Pronouncements
Effective January 1, 2006, we adopted SFAS No. 123R. This statement addresses the accounting for share-based payment transactions in which a company receives employee and non-employee services in exchange for the company’s equity instruments or liabilities that are based on the fair value of the company’s equity securities or may be settled by the issuance of these securities. SFAS No. 123R eliminates the ability to account for share-based compensation using Accounting Principles Board Opinion No. 25 and generally requires that such transactions be accounted for using a fair value method. We adopted SFAS No. 123R using the modified prospective method and apply the Black-Scholes method of valuation in determining share-based compensation expense. We recorded share-based compensation cost of approximately $7.0 million in the year ended December 31, 2006.
In June 2005, the Financial Accounting Standards Board, or FASB, ratified the Emerging Issues Task Force, or EITF, issue No. 04-5, “Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights.” EITF No. 04-5 provides a framework for determining whether a general partner controls, and should consolidate, a limited partnership or a similar entity. EITF No. 04-5 became effective for all limited partnerships formed after June 29, 2005 and for any limited partnerships in existence on June 29, 2005 that modify their partnership agreements after that date. EITF No. 04-5 became effective for all our partnerships beginning January 1, 2006. The adoption of the provisions of EITF No. 04-5 did not have a material effect on our consolidated financial position and consolidated results of operations.
In June 2006, the FASB issued FASB Interpretation, or FIN, No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of SFAS No. 109,” which clarifies the accounting for uncertainty in income taxes recognized in
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - (continued)
financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” FIN No. 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The provisions of FIN No. 48 are effective for fiscal years beginning after December 15, 2006, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. We believe the adoption of FIN 48 will not have a material effect on our financial statements and note disclosures.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” This statement defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The statement is effective for financial statements issued for fiscal years beginning after November 15, 2007 and will become effective for us beginning with the first quarter of 2008. We have not yet determined the impact of the adoption of SFAS No. 157 on our financial statements and note disclosures.
In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin, or SAB, No. 108 which provides guidance on materiality. SAB No. 108 states that registrants should use both a balance sheet and an income statement approach when quantifying and evaluating the materiality of a misstatement. In addition, SAB No. 108 contains guidance on correcting errors under the dual approach and provides transition guidance for correcting errors existing in prior years. The guidance in SAB No. 108 is effective for annual financial statements covering the first fiscal year ending after November 15, 2006 and is effective for us for the fiscal year ended December 31, 2006. The adoption of SAB No. 108 did not have a material effect on the Company’s financial statements and note disclosures.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are subject to market risk from exposure to changes in interest rates based on our financing, investing and cash management activities. We utilize a balanced mix of maturities along with both fixed-rate and variable-rate debt to manage our exposures to changes in interest rates. Our debt instruments are primarily indexed to the prime rate or LIBOR. We entered into an interest rate swap agreement in April 2006 in which $50.0 million of the principal amount outstanding under the revolving credit facility will bear interest at a fixed rate of 5.365% for the period from April 28, 2006 to April 28, 2011. Although there can be no assurances that interest rates will not change significantly, we do not expect changes in interest rates to have a material effect on our income or cash flows in 2007.
The table below provides information as of December 31, 2006 about our long-term debt obligations based on maturity dates that are sensitive to changes in interest rates, including principal cash flows and related weighted average interest rates by expected maturity dates (in thousands, except percentage data):
The difference in maturities of long-term obligations and overall increase in total borrowings from 2005 to 2006 principally resulted from our borrowings associated with our acquisitions of surgery centers and stock repurchase programs. The average interest rates on these borrowings at December 31, 2006 increased as compared to December 31, 2005 due to an overall increase in market rates.
Item 8.
Item 8. Financial Statements and Supplementary Data
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
AmSurg Corp.
Nashville, Tennessee
We have audited the accompanying consolidated balance sheets of AmSurg Corp. and subsidiaries (the “Company”) as of December 31, 2006 and 2005, and the related consolidated statements of earnings, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2006. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 1 to the consolidated financial statements, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards No. 123 (Revised 2004), Share Based Payment effective January 1, 2006, which resulted in the Company changing the method in which it accounts for share-based compensation.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2006, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 27, 2007 expressed an unqualified opinion on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
/s/ DELOITTE & TOUCHE LLP
Nashville, Tennessee
February 27, 2007
Item 8. Financial Statements and Supplementary Data - (continued)
AmSurg Corp.
Consolidated Balance Sheets
December 31, 2006 and 2005
(Dollars in thousands)
See accompanying notes to the consolidated financial statements.
Item 8. Financial Statements and Supplementary Data - (continued)
AmSurg Corp.
Consolidated Statements of Earnings
Years Ended December 31, 2006, 2005 and 2004
(In thousands, except earnings per share)
See accompanying notes to the consolidated financial statements.
Item 8. Financial Statements and Supplementary Data - (continued)
AmSurg Corp.
Consolidated Statements of Changes in Shareholders’ Equity
Years Ended December 31, 2006, 2005 and 2004
(In thousands)
See accompanying notes to the consolidated financial statements.
Item 8. Financial Statements and Supplementary Data - (continued)
AmSurg Corp.
Consolidated Statements of Cash Flows
Years Ended December 31, 2006, 2005 and 2004
(In thousands)
See accompanying notes to the consolidated financial statements.
Item 8. Financial Statements and Supplementary Data - (continued)
AmSurg Corp.
Notes to the Consolidated Financial Statements
1. Summary of Significant Accounting Policies
a. Principles of Consolidation
AmSurg Corp. (the “Company”), through its wholly owned subsidiaries, owns majority interests, primarily 51%, in limited partnerships and limited liability companies (“LLCs”) which own and operate practice-based ambulatory surgery centers (“centers”). The Company also has majority ownership interests in other limited partnerships and LLCs formed to develop additional centers. The consolidated financial statements include the accounts of the Company and its subsidiaries and the majority owned limited partnerships and LLCs in which the Company’s wholly owned subsidiaries are the general partner or majority member. Consolidation of such limited partnerships and LLCs is necessary as the Company’s wholly owned subsidiaries have 51% or more of the financial interest, are the general partner or majority member with all the duties, rights and responsibilities thereof, are responsible for the day-to-day management of the limited partnerships and LLCs and have control of the entities. The responsibilities of the Company’s minority partners (limited partners and minority members) are to supervise the delivery of medical services, with their rights being restricted to those that protect their financial interests, such as approval of the acquisition of significant assets or the incurrence of debt that they are required to guarantee on a pro rata basis based upon their respective ownership interests. Intercompany profits, transactions and balances have been eliminated. All limited partnerships and LLCs and minority owners are referred to herein as partnerships and partners, respectively.
Surgery center profits are allocated to the Company’s partners in proportion to their individual ownership percentages and reflected in the aggregate as minority interest. The partners of the Company’s surgery center partnerships typically are organized as general partnerships, limited partnerships or limited liability companies that are not subject to federal income tax. Each partner shares in the pre-tax earnings of the surgery center in which it is a partner. Accordingly, the minority interest in each of the Company’s partnerships is determined on a pre-tax basis and presented before earnings before income taxes in order to present that amount of earnings on which the Company must determine its tax expense. In addition, distributions from the partnerships are made to both the Company’s wholly owned subsidiaries and the partners on a pre-tax basis.
As described above, the Company is a holding company and its ability to service corporate debt is dependent upon distributions from its partnerships. Positive operating cash flows of individual centers are the sole source of cash used to make distributions to the Company’s wholly owned subsidiaries as well as to the partners, which the Company is obligated to make on a monthly basis in accordance with each partnership’s partnership or operating agreement. Accordingly, distributions to the minority partners are included in the consolidated financial statements as a component of the Company’s cash flows from operating activities.
The Company operates in one reportable business segment, the ownership and operation of ambulatory surgery centers.
b. Cash and Cash Equivalents
Cash and cash equivalents are comprised principally of demand deposits at banks and other highly liquid short-term investments with maturities of less than three months when purchased.
c. Supplies Inventory
Supplies inventory consists of medical and drug supplies and is recorded at cost on a first-in, first-out basis.
d. Prepaid and Other Current Assets
At December 31, 2006, prepaid and other current assets were comprised of prepaid insurance expense of $2,643,000, other prepaid expenses of $2,385,000, income taxes receivable of $93,000, current portion of notes receivable of $2,761,000, short-term investments of $2,928,000 and other current assets of $4,466,000. At December 31, 2005, prepaid and other current assets were comprised of prepaid insurance expense of $2,736,000,
Item 8. Financial Statements and Supplementary Data - (continued)
AmSurg Corp.
Notes to the Consolidated Financial Statements - (continued)
prepaid other expenses of $1,851,000, income taxes receivable of $266,000, current portion of notes receivable of $2,708,000, short-term investments of $2,269,000 and other current assets of $4,814,000.
e. Property and Equipment, net
Property and equipment are stated at cost. Equipment held under capital leases is stated at the present value of minimum lease payments at the inception of the related leases. Depreciation for buildings and improvements is recognized under the straight-line method over 20 to 40 years or, for leasehold improvements, over the remaining term of the lease plus renewal options for which failure to renew the lease imposes a penalty on the Company in such an amount that a renewal appears, at the inception of the lease, to be reasonably assured. The primary penalty to which the Company is subject is the economic detriment associated with existing leasehold improvements which might be impaired if a decision is made not to continue the use of the leased property. Depreciation for movable equipment is recognized over useful lives of three to ten years.
f. Intangible Assets
Goodwill
The Company applies the provision of Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets,” which requires that goodwill be evaluated for impairment at least on an annual basis; impairment of carrying value will be evaluated more frequently if certain indicators are encountered. SFAS No. 142 requires that goodwill be tested at the reporting unit level, defined as an operating segment or one level below an operating segment (referred to as a component), with the fair value of the reporting unit being compared to its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is not considered to be impaired. The Company has determined that it has one operating, as well as one reportable, segment. For impairment testing purposes, the centers qualify as components of that operating segment. Because they have similar economic characteristics, the components are aggregated and deemed a single reporting unit. The Company completed its annual impairment test as required by SFAS No. 142 as of December 31, 2006, and determined that goodwill was not impaired.
Other Intangible Assets
Other intangible assets consist primarily of deferred financing costs of the Company and certain amortizable and non-amortizable non-compete agreements and arrangements. Deferred finance costs and amortizable non-compete agreements are amortized over the term of the related debt as interest expense and the contractual term (five years) of the non-compete agreements as amortization expense, respectively.
g. Other Long Term Liabilities
Other long term liabilities is primarily comprised of purchase price obligations and deferred rent credits, which are a result of the Company accounting for rent escalations, rent holidays and lease incentives included in various lease agreements.
h. Revenue Recognition
Center revenues consist of billing for the use of the centers’ facilities (the “facility fee”) directly to the patient or third-party payor and, in limited instances, billing for anesthesia services. Such revenues are recognized when the related surgical procedures are performed. Revenues exclude any amounts billed for physicians’ surgical services, which are billed separately by the physicians to the patient or third-party payor.
Revenues from centers are recognized on the date of service, net of estimated contractual adjustments from third-party medical service payors including Medicare and Medicaid (see note 1(n)). During the years ended December 31, 2006, 2005 and 2004, the Company derived approximately 35%, 35% and 37%, respectively, of its revenues
Item 8. Financial Statements and Supplementary Data - (continued)
AmSurg Corp.
Notes to the Consolidated Financial Statements - (continued)
from Medicare and Medicaid. Concentration of credit risk with respect to other payors is limited due to the large number of such payors.
i. Operating Expenses
Substantially all of the Company’s operating expenses relate to the cost of revenues and the delivery of care at the Company’s surgery centers. Such costs primarily include the surgery centers’ clinical and administrative salaries and benefits, supply cost, rent and other variable expenses, such as linen cost, repair and maintenance of equipment, billing fees and bad debt expense.
j. Income Taxes
The Company files a consolidated federal income tax return. Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
k. Earnings Per Share
Basic earnings per share is computed by dividing net earnings available to common shareholders by the combined weighted average number of common shares, while diluted earnings per share is computed by dividing net earnings available to common shareholders by the weighted average number of such common shares and dilutive share equivalents.
l. Fair Value of Financial Instruments
Cash and cash equivalents, receivables and payables are reflected in the financial statements at cost, which approximates fair value. The fair value of fixed-rate long-term debt, with a carrying value of $57,442,000, is $56,424,000 at December 31, 2006. Management believes that the carrying amounts of variable-rate long-term debt approximate market value, because it believes the terms of its borrowings approximate terms which it would incur currently.
m. Share-Based Compensation
Beginning January 1, 2006, the Company adopted SFAS No. 123R, “Share-Based Payment (Revised 2004).” This statement addresses the accounting for share-based payment transactions in which a company receives employee and non-employee services in exchange for the company’s equity instruments or liabilities that are based on the fair value of the company’s equity securities or may be settled by the issuance of these securities. SFAS No. 123R eliminates the ability to account for share-based compensation using Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and generally requires that such transactions be accounted for using a fair value method. The Company adopted SFAS No. 123R using the modified prospective method, which does not require restatement of prior periods, and applies the Black-Scholes method of valuation in determining share-based compensation expense. The Company recorded share-based expense of $7,030,000 and a related tax benefit of $2,756,000 in the year ended December 31, 2006. The effect of adopting SFAS No. 123R on both basic and diluted earnings per share for the year ended December 31, 2006 was $0.14. Prior to 2006, the Company accounted for its stock option plans in accordance with the provisions of APB Opinion No. 25 and related interpretations. Under APB Opinion No. 25, compensation expense was recorded on the date of grant if the current market price of the underlying stock exceeded the exercise price.
SFAS No. 123R also requires companies to calculate an initial “pool” of excess tax benefits available at the adoption date to absorb any tax deficiencies that may be recognized under SFAS No. 123R. The pool includes the net excess
Item 8. Financial Statements and Supplementary Data - (continued)
AmSurg Corp.
Notes to the Consolidated Financial Statements - (continued)
tax benefits that would have been recognized if the company had adopted SFAS No. 123, “Accounting for Stock-Based Compensation,” for recognition purposes on its effective date. The Company elected to calculate the pool of excess tax benefits under the alternative transition method described in Financial Accounting Standards Board (“FASB”) Staff Position No. FAS 123R-3, “Transition Election to Accounting for Tax Effects of Share-Based Payment Awards.”
SFAS No. 123R also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under APB Opinion No. 25 and related interpretations. This requirement reduced the Company’s net operating cash flows and increased its financing cash flows by $1,070,000 for the year ended December 31, 2006.
As part of its SFAS No. 123R adoption, the Company examined concentrations of holdings, its historical patterns of option exercises and forfeitures as well as forward looking factors, in an effort to determine if there were any discernable employee populations. From this analysis, the Company identified three employee populations, consisting of senior executives, officers and all other recipients.
The expected volatility rate applied was estimated based on historical volatility. The expected term assumption applied is based on contractual terms, historical exercise and cancellation patterns and forward looking factors where present for each population identified. The risk-free interest rate used is based on the U.S. Treasury yield curve in effect at the time of the grant. The pre-vesting forfeiture rate is based on historical rates and forward looking factors for each population identified. As required under SFAS No. 123R, the Company will adjust the estimated forfeiture rate to its actual experience. The Company is precluded from paying dividends under its credit facility, and therefore, there is no expected dividend yield.
Item 8. Financial Statements and Supplementary Data - (continued)
AmSurg Corp.
Notes to the Consolidated Financial Statements - (continued)
Applied assumptions for the year ended December 31, 2006 and applied assumptions and pro forma earnings and earnings per share for the years ended December 31, 2005 and 2004, as if the fair value of all share-based awards on the date of grant are recognized over the vesting period by applying the Black-Scholes option pricing model, are presented below (dollars in thousands, except per share amounts):
As of December 31, 2006, the Company had total compensation cost of approximately $5,500,000 related to non-vested awards not yet recognized, which the Company expects to recognize systematically through 2010 and over a weighted-average period of 1.1 years.
Item 8. Financial Statements and Supplementary Data - (continued)
AmSurg Corp.
Notes to the Consolidated Financial Statements - (continued)
n. Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
The determination of contractual and bad debt allowances constitutes a significant estimate. Some of the factors considered by management in determining the amount of allowances to establish are the historical trends of the centers’ cash collections and contractual and bad debt write-offs, accounts receivable agings, established fee schedules, contracts with payors and procedure statistics. Accordingly, net accounts receivable at December 31, 2006 and 2005 reflect allowances for contractual adjustments of $63,721,000 and $52,916,000, respectively, and allowance for bad debt expense of $6,628,000 and $6,189,000, respectively.
o. Recent Accounting Pronouncements
In June 2005, the FASB ratified the Emerging Issues Task Force (“EITF”) issue No. 04-5, "Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights.” EITF No. 04-5 provides a framework for determining whether a general partner controls, and should consolidate, a limited partnership or a similar entity. EITF No. 04-5 became effective for all limited partnerships formed after June 29, 2005 and for any limited partnerships in existence on June 29, 2005 that modify their partnership agreements after that date. EITF No. 04-5 became effective for all the Company’s partnerships on January 1, 2006. The adoption of the provisions of EITF No. 04-5 did not have a material effect on the Company’s consolidated financial position and consolidated results of operations.
In June 2006, the FASB issued FASB Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of SFAS No. 109,” which clarifies the accounting for uncertainty in income taxes recognized in financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” FIN No. 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The provisions of FIN No. 48 are effective for fiscal years beginning after December 15, 2006, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. The Company believes the adoption of FIN No. 48 will not have a material effect on its financial statements and note disclosures.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” This statement defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The statement is effective for financial statements issued for fiscal years beginning after November 15, 2007 and will become effective for the Company beginning with the first quarter of 2008. The Company has not yet determined the impact of the adoption of SFAS No. 157 on its financial statements and note disclosures.
In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin (“SAB”) No. 108 which provides guidance on materiality. SAB No. 108 states that registrants should use both a balance sheet and an income statement approach when quantifying and evaluating the materiality of a misstatement. In addition, SAB No. 108 contains guidance on correcting errors under the dual approach and provides transition guidance for correcting errors existing in prior years. The guidance in SAB No. 108 is effective for annual financial statements covering the first fiscal year ending after November 15, 2006 and is effective for the Company for the fiscal year ended December 31, 2006. The adoption of SAB No. 108 did not have a material effect on the Company’s financial statements and note disclosures.
p. Reclassifications and Restatements
Certain prior year amounts have been restated to reflect discontinued operations as further discussed in note 2(c).
Item 8. Financial Statements and Supplementary Data - (continued)
AmSurg Corp.
Notes to the Consolidated Financial Statements - (continued)
2. Acquisitions and Dispositions
a. Acquisitions
The Company, through wholly owned subsidiaries and in separate transactions, acquired a majority interest in eight and 17 practice-based surgery centers during 2006 and 2005, respectively. Consideration paid for the acquired interests consisted of cash in 2006 and cash and purchase price obligation in 2005. Total acquisition price and cost in 2006 and 2005 was $57,029,000 and $83,586,000, respectively, of which the Company assigned $53,138,000 and $81,809,000, respectively, to goodwill and other non-amortizable intangible assets. The goodwill is expected to be fully deductible for tax purposes. At December 31, 2005, the Company had purchase price obligations of $17,507,000 associated with then recent acquisitions, which were funded shortly thereafter through long-term borrowings under the Company’s credit facility (see note 5), and have been reflected as other long-term liabilities in the balance sheet. All acquisitions were accounted for as purchases, and the accompanying consolidated financial statements include the results of their operations from the dates of acquisition.
At December 31, 2006, the Company had contingent purchase price obligations relating to two of its 2006 acquisitions dependent upon final rulemaking by The Centers for Medicare and Medicaid Services related to a change in the rate setting methodology, payment rates, payment policies and the list of covered surgical procedures for ambulatory surgery centers. Until the final rules are effective, the Company will make bi-annual installment payments beginning July 2008 through December 2013 of a maximum aggregate amount of approximately $870,000.
b. Pro Forma Information
The unaudited consolidated pro forma results for the years ended December 31, 2006 and 2005, assuming all 2006 and 2005 acquisitions had been consummated on January 1, 2005, are as follows (in thousands, except per share data):
c. Dispositions
During 2006, the Company sold its interest in four surgery centers and recognized an after tax loss of $463,000. During 2005, the Company sold its interests in two surgery centers. In addition, one center was rendered non-operational by Hurricane Katrina in August 2005 and was abandoned. The Company recognized a combined after tax loss of $986,000 associated with these three centers, primarily attributable to the center affected by the hurricane. In three separate transactions in 2004, the Company sold its interests in four surgery centers and recognized a combined after tax gain of $5,598,000. In the aggregate, the Company received $1,076,000 in cash and a secured note receivable of $108,000 associated with the 2006 transactions, $2,400,000 in cash associated with the 2005 transactions and cash totaling $4,700,000 and a secured note receivable of $12,500,000 in conjunction with the 2004 transactions. The Company’s sale of its interests in the ten surgery centers in 2006, 2005 and 2004 as described above resulted from management’s assessment of the limited growth opportunities at these centers. The
Item 8. Financial Statements and Supplementary Data - (continued)
AmSurg Corp.
Notes to the Consolidated Financial Statements - (continued)
results of operations of the eleven centers have been classified as discontinued operations and prior periods have been restated. Results of operations of the combined discontinued surgery centers for the years ended December 31, 2006, 2005 and 2004 are as follows (in thousands):
3. Property and Equipment
Property and equipment at December 31, 2006 and 2005 were as follows (in thousands):
The Company capitalized interest for continuing centers in the amount of $222,000, $144,000 and $204,000 for the years ended December 31, 2006, 2005 and 2004, respectively. At December 31, 2006, the Company and its partnerships had unfunded construction and equipment purchases of approximately $1,703,000 in order to complete construction in progress. Depreciation expense for continuing and discontinued operations for the years ended December 31, 2006, 2005 and 2004 was $17,315,000, $15,635,000 and $13,448,000, respectively.
4. Intangible Assets
Amortizable intangible assets at December 31, 2006 and 2005 consisted of the following (in thousands):
Amortization of intangible assets for the years ended December 31, 2006, 2005 and 2004 was $349,000, $371,000 and $338,000, respectively. Estimated amortization of intangible assets for the five years and thereafter subsequent to December 31, 2006 is $221,000, $222,000, $222,000, $221,000, $111,000 and $3,000.
Item 8. Financial Statements and Supplementary Data - (continued)
AmSurg Corp.
Notes to the Consolidated Financial Statements - (continued)
The changes in the carrying amount of goodwill for the years ended December 31, 2006 and 2005 are as follows (in thousands):
At December 31, 2006 and 2005, other non-amortizable intangible assets related to non-compete arrangements was $4,616,000 and $1,923,000, respectively.
5. Long-term Debt
Long-term debt at December 31, 2006 and 2005 was comprised of the following (in thousands):
The Company amended its revolving credit facility on July 28, 2006. The amended revolving credit facility permits the Company to borrow up to $200,000,000 to, among other things, finance its acquisition and development projects and any future stock repurchase programs at an interest rate equal to, at the Company’s option, the prime rate, or LIBOR plus 0.50% to 1.50%, or a combination thereof; provides for a fee of 0.15% to 0.30% of unused commitments; prohibits the payment of dividends; and contains certain covenants relating to the ratio of debt to net worth, operating performance and minimum net worth. Borrowings under the revolving credit facility mature in July 2011. At December 31, 2006, the Company had $114,000,000 outstanding under its revolving credit facility and was in compliance with all covenants.
Certain partnerships included in the Company’s consolidated financial statements have loans with local lending institutions, included above in other debt, which are collateralized by certain assets of the centers with a book value of approximately $22,900,000. The Company and the partners have guaranteed payment of the loans in proportion to the relative partnership interests.
Principal payments required on long-term debt in the five years and thereafter subsequent to December 31, 2006 are $3,367,000, $2,690,000, $1,983,000, $1,325,000, $115,292,000 and $2,658,000.
The Company entered into an interest rate swap agreement in April 2006, the objective of which is to hedge exposure to the variability of the future expected cash flows attributable to the variable interest rate of a portion of the Company’s outstanding balance under its revolving credit facility. The interest rate swap has a notional amount of $50,000,000. The Company pays to the counterparty a fixed rate of 5.365% of the notional amount of the interest rate swap and receives a floating rate from the counterparty based on LIBOR. The interest rate swap matures in
Item 8. Financial Statements and Supplementary Data - (continued)
AmSurg Corp.
Notes to the Consolidated Financial Statements - (continued)
April 2011. In the opinion of management and as permitted by SFAS No. 133, “Accounting for Derivative Investments and Hedging Activities,” the interest rate swap (as a cash flow hedge) is a fully effective hedge. Payments or receipts of cash under the interest rate swap are shown as a part of operating cash flow, consistent with the interest expense incurred pursuant to the credit facility. The swap had a negative fair value of $773,000 and is included as part of other long-term liabilities. The value of the swap represents the estimated amount the Company would have paid as of December 31, 2006 upon termination of the agreement based on a valuation obtained from the financial institution that is the counterparty to the interest rate swap agreement. The fair value of the interest rate swap decreased by $470,000, net of income taxes, from its inception through December 31, 2006 and, accordingly, accumulated other comprehensive loss, net of income taxes, was $470,000 at December 31, 2006.
6. Leases
The Company has entered into various building and equipment operating leases and equipment capital leases for its surgery centers in operation and under development and for office space, expiring at various dates through 2027. Future minimum lease payments, including payments during expected renewal option periods, at December 31, 2006 were as follows (in thousands):
At December 31, 2006, equipment with a cost of approximately $2,256,000 and accumulated depreciation of approximately $737,000 was held under capital lease. The Company and the partners in the partnerships have guaranteed payment of certain of these leases. Rental expense for operating leases for the years ended December 31, 2006, 2005 and 2004 was approximately $24,173,000, $20,402,000 and $16,886,000, respectively (see note 9).
7. Shareholders’ Equity
a. Common Stock
In February 2004, the Company’s Board of Directors approved a 3-for-2 stock split to be effected in the form of a 50% stock dividend. The new shares were distributed on March 24, 2004 to shareholders of record at the close of business on March 8, 2004. All prior period shares outstanding, earnings per share and prices per share have been adjusted to reflect the stock split.
Effective May 21, 2004, the Company’s Second Amended and Restated Charter was amended to increase its authorized shares of capital stock from 44,800,000 to 75,000,000 and to increase its authorized shares of common stock, no par value, from 39,800,000 to 70,000,000.
In January 2003 and March 2004, the Company’s Board of Directors authorized stock repurchase programs which allowed the Company to purchase under each program up to $25,000,000 of its common stock. As of December 31, 2003, the Company had purchased and retired 1,267,800 shares of the Company’s common stock for $21,243,000,
Item 8. Financial Statements and Supplementary Data - (continued)
AmSurg Corp.
Notes to the Consolidated Financial Statements - (continued)
at an average price per share of $16.77 under the 2003 program. In 2004, the Company completed the remaining 2003 stock repurchase program and the 2004 stock repurchase program by acquiring and retiring 1,290,214 shares of its common stock for $28,757,000, at an average price per share of $22.29. These stock repurchase programs were funded primarily through borrowings under the Company’s credit facility.
b. Shareholder Rights Plan
In 1999, the Company’s Board of Directors adopted a shareholder rights plan and declared a distribution of one stock purchase right for each outstanding share of the Company’s common stock to shareholders of record on December 16, 1999 and for each share of common stock issued thereafter. Each right initially entitles its holder to purchase one one-hundredth of a share of Series C Junior Participating Preferred Stock, at $48, subject to adjustment. With certain exceptions, each right will become exercisable only when a person or group acquires, or commences a tender or exchange offer for, 20% or more of the Company’s outstanding common stock. Rights will also become exercisable in the event of certain mergers or asset sales involving more than 50% of the Company’s assets or earning power. Upon becoming exercisable, each right will allow the holder (other than the person or group whose actions triggered the exercisability of the rights), under specified circumstances, to buy either securities of the Company or securities of the acquiring company (depending on the form of the transaction) having a value of twice the then current exercise price of the rights. The rights expire on December 2, 2009.
Item 8. Financial Statements and Supplementary Data - (continued)
AmSurg Corp.
Notes to the Consolidated Financial Statements - (continued)
c. Earnings per Share
The following is a reconciliation of the numerator and denominators of basic and diluted earnings per share (in thousands, except per share amounts):
Item 8. Financial Statements and Supplementary Data - (continued)
AmSurg Corp.
Notes to the Consolidated Financial Statements - (continued)
d. Stock Options
In May 2006, the Company adopted the AmSurg Corp. 2006 Stock Incentive Plan. The Company also has options outstanding under the AmSurg Corp. 1997 Stock Incentive Plan, under which no additional options may be granted. Under these plans, the Company has granted non-qualified options to purchase shares of common stock to employees and outside directors from its authorized but unissued common stock. Options are granted at market value on the date of the grant and vest ratably over four years. Options have a term of 10 years from the date of grant. At December 31, 2006, 1,686,778 shares were authorized for grant and 1,358,532 shares were available for future option grants. Stock option activity for the three years ended December 31, 2006 is summarized as follows:
The aggregate intrinsic value represents the total pre-tax intrinsic value received by the option holders on the exercise date or that would have been received by the option holders had all holders of in-the-money outstanding options at December 31, 2006 exercised their options at the Company’s closing stock price on December 31, 2006.
Item 8. Financial Statements and Supplementary Data - (continued)
AmSurg Corp.
Notes to the Consolidated Financial Statements - (continued)
The following table summarizes information concerning outstanding and exercisable options at December 31, 2006:
8. Income Taxes
Total income taxes expense (benefit) for the years ended December 31, 2006, 2005 and 2004 was included within the following sections of the consolidated financial statements as follows (in thousands):
Income tax expense from continuing operations for the years ended December 31, 2006, 2005 and 2004 was comprised of the following (in thousands):
Item 8. Financial Statements and Supplementary Data - (continued)
AmSurg Corp.
Notes to the Consolidated Financial Statements - (continued)
Income tax expense from continuing operations for the years ended December 31, 2006, 2005 and 2004 differed from the amount computed by applying the U.S. federal income tax rate of 35% to earnings before income taxes as a result of the following (in thousands):
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2006 and 2005 were as follows (in thousands):
The net deferred tax liability at December 31, 2006 and 2005, were recorded as follows (in thousands):
The Company has provided valuation allowances on its gross deferred tax asset related to net operating and capital losses to the extent that management does not believe that it is more likely than not that such asset will be realized. The net operating loss carryforwards will begin to expire in 2007. The capital loss carryforwards will begin to expire in 2010.
Item 8. Financial Statements and Supplementary Data - (continued)
AmSurg Corp.
Notes to the Consolidated Financial Statements - (continued)
9. Related Party Transactions
The Company leases space for certain surgery centers from its physician partners affiliated with its centers at rates that management believes approximate fair market value at the inception of the leases. Payments on these leases were approximately $11,681,000, $9,799,000 and $8,844,000 for the years ended December 31, 2006, 2005 and 2004, respectively.
The Company reimburses certain of its partners for salaries and benefits related to time spent by employees of their practices on activities of the centers. Total reimbursement of such salary and benefit costs totaled approximately $44,045,000, $40,002,000 and $35,102,000 for the years ended December 31, 2006, 2005 and 2004, respectively.
The Company received capitated reimbursement at one of its centers, which was sold in 2004, from a non-physician minority partner associated with the center. Total capitated revenue received was approximately $201,000 for the year ended December 31, 2004.
The Company believes that the foregoing transactions are in its best interests.
It is the Company’s policy that all transactions by the Company with officers, directors, five percent shareholders and their affiliates be entered into only if such transactions are on terms no less favorable to the Company than could be obtained from unaffiliated third parties, are reasonably expected to benefit the Company and are approved by the audit committee of the Company’s Board of Directors.
10. Employee Benefit Programs
As of January 1, 1999, the Company adopted the AmSurg 401(k) Plan and Trust. This plan is a defined contribution plan covering substantially all employees of the Company and provides for voluntary contributions by these employees, subject to certain limits. Company contributions are based on specified percentages of employee compensation. The Company funds contributions as accrued. The Company’s contributions for the years ended December 31, 2006, 2005 and 2004 were approximately $335,000, $271,000 and $225,000, respectively, and vest incrementally over four years.
As of January 1, 2000, the Company adopted the Supplemental Executive Retirement Savings Plan. This plan is a defined contribution plan covering all officers of the Company and provides for voluntary contributions up to 5% of employee annual compensation. Company contributions are at the discretion of the Compensation Committee of the Board of Directors and vest incrementally over four years. The employee and employer contributions are placed in a Rabbi Trust. Employer contributions to this plan for the year ended December 31, 2006, 2005 and 2004 were approximately $365,000, $92,000 and $0, respectively.
11. Commitments and Contingencies
The Company and its partnerships are insured with respect to medical malpractice risk on a claims-made basis. The Company also maintains insurance for general liability, director and officer liability and property. Certain policies are subject to deductibles. In addition to the insurance coverage provided, the Company indemnifies certain officers and directors for actions taken on behalf of the Company and its partnerships. Management is not aware of any claims against it or its partnerships which would have a material financial impact.
The Company’s wholly owned subsidiaries, as general partners in the partnerships, are responsible for all debts incurred but unpaid by the partnership. As manager of the operations of the partnership, the Company has the ability to limit its potential liabilities by curtailing operations or taking other operating actions.
Item 8. Financial Statements and Supplementary Data - (continued)
AmSurg Corp.
Notes to the Consolidated Financial Statements - (continued)
In the event of a change in current law, which would prohibit the physicians’ current form of ownership in the partnerships, the Company would be obligated to purchase the physicians’ interests in substantially all of the Company’s partnerships. The purchase price to be paid in such event would be determined by a predefined formula, as specified in the partnership agreements. The Company believes the likelihood of a change in current law, which would trigger such purchases, was remote as of December 31, 2006.
12. Supplemental Cash Flow Information
Supplemental cash flow information for the years ended December 31, 2006, 2005 and 2004 is as follows (in thousands):
13. Subsequent Events
Subsequent to December 31, 2006, the Company, through two wholly owned subsidiaries and in six separate transactions, acquired majority interests in seven physician practice-based surgery centers for an aggregate purchase price of approximately $41,800,000, which was funded by borrowings under our credit facility.
Item 8. Financial Statements and Supplementary Data - (continued)
Quarterly Statement of Earnings Data (Unaudited)
The following table presents certain quarterly statement of earnings data for the years ended December 31, 2005 and 2006. The quarterly statement of earnings data set forth below was derived from our unaudited financial statements and includes all adjustments, consisting of normal recurring adjustments, which we consider necessary for a fair presentation thereof. Results of operations for any particular quarter are not necessarily indicative of results of operations for a full year or predictive of future periods.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable.
Item 9A.
Item 9A. Controls and Procedures
Management’s Report on Internal Control over Financial Reporting
We are responsible for the preparation and integrity of the consolidated financial statements appearing in our Annual Report. The consolidated financial statements were prepared in conformity with United States generally accepted accounting principles and include amounts based on management’s estimates and judgments. All other financial information in this report has been presented on a basis consistent with the information included in the consolidated financial statements.
We are also responsible for establishing and maintaining adequate internal controls over financial reporting. We maintain a system of internal controls that is designed to provide reasonable assurance as to the fair and reliable preparation and presentation of the consolidated financial statements, as well as to safeguard assets from unauthorized use or disposition. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs.
Our control environment is the foundation for our system of internal controls over financial reporting and is embodied in our Code of Conduct. It sets the tone of our organization and includes factors such as integrity and ethical values. Our internal controls over financial reporting are supported by formal policies and procedures which are reviewed, modified and improved as changes occur in business conditions and operations.
We conducted an evaluation of effectiveness of our internal controls over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. This evaluation included review of the documentation of controls, effectiveness of controls and a conclusion on this evaluation. Although there are inherent limitations in the effectiveness of any system of internal controls over financial reporting, based on our evaluation, we have concluded that our internal controls over financial reporting were effective as of December 31, 2006.
Deloitte & Touche LLP, an independent registered public accounting firm, has issued an attestation report on management’s assessment of internal control over financial reporting, which is included herein.
Item 9A. Controls and Procedures - (continued)
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of
AmSurg Corp.
Nashville, Tennessee
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting, that AmSurg Corp. and subsidiaries (the “Company”) maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel 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 the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the 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, management’s assessment that the Company maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States of America), the consolidated financial statements as of and for the year ended December 31, 2006, of the Company and our report dated February 27, 2007, expressed an unqualified opinion on those consolidated financial statements and included an explanatory paragraph referring to the Company adopting the fair value recognition provisions of Statement of Financial Accounting Standards No. 123 (Revised 2004), Share Based Payment effective January 1, 2006.
/s/ DELOITTE & TOUCHE LLP
Nashville, Tennessee
February 27, 2007
Item 9A. Controls and Procedures - (continued)
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management team, including our chief executive officer and chief financial officer, we conducted an evaluation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended, or the Exchange Act) as of December 31, 2006. Based on that evaluation, our chief executive officer (principal executive officer) and chief financial officer (principal accounting officer) have concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic reports.
Changes in Internal Control Over Financial Reporting
During the fourth fiscal quarter of the period covered by this report, there has been no change in our internal control over financial reporting that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.
Item 9B.
Item 9B. Other Information
Not applicable.
Part III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
Information with respect to the directors of AmSurg, set forth in AmSurg’s Definitive Proxy Statement for the Annual Meeting of Shareholders to be held May 17, 2007, under the caption “Election of Directors,” is incorporated herein by reference. Pursuant to General Instruction G(3), information concerning executive officers of AmSurg is included in Part I of this Annual Report on Form 10-K under the caption “Executive Officers of the Registrant.”
Information with respect to compliance with Section 16(a) of the Securities Exchange Act of 1934, set forth in AmSurg’s Definitive Proxy Statement for the Annual Meeting of Shareholders to be held May 17, 2007, under the caption “Section 16(a) Beneficial Ownership Reporting Compliance,” is incorporated herein by reference.
Information with respect to our code of ethics, set forth in AmSurg’s Definitive Proxy Statement for the Annual Meeting of Shareholders to be held May 17, 2007, under the caption “Code of Conduct” and “Code of Ethics,” is incorporated herein by reference.
Item 11.
Item 11. Executive Compensation
Information with respect to executive officers of AmSurg, set forth in AmSurg’s Definitive Proxy Statement for the Annual Meeting of Shareholders to be held May 17, 2007, under the caption “Executive Compensation,” is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information with respect to security ownership of certain beneficial owners and management and related stockholder matters, set forth in AmSurg’s Definitive Proxy Statement for the Annual Meeting of Shareholders to be held May 17, 2007, under the captions “Stock Ownership” and “Equity Compensation Plan Information,” is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Information with respect to certain relationships and related transactions, set forth in AmSurg’s Definitive Proxy Statement for the Annual Meeting of Shareholders to be held May 17, 2007, under the caption “Certain Relationships and Related Transactions,” is incorporated herein by reference.
Item 14.
Item 14. Principal Accounting Fees and Services
Information with respect to the fees paid to and services provided by our principal accountant, set forth in AmSurg’s Definitive Proxy Statement for the Annual Meeting of Shareholders to be held May 17, 2007, under the caption “Fees Billed to Us by Deloitte & Touche LLP During 2006 and 2005,” is incorporated herein by reference.
Part IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules
(a)
Financial Statements, Financial Statement Schedules and Exhibits
(3) Exhibits
(3) Exhibits
*
Management contract or compensatory plan, contract or arrangement
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.
KNOW ALL MEN BY THESE PRESENTS, each person whose signature appears below hereby constitutes and appoints Ken P. McDonald and Claire M. Gulmi, and each of them, his or her true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him or her and in his or her name, place, and stead, in any and all capacities, to sign any and all amendments (including post-effective amendments) to this report, and to file the same with all exhibits thereto and all documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or their substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
AmSurg Corp.
Nashville, Tennessee
We have audited the consolidated financial statements of AmSurg Corp. and subsidiaries (the “Company”) as of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006, management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2006, and the effectiveness of the Company’s internal control over financial reporting as of December 31, 2006, and have issued our reports thereon dated February 27, 2007; such reports are included elsewhere in this Form 10-K. Our audits also included the consolidated financial statement schedule of the Company listed in Item 15. This consolidated financial statement schedule is the responsibility of the Company’s management. Our responsibility is to express an opinion based on our audits. In our opinion, such consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
/s/ DELOITTE & TOUCHE LLP
Nashville, Tennessee
February 27, 2007
S-1
AmSurg Corp.
Schedule II - Valuation and Qualifying Accounts
For the Years Ended December 31, 2006, 2005 and 2004
(In thousands)
(1)
Valuation of allowance for uncollectible accounts as of the acquisition date of physician practice-based surgery centers, net of dispositions. See “Notes to the Consolidated Financial Statements - Note 2.”
S-2