UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
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þ | | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2010
OR
| | |
o | | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number: 001-33881
MEDASSETS, INC.
(Exact name of registrant as specified in its charter)
| | |
|
DELAWARE (State or other jurisdiction of incorporation or organization) | | 51-0391128 (I.R.S. Employer Identification No.) |
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100 North Point Center East, Suite 200 Alpharetta, Georgia | | 30022 |
(Address of principal executive offices) | | (Zip Code) |
Registrant’s telephone number, including area code: (678) 323-2500
(Former name, former address and former fiscal year, if changed since last report)
N/A
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesþ Noo
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yeso Noo
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):
Large accelerated filer þ | Accelerated filer o | Non-accelerated filer o (Do not check if a smaller reporting company) | Smaller Reporting Company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso Noþ
As of May 5, 2010, the registrant had 57,157,557 shares of $0.01 par value common stock outstanding.
MEDASSETS, INC.
FORM 10-Q
INDEX
2
Part I. FINANCIAL INFORMATION
| | |
Item 1. | | Financial Statements |
MedAssets, Inc.
Condensed Consolidated Balance Sheets
(In thousands, except share and per share amounts)
(Unaudited)
| | | | | | | | |
| | March 31, | | | December 31, | |
| | 2010 | | | 2009 | |
| | | | | | | | |
ASSETS
| | | | | | | | |
Current | | | | | | | | |
Cash and cash equivalents | | $ | 4,981 | | | $ | 5,498 | |
Accounts receivable, net of allowances of $3,767 and $4,189 as of March 31, 2010 and December 31, 2009, respectively | | | 70,323 | | | | 67,617 | |
Deferred tax asset, current | | | 14,423 | | | | 14,423 | |
Prepaid expenses and other current assets | | | 15,283 | | | | 8,442 | |
| | | | | | |
Total current assets | | | 105,010 | | | | 95,980 | |
Property and equipment, net | | | 58,720 | | | | 54,960 | |
Other long term assets | | | | | | | | |
Goodwill | | | 511,861 | | | | 511,861 | |
Intangible assets, net | | | 89,320 | | | | 95,589 | |
Other | | | 20,407 | | | | 20,154 | |
| | | | | | |
Other long term assets | | | 621,588 | | | | 627,604 | |
| | | | | | |
Total assets | | $ | 785,318 | | | $ | 778,544 | |
| | | | | | |
| | | | | | | | |
LIABILITIES AND STOCKHOLDERS’ EQUITY
| | | | | | | | |
Current liabilities | | | | | | | | |
Accounts payable | | $ | 9,300 | | | $ | 8,680 | |
Accrued revenue share obligation and rebates | | | 27,084 | | | | 31,948 | |
Accrued payroll and benefits | | | 15,074 | | | | 12,874 | |
Other accrued expenses | | | 11,309 | | | | 7,410 | |
Deferred revenue, current portion | | | 30,848 | | | | 24,498 | |
Current portion of notes payable | | | 2,499 | | | | 13,771 | |
Current portion of finance obligation | | | 166 | | | | 163 | |
| | | | | | |
Total current liabilities | | | 96,280 | | | | 99,344 | |
Notes payable, less current portion | | | 200,765 | | | | 201,390 | |
Finance obligation, less current portion | | | 9,651 | | | | 9,694 | |
Deferred revenue, less current portion | | | 7,606 | | | | 7,380 | |
Deferred tax liability | | | 19,358 | | | | 19,239 | |
Other long term liabilities | | | 2,465 | | | | 4,125 | |
| | | | | | |
Total liabilities | | | 336,125 | | | | 341,172 | |
Commitments and contingencies | | | | | | | | |
Stockholders’ equity | | | | | | | | |
Common stock, $0.01 par value, 150,000,000 shares authorized; 57,000,000 and 56,715,000 | | | | | | | | |
shares issued and outstanding as of March 31, 2010 and December 31, 2009, respectively | | | 570 | | | | 567 | |
Additional paid-in capital | | | 645,544 | | | | 639,315 | |
Accumulated other comprehensive loss | | | (1,536 | ) | | | (1,605 | ) |
Accumulated deficit | | | (195,385 | ) | | | (200,905 | ) |
| | | | | | |
Total stockholders’ equity | | | 449,193 | | | | 437,372 | |
| | | | | | |
Total liabilities and stockholders’ equity | | $ | 785,318 | | | $ | 778,544 | |
| | | | | | |
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
3
MedAssets, Inc.
Condensed Consolidated Statements of Operations
(Unaudited)
| | | | | | | | |
| | Three Months Ended March 31, | |
| | 2010 | | | 2009 | |
| | (In thousands, except per share amounts) | |
| | | | | | | | |
Revenue: | | | | | | | | |
Administrative fees, net | | $ | 28,590 | | | $ | 27,486 | |
Other service fees | | | 64,816 | | | | 51,498 | |
| | | | | | |
Total net revenue | | | 93,406 | | | | 78,984 | |
| | | | | | |
Operating expenses: | | | | | | | | |
Cost of revenue (inclusive of certain depreciation and amortization expense) | | | 21,722 | | | | 16,745 | |
Product development expenses | | | 5,370 | | | | 6,018 | |
Selling and marketing expenses | | | 10,668 | | | | 10,896 | |
General and administrative expenses | | | 32,151 | | | | 27,451 | |
Depreciation | | | 4,293 | | | | 2,910 | |
Amortization of intangibles | | | 6,084 | | | | 7,011 | |
| | | | | | |
Total operating expenses | | | 80,288 | | | | 71,031 | |
| | | | | | |
Operating income | | | 13,118 | | | | 7,953 | |
Other income (expense): | | | | | | | | |
Interest (expense) | | | (3,932 | ) | | | (4,993 | ) |
Other income | | | 67 | | | | 214 | |
| | | | | | |
Income before income taxes | | | 9,253 | | | | 3,174 | |
Income tax expense | | | 3,733 | | | | 1,269 | |
| | | | | | |
Net income | | $ | 5,520 | | | $ | 1,905 | |
| | | | | | |
Basic and diluted income per share: | | | | | | | | |
Basic net income | | $ | 0.10 | | | $ | 0.04 | |
| | | | | | |
Diluted net income | | $ | 0.09 | | | $ | 0.03 | |
| | | | | | |
Weighted average shares — basic | | | 55,817 | | | | 54,102 | |
Weighted average shares — diluted | | | 58,829 | | | | 56,302 | |
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
4
MedAssets, Inc.
Condensed Consolidated Statement of Stockholders’ Equity (Unaudited)
Three Months Ended March 31, 2010
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | Accumulated | | | | | | | | |
| | | | | | | | | | Additional | | | Other | | | | | | | Total | |
| | Common Stock | | | Paid-In | | | Comprehensive | | | Accumulated | | | Stockholders’ | |
| | Shares | | | Par Value | | | Capital | | | Income (Loss) | | | Deficit | | | Equity | |
| | (In thousands) | |
Balances at December 31, 2009 | | | 56,715 | | | $ | 567 | | | $ | 639,315 | | | $ | (1,605 | ) | | $ | (200,905 | ) | | $ | 437,372 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Issuance of common stock from equity award exercises | | | 245 | | | | 2 | | | | 1,938 | | | | — | | | | — | | | | 1,940 | |
Issuance of common restricted stock | | | 40 | | | | 1 | | | | (1 | ) | | | — | | | | — | | | | — | |
Stock compensation expense | | | — | | | | — | | | | 3,472 | | | | — | | | | — | | | | 3,472 | |
Excess tax benefit from equity award exercises | | | — | | | | — | | | | 820 | | | | — | | | | — | | | | 820 | |
Other comprehensive income: | | | | | | | | | | | | | | | | | | | | | | | | |
Unrealized gain from hedging activities (net of a tax expense of $48) | | | — | | | | — | | | | — | | | | 69 | | | | — | | | | 69 | |
Net income | | | — | | | | — | | | | — | | | | — | | | | 5,520 | | | | 5,520 | |
| | | | | | | | | | | | | | | | | | |
Comprehensive income | | | — | | | | — | | | | — | | | | 69 | | | | 5,520 | | | | 5,589 | |
| | | | | | | | | | | | | | | | | | |
Balances at March 31, 2010 | | | 57,000 | | | $ | 570 | | | $ | 645,544 | | | $ | (1,536 | ) | | $ | (195,385 | ) | | $ | 449,193 | |
| | | | | | | | | | | | | | | | | | |
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
5
MedAssets, Inc.
Condensed Consolidated Statements of Cash Flows
(Unaudited)
| | | | | | | | |
| | Three Months Ended March 31, | |
| | 2010 | | | 2009 | |
| | (In thousands) | |
Operating activities | | | | | | | | |
Net income | | $ | 5,520 | | | $ | 1,905 | |
Adjustments to reconcile income from continuing operations to net cash provided by operating activities: | | | | | | | | |
Bad debt expense | | | 407 | | | | 1,284 | |
Depreciation | | | 5,015 | | | | 3,514 | |
Amortization of intangibles | | | 6,269 | | | | 7,196 | |
Loss on sale of assets | | | 1 | | | | 21 | |
Noncash stock compensation expense | | | 3,472 | | | | 4,386 | |
Excess tax benefit from exercise of equity awards | | | (820 | ) | | | (1,075 | ) |
Amortization of debt issuance costs | | | 458 | | | | 462 | |
Noncash interest expense, net | | | 134 | | | | 518 | |
Deferred income tax expense | | | 71 | | | | 124 | |
Changes in assets and liabilities: | | | | | | | | |
Accounts receivable | | | (3,113 | ) | | | (3,858 | ) |
Prepaid expenses and other assets | | | (6,841 | ) | | | (3,367 | ) |
Other long-term assets | | | (1,163 | ) | | | (1,265 | ) |
Accounts payable | | | 1,439 | | | | 2,136 | |
Accrued revenue share obligations and rebates | | | (4,865 | ) | | | (4,938 | ) |
Accrued payroll and benefits | | | 2,200 | | | | (5,267 | ) |
Other accrued expenses | | | 2,316 | | | | 1,914 | |
Deferred revenue | | | 6,575 | | | | 471 | |
| | | | | | |
Cash provided by operating activities | | | 17,075 | | | | 4,161 | |
| | | | | | |
Investing activities | | | | | | | | |
Purchases of property, equipment and software | | | (4,493 | ) | | | (3,396 | ) |
Capitalized software development costs | | | (3,798 | ) | | | (3,218 | ) |
| | | | | | |
Cash used in investing activities | | | (8,291 | ) | | | (6,614 | ) |
| | | | | | |
Financing activities | | | | | | | | |
Proceeds from notes payable | | | — | | | | 29,995 | |
Repayment of notes payable and capital lease obligations | | | (11,897 | ) | | | (35,430 | ) |
Repayment of finance obligations | | | (164 | ) | | | (164 | ) |
Excess tax benefit from exercise of equity awards | | | 820 | | | | 1,075 | |
Issuance of common stock | | | 1,940 | | | | 1,548 | |
| | | | | | |
Cash used in financing activities | | | (9,301 | ) | | | (2,976 | ) |
| | | | | | |
Net decrease in cash and cash equivalents | | | (517 | ) | | | (5,429 | ) |
Cash and cash equivalents, beginning of period | | | 5,498 | | | | 5,429 | |
| | | | | | |
Cash and cash equivalents, end of period | | $ | 4,981 | | | $ | — | |
| | | | | | |
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
6
MedAssets, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited)
(In thousands, except share and per share amounts)
Unless the context indicates otherwise, references in this Quarterly Report to “MedAssets,” the “Company,” “we,” “our” and “us” mean MedAssets, Inc., and its subsidiaries and predecessor entities.
1. BUSINESS DESCRIPTION AND BASIS OF PRESENTATION
We provide technology-enabled products and services which together deliver solutions designed to improve operating margin and cash flow for hospitals, health systems and other ancillary healthcare providers. Our customer-specific solutions are designed to efficiently analyze detailed information across the spectrum of revenue cycle and spend management processes. Our solutions integrate with existing operations and enterprise software systems of our customers and provide financial improvement with minimal upfront costs or capital expenditures. Our operations and customers are primarily located throughout the United States.
The accompanying unaudited Condensed Consolidated Financial Statements, and Condensed Consolidated Balance Sheet as of December 31, 2009, derived from audited financial statements, have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial reporting and as required by Regulation S-X, Rule 10-01 of the U.S. Securities and Exchange Commission (“SEC”). Accordingly, certain information and footnote disclosures required for complete financial statements are not included herein. In the opinion of management, all adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation of the interim financial information have been included. When preparing financial statements in conformity with GAAP, we must make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures at the date of the financial statements. Actual results could differ materially from those estimates. Operating results for the three months ended March 31, 2010 are not necessarily indicative of the results that may be expected for any other interim period or for the fiscal year ending December 31, 2010.
The accompanying unaudited Condensed Consolidated Financial Statements and notes thereto should be read in conjunction with the audited Consolidated Financial Statements for the year ended December 31, 2009 included in our Form 10-K as filed with the SEC on March 1, 2010. These financial statements include the accounts of MedAssets, Inc. and our wholly owned subsidiaries. All significant intercompany accounts have been eliminated in consolidation.
Cash and Cash Equivalents
All of our highly liquid investments with original maturities of three months or less at the date of purchase are carried at cost which approximates fair value and are considered to be cash equivalents. Currently, our excess cash on hand is voluntarily used to repay our swing-line credit facility, if any, on a daily basis and applied against our revolving credit facility on a routine basis when our swing-line credit facility is undrawn. In addition, we may periodically make voluntary repayments on our term loan. Cash and cash equivalents were $4,981 and $5,498 as of March 31, 2010 and December 31, 2009, respectively, as our revolver and swing-line balances were zero. See Note 5 for immediately available cash under our revolving credit facility.
2. RECENT ACCOUNTING PRONOUNCEMENTS
Revenue Recognition
In October 2009, the Financial Accounting Standards Board (“FASB”) issued an accounting standards update for multiple-deliverable revenue arrangements. The update addressed the accounting for multiple-deliverable arrangements to enable vendors to account for products or services separately rather than as a combined unit. The update also addresses how to separate deliverables and how to measure and allocate arrangement consideration to one or more units of accounting. The amendments in the update significantly expand the disclosures related to a vendor’s multiple-deliverable revenue arrangements with the objective of providing information about the significant judgments made and changes to those judgments and how the application of the relative selling-price method of determining stand-alone value affects the timing or amount of revenue recognition. The accounting standards update will be applicable for annual periods beginning after June 15, 2010, however, early adoption is permitted. We are currently assessing the impact of the adoption of this update on our Condensed Consolidated Financial Statements.
In October 2009, the FASB issued an accounting standards update relating to certain revenue arrangements that include software elements. The update will change the accounting model for revenue arrangements that include both tangible products and software
7
MedAssets, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) — (continued)
(In thousands, except share and per share amounts)
elements. Among other things, tangible products containing software and non-software components that function together to deliver the tangible product’s essential functionality are no longer within the scope of software revenue guidance. In addition, the update also provides guidance on how a vendor should allocate arrangement consideration to deliverables in an arrangement that includes tangible products and software. The accounting standards update will be applicable for annual periods beginning after June 15, 2010, however, early adoption is permitted. The adoption of this update is not expected to have a material impact on our Condensed Consolidated Financial Statements.
In April 2010, the FASB issued new standards for vendors who apply the milestone method of revenue recognition to research and development arrangements. These new standards apply to arrangements with payments that are contingent, at inception, upon achieving substantively uncertain future events or circumstances. The guidance will be applicable for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010. Early adoption is permitted. We are currently assessing the impact of the adoption of this guidance on our Condensed Consolidated Financial Statements as it may impact revenue recognition on certain arrangements.
Subsequent Events
In February 2010, the FASB issued amended guidance on subsequent events. Under this amended guidance, SEC filers are no longer required to disclose the date through which subsequent events have been evaluated in originally issued and revised financial statements. This guidance was effective immediately and the Company adopted these new requirements for the period ended March 31, 2010.
3. ACQUISITION AND RESTRUCTURING ACTIVITIES
Accuro Restructuring Plan
In connection with the Accuro Healthcare Solutions, Inc. acquisition (“Accuro” or “Accuro Acquisition”), our management approved, committed and initiated a plan to restructure our operations resulting in certain management, system and organizational changes within our Revenue Cycle Management segment. Any increases or decreases to the estimates of executing the restructuring plan subsequent to June 2009 will be recorded as an adjustment to operating expense. There were no such adjustments made during the three months ended March 31, 2010.
The changes in the plan are summarized as follows:
| | | | | | | | | | | | |
| | Accrued | | | | | | | Accrued | |
| | December 31, | | | Cash | | | March 31, | |
| | 2009 | | | Payments | | | 2010 | |
Accuro Restructuring Plan | | | | | | | | | | | | |
Severance | | $ | 246 | | | $ | (246 | ) | | $ | — | |
Lease termination penalty and other costs | | | 2,813 | | | | (338 | ) | | | 2,475 | |
| | | | | | | | | |
Total Accuro Restructuring Costs | | $ | 3,059 | | | $ | (584 | ) | | $ | 2,475 | |
| | | | | | | | | |
We expect that $1,429 of the remaining lease termination penalty will be paid ratably from April 2010 through January 2011 and $1,046 will be paid in February 2011.
4. DEFERRED REVENUE
Deferred revenue consists of unrecognized revenue related to advanced customer invoicing or customer payments received prior to revenue being realized and earned. Substantially all of our deferred revenue consists of: (i) deferred administrative fees, net; (ii) deferred service fees; (iii) deferred software and implementation fees; and (iv) other deferred fees, including receipts for our annual customer and vendor meeting received prior to the event.
The following table summarizes the deferred revenue categories and balances as of:
8
MedAssets, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) — (continued)
(In thousands, except share and per share amounts)
| | | | | | | | |
| | March 31, | | | December 31, | |
| | 2010 | | | 2009 | |
Software and implementation fees | | $ | 14,203 | | | $ | 14,080 | |
Service fees | | | 18,735 | | | | 15,786 | |
Administrative fees | | | 2,278 | | | | 924 | |
Other fees | | | 3,238 | | | | 1,088 | |
| | | | | | |
Deferred revenue, total | | | 38,454 | | | | 31,878 | |
Less: Deferred revenue, current portion | | | (30,848 | ) | | | (24,498 | ) |
| | | | | | |
Deferred revenue, non-current portion | | $ | 7,606 | | | $ | 7,380 | |
| | | | | | |
As of March 31, 2010 and December 31, 2009, deferred revenue included in our Condensed Consolidated Balance Sheets that was contingent upon meeting performance targets was $2,159 and $686, respectively.
5. NOTES PAYABLE
The balances of our notes payable are summarized as follows as of:
| | | | | | | | |
| | March 31, | | | December 31, | |
| | 2010 | | | 2009 | |
Notes payable — senior | | $ | 203,264 | | | $ | 215,161 | |
Less: current portion | | | (2,499 | ) | | | (13,771 | ) |
| | | | | | |
Total long-term notes payable | | $ | 200,765 | | | $ | 201,390 | |
| | | | | | |
The principal amount of our long-term notes payable consists of our senior term loan facility which had an outstanding balance of $203,264 as of March 31, 2010. We had zero dollars drawn on our revolving credit facility, and zero dollars drawn on our swing-line component, resulting in approximately $124,000 of availability under our credit facility inclusive of the swing-line (after giving effect to $1,000 of outstanding but undrawn letters of credit on such date) as of March 31, 2010 and December 31, 2009. During the three months ended March 31, 2010, we made payments on our term loan balance which included an annual excess cash flow payment to our lender in accordance with our credit facility of approximately $11,272 and scheduled principal payments on our senior term loan facility of $625. The applicable weighted average interest rate (inclusive of the applicable bank margin and impact of our interest rate collar) on our senior term loan facility at March 31, 2010 was 6.1%. Total interest paid during the three months ended March 31, 2010 and 2009 was approximately $3,160 and $3,940, respectively.
As of March 31, 2010, we had approximately $5,472 of debt issuance costs related to our credit agreement which will be amortized into interest expense using the effective interest method until the maturity date. Our revolving credit facility matures on October 23, 2011 and our term loan matures on October 23, 2013. For the three months ended March 31, 2010 and 2009, we recognized approximately $458 and $462 in interest expense related to the amortization of debt issuance costs.
Our credit agreement contains certain provisions that require us to pay a portion of our outstanding obligations one quarter subsequent to the end of each fiscal year in the form of an excess cash flow payment on the term loan. The amount is determined based on defined percentages of excess cash flow required in the credit agreement. Our current portion of notes payable does not include an amount with respect to any 2011 excess cash flow payment. We will reclassify a portion of our long-term notes payable to a current classification at such time that any 2011 excess cash flow payment becomes estimable.
Future maturities of principal of notes payable as of March 31, 2010 are as follows:
9
MedAssets, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) — (continued)
(In thousands, except share and per share amounts)
| | | | |
| | Amount | |
2010 | | $ | 1,874 | (1) |
2011 | | | 2,499 | |
2012 | | | 2,499 | |
2013 | | | 196,392 | |
| | | |
Total notes payable | | $ | 203,264 | |
| | | |
(1) Represents remaining quarterly principal payments due during the fiscal year ended December 31, 2010.
6. COMMITMENTS AND CONTINGENCIES
Performance Targets
In the ordinary course of contracting with our customers, we may agree to make some or all of our fees contingent upon a customer’s achievement of financial improvement targets from the use of our services and software. These contingent fees are not recognized as revenue until a customer confirms achievement of the performance targets. We generally receive customer acceptance as and when the performance targets are achieved. Prior to customer confirmation that a performance target has been achieved, we record billed contingent fees as deferred revenue on our Condensed Consolidated Balance Sheet. Often, recognition of this revenue occurs in periods subsequent to the recognition of the associated costs.
Legal Proceedings
In August 2007, Jacqueline Hodges, the former owner of Med-Data Management, Inc. (or “Med-Data”) disputed our earn-out calculation made under the Med-Data Asset Purchase Agreement and alleged that we failed to fulfill our obligations with respect to the earn-out. In November 2007, Ms. Hodges filed a complaint in the Federal District Court for the Northern District of Georgia, alleging that we failed to act in good faith with respect to the operation of Med-Data subsequent to the acquisition which affected the earn-out calculation. On March 21, 2008, we filed an answer denying the plaintiffs’ allegations and also filed a counterclaim alleging that the plaintiffs fraudulently induced us to enter into the purchase agreement by intentionally concealing the status of their relationship with their largest customer.
On March 31, 2010, the Court entered summary judgment in favor of the Company and dismissed Ms. Hodges’ claims. Though Ms. Hodges filed a motion for summary judgment as well to dismiss the Company’s counterclaim, the Court denied this motion, and the Company is free to proceed to trial on its claims. The Company is in the process of negotiating a settlement of its counterclaim filed in this lawsuit.
Other than the Med-Data dispute noted above, as of March 31, 2010, we are not presently involved in any other legal proceedings, the outcome of which, if determined adversely to us, would have a material adverse affect on our business, operating results or financial condition.
7. STOCKHOLDERS’ EQUITY AND SHARE-BASED COMPENSATION
Common Stock
During the three months ended March 31, 2010, we issued approximately 245,000 shares of common stock in connection with employee stock option and stock-settled stock appreciation rights (or “SSARs”) exercises for aggregate exercise proceeds of $1,940.
Share-Based Compensation
As of March 31, 2010, we had restricted common stock, SSARs and common stock option equity awards outstanding under three share-based compensation plans. As of March 31, 2010, we had approximately 1,626,000 shares reserved under our 2008 equity incentive plan available for grant.
The share-based compensation expense related to equity awards that has been charged against income was $3,472 and $4,386 for the three months ended March 31, 2010 and 2009, respectively. The total income tax benefit recognized in the Condensed Consolidated Statement of Operations for share-based compensation arrangements related to equity awards was $1,309 and $1,656 for the three months ended March 31, 2010 and 2009, respectively. There were no capitalized share-based compensation expenses at March 31, 2010.
10
MedAssets, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) — (continued)
(In thousands, except share and per share amounts)
Total share-based compensation expense (inclusive of restricted common stock, SSARs and common stock options) for the three months ended March 31, 2010 and 2009 is reflected in our Condensed Consolidated Statements of Operations as noted below:
| | | | | | | | |
| | Three Months Ended March 31, | |
| | 2010 | | | 2009 | |
Cost of revenue | | $ | 566 | | | $ | 860 | |
Product development | | | 197 | | | | 309 | |
Selling and marketing | | | 614 | | | | 798 | |
General and administrative | | | 2,095 | | | | 2,419 | |
| | | | | | |
Total share-based compensation expense | | $ | 3,472 | | | $ | 4,386 | |
| | | | | | |
Equity Award Grants
During the three months ended March 31, 2010, we granted the following equity awards to certain of our employees, our board of directors and our senior advisory board.
Common Stock Option Awards
During the three months ended March 31, 2010, we granted stock options for the purchase of approximately 102,000 shares. The stock options granted during the three months ended March 31, 2010 have a weighted average exercise price of $21.50 and have a service vesting period of five years. The weighted-average grant date fair value of each stock option granted during the three months ended March 31, 2010 was $6.84.
As of March 31, 2010, there was approximately $8,000 of total unrecognized compensation expense related to all outstanding stock option awards that will be recognized over a weighted average period of 1.6 years.
Restricted Common Stock Awards
During the three months ended March 31, 2010 we issued restricted common stock awards of approximately 77,000 (or 40,000 shares net of forfeitures). The weighted-average grant date fair value of each restricted common stock share was $21.46. Approximately 42,000 restricted shares will vest on December 31, 2012 provided certain performance criteria are achieved. Approximately 21,000 restricted shares vest over four years; 12,000 shares vest ratably each month through December 31, 2010; and 2,000 restricted shares were fully vested at the date of grant.
As of March 31, 2010, there was approximately $10,000 of total unrecognized compensation expense related to all unvested restricted common stock awards that will be recognized over a weighted average period of 1.8 years.
SSARs Awards
During the three months ended March 31, 2010, we issued approximately 291,000 SSARs (or 215,000 SSARs net of forfeitures) awards. The weighted-average grant date base price of each SSAR was $21.42 and the weighted-average grant date fair value of each SSAR was $5.89 for the three months ended March 31, 2010. Approximately 128,000 SSARs will vest on December 31, 2012 provided certain performance criteria are achieved. Approximately 57,000 SSARs vest over four years and 106,000 SSARs vest ratably each month through December 31, 2010.
As of March 31, 2010, there was approximately $8,000 of total unrecognized compensation expense related to all unvested SSARs that will be recognized over a weighted average period of 1.7 years.
11
MedAssets, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) — (continued)
(In thousands, except share and per share amounts)
8. INCOME TAXES
Income tax expense recorded during the three months ended March 31, 2010 and 2009 reflected an effective income tax rate of 40.3% and 40.0%, respectively. There was no significant change in the Company’s liabilities related to accounting for uncertainty in income taxes for the three months ended March 31, 2010 and 2009, respectively.
9. INCOME PER SHARE
We calculate earnings per share (or “EPS”) in accordance with GAAP. Basic EPS is calculated by dividing reported net income available to common shareholders by the weighted-average number of common shares outstanding for the reporting periods. Diluted EPS reflects the potential dilution that could occur if our stock options, stock warrants, SSARs and unvested restricted stock were included in our common shares outstanding during the reporting periods.
| | | | | | | | |
| | Three Months Ended March 31, | |
| | 2010 | | | 2009 | |
Numerator for Basic and Diluted Income Per Share: | | | | | | | | |
Net income | | $ | 5,520 | | | $ | 1,905 | |
Denominator for basic income per share weighted average shares | | | 55,817,000 | | | | 54,102,000 | |
Effect of dilutive securities: | | | | | | | | |
Stock options | | | 2,160,000 | | | | 2,102,000 | |
Stock settled stock appreciation rights | | | 383,000 | | | | — | |
Restricted stock and stock warrants | | | 469,000 | | | | 98,000 | |
| | | | | | |
Denominator for diluted income per share — adjusted weighted average shares and assumed conversions | | | 58,829,000 | | | | 56,302,000 | |
Basic income per share: | | | | | | | | |
Basic net income per common share | | $ | 0.10 | | | $ | 0.04 | |
| | | | | | |
Diluted net income per share: | | | | | | | | |
Diluted net income per common share | | $ | 0.09 | | | $ | 0.03 | |
| | | | | | |
12
MedAssets, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) — (continued)
(In thousands, except share and per share amounts)
The effect of certain dilutive securities has been excluded for the three months ended March 31, 2010 and 2009 because the impact is anti-dilutive as a result of certain securities strike price being greater than the average market price (or, out of the money) during the periods presented. The following table provides a summary of those potentially dilutive securities that have been excluded from the above calculation of basic and diluted EPS:
| | | | | | | | |
| | Three Months Ended March 31, |
| | 2010 | | 2009 |
Stock options | | | 77,000 | | | | 350,000 | |
SSARs | | | 43,000 | | | | 469,000 | |
| | | | | | | | |
Total | | | 120,000 | | | | 819,000 | |
10. SEGMENT INFORMATION
We deliver our solutions and manage our business through two reportable business segments, Revenue Cycle Management (or “RCM”) and Spend Management (or “SM”):
| • | | Revenue Cycle Management. Our Revenue Cycle Management segment provides a comprehensive suite of software and services spanning the hospital, health system and other ancillary healthcare provider revenue cycle workflow — from patient admission and financial responsibility, patient financial liability estimation, charge capture, case management, contract management and health information management through claims processing and accounts receivable management. Our workflow solutions, together with our data management and business intelligence tools, increase revenue capture and cash collections, reduce accounts receivable balances and increase regulatory compliance. |
|
| • | | Spend Management. Our Spend Management segment provides a comprehensive suite of technology-enabled services that help our customers manage their non-labor expense categories. Our solutions lower supply and medical device pricing and utilization by managing the procurement process through our group purchasing organization portfolio of contracts, consulting services and business intelligence tools. |
GAAP relating to segment reporting, defines reportable segments as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing financial performance. The guidance indicates that financial information about segments should be reported on the same basis as that which is used by the chief operating decision maker in the analysis of performance and allocation of resources. Management of the Company, including our chief operating decision maker, uses what we refer to as Segment Adjusted EBITDA as its primary measure of profit or loss to assess segment performance and to determine the allocation of resources. We define Segment Adjusted EBITDA as segment net income (loss) before net interest expense, income tax expense (benefit), depreciation and amortization (“EBITDA”) as adjusted for other non-recurring, non-cash or non-operating items. Our chief operating decision maker uses Segment Adjusted EBITDA to facilitate a comparison of our operating performance on a consistent basis from period to period. Segment Adjusted EBITDA includes expenses associated with sales and marketing, general and administrative and product development activities specific to the operation of the segment. General and administrative corporate expenses that are not specific to the segments are not included in the calculation of Segment Adjusted EBITDA. These expenses include the costs to manage our corporate offices, interest expense on our credit facilities and expenses related to being a publicly-held company. All reportable segment revenues are presented net of inter-segment eliminations and represent revenues from external customers.
The following tables present Segment Adjusted EBITDA and financial position information as utilized by our chief operating decision maker. A reconciliation of Segment Adjusted EBITDA to consolidated net income is included. General corporate expenses are included in the “Corporate” column. “RCM” represents the Revenue Cycle Management segment and “SM” represents the Spend Management segment. Other assets and liabilities are included to provide a reconciliation to total assets and total liabilities.
The following tables represent our results of operations, by segment, for the three months ended March 31, 2010 and 2009:
13
MedAssets, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) — (continued)
(In thousands, except share and per share amounts)
| | | | | | | | | | | | | | | | |
| | Three Months Ended March 31, 2010 | |
| | RCM | | | SM | | | Corporate | | | Total | |
Results of Operations: | | | | | | | | | | | | | | | | |
Revenue: | | | | | | | | | | | | | | | | |
Gross administrative fees(1) | | $ | — | | | $ | 43,029 | | | $ | — | | | $ | 43,029 | |
Revenue share obligation(1) | | | — | | | | (14,439 | ) | | | — | | | | (14,439 | ) |
Other service fees | | | 58,684 | | | | 6,132 | | | | — | | | | 64,816 | |
| | | | | | | | | | | | |
Total net revenue | | | 58,684 | | | | 34,722 | | | | — | | | | 93,406 | |
Total operating expenses | | | 51,588 | | | | 19,600 | | | | 9,100 | | | | 80,288 | |
| | | | | | | | | | | | |
Operating income (loss) | | | 7,096 | | | | 15,122 | | | | (9,100 | ) | | | 13,118 | |
Interest (expense) | | | — | | | | — | | | | (3,932 | ) | | | (3,932 | ) |
Other (expense) income | | | (33 | ) | | | (10 | ) | | | 110 | | | | 67 | |
| | | | | | | | | | | | |
Income (loss) before income taxes | | $ | 7,063 | | | $ | 15,112 | | | $ | (12,922 | ) | | $ | 9,253 | |
Income tax (benefit) | | | 2,849 | | | | 6,096 | | | | (5,212 | ) | | | 3,733 | |
| | | | | | | | | | | | |
Net income (loss) | | | 4,214 | | | | 9,016 | | | | (7,710 | ) | | | 5,520 | |
| | | | | | | | | | | | |
Segment Adjusted EBITDA | | $ | 17,482 | | | $ | 16,957 | | | $ | (6,627 | ) | | $ | 27,812 | |
| | |
(1) | | These are non-GAAP measures. See “Use of Non-GAAP Financial Measures” section for additional information. |
| | | | | | | | | | | | | | | | |
| | As of March 31, 2010 | |
| | RCM | | | SM | | | Corporate | | | Total | |
Financial Position: | | | | | | | | | | | | | | | | |
Accounts receivable, net | | $ | 53,765 | | | $ | 38,558 | | | $ | (22,000 | ) | | $ | 70,323 | |
Other assets | | | 562,955 | | | | 94,484 | | | | 57,556 | | | | 714,995 | |
| | | | | | | | | | | | |
Total assets | | | 616,720 | | | | 133,042 | | | | 35,556 | | | | 785,318 | |
Accrued revenue share obligation | | | — | | | | 27,084 | | | | — | | | | 27,084 | |
Deferred revenue | | | 30,159 | | | | 8,295 | | | | — | | | | 38,454 | |
Other liabilities | | | 38,249 | | | | 30,914 | | | | 201,424 | | | | 270,587 | |
| | | | | | | | | | | | |
Total liabilities | | $ | 68,408 | | | $ | 66,293 | | | $ | 201,424 | | | $ | 336,125 | |
14
MedAssets, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) — (continued)
(In thousands, except share and per share amounts)
| | | | | | | | | | | | | | | | |
| | Three Months Ended March 31, 2009 | |
| | RCM | | | SM | | | Corporate | | | Total | |
Results of Operations: | | | | | | | | | | | | | | | | |
Revenue: | | | | | | | | | | | | | | | | |
Gross administrative fees(1) | | $ | — | | | $ | 40,932 | | | $ | — | | | $ | 40,932 | |
Revenue share obligation(1) | | | — | | | | (13,446 | ) | | | — | | | | (13,446 | ) |
Other service fees | | | 47,020 | | | | 4,478 | | | | — | | | | 51,498 | |
| | | | | | | | | | | | |
Total net revenue | | | 47,020 | | | | 31,964 | | | | — | | | | 78,984 | |
Total operating expenses | | | 45,523 | | | | 18,201 | | | | 7,307 | | | | 71,031 | |
| | | | | | | | | | | | |
Operating income (loss) | | | 1,497 | | | | 13,763 | | | | (7,307 | ) | | | 7,953 | |
Interest (expense) | | | (1 | ) | | | — | | | | (4,992 | ) | | | (4,993 | ) |
Other income | | | 35 | | | | 51 | | | | 128 | | | | 214 | |
| | | | | | | | | | | | |
Income (loss) before income taxes | | $ | 1,531 | | | $ | 13,814 | | | $ | (12,171 | ) | | $ | 3,174 | |
Income tax (benefit) | | | 612 | | | | 5,523 | | | | (4,866 | ) | | | 1,269 | |
| | | | | | | | | | | | |
Net income (loss) | | | 919 | | | | 8,291 | | | | (7,305 | ) | | | 1,905 | |
| | | | | | | | | | | | |
Segment Adjusted EBITDA | | $ | 12,326 | | | $ | 16,252 | | | $ | (5,249 | ) | | $ | 23,329 | |
| | |
(1) | | These are non-GAAP measures. See “Use of Non-GAAP Financial Measures” section for additional information. |
| | | | | | | | | | | | | | | | |
| | As of March 31, 2009 | |
| | RCM | | | SM | | | Corporate | | | Total | |
Financial Position: | | | | | | | | | | | | | | | | |
Accounts receivable, net | | $ | 43,557 | | | $ | 30,964 | | | $ | (16,899 | ) | | $ | 57,622 | |
Other assets | | | 576,196 | | | | 96,211 | | | | 40,962 | | | | 713,369 | |
| | | | | | | | | | | | |
Total assets | | | 619,753 | | | | 127,175 | | | | 24,063 | | | | 770,991 | |
Accrued revenue share obligation | | | — | | | | 24,760 | | | | — | | | | 24,760 | |
Deferred revenue | | | 25,427 | | | | 5,735 | | | | — | | | | 31,162 | |
Other liabilities | | | 29,110 | | | | 32,057 | | | | 261,804 | | | | 322,971 | |
| | | | | | | | | | | | |
Total liabilities | | $ | 54,537 | | | $ | 62,552 | | | $ | 261,804 | | | $ | 378,893 | |
GAAP for segment reporting require that the total of the reportable segments’ measures of profit or loss be reconciled to the Company’s consolidated operating results. The following table reconciles Segment Adjusted EBITDA to consolidated net income for each of the three months ended March 31, 2010 and 2009:
15
MedAssets, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) — (continued)
(In thousands, except share and per share amounts)
| | | | | | | | |
| | Three Months Ended March 31, | |
| | 2010 | | | 2009 | |
RCM Adjusted EBITDA | | $ | 17,482 | | | $ | 12,326 | |
SM Adjusted EBITDA | | | 16,957 | | | | 16,252 | |
| | | | | | |
Total reportable Segment Adjusted EBITDA | | | 34,439 | | | | 28,578 | |
Depreciation expense | | | (3,470 | ) | | | (2,438 | ) |
Depreciation expense (included in cost of revenue) | | | (722 | ) | | | (603 | ) |
Amortization of intangibles | | | (6,084 | ) | | | (7,011 | ) |
Amortization of intangibles (included in cost of revenue) | | | (185 | ) | | | (185 | ) |
Interest expense, net of interest income(1) | | | 18 | | | | 7 | |
Income tax expense | | | (8,945 | ) | | | (6,135 | ) |
Share-based compensation expense(2) | | | (1,821 | ) | | | (2,814 | ) |
Accuro purchase accounting adjustment(3) | | | — | | | | (189 | ) |
| | | | | | |
Total reportable segment net income | | | 13,230 | | | | 9,210 | |
Corporate net (loss) | | | (7,710 | ) | | | (7,305 | ) |
| | | | | | |
Consolidated net income | | $ | 5,520 | | | $ | 1,905 | |
| | |
(1) | | Interest income is included in other income (expense) and is not netted against interest expense in our Condensed Consolidated Statement of Operations. |
|
(2) | | Represents non-cash share-based compensation to both employees and directors. We believe excluding this non-cash expense allows us to compare our operating performance without regard to the impact of share-based compensation, which varies from period to period based on amount and timing of equity grants. |
|
(3) | | These adjustments include the effect on revenue of adjusting acquired deferred revenue balances, net of any reduction in associated deferred costs, to fair value as of the respective acquisition date for Accuro. The reduction of the deferred revenue balances materially affects period-to-period financial performance comparability and revenue and earnings growth in periods subsequent to the acquisition and is not indicative of the changes in the underlying results of operations. In 2010, these adjustments will no longer be reconciling items related to acquired deferred revenue balances because the amounts were fully amortized in 2009. We may have this adjustment in future periods if required by GAAP. |
11. DERIVATIVE FINANCIAL INSTRUMENTS
Effective January 1, 2009, we adopted GAAP for derivatives and hedging which requires companies to provide enhanced qualitative and quantitative disclosures about how and why an entity uses derivative instruments and how derivative instruments and related hedged items are accounted. The Company has established policies and procedures for risk assessment and the approval, reporting and monitoring of derivative financial instruments. Our interest rate risk management policy permits the use of derivative instruments, such as interest rate swaps and collars, to reduce volatility in our results of operations and/or cash flows resulting from interest rate fluctuations. All of our derivative instruments are utilized for risk management purposes and we do not use derivatives for speculative trading purposes.
As of March 31, 2010, we had an interest rate swap, an interest rate collar and a par forward contract as described below. These derivatives were highly effective and, as a result, we did not record any gain or loss from ineffectiveness in our Condensed Consolidated Statements of Operations for the three months ended March 31, 2010 and 2009.
Interest rate swap
On May 21, 2009, we entered into a forward starting London Inter-bank Offered Rate (or “LIBOR”) interest rate swap with a notional amount of $138,276 beginning June 30, 2010, which effectively converts a portion of our variable rate term loan credit facility to a fixed rate debt. The notional amount subject to the swap has pre-set quarterly step downs corresponding to our anticipated principal reduction schedule.
The interest rate swap converts the three-month LIBOR rate on the corresponding notional amount of debt to an effective fixed rate of 1.99% (exclusive of the applicable bank margin charged by our lender). The interest rate swap terminates on March 31, 2012 and qualifies as a highly effective cash flow hedge under U.S. GAAP.
As such, the fair value of the derivative will be recorded in our Condensed Consolidated Balance Sheets. Accordingly, as of March 31, 2010, we recorded the fair value of the swap on our balance sheet as a liability of approximately $1,451 in other long-term
16
MedAssets, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) — (continued)
(In thousands, except share and per share amounts)
liabilities, and the offsetting loss ($904 net of tax) was recorded in Accumulated Other Comprehensive Loss (“AOCI”) in our stockholders’ equity. If we assess any portion of this to be ineffective, we will reclassify the ineffective portion to current period earnings or loss accordingly.
We determined the fair values of the swap using Level 2 inputs as defined under GAAP for fair value measurements and disclosures because our valuation techniques included inputs that are considered significantly observable in the market, either directly or indirectly. Our valuation technique assessed the swap by comparing each fixed interest payment, or cash flow, to a hypothetical cash flow utilizing an observable market 3-month floating LIBOR rate as of March 31, 2010. Future hypothetical cash flows utilize projected market-based LIBOR rates. Each fixed cash flow and hypothetical cash flow is then discounted to present value utilizing a market observable discount factor for each cash flow. The discount factor fluctuates based on the timing of each future cash flow. The fair value of the swap represents a cumulative total of the differences between the discounted cash flows that are fixed from those that are hypothetical using floating rates.
We considered the credit worthiness of the counterparty of the hedged instrument. Given the recent events in the credit markets and specific challenges related to financial institutions, the Company continues to believe that the size, international presence and US government cash infusion, and track record of the counterparty will allow them to perform under the obligations of the contract and are not a risk of default that would change the highly effective status of the hedged instruments.
Interest rate collar
On June 24, 2008 (effective June 30, 2008), we entered into an interest rate collar to hedge our interest rate exposure on a notional $155,000 of our outstanding term loan credit facility of $203,264. The collar sets a maximum interest rate of 6.00% and a minimum interest rate of 2.85% on the 3-month London Inter-bank Offered Rate (or “LIBOR”) applicable to a notional $155,000 of term loan debt. This collar effectively limits our LIBOR interest exposure on this portion of our term loan debt to within that range (2.85% to 6.00%). The collar also does not hedge the applicable margin payable to our lenders on our indebtedness. Settlement payments are made between the hedge counterparty and us on a quarterly basis, coinciding with our term loan installment payment dates, for any rate overage on the maximum rate and any rate deficiency on the minimum rate on the notional amount outstanding. The collar terminates on June 30, 2010 and no consideration was exchanged with the counterparty to enter into the hedging arrangement.
The collar is a highly effective cash flow hedge under GAAP relating to derivatives and hedging, as the payment and interest rate terms of the instrument coincide with that of our term loan and the instrument was designed to perfectly hedge our variable cash flow risk. Accordingly as of March 31, 2010, we recorded the fair value of the collar on our balance sheet as a liability of approximately $1,002 in Other accrued expenses, and the offsetting loss of ($624 net of tax) was recorded in AOCI in our Stockholders’ equity. If we assess any portion of any of this to be ineffective, we will reclassify the ineffective portion to current period earnings or loss accordingly.
We determined the fair values of the collar using Level 2 inputs as defined under GAAP for fair value measurements and disclosures because our valuation technique included inputs that are considered significantly observable in the market, either directly or indirectly. Our valuation technique assesses the present value of future expected cash flows using a market observable discount factor that is based on a 3-month LIBOR yield curve adjusted for interest rate volatility. The assumptions utilized to assess volatility are also observable in the market.
We considered the credit worthiness of the counterparty of our hedged instrument. The Company believes that given the size of the hedged instrument and the likelihood that the counterparty would have to perform under the contract (i.e. LIBOR goes above 6.00%) mitigates any potential credit risk and risk of non-performance under the contract.
Par forward contracts
We have a series of par forward contracts to lock in the rate of exchange in U.S. dollar terms at a specific par forward exchange rate of Canadian dollars to one U.S. dollar, with respect to one specific Canadian customer contract. This three-year customer contract extends through April 30, 2010. The combination of options is considered purchased options under implementation guidance under GAAP for derivatives and hedging. The hedged instruments are classified as cash flow hedges and are designed to be highly effective at minimizing exchange rate risk on the contract. We designated this hedge as effective and recorded the fair
17
MedAssets, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) — (continued)
(In thousands, except share and per share amounts)
value of this instrument as a liability of approximately $12 in Other accrued expenses as of March 31, 2010. The offsetting unrealized loss of ($7 net of tax) is recorded as AOCI in our Stockholders’ equity as of March 31, 2010. If we assess any material portion of this to be ineffective, we will reclassify that ineffective portion to current period earnings or loss accordingly.
We determined the fair values of the par forward contracts using Level 2 inputs as defined under GAAP relating to fair value measurements and disclosures because our valuation techniques included inputs that are considered significantly observable in the market, either directly or indirectly. However, these instruments are not traded in active markets, thus they are not valued using Level 1 inputs. Our valuation technique assessed the par forward contract by comparing each fixed cash flow to a hypothetical cash flow utilizing an observable market spot exchange rate as of March 31, 2010, and then discounting each of those cash flows to present value utilizing a market observable discount factor for each cash flow. The discount factor fluctuates based on the timing of each future cash flow. The fair value represents a cumulative total of each par forward contract calculated fair value.
We considered the credit worthiness of the counterparty of the hedged instrument. Given the current situation in the credit markets and specific challenges related to financial institutions, the Company continues to believe that the underlying size, international presence and US government cash infusion, and track record of the counterparty will allow them to perform under the obligations of the contract and are not a risk of default that would change the highly effective status of the hedged instruments.
A following table presents the fair value of our outstanding derivative instruments as of March 31, 2010 and December 31, 2009:
| | | | | | | | | | |
| | | | Fair Value of Financial | |
| | | | Instruments | |
| | | | As of | | | As of | |
| | | | March 31, | | | December | |
| | Balance Sheet Location | | 2010 | | | 31, 2009 | |
Derivative Liabilities | | | | | | | | | | |
Derivatives designated as hedging instruments: | | | | | | | | | | |
Interest rate contracts | | Other accrued expenses | | $ | 1,002 | | | $ | — | |
Interest rate contracts | | Other long term liabilities | | | 1,451 | | | | 2,575 | |
Foreign exchange contracts | | Other accrued expenses | | | 12 | | | | — | |
Foreign exchange contracts | | Other long term liabilities | | | — | | | | 8 | |
| | | | | | | | |
Total | | | | $ | 2,465 | | | $ | 2,583 | |
| | | | | | | | |
The effects of derivative instruments designated as cash flow hedges on income and AOCI are summarized below:
18
MedAssets, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) — (continued)
(In thousands, except share and per share amounts)
| | | | | | | | | | | | | | | | | | | | | | | | |
| | Amount of Gain or (Loss) | | | Location of Gain or (Loss) | | | Amount of Gain or (Loss) | |
| | Recognized in OCI on | | | Reclassified from | | | Reclassified from | |
| | Derivative (Effective | | | Accumulated OCI into | | | Accumulated OCI into | |
| | Portion) | | | Income (Effective Portion) | | | Income (Effective Portion) | |
| | Three Months Ended | | | Three Months Ended | | | Three Months Ended | |
Derivatives designated as | | March 31, | | | March 31, | | | March 31, | |
cash flow Hedges | | 2010 | | | 2009 | | | 2010 | | | 2009 | | | 2010 | | | 2009 | |
| | | | | | | | (Unaudited) | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Interest rate contracts | | $ | 71 | | | $ | 260 | | | | n/a | | | | n/a | | | $ | — | | | $ | — | |
Foreign exchange contracts | | | (2 | ) | | | (15 | ) | | | n/a | | | | n/a | | | | — | | | | — | |
| | | | | | | | | | | | | | | | | | | | |
Total gain recognized in other comprehensive income | | $ | 69 | | | $ | 245 | | | | | | | | | | | $ | — | | | $ | — | |
| | | | | | | | | | | | | | | | | | | | |
12. FAIR VALUE MEASUREMENTS
We measure fair value for financial instruments, such as derivatives and non-financial assets, when a valuation is necessary, such as for impairment of long-lived and indefinite-lived assets when indicators of impairment exist in accordance with GAAP for fair value measurements and disclosures. This defines fair value, establishes a framework for measuring fair value and enhances disclosures about fair value measures required under other accounting pronouncements, but does not change existing guidance as to whether or not an instrument is carried at fair value. We adopted the provisions of GAAP for fair value measurements and disclosures for financial instruments effective January 1, 2008 and for non-financial assets effective January 1, 2009.
Refer to Note 11 for information and fair values of our derivative instruments measured on a recurring basis under GAAP for fair value measurements and disclosures.
In estimating our fair value disclosures for financial instruments, we use the following methods and assumptions:
| • | | Cash and cash equivalents:The carrying value reported in the Condensed Consolidated Balance Sheets for these items approximates fair value due to the high credit standing of the financial institutions holding these items and their liquid nature; |
|
| • | | Accounts receivable, net:The carrying value reported in the Condensed Consolidated Balance Sheets is net of allowances for doubtful accounts which includes a degree of counterparty non-performance risk; |
|
| • | | Accounts payable and current liabilities:The carrying value reported in the Condensed Consolidated Balance Sheets for these items approximates fair value, which is the likely amount for which the liability with short settlement periods would be transferred to a market participant with a similar credit standing as the Company; |
|
| • | | Finance obligation:The carrying value of our finance obligation reported in the Condensed Consolidated Balance Sheets approximates fair value based on current interest rates; and |
|
| • | | Notes payable:The carrying value of our long-term notes payable reported in the Condensed Consolidated Balance Sheets approximates fair value since they bear interest at variable rates or fixed rates which contain an element of default risk. Refer to Note 5. |
13. RELATED PARTY TRANSACTION
We have an agreement with John Bardis, our chief executive officer, for the use of an airplane owned by JJB Aviation, LLC, a limited liability company, owned by Mr. Bardis. We pay Mr. Bardis at market-based rates for the use of the airplane for business
19
MedAssets, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) — (continued)
(In thousands, except share and per share amounts)
purposes. The audit committee of the Board reviews such usage of the airplane annually. During the three months ended March 31, 2010 and 2009, we incurred charges of $581 and $346, respectively, related to transactions with Mr. Bardis.
14. SUBSEQUENT EVENTS
We have evaluated subsequent events for recognition or disclosure in the Condensed Consolidated Financial Statements filed on Form 10-Q with the SEC and no events have occurred that require disclosure.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
NOTE ON FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains certain “forward-looking statements” (as defined in Section 27A of the U.S. Securities Act of 1933, as amended, or the “Securities Act,” and Section 21E of the U.S. Securities Exchange Act of 1934, as amended, or the “Exchange Act”) that reflect our expectations regarding our future growth, results of operations, performance and business prospects and opportunities. Words such as “anticipates,” “believes,” “plans,” “expects,” “intends,” “estimates,” “projects,” “targets,” “can,” “could,” “may,” “should,” “will,” “would,” and similar expressions have been used to identify these forward-looking statements, but are not the exclusive means of identifying these statements. For purposes of this Quarterly Report on Form 10-Q, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. These statements reflect our current beliefs and expectations and are based on information currently available to us. As such, no assurance can be given that our future growth, results of operations, performance and business prospects and opportunities covered by such forward-looking statements will be achieved. We have no intention or obligation to update or revise these forward-looking statements to reflect new events, information or circumstances.
A number of important factors could cause our actual results to differ materially from those indicated by such forward-looking statements, including those described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2009, as filed with the SEC on March 1, 2010.
Overview
We provide technology-enabled products and services which together deliver solutions designed to improve operating margin and cash flow for hospitals, health systems and other ancillary healthcare providers. Our solutions are designed to efficiently analyze detailed information across the spectrum of revenue cycle and spend management processes. Our solutions integrate with existing operations and enterprise software systems of our customers and provide financial improvement with minimal upfront costs or capital expenditures. Our operations and customers are primarily located throughout the United States and to a lesser extent, Canada.
Management’s primary metrics to measure the consolidated financial performance of the business are net revenue, non-GAAP gross fees, non-GAAP revenue share obligation, non-GAAP adjusted EBITDA, non-GAAP adjusted EBITDA margin and non-GAAP diluted cash EPS.
For the three months ended March 31, 2010 and 2009, our primary results of operations included the following (unaudited):
| | | | | | | | | | | | | | | | |
| | Three Months Ended March 31, | |
| | 2010 | | | 2009 | | | Change | |
| | Amount | | | Amount | | | Amount | | | % | |
| | | | | | (In millions) | | | | | |
Gross fees(1) | | $ | 107.8 | | | $ | 92.4 | | | $ | 15.4 | | | | 16.7 | % |
Revenue share obligation(1) | | | (14.4 | ) | | | (13.4 | ) | | | (1.0 | ) | | | 7.5 | |
| | | | | | | | | | | | |
Total net revenue | | | 93.4 | | | | 79.0 | | | | 14.4 | | | | 18.3 | |
Operating income | | | 13.1 | | | | 8.0 | | | | 5.1 | | | | 63.8 | |
Net income | | $ | 5.5 | | | $ | 1.9 | | | $ | 3.6 | | | | 189.5 | % |
Adjusted EBITDA(1) | | $ | 27.8 | | | $ | 23.3 | | | $ | 4.5 | | | | 19.3 | % |
Adjusted EBITDA margin(1) | | | 29.8 | % | | | 29.5 | % | | | | | | | | |
Diluted Cash EPS(1) | | $ | 0.19 | | | $ | 0.16 | | | $ | 0.03 | | | | 18.8 | % |
| | | | | | | | | | | | | | | | |
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(1) | | These are non-GAAP measures. See “Use of Non-GAAP Financial Measures” section for additional information. |
For the three months ended March 31, 2010 and 2009, we generated non-GAAP gross fees of $107.8 million and $92.4 million, respectively, and total net revenue of $93.4 million and $79.0 million, respectively. The increases in non-GAAP gross fees and total net revenue during the three months ended March 31, 2010 compared to the three months ended March 31, 2009 were primarily attributable to:
| • | | growth in our Revenue Cycle Management segment from our comprehensive revenue cycle services and technology solutions, claims and denial management tools and charge integrity consulting services; and |
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| • | | growth in our Spend Management segment from our medical device consulting and strategic sourcing services and our vendor administrative fees. |
For the three months ended March 31, 2010 and 2009, we generated operating income of $13.1 million and $8.0 million, respectively. The increase in operating income compared to the prior period was primarily attributable to the net revenue increase discussed above partially offset by the following:
| • | | increased cost of revenue attributable to a higher percentage of net revenue being derived from service-based engagements within our Revenue Cycle Management and Spend Management segments; and |
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| • | | higher operating expenses related to new employee compensation expense primarily associated with our expanding services-based business and other infrastructure expense. |
For the three months ended March 31, 2010, increases in consolidated non-GAAP Adjusted EBITDA and consolidated non-GAAP Adjusted EBITDA margin compared to the three months ended March 31, 2009 were primarily attributable to the net revenue growth discussed above. This was partially offset by (i) higher cost of revenue resulting from a shift to more service-based revenue; (ii) the unfavorable timing of recognized contingency-based revenue recognition in our Spend Management segment; and (iii) an increase in our corporate expenses primarily relating to compensation expense associated with certain technology infrastructure investments.
Segment Structure and Revenue Streams
We deliver our solutions through two business segments, Revenue Cycle Management (or “RCM”) and Spend Management (or “SM”). Management’s primary metrics to measure segment financial performance are net revenue, non-GAAP gross fees and Segment Adjusted EBITDA. All of our revenues are from external customers and inter-segment revenues have been eliminated. See Note 10 of the Notes to our Condensed Consolidated Financial Statements herein for discussion on Segment Adjusted EBITDA and certain items of our segment results of operations and financial position.
Revenue Cycle Management
Our Revenue Cycle Management segment provides a comprehensive suite of SaaS-based software services spanning the hospital revenue cycle workflow — from patient admission, charge capture, case management and health information management through claims processing and accounts receivable management. Our workflow solutions, together with our data management and business intelligence tools, increase revenue capture and cash collections, reduce accounts receivable balances and improve regulatory compliance. Our Revenue Cycle Management segment revenue is listed under the caption “Other service fees” on our Condensed Consolidated Statements of Operations and consists of the following components:
| • | | Subscription and implementation fees.We earn fixed subscription fees on a monthly or annual basis on multi-year contracts for customer access to our software as a service (“SaaS”) based solutions. We also charge our customers upfront fees for implementation services. Implementation fees are earned over the subscription period or estimated customer relationship period, whichever is longer. |
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| | | We defer costs related to implementation services and expense these costs in proportion to the revenue earned over the subscription period or customer relationship period, as applicable. |
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| | | In addition, we defer upfront sales commissions related to subscription and implementation fees and expense these costs ratably over the related contract term. |
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| • | | Transaction fees.For certain revenue cycle management solutions, we earn fees that vary based on the volume of customer transactions or enrolled members. |
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| • | | Licensed-software fees.We earn license, implementation, maintenance and other software-related service fees for our business intelligence, decision support and other software products. These software revenues are typically recognized |
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| | | ratably over the contract period as these are effectively annual licenses. We have certain Revenue Cycle Management contracts that are sold in multiple-element arrangements and include software products. We have considered Rule 5-03 of Regulation S-X for these types of multiple-element arrangements that include software products and determined the amount is below the threshold that would require separate disclosure on our statement of operations. |
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| • | | Service fees.For certain revenue cycle management solutions, we earn fees based on a percentage of cash remittances collected, fixed-fee and cost-plus consulting arrangements. The related revenues are earned as services are rendered. |
Spend Management
Our Spend Management segment provides a suite of technology-enabled services that help our customers manage their non-labor expense categories. Our solutions lower supply and medical device pricing and supply utilization by managing the procurement process through our group purchasing organization’s portfolio of contracts, our consulting services and analytical tool sets. Our Spend Management segment revenue consists of the following components:
| • | | Administrative fees and revenue share obligation.We earn administrative fees from manufacturers, distributors and other vendors of products and services with whom we have contracts under which our group purchasing organization customers may purchase products and services. Administrative fees represent a percentage, which we refer to as our administrative fee ratio, typically ranging from 0.25% to 3.00% of the purchases made by our group purchasing organization customers through contracts with our vendors. |
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| | | Our group purchasing organization customers make purchases, and receive shipments, directly from the vendors. Generally on a monthly or quarterly basis, vendors provide us with a report describing the purchases made by our customers through our group purchasing organization vendor contracts, including associated administrative fees. We recognize revenue upon the receipt of these reports from vendors. |
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| | | Some customer contracts require that a portion of our administrative fees are contingent upon achieving certain financial improvements, such as lower supply costs, which we refer to as performance targets. Contingent administrative fees are not recognized as revenue until the customer confirms achievement of those contractual performance targets. Prior to customer confirmation that a performance target has been achieved, we record contingent administrative fees as deferred revenue on our consolidated balance sheet. Often, recognition of this revenue occurs in periods subsequent to the recognition of the associated costs. Should we fail to meet a performance target, we may be contractually obligated to refund some or all of the contingent fees. |
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| | | Additionally, in many cases, we are contractually obligated to pay a portion of the administrative fees to our hospital and health system customers. Typically this amount, which we refer to as our revenue share obligation, is calculated as a percentage of administrative fees earned on a particular customer���s purchases from our vendors. Our total net revenue on our Condensed Consolidated Statements of Operations is shown net of the revenue share obligation. |
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| • | | Other service fees.The following items are included as “Other service fees” in our Condensed Consolidated Statement of Operations: |
| • | | Consulting fees.We consult with our customers regarding the costs and utilization of medical devices and implantable physician preference items, or PPI, and the efficiency and quality of their key clinical service lines. Our consulting projects are typically fixed fee projects with an average duration of six to nine months, and the related revenues are earned as services are rendered. |
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| • | | Subscription fees.We also offer technology-enabled services that provide spend management analytics and data services to improve operational efficiency, reduce supply costs, and increase transparency across spend management processes. We earn fixed subscription fees on a monthly basis for these Company-hosted SaaS-based solutions. |
Operating Expenses
We classify our operating expenses as follows:
| • | | Cost of revenue.Cost of revenue primarily consists of the direct labor costs incurred to generate our revenue. Direct labor |
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| | | costs consist primarily of salaries, benefits, and other direct costs and share-based compensation expenses related to personnel who provide services to implement our solutions for our customers. As the majority of our services are generated internally, our costs to provide these services are primarily labor-driven. A less significant portion of our cost of revenue consists of costs of third-party products and services and client reimbursed out-of-pocket costs. Cost of revenue does not include certain expenses relating to hosting our services and providing support and related data center capacity, and allocated amounts for rent, depreciation, amortization or other indirect operating costs because we do not consider the inclusion of these items in cost of revenue relevant to our business. However, cost of revenue does include the amortization for the cost of software to be sold, leased, or otherwise marketed. As a result of the Accuro Acquisition and related integration, there may be some re-allocation of expenses primarily between cost of revenue and general and administrative expense resulting from the implementation of our accounting expense allocation policies that could affect period over period comparability. In addition, any changes in revenue mix between our Revenue Cycle Management and Spend Management segments including changes in revenue mix towards SaaS-based revenue and consulting services, may cause significant fluctuations in our cost of revenue and have a favorable or unfavorable impact on operating income. |
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| • | | Product development expenses.Product development expenses primarily consist of the salaries, benefits, and share-based compensation expense of the technology professionals who develop, support and maintain our software-related products and services. Product development expenses are net of capitalized software development costs. |
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| • | | Selling and marketing expenses.Selling and marketing expenses consist primarily of costs related to marketing programs (including trade shows and brand messaging), personnel-related expenses for sales and marketing employees (including salaries, benefits, incentive compensation and share-based compensation expense), certain meeting costs and travel-related expenses. |
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| • | | General and administrative expenses.General and administrative expenses consist primarily of personnel-related expenses for administrative employees (including salaries, benefits, incentive compensation and share-based compensation expense) and travel-related expenses, occupancy and other indirect costs, insurance costs, professional fees, and other general overhead expenses. |
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| • | | Depreciation.Depreciation expense consists primarily of depreciation of fixed assets and the amortization of software, including capitalized costs of software developed for internal use. |
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| • | | Amortization of intangibles.Amortization of intangibles includes the amortization of all identified intangible assets (with the exception of software), primarily resulting from acquisitions. |
Results of Operations
Consolidated Tables
The following table sets forth our consolidated results of operations grouped by segment for the periods shown:
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| | | | | | | | |
| | Three Months Ended March 31, | |
| | 2010 | | | 2009 | |
| | (Unaudited, in thousands) | |
| | | | | | | | |
Net revenue: | | | | | | | | |
Revenue Cycle Management | | $ | 58,684 | | | $ | 47,020 | |
Spend Management | | | | | | | | |
Gross administrative fees(1) | | | 43,029 | | | | 40,932 | |
Revenue share obligation(1) | | | (14,439 | ) | | | (13,446 | ) |
Other service fees | | | 6,132 | | | | 4,478 | |
| | | | | | |
Total Spend Management | | | 34,722 | | | | 31,964 | |
| | | | | | |
Total net revenue | | | 93,406 | | | | 78,984 | |
Operating expenses: | | | | | | | | |
Revenue Cycle Management | | | 51,588 | | | | 45,523 | |
Spend Management | | | 19,600 | | | | 18,201 | |
| | | | | | |
Total segment operating expenses | | | 71,188 | | | | 63,724 | |
Operating income | | | | | | | | |
Revenue Cycle Management | | | 7,096 | | | | 1,497 | |
Spend Management | | | 15,122 | | | | 13,763 | |
| | | | | | |
Total segment operating income | | | 22,218 | | | | 15,260 | |
Corporate expenses(2) | | | 9,100 | | | | 7,307 | |
| | | | | | |
Operating income | | | 13,118 | | | | 7,953 | |
Other income (expense): | | | | | | | | |
Interest expense | | | (3,932 | ) | | | (4,993 | ) |
Other income | | | 67 | | | | 214 | |
| | | | | | |
Income before income taxes | | | 9,253 | | | | 3,174 | |
Income tax expense | | | 3,733 | | | | 1,269 | |
| | | | | | |
Net income | | | 5,520 | | | | 1,905 | |
Reportable segment adjusted EBITDA(3): | | | | | | | | |
Revenue Cycle Management | | | 17,482 | | | | 12,326 | |
Spend Management | | $ | 16,957 | | | $ | 16,252 | |
Reportable segment adjusted EBITDA margin(4): | | | | | | | | |
Revenue Cycle Management | | | 29.8 | % | | | 26.2 | % |
Spend Management | | | 48.8 | % | | | 50.8 | % |
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(1) | | These are non-GAAP measures. See “Use of Non-GAAP Financial Measures” section for additional information. |
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(2) | | Represents the expenses of corporate office operations. Corporate does not represent an operating segment of the Company. |
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(3) | | Management’s primary metric of segment profit or loss is Segment Adjusted EBITDA. See Note 10 of the Notes to Condensed Consolidated Financial Statements. |
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(4) | | Reportable segment Adjusted EBITDA margin represents each reportable segment’s Adjusted EBITDA as a percentage of each segment’s respective net revenue. |
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Comparison of the Three Months Ended March 31, 2010 and March 31, 2009
| | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended March 31, | |
| | 2010 | | | 2009 | | | Change | |
| | | | | | % of | | | | | | | % of | | | | | | | |
| | Amount | | | Revenue | | | Amount | | | Revenue | | | Amount | | | % | |
| | | | | | | | | | (Unaudited, in thousands) | | | | | | | | | |
Net revenue: | | | | | | | | | | | | | | | | | | | | | | | | |
Revenue Cycle Management | | $ | 58,684 | | | | 62.8 | % | | $ | 47,020 | | | | 59.5 | % | | $ | 11,664 | | | | 24.8 | % |
Spend Management | | | | | | | | | | | | | | | | | | | | | | | | |
Gross administrative fees(1) | | | 43,029 | | | | 46.1 | | | | 40,932 | | | | 51.8 | | | | 2,097 | | | | 5.1 | |
Revenue share obligation(1) | | | (14,439 | ) | | | (15.5 | ) | | | (13,446 | ) | | | (17.0 | ) | | | (993 | ) | | | 7.4 | |
Other service fees | | | 6,132 | | | | 6.6 | | | | 4,478 | | | | 5.7 | | | | 1,654 | | | | 36.9 | |
| | | | | | | | | | | | | | | | | | |
Total Spend Management | | | 34,722 | | | | 37.2 | | | | 31,964 | | | | 40.5 | | | | 2,758 | | | | 8.6 | |
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Total net revenue | | $ | 93,406 | | | | 100.0 | % | | $ | 78,984 | | | | 100.0 | % | | $ | 14,422 | | | | 18.3 | % |
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(1) | | These are non-GAAP measures. See “Use of Non-GAAP Financial Measures” section for additional information. |
Total net revenue.Total net revenue for the three months ended March 31, 2010 was $93.4 million, an increase of $14.4 million, or 18.3%, from total net revenue of $79.0 million for the three months ended March 31, 2009. The increase in total net revenue was comprised of an $11.7 million increase in Revenue Cycle Management revenue and an increase of $2.7 million in Spend Management revenue.
Revenue Cycle Management net revenue.Revenue Cycle Management net revenue for the three months ended March 31, 2010 was $58.7 million, an increase of $11.7 million, or 24.8%, from net revenue of $47.0 million for the three months ended March 31, 2009. The increase was primarily attributable to a $10.1 million increase in revenue from our comprehensive revenue cycle service engagements including certain performance fees earned; a $0.8 million increase in revenue from our claims and denial management tools; and a $0.5 million increase in our charge integrity consulting services.
Spend Management net revenue.Spend Management net revenue for the three months ended March 31, 2010 was $34.7 million, an increase of $2.7 million, or 8.6%, from net revenue of $32.0 million for the three months ended March 31, 2009. The increase was primarily the result of a $2.1 million, or 5.1% increase, in gross administrative fees and a $1.6 million, or 36.9% increase, in other service fees. This was partially offset by a $1.0 million increase in revenue share obligation; as discussed further below:
| • | | Gross administrative fees.Non-GAAP gross administrative fee revenue increased by $2.1 million, or 5.1%, as compared to the prior period, primarily due to higher purchasing volumes by new and existing customers under our group purchasing organization (or “GPO”) contracts with our manufacturer and distributor vendors. This net increase in non-GAAP gross administrative fee revenue was comprised of a $2.4 million, or 6.0% increase, in non-GAAP gross administrative fee revenue not associated with performance targets. This increase was partially offset by an approximate $0.3 million increase in the deferral of contingent revenue, which will be recognized upon confirmation from certain customers that respective performance targets were achieved, during the three months ended March 31, 2010 compared to the three months ended March 31, 2009. We may have fluctuations in our non-GAAP gross administrative fee revenue in future periods as the timing of vendor reporting and customer acknowledgement of achieved performance targets vary in their timing and may not result in discernible trends. |
| • | | Revenue share obligation.Non-GAAP revenue share obligation increased $1.0 million, or 7.4%, as compared to the prior period. We analyze the impact of our non-GAAP revenue share obligation on our results of operations by calculating the ratio of non-GAAP revenue share obligation to non-GAAP gross administrative fees (or the “revenue share ratio”). Our revenue share ratio was 33.6% and 32.8% for the three months ended March 31, 2010 and 2009, respectively. Excluding the impact of contingent revenue mentioned above and the related revenue share obligation, our revenue share ratio remained consistent at 31.9% and 31.7% for the three months ended March 31, 2010 and 2009, respectively. We have not had any significant changes in our customer revenue mix during the year that would cause a notable impact on our revenue share ratio. We may experience fluctuations in our revenue share ratio because of the timing of vendor reporting and the timing of revenue recognition based on performance target achievement for certain customers. |
| • | | Other service fees.The $1.6 million, or 36.9%, increase in other service fees primarily related to higher revenues from medical device consulting and strategic sourcing services. The growth in supply chain consulting was mainly due to an increased number of engagements from new and existing customers. |
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Total Operating Expenses
| | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended March 31, | |
| | 2010 | | | 2009 | | | Change | |
| | | | | | % of | | | | | | | % of | | | | | | | |
| | Amount | | | Revenue | | | Amount | | | Revenue | | | Amount | | | % | |
| | (Unaudited, in thousands) | |
Operating expenses: | | | | | | | | | | | | | | | | | | | | | | | | |
Cost of revenue | | $ | 21,722 | | | | 23.3 | % | | $ | 16,745 | | | | 21.2 | % | | $ | 4,977 | | | | 29.7 | % |
Product development expenses | | | 5,370 | | | | 5.7 | | | | 6,018 | | | | 7.6 | | | | (648 | ) | | | (10.8 | ) |
Selling and marketing expenses | | | 10,668 | | | | 11.4 | | | | 10,896 | | | | 13.8 | | | | (228 | ) | | | (2.1 | ) |
General and administrative expenses | | | 32,151 | | | | 34.4 | | | | 27,451 | | | | 34.8 | | | | 4,700 | | | | 17.1 | |
Depreciation | | | 4,293 | | | | 4.6 | | | | 2,910 | | | | 3.7 | | | | 1,383 | | | | 47.5 | |
Amortization of intangibles | | | 6,084 | | | | 6.5 | | | | 7,011 | | | | 8.9 | | | | (927 | ) | | | (13.2 | ) |
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Total operating expenses | | | 80,288 | | | | 86.0 | | | | 71,031 | | | | 89.9 | | | | 9,257 | | | | 13.0 | |
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Operating expenses by segment: | | | | | | | | | | | | | | | | | | | | | | | | |
Revenue Cycle Management | | | 51,588 | | | | 55.2 | | | | 45,523 | | | | 57.6 | | | | 6,065 | | | | 13.3 | |
Spend Management | | | 19,600 | | | | 21.0 | | | | 18,201 | | | | 23.0 | | | | 1,399 | | | | 7.7 | |
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Total segment operating expenses | | | 71,188 | | | | 76.2 | | | | 63,724 | | | | 80.7 | | | | 7,464 | | | | 11.7 | |
Corporate expenses | | | 9,100 | | | | 9.7 | | | | 7,307 | | | | 9.3 | | | | 1,793 | | | | 24.5 | |
| | | | | | | | | | | | | | | | | | |
Total operating expenses | | $ | 80,288 | | | | 86.0 | % | | $ | 71,031 | | | | 89.9 | % | | $ | 9,257 | | | | 13.0 | % |
Cost of revenue.Cost of revenue for the three months ended March 31, 2010 was $21.7 million, or 23.3% of total net revenue, an increase of $5.0 million, or 29.7%, from cost of revenue of $16.7 million, or 21.2% of total net revenue, for the three months ended March 31, 2009.
The increase was primarily attributable to: (i) the continuing change in our revenue mix toward the Revenue Cycle Management segment, which provided a higher percentage of consolidated net revenue compared to the prior year increasing from 59.5% to 62.8%; and (ii) an increase in service-related engagements in both our Revenue Cycle Management and Spend Management segments, which provides for a higher cost of revenue given these activities are more labor intensive.
Revenue Cycle Management SaaS-based revenue results in a higher cost of revenue than net administrative fee revenue included in our Spend Management revenue. We may experience higher cost of revenue if: (i) the revenue mix continues to shift towards Revenue Cycle Management segment products and services and specifically if the revenue mix within the Revenue Cycle Management segment shifts towards more service-related engagements; and (ii) we experience continued growth for our consulting services within the Spend Management segment.
Product development expenses.Product development expenses for the three months ended March 31, 2010 were $5.4 million, or 5.7% of total net revenue, a decrease of $0.6 million, or 10.8%, from product development expenses of $6.0 million, or 7.6% of total net revenue, for the three months ended March 31, 2009.
The decrease during the three months ended March 31, 2010 was primarily attributable to an increase in software development costs that were capitalized in connection with new product development and enhancements to existing products during the period. We have continued our focus on development designed to integrate, enhance and standardize our products. We will also continue to develop a number of new Revenue Cycle Management products and services and enhance our existing products in both segments and expect to maintain or increase our product development spending for the rest of 2010.
Selling and marketing expenses.Selling and marketing expenses for the three months ended March 31, 2010 were $10.7 million, or 11.4% of total net revenue, a decrease of $0.2 million, or 2.1%, from selling and marketing expenses of $10.9 million, or 13.8% of total net revenue, for the three months ended March 31, 2009. The decrease was primarily attributable to lower share-based compensation expense. The decrease in share-based compensation expense resulted from the use of the accelerated method of expense attribution used
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for our service-based equity awards that are subject to graded vesting, which comprises a majority of our total equity awards. This method results in a continual decrease in annual share-based compensation expense over the requisite service period of each grant. We expect the utilization of this expense attribution method for our service-based equity awards to impact share-based compensation in future periods in a favorable or unfavorable manner.
General and administrative expenses.General and administrative expenses for the three months ended March 31, 2010 were $32.2 million, or 34.4% of total net revenue, an increase of $4.7 million, or 17.1%, from general and administrative expenses of $27.5 million, or 34.8% of total net revenue, for the three months ended March 31, 2009.
The increase during the three months ended March 31, 2010 was primarily attributable to a $6.8 million increase in compensation expense to new employees and a $0.4 million increase to other operating infrastructure expense. The increase was partially offset by a $1.1 million decrease in bad debt expense due to significantly lower uncollectable accounts compared to the prior year; a $1.0 million decrease in legal expenses due to lower activity than in the prior year; and a $0.4 million decrease in share-based compensation (as described within “Selling and marketing expenses”).
Depreciation.Depreciation expense for the three months ended March 31, 2010 was $4.3 million, or 4.6% of total net revenue, an increase of $1.4 million, or 47.5%, from depreciation of $2.9 million, or 3.7% of total net revenue, for the three months ended March 31, 2009. The increase was primarily attributable to depreciation resulting from the additions to property and equipment subsequent to March 31, 2009.
Amortization of intangibles.Amortization of intangibles for the three months ended March 31, 2010 was $6.1 million, or 6.5% of total net revenue, a decrease of $0.9 million, or 13.2%, from amortization of intangibles of $7.0 million, or 8.9% of total net revenue, for the three months ended March 31, 2009. The decrease was primarily attributable to the amortization of certain identified intangible assets that are nearing the end of their useful life under an accelerated method of amortization.
Segment Operating Expenses
Revenue Cycle Management expenses.Revenue Cycle Management operating expenses for the three months ended March 31, 2010 were $51.6 million, or 55.2% of total net revenue, an increase of $6.1 million, or 13.3%, from $45.5 million, or 57.6% of total net revenue, for the three months ended March 31, 2009.
Revenue Cycle Management operating expenses increased as a result of a $5.8 million increase in compensation expense primarily to new operational service-based employees for their indirect project time incurred; a $3.8 million increase in cost of revenue in connection with direct labor costs associated with revenue growth; and a $1.0 million increase in depreciation expense. The increase was partially offset by a $1.2 million decrease in bad debt expense due to significantly lower uncollectable accounts compared to the prior year; a $0.9 million decrease in legal expenses due to lower activity than in the prior year; a $0.8 million decrease in share-based compensation (for the reason described within “Selling and marketing expenses”); a $0.6 million decrease in amortization of intangibles; and a $1.0 million decrease in our operating infrastructure expense.
As a percentage of Revenue Cycle Management segment net revenue, segment expenses decreased to 87.9% from 96.8% for the three months ended March 31, 2010 and 2009, respectively, primarily related to the net revenue increase during the period.
Spend Management expenses.Spend Management operating expenses for the three months ended March 31, 2010 were $19.6 million, or 21.0% of total net revenue, an increase of $1.4 million, or 7.7%, from $18.2 million, or 23.0% of total net revenue for the three months ended March 31, 2009. The increase in Spend Management expenses was primarily attributable to a $1.4 million increase in cost of revenues associated with new customers and the revenue shift mix in the segment towards supply chain consulting services.
As a percentage of Spend Management segment net revenue, segment expenses remained consistent decreasing to 56.4% from 56.9% for the three months ended March 31, 2010 and 2009, respectively.
Corporate expenses.Corporate expenses for the three months ended March 31, 2010 were $9.1 million, an increase of $1.8 million, or 24.5%, from $7.3 million for the three months ended March 31, 2009, or 9.7% and 9.3% of total net revenue, respectively. The increase in corporate expenses was primarily attributable to a $0.9 million increase in other operating infrastructure expense; $0.5 million increase in compensation expense to new employees; and a $0.4 million increase in depreciation expense.
Non-operating Expenses
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Interest expense.Interest expense for the three months ended March 31, 2010 was $3.9 million, a decrease of $1.1 million, or 21.2%, from interest expense of $5.0 million for the three months ended March 31, 2009. As of March 31, 2010, we had total indebtedness of $203.3 million compared to $240.2 million as of March 31, 2009. The decrease in interest expense is attributable to the decrease in our indebtedness and lower interest rates period over period. Our interest expense may vary for the remainder of 2010 as a result of fluctuations in interest rates.
Other income.Other income for the three months ended March 31, 2010 was $0.1 million, comprised principally of rental income. Other income for the three months ended March 31, 2009 was $0.2 million also principally comprised of rental income.
Income tax expense. Income tax expense for the three months ended March 31, 2010 was $3.7 million, an increase of $2.5 million from an income tax expense of $1.3 million for the three months ended March 31, 2009. The increase was primarily attributable to higher income before taxes in the three months ended March 31, 2010 as compared to the prior period. The income tax expense recorded during the three months ended March 31, 2010 and 2009 reflected an effective tax rate of 40.3% and 40.0%, respectively. Our estimated annual effective tax rate was higher than expected primarily attributable to the expiration of the credit for research and development expenditures. Although legislation extending this credit was originally expected to pass prior to the three months ended March 31, 2010, Congress has not yet reenacted this tax provision. If the legislation extending this credit is passed during the year ending December 31, 2010, retrospectively, our estimated annual effective tax rate will be impacted favorably.
Critical Accounting Policies
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenue and expenses during the reporting period. We base our estimates and judgments on historical experience and other assumptions that we find reasonable under the circumstances. Actual results may differ materially from such estimates under different conditions.
Management considers an accounting policy to be critical if the accounting policy requires management to make particularly difficult, subjective or complex judgments about matters that are inherently uncertain. A summary of our critical accounting policies is included in Item 7 (Management’s Discussion and Analysis of Financial Condition and Results of Operations) of Part II, of our Annual Report on Form 10-K for the fiscal year ended December 31, 2009. There have been no material changes to the critical accounting policies disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2009, except as discussed below.
Allowance for Doubtful Accounts
In evaluating the collectibility of our accounts receivable, we assess a number of factors, including a specific client’s ability to meet its financial obligations to us, such as whether a customer declares bankruptcy. Other factors include the length of time the receivables are past due and historical collection experience. Based on these assessments, we record a reserve for specific account balances as well as a general reserve based on our historical experience for bad debt to reduce the related receivables to the amount we expect to collect from clients. If circumstances related to specific clients change, or economic conditions deteriorate such that our past collection experience is no longer relevant, our estimate of the recoverability of our accounts receivable could be further reduced from the levels provided for in the Condensed Consolidated Financial Statements. If actual results are not consistent with our estimates or assumptions, we may experience a higher or lower expense.
We have not made any material changes in the accounting methodology used to estimate the allowance for doubtful accounts. If actual results are not consistent with our estimates or assumptions, we may experience a higher or lower expense.
Our bad debt expense to total net revenue ratio for the three months ended March 31, 2010 and 2009 was 0.4% and 1.6% (or 0.6% and 2.5% of other service fee revenue), respectively. The decrease was attributable to the decline in potentially uncollectible accounts and bankruptcies that occurred during the prior period with respect to customers in our Revenue Cycle Management segment. However, as our revenue mix continues to shift more towards our Revenue Cycle Management segment, we may experience a higher bad debt expense to total revenue ratio percentage based on our historical collections experience with our hospital customers.
Given the lingering effect of the weakened economy and customer financial constraints, we may experience collectibility challenges that affect our ability to collect customer payments in future periods. This could require additional charges to bad debt expense.
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Liquidity and Capital Resources
Our primary cash requirements involve payment of ordinary expenses, working capital fluctuations, debt service obligations and capital expenditures. Our capital expenditures typically consist of software purchases, internal product development capitalization and computer hardware purchases. Historically, the acquisition of complementary businesses has resulted in a significant use of cash. Our principal sources of funds have primarily been cash provided by operating activities and borrowings under our credit facilities.
We believe we currently have adequate cash flow from operations, capital resources and liquidity to meet our cash flow requirements including the following near term obligations: (i) our working capital needs; (ii) our debt service obligations; (iii) planned capital expenditures for the remainder of the year; (iv) our revenue share obligation and rebate payments; and (v) estimated federal and state income tax payments.
Historically, we have utilized federal net operating loss carryforwards (“NOLs”) for both regular and Alternative Minimum Tax payment purposes. Consequently, our federal cash tax payments in past reporting periods have been minimal. However, given the limited remaining balance of our NOLs, we expect to become a full cash taxpayer in 2010.
We have not historically utilized borrowings available under our credit agreement to fund operations. However, pursuant to the change in our cash management practice in 2008, we currently use the swing-line component of our revolving credit facility for funding operations while we voluntarily apply our excess cash balances to reduce our swing-line loan on a daily basis and to reduce our revolving credit facility on a routine basis. In addition, we may periodically make voluntary repayments on our term loan. In April 2010, we made a $10.0 million voluntary repayment on our term loan.
As of March 31, 2010, we had zero dollars drawn on our revolving credit facility resulting in $124.0 million of availability under our revolving credit facility inclusive of the swing-line (netted for a $1.0 million letter of credit). Based on our analysis as of March 31, 2010, we are in compliance with all applicable covenant requirements of our credit agreement. We may observe fluctuations in cash flows provided by operations from period to period. Certain events may cause us to draw additional amounts under our swing-line or revolving facility and may include the following:
| • | | changes in working capital due to inconsistent timing of cash receipts and payments for major recurring items such as trade accounts payable, revenue share obligation, incentive compensation, changes in deferred revenue, and other various items; |
| • | | unforeseeable events or transactions |
We may continue to pursue acquisitions or investments in the future. We may also increase our capital expenditures consistent with our anticipated growth in infrastructure, software solutions, and personnel, and as we expand our market presence. Cash provided by operating activities may not be sufficient to fund such expenditures. Accordingly, in addition to the use of our available revolving credit facility, we may need to engage in additional equity or debt financings to secure additional funds for such purposes. Any debt financing obtained by us in the future could involve restrictive covenants relating to our capital raising activities and other financial and operational matters including higher interest costs, which may make it more difficult for us to obtain additional capital and to pursue business opportunities, including potential acquisitions. In addition, we may not be able to obtain additional financing on terms favorable to us, if at all. If we are unable to obtain required financing on terms satisfactory to us, our ability to continue to support our business growth and to respond to business challenges could be limited.
Discussion of Cash Flow
Cash and cash equivalents at March 31, 2010 were $5.0 million representing a $0.5 million decrease from December 31, 2009.
Operating Activities.
The following table summarizes the cash provided by operating activities for the three months ended March 31, 2010 and 2009:
| | | | | | | | | | | | | | | | |
| | Three Months Ended March 31, | |
| | 2010 | | | 2009 | | | Change | |
| | Amount | | | Amount | | | Amount | | | % | |
| | (In millions) | |
Net income | | $ | 5.5 | | | $ | 1.9 | | | $ | 3.6 | | | | 189.5 | % |
Non-cash items | | | 15.1 | | | | 16.5 | | | | (1.4 | ) | | | (8.5 | ) |
Net changes in working capital | | | (3.5 | ) | | | (14.2 | ) | | | 10.7 | | | | (75.4 | ) |
| | | | | | | | | | | | |
Net cash provided by operations | | $ | 17.1 | | | $ | 4.2 | | | $ | 12.9 | | | | 307.1 | % |
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Net income represents the profitability attained during the periods presented and is inclusive of certain non-cash expenses. These non-cash expenses include depreciation for fixed assets, amortization of intangible assets, stock compensation expense, bad debt expense, deferred income tax expense, excess tax benefit from the exercise of stock options, loss on sale of assets and non-cash interest expense. The total for these non-cash expenses was $15.1 million and $16.5 million for the three months ended March 31, 2010 and 2009, respectively.
Working capital is a measure of our liquid assets. Changes in working capital are included in the determination of cash provided by operating activities. For the three months ended March 31, 2010, working capital changes resulting in a reduction to cash flow from operations of $3.5 million were:
Reduction of cash flow
| • | | an increase in prepaid expenses and other assets of $6.8 million primarily related to sales incentive compensation payments and payroll cycle timing; |
| • | | an increase in accounts receivable of $3.1 million primarily related to unbilled revenues and the timing of our customer cash collections; |
| • | | an increase in other long term assets of $1.2 million primarily related to the timing of cash payments for our deferred sales expenses; and |
| • | | a decrease in accrued revenue share obligation and rebates of $4.9 million due to the timing of cash payments and customer purchasing volume at our GPO. |
The working capital changes resulting in reductions to the 2010 operating cash flow discussed above were partially offset by the following increases to cash flow:
Increase to cash flow
| • | | a $6.6 million increase in deferred revenue for cash receipts not yet recognized as revenue; |
| • | | a $2.3 million increase in other accrued expenses due to the timing of various payment obligations; |
| • | | a $2.2 million increase in accrued payroll and benefits due to payroll cycle timing; and |
| • | | a $1.4 million working capital increase in trade accounts payable due to the timing of various payment obligations. |
For the three months ended March 31, 2009, working capital changes resulting in a reduction to cash flow from operations of $14.2 million primarily consisted of the following:
Reduction of cash flow
| • | | an increase in accounts receivable of $3.9 million related to the timing of invoicing and cash collections and our revenue growth; |
| • | | an increase in prepaid expenses and other assets of $3.4 million primarily related to sales incentive compensation payments; |
| • | | an increase in other long term assets of $1.3 million related to the timing of cash payments for our deferred sales expenses; |
| • | | a decrease in accrued payroll and benefits of $5.3 million due to bonus payment timing; and |
| • | | a decrease in accrued revenue share obligation and rebates of $4.9 million due to the timing of cash payments and customer purchasing volume at our GPO. |
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The working capital changes resulting in reductions to the 2009 operating cash flow discussed above were partially offset by the following increases to cash flow:
Increase to cash flow
| • | | a $2.1 million working capital increase in trade accounts payable due to the timing of various payment obligations; and |
| • | | a $1.9 million increase in other accrued expenses due to the timing of various payment obligations. |
Investing Activities.
Investing activities used $8.3 million of cash for the three months ended March 31, 2010 which included: $4.5 million of capital expenditures that were primarily related to the growth in our RCM segment and $3.8 million for investment in software development.
Investing activities used $6.6 million of cash for the three months ended March 31, 2009 which included: $3.4 million of capital expenditures that were primarily related to the infrastructure growth in our RCM segment; and $3.2 million for investment in software development.
We believe that cash used in investing activities will continue to be materially impacted by continued growth in investments in property and equipment, future acquisitions and capitalized software. Our property, equipment, and software investments consist primarily of SaaS-based technology infrastructure to provide capacity for expansion of our customer base, including computers and related equipment and software purchased or implemented by outside parties. Our software development investments consist primarily of company-managed design, development, testing and deployment of new application functionality.
Financing Activities.
Financing activities used $9.3 million of cash for the three months ended March 31, 2010. We received $1.9 million from the issuance of common stock and $0.8 million from the excess tax benefit from the exercise of stock options. This was offset by payments made on our credit facility of $11.9 million (comprised of our 2009 excess cash flow payment of $11.3 million and a $0.6 million mandatory quarterly principal payment) in addition to payments of $0.2 million that were made on our finance obligation. Our credit agreement requires an annual payment of excess cash flow which we expect to pay in the first quarter of 2011 provided our consolidated leverage ratio is more than 1.5 to 1.0.
Financing activities used $3.0 million of cash for the three months ended March 31, 2009. We borrowed $30.0 million on our credit facility during the period. We also received $1.5 million from the issuance of common stock and $1.1 million from the excess tax benefit from the exercise of stock options. This was offset by payments made on our credit facility of $35.4 million and $0.2 million that were made on our finance obligation.
Off-Balance Sheet Arrangements and Commitments
We have provided a $1.0 million letter of credit to guarantee our performance under the terms of a ten-year lease agreement. The letter of credit is associated with the capital lease of a building located in Cape Girardeau, Missouri under a finance obligation. We do not believe that this letter of credit will be drawn.
We lease office space and equipment under operating leases. Some of these operating leases include rent escalations, rent holidays, and rent concessions and incentives. However, we recognize lease expense on a straight-line basis over the minimum lease term utilizing total future minimum lease payments. Our consolidated future minimum rental payments under our operating leases with initial or remaining non-cancelable lease terms of at least one year are as follows as of March 31, 2010 for each respective year (in thousands):
| | | | |
| | Amount | |
| | (Unaudited) | |
2010 | | $ | 6,496 | |
2011 | | | 7,516 | |
2012 | | | 7,605 | |
2013 | | | 7,294 | |
2014 | | | 6,616 | |
Thereafter | | | 20,040 | |
| | | |
Total future minimum rental payments | | $ | 55,567 | |
| | | |
In March 2010, we amended the lease for our office in Mahwah, New Jersey acquiring 6,000 square feet of additional office space and extended the original term of the existing lease for an additional 39 months, which will now expire on September 30, 2013. The total incremental rental commitment under the lease is approximately $1.1 million and is included in the table above.
In April 2010, we amended the lease for our office in Alpharetta, Georgia acquiring approximately 9,400 square feet of additional office space. The total additional rental commitment under the lease is approximately $0.9 million.
In April 2010, we entered into a new lease acquiring approximately 6,100 square feet for our office in Plano, Texas. The term of the lease is for approximately 79 months commencing on May 1, 2010 and terminating on November 30, 2016. The total additional rental commitment under the lease is approximately $1.0 million.
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Other than the additional lease commitments above, we did not have any other off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Use of Non-GAAP Financial Measures
In order to provide investors with greater insight, promote transparency and allow for a more comprehensive understanding of the information used by management and the Board in its financial and operational decision-making, we supplement our Condensed Consolidated Financial Statements presented on a GAAP basis in this Quarterly Report on Form 10-Q with the following non-GAAP financial measures: gross fees, gross administrative fees, revenue share obligation, EBITDA, Adjusted EBITDA, Adjusted EBITDA margin and cash diluted earnings per share.
These non-GAAP financial measures have limitations as analytical tools and should not be considered in isolation or as a substitute for analysis of our results as reported under GAAP. We compensate for such limitations by relying primarily on our GAAP results and using non-GAAP financial measures only supplementally. We provide reconciliations of non-GAAP measures to their most directly comparable GAAP measures, where possible. Investors are encouraged to carefully review those reconciliations. In addition, because these non-GAAP measures are not measures of financial performance under GAAP and are susceptible to varying calculations, these measures, as defined by us, may differ from and may not be comparable to similarly titled measures used by other companies.
Gross Fees, Gross Administrative Fees and Revenue Share Obligation.Gross fees include all gross administrative fees we receive pursuant to our vendor contracts and all other fees we receive from customers. Our revenue share obligation represents the portion of the gross administrative fees we are contractually obligated to share with certain of our GPO customers. Total net revenue (a GAAP measure) reflects our gross fees net of our revenue share obligation. These non-GAAP measures assist management and the Board and may be helpful to investors in analyzing our growth in the Spend Management segment given that administrative fees constitute a material portion of our revenue and are paid to us by over 1,150 vendors contracted by our GPO, and that our revenue share obligation constitutes a significant outlay to certain of our GPO customers. A reconciliation of these non-GAAP measures to their most directly comparable GAAP measure can be found in the “Overview” and “Results of Operations” section of Item 2.
EBITDA, Adjusted EBITDA and Adjusted EBITDA margin.We define: (i) EBITDA, as net income (loss) before net interest expense, income tax expense (benefit), depreciation and amortization; (ii) Adjusted EBITDA, as net income (loss) before net interest expense, income tax expense (benefit), depreciation and amortization and other non-recurring, non-cash or non-operating items; and (iii) Adjusted EBITDA margin, as Adjusted EBITDA as a percentage of net revenue. We use EBITDA, Adjusted EBITDA and Adjusted EBITDA margin to facilitate a comparison of our operating performance on a consistent basis from period to period and provide for a more complete understanding of factors and trends affecting our business than GAAP measures alone. These measures assist management and the Board and may be useful to investors in comparing our operating performance consistently over time as it removes the impact of our capital structure (primarily interest charges and amortization of debt issuance costs), asset base (primarily depreciation and amortization) and items outside the control of the management team (taxes), as well as other non-cash (purchase accounting adjustments, and imputed rental income) and non-recurring items, from our operational results. Adjusted EBITDA also removes the impact of non-cash share-based compensation expense.
Our Board and management also use these measures as (i) one of the primary methods for planning and forecasting overall expectations and for evaluating, on at least a quarterly and annual basis, actual results against such expectations; and, (ii) as a performance evaluation metric in determining achievement of certain executive incentive compensation programs, as well as for incentive compensation plans for employees generally.
Additionally, research analysts, investment bankers and lenders may use these measures to assess our operating performance. For example, our credit agreement requires delivery of compliance reports certifying compliance with financial covenants certain of which are, in part, based on an adjusted EBITDA measurement that is similar to the Adjusted EBITDA measurement reviewed by our management and our Board. The principal difference is that the measurement of adjusted EBITDA considered by our lenders under our credit agreement allows for certain adjustments (e.g., inclusion of interest income, franchise taxes and other non-cash expenses, offset by the deduction of our capitalized lease payments for one of our office leases) that result in a higher adjusted EBITDA than the Adjusted EBITDA measure reviewed by our Board and management and disclosed in our Annual Report on Form 10-K. Additionally, our credit agreement contains provisions that utilize other measures, such as excess cash flow, to measure liquidity.
EBITDA, Adjusted EBITDA and Adjusted EBITDA margin are not measures of liquidity under GAAP, or otherwise, and are not alternatives to cash flow from continuing operating activities. Despite the advantages regarding the use and analysis of these measures as
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mentioned above, EBITDA, Adjusted EBITDA and Adjusted EBITDA margin, as disclosed in this Quarterly Report on Form 10-Q, have limitations as analytical tools, and you should not consider these measures in isolation, or as a substitute for analysis of our results as reported under GAAP; nor are these measures intended to be measures of liquidity or free cash flow for our discretionary use. Some of the limitations of EBITDA are:
| • | | EBITDA does not reflect our cash expenditures or future requirements for capital expenditures or contractual commitments; |
| • | | EBITDA does not reflect changes in, or cash requirements for, our working capital needs; |
| • | | EBITDA does not reflect the interest expense, or the cash requirements to service interest or principal payments under our credit agreement; |
| • | | EBITDA does not reflect income tax payments we are required to make; and |
| • | | Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized often will have to be replaced in the future, and EBITDA does not reflect any cash requirements for such replacements. |
Adjusted EBITDA has all the inherent limitations of EBITDA. To properly and prudently evaluate our business, we encourage you to review the GAAP financial statements included elsewhere in this Quarterly Report on Form 10-Q, and not rely on any single financial measure to evaluate our business. We also strongly urge you to review the reconciliation of net income to Adjusted EBITDA in this section, along with our Condensed Consolidated Financial Statements included elsewhere in this Quarterly Report on Form 10-Q.
The following table sets forth a reconciliation of EBITDA and Adjusted EBITDA to net income, a comparable GAAP-based measure. All of the items included in the reconciliation from net income to EBITDA to Adjusted EBITDA are either (i) non-cash items (e.g., depreciation and amortization, impairment of intangibles and share-based compensation expense) or (ii) items that management does not consider in assessing our on-going operating performance (e.g., income taxes and interest expense). In the case of the non-cash items, management believes that investors may find it useful to assess our comparative operating performance because the measures without such items are less susceptible to variances in actual performance resulting from depreciation, amortization and other non-cash charges and more reflective of other factors that affect operating performance. In the case of the other non-recurring items, management believes that investors may find it useful to assess our operating performance if the measures are presented without these items because their financial impact does not reflect ongoing operating performance.
The following table reconciles net income to Adjusted EBITDA for the three months ended March 31, 2010 and 2009:
| | | | | | | | |
| | Three Months Ended March 31, | |
| | 2010 | | | 2009 | |
| | (Unaudited, in thousands) | |
Net income | | $ | 5,520 | | | $ | 1,905 | |
Depreciation | | | 4,293 | | | | 2,910 | |
Depreciation (included in cost of revenue) | | | 722 | | | | 603 | |
Amortization of intangibles, acquisition related | | | 6,084 | | | | 7,011 | |
Amortization of intangibles (included in cost of revenue) | | | 185 | | | | 185 | |
Interest expense, net of interest income(1) | | | 3,913 | | | | 4,981 | |
Income tax expense | | | 3,733 | | | | 1,269 | |
| | | | | | |
EBITDA | | | 24,450 | | | | 18,864 | |
Share-based compensation(2) | | | 3,472 | | | | 4,386 | |
Rental income from capitalizing building lease(3) | | | (110 | ) | | | (110 | ) |
Purchase accounting adjustment(4) | | | — | | | | 189 | |
| | | | | | |
Adjusted EBITDA | | $ | 27,812 | | | $ | 23,329 | |
| | |
(1) | | Interest income is included in other income (expense) and is not netted against interest expense in our Condensed Consolidated Statement of Operations. |
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| | |
(2) | | Represents non-cash share-based compensation to both employees and directors. We believe excluding this non-cash expense allows us to compare our operating performance without regard to the impact of share-based compensation expense, which varies from period to period based on the amount and timing of grants. |
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(3) | | The imputed rental income recognized with respect to a capitalized building lease is deducted from net income (loss) due to its non-cash nature. We believe this income is not a useful measure of continuing operating performance. See our Consolidated Financial Statements filed in our annual report on Form 10-K for the year ended December 31, 2009 for further discussion of this rental income. |
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(4) | | These adjustments include the effect on revenue of adjusting acquired deferred revenue balances, net of any reduction in associated deferred costs, to fair value as of the acquisition date for Accuro. The reduction of the deferred revenue balance materially affects period-to-period financial performance comparability and revenue and earnings growth in future periods subsequent to the acquisition and is not indicative of changes in underlying results of operations. In 2010, these adjustments will no longer be reconciling items related to acquired deferred revenue balances because the amounts were fully amortized in 2009. We may have this adjustment in future periods if we have any new acquisitions. |
Diluted Cash Earnings Per Share
The Company defines diluted cash EPS as diluted earnings per share excluding non-cash acquisition-related intangible amortization, non-recurring expense items on a tax-adjusted basis and non-cash tax-adjusted shared-based compensation expense. Diluted cash EPS is not a measure of liquidity under GAAP, or otherwise, and is not an alternative to cash flow from continuing operating activities. Diluted cash EPS growth is used by the Company as the financial performance metric that determines whether certain equity awards granted pursuant to the Company’s Long-Term Performance Incentive Plan will vest. Use of this measure for this purpose allows management and the Board to analyze the Company’s operating performance on a consistent basis by removing the impact of certain non-cash and non-recurring items from our operations and reward organic growth and accretive business transactions. As a significant portion of senior management’s incentive based compensation is based on the achievement of certain diluted cash EPS growth over time, investors may find such information useful; however, as a non-GAAP financial measure, diluted cash EPS is not the sole measure of the Company’s financial performance and may not be the best measure for investors to gauge such performance.
| | | | | | | | |
| | Three Months Ended | |
| | March 31, | |
Per share data | | 2010 | | | 2009 | |
| | (Unaudited) | |
EPS — diluted | | $ | 0.09 | | | $ | 0.03 | |
Pre-tax non-cash, aquisition-related intangible amortization | | | 0.11 | | | | 0.13 | |
Pre-tax non-cash, share-based compensation(1) | | | 0.06 | | | | 0.08 | |
| | | | | | |
Tax effect on pre-tax adjustments(2) | | | (0.07 | ) | | | (0.08 | ) |
| | | | | | |
Non-GAAP cash EPS — diluted | | $ | 0.19 | | | $ | 0.16 | |
| | | | | | |
Weighted average shares — diluted | | | 58,829 | | | | 56,302 | |
| | |
(1) | | Represents the per share impact, on a tax-adjusted basis of non-cash share-based compensation to both employees and directors. We believe excluding this non-cash expense allows us to compare our operating performance without regard to the impact of share-based compensation expense, which varies from period to period based on the amount and timing of grants. |
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(2) | | This amount reflects the tax impact to the adjustments used to derive Non-GAAP diluted cash EPS. The Company uses its effective tax rate for each respective period to tax effect the adjustments. The effective tax rate for the three months ended March 31, 2010 and 2009 was 40.3% and 40.0%, respectively. |
New Pronouncements
Revenue Recognition
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In October 2009, the Financial Accounting Standards Board (“FASB”) issued an accounting standards update for multiple-deliverable revenue arrangements. The update addressed the accounting for multiple-deliverable arrangements to enable vendors to account for products or services separately rather than as a combined unit. The update also addresses how to separate deliverables and how to measure and allocate arrangement consideration to one or more units of accounting. The amendments in the update significantly expand the disclosures related to a vendor’s multiple-deliverable revenue arrangements with the objective of providing information about the significant judgments made and changes to those judgments and how the application of the relative selling-price method of determining stand-alone value affects the timing or amount of revenue recognition. The accounting standards update will be applicable for annual periods beginning after June 15, 2010, however, early adoption is permitted. We are currently assessing the impact of the adoption of this update on our Condensed Consolidated Financial Statements.
In October 2009, the FASB issued an accounting standards update relating to certain revenue arrangements that include software elements. The update will change the accounting model for revenue arrangements that include both tangible products and software elements. Among other things, tangible products containing software and non-software components that function together to deliver the tangible product’s essential functionality are no longer within the scope of software revenue guidance. In addition, the update also provides guidance on how a vendor should allocate arrangement consideration to deliverables in an arrangement that includes tangible products and software. The accounting standards update will be applicable for annual periods beginning after June 15, 2010, however, early adoption is permitted. The adoption of this update is not expected to have a material impact on our Condensed Consolidated Financial Statements.
In April 2010, the FASB issued new standards for vendors who apply the milestone method of revenue recognition to research and development arrangements. These new standards apply to arrangements with payments that are contingent, at inception, upon achieving substantively uncertain future events or circumstances. The guidance will be applicable for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010. Early adoption is permitted. We are currently assessing the impact of the adoption of this guidance on our Condensed Consolidated Financial Statements as it may impact revenue recognition on certain arrangements.
Subsequent Events
In February 2010, the FASB issued amended guidance on subsequent events. Under this amended guidance, SEC filers are no longer required to disclose the date through which subsequent events have been evaluated in originally issued and revised financial statements. This guidance was effective immediately and the Company adopted these new requirements for the period ended March 31, 2010.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Foreign currency exchange risk.Certain of our contracts are denominated in Canadian dollars. As our Canadian sales have not historically been significant to our operations, we do not believe that changes in the Canadian dollar relative to the U.S. dollar will have a significant impact on our financial condition, results of operations or cash flows. On August 2, 2007, we entered into a series of forward contracts to fix the Canadian dollar-to-U.S. dollar exchange rates on a Canadian customer contract, as discussed in Note 11 to our Condensed Consolidated Financial Statements herein. We have one other Canadian dollar contract that we have not elected to hedge. We currently do not transact any other business in any currency other than the U.S. dollar. As we continue to grow our operations, we may increase the amount of our sales to foreign customers. Although we do not expect foreign currency exchange risk to have a significant impact on our future operations, we will assess the risk on a case-specific basis to determine whether any forward currency hedge instrument would be warranted.
We continue to evaluate the credit worthiness of the counterparty of the hedge instruments. Considering the current state of the credit markets and specific challenges related to financial institutions, the Company continues to believe that the size, international presence and US government cash infusion, and operating history of the counterparty will allow them to perform under the obligations of the contract and are not a risk of default that would change the highly effective status of the hedged instruments.
Interest rate risk.We had outstanding borrowings on our term loan and revolving credit facility of $203.3 million as of March 31, 2010. The term loan and revolving credit facility bear interest at LIBOR plus an applicable margin.
On May 21, 2009, we entered into a London Inter-bank Offered Rate (or “LIBOR”) interest rate swap with a notional amount of $138.3 million beginning June 30, 2010, which effectively converts a portion of our variable rate term loan credit facility to a fixed rate debt. The notional amount subject to the swap has pre-set quarterly step downs corresponding to our anticipated principal reduction schedule.
The interest rate swap converts the three-month LIBOR rate on the corresponding notional amount of debt to an effective fixed rate of 1.99% (exclusive of the applicable bank margin charged by our lender). The interest rate swap terminates on March 31, 2012 and qualifies as a highly effective cash flow hedge under GAAP for derivatives and hedging.
As such, the fair value of the derivative will be recorded on our Consolidated Balance Sheet. The interest rate swap matures on March 31, 2012. As of March 31, 2010, the interest rate swap had a market value of $1.5 million ($0.9 million net of tax). The liability is
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included in other long-term liabilities in the accompanying Condensed Consolidated Balance Sheet as of March 31, 2010. The unrealized loss is recorded in other comprehensive loss, net of tax, in the Condensed Consolidated Statement of Stockholders’ Equity.
We considered the credit worthiness of the counterparty of the hedged instrument. Given the recent events in the credit markets and specific challenges related to financial institutions, the Company continues to believe that the size, international presence and US government cash infusion, and track record of the counterparty will allow them to perform under the obligations of the contract and are not a risk of default that would change the highly effective status of the hedged instruments.
On June 24, 2008 (effective June 30, 2008), we entered into an interest rate collar to hedge our interest rate exposure on a notional $155.0 million of our outstanding term loan credit facility of $203.3 million. The collar sets a maximum interest rate of 6.00% and a minimum interest rate of 2.85% on the 3-month London Inter-bank Offered Rate (or “LIBOR”) applicable to a notional $155.0 million of term loan debt. This collar effectively limits our LIBOR interest exposure on this portion of our term loan debt to within that range (2.85% to 6.00%). The collar also does not hedge the applicable margin payable to our lenders on our indebtedness. Settlement payments are made between the hedge counterparty and us on a quarterly basis, coinciding with our term loan installment payment dates, for any rate overage on the maximum rate and any rate deficiency on the minimum rate on the notional amount outstanding. The collar terminates on June 30, 2010 and no consideration was exchanged with the counterparty to enter into the hedging arrangement. As of March 31, 2010, we pay an effective interest rate of 2.85% on $155.0 million of notional term loan debt outstanding before applying the applicable margin.
The collar is a highly effective cash flow hedge under GAAP relating to derivatives and hedging, as the payment and interest rate terms of the instrument coincide with that of our term loan and the instrument was designed to perfectly hedge our variable cash flow risk. Accordingly as of March 31, 2010, we recorded the fair value of the collar on our balance sheet as a liability of approximately $1.0 million in Other accrued expenses, and the offsetting loss of ($0.6 million net of tax) was recorded in Accumulated other comprehensive loss in our Stockholders’ equity. If we assess any portion of any of this to be ineffective, we will reclassify the ineffective portion to current period earnings or loss accordingly.
We considered the credit worthiness of the counterparty of our hedged instrument. The Company believes that given the size of the hedged instrument and the likelihood that the counterparty would have to perform under the contract (i.e. LIBOR goes above 6.00%) mitigates any potential credit risk and risk of non-performance under the contract.
A hypothetical 100 basis point increase or decrease in LIBOR would have resulted in an approximate $0.1 million change to our interest expense for the three months ended March 31, 2010, which represents potential interest rate change exposure on our outstanding unhedged portion of our term loan and revolving credit facility.
Item 4. Controls and Procedures
Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by us in reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating disclosure controls and procedures, management recognizes that any control and procedure, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship regarding the potential utilization of certain controls and procedures.
As required by Rule 13a-15(b) under the Exchange Act, our management, with the participation of our chief executive officer and chief financial officer, evaluated the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act). Based on such evaluation, our chief executive officer and chief financial officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective and were operating at a reasonable assurance level.
Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financial reporting for the three months ended March 31, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
From time to time, we may become involved in legal proceedings arising in the ordinary course of our business. Other than the Med-Data dispute noted below, we are not presently involved in any other legal proceedings, the outcome of which, if determined adversely to us, would have a material adverse affect on our business, operating results or financial condition.
In August 2007, Jacqueline Hodges, the former owner of Med-Data Management, Inc. (or “Med-Data”) disputed our earn-out calculation made under the Med-Data Asset Purchase Agreement and alleged that we failed to fulfill our obligations with respect to the earn-out. In November 2007, Ms. Hodges filed a complaint in the Federal District Court for the Northern District of Georgia, alleging that we failed to act in good faith with respect to the operation of Med-Data subsequent to the acquisition which affected the earn-out calculation. On March 21, 2008, we filed an answer denying the plaintiffs’ allegations and also filed a counterclaim alleging that the plaintiffs fraudulently induced us to enter into the purchase agreement by intentionally concealing the status of their relationship with their largest customer. On March 31, 2010, the Court entered summary judgment in favor of the Company and dismissed Ms. Hodges’ claims. Though Ms. Hodges filed a motion for summary judgment as well to dismiss the Company’s counterclaim, the Court denied this motion, and the Company is free to proceed to trial on its claims. The Company is in the process of negotiating a settlement of its counterclaim filed in this lawsuit.
Item 1A. Risk Factors
There have been no material changes in the risk factors as disclosed in our annual report on Form 10-K for the fiscal year ended December 31, 2009.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
During the three months ended March 31, 2010, we issued approximately 28,000 unregistered shares of our common stock in connection with stock option exercises related to stock options issued in connection with our acquisition of OSI Systems, Inc. in June 2003. We received approximately $0.1 million in consideration in connection with these stock option exercises.
These issuances of our common stock were deemed to be exempt from registration in reliance on Section 4(2) of the Securities Act, or Regulation D or Rule 701 promulgated thereunder, as transactions by an issuer not involving any public offering.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
Item 5. Other Information
Not applicable.
Item 6. Exhibits
| | |
Exhibit | | |
No. | | Description of Exhibit |
31.1* | | Sarbanes-Oxley Act of 2002, Section 302 Certification for President and Chief Executive Officer |
| | |
31.2* | | Sarbanes-Oxley Act of 2002, Section 302 Certification for Chief Financial Officer |
| | |
32.1* | | Sarbanes-Oxley Act of 2002, Section 906 Certification for President and Chief Executive Officer and Chief Financial Officer |
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Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | | | |
Signature | | Title | | Date |
| | | | |
/s/ JOHN A. BARDIS Name: John A. Bardis | | Chairman of the Board of Directors and Chief Executive Officer (Principal Executive Officer) | | May 7, 2010 |
| | | | |
/s/ L. NEIL HUNN Name: L. Neil Hunn | | Chief Financial Officer (Principal Financial Officer) | | May 7, 2010 |
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EXHIBIT INDEX
| | |
Exhibit | | |
No. | | Description of Exhibit |
31.1* | | Sarbanes-Oxley Act of 2002, Section 302 Certification for President and Chief Executive Officer |
| | |
31.2* | | Sarbanes-Oxley Act of 2002, Section 302 Certification for Chief Financial Officer |
| | |
32.1* | | Sarbanes-Oxley Act of 2002, Section 906 Certification for President and Chief Executive Officer and Chief Financial Officer |
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