Filed Pursuant to Rule 424(b)(3)
Registration No. 333-168159
PROSPECTUS |
Apria Healthcare Group Inc.
Offers to Exchange
$700,000,000 aggregate principal amount of 11.25% Senior Secured Notes due 2014 (Series A-1) (the exchange Series A-1 Notes), which have been registered under the Securities Act of 1933, as amended (the Securities Act), for any and all outstanding 11.25% Senior Secured Notes due 2014 (Series A-1) (the outstanding Series A-1 Notes).
$317,500,000 aggregate principal amount of 12.375% Senior Secured Notes due 2014 (Series A-2) (the exchange Series A-2 Notes and, together with the exchange Series A-1 Notes, the exchange notes), which have been registered under the Securities Act, for any and all outstanding 12.375% Senior Secured Notes due 2014 (Series A-2) (the outstanding Series A-2 Notes and, together with the outstanding Series A-1 Notes, the outstanding notes).
The exchange notes will be fully and unconditionally guaranteed on a senior secured basis by our existing and future wholly-owned domestic subsidiaries that guarantee our existing senior secured asset-based revolving credit facility and the outstanding notes.
We are conducting the exchange offers in order to provide you with an opportunity to exchange your unregistered outstanding notes for freely tradeable exchange notes that have been registered under the Securities Act.
The Exchange Offers:
| We will exchange all outstanding notes that are validly tendered and not validly withdrawn for an equal principal amount of exchange notes that are freely tradeable. |
| You may withdraw tenders of outstanding notes at any time prior to the expiration date of the applicable exchange offer. |
| The exchange offers expire at 5:00 p.m., New York City time, on September 15, 2010 which is the 21st business day after the date of this prospectus. |
| The exchange of outstanding notes for exchange notes in the exchange offers will not be a taxable event for U.S. federal income tax purposes. |
| The terms of the exchange notes to be issued in the exchange offers are substantially identical to the outstanding notes, except that the exchange notes will be freely tradeable. |
Results of the Exchange Offers:
| The exchange notes may be sold in the over-the-counter-market, in negotiated transactions or through a combination of such methods. We do not plan to list the exchange notes on a national market. |
All untendered outstanding notes will continue to be subject to the restrictions on transfer set forth in the outstanding notes and in the indenture. In general, the outstanding notes may not be offered or sold, unless registered under the Securities Act, except pursuant to an exemption from, or in a transaction not subject to, the Securities Act and applicable state securities laws. Other than in connection with the exchange offers, we do not currently anticipate that we will register the outstanding notes under the Securities Act.
You should carefully consider the Risk Factors beginning on page 24 of this prospectus before participating in the exchange offers.
Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of the exchange notes to be distributed in the exchange offers or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.
The date of this prospectus is August 16, 2010.
You should rely only on the information contained in this prospectus. We have not authorized anyone to provide you with different information. This prospectus may be used only for the purposes for which it has been published and no person has been authorized to give any information not contained herein. If you receive any other information, you should not rely on it. We are not making an offer of these securities in any state where the offer is not permitted.
Page | ||
ii | ||
ii | ||
ii | ||
iii | ||
1 | ||
24 | ||
47 | ||
49 | ||
50 | ||
51 | ||
Managements Discussion and Analysis of Financial Condition and Results of Operations |
53 | |
92 | ||
120 | ||
147 | ||
150 | ||
153 | ||
163 | ||
239 | ||
242 | ||
249 | ||
251 | ||
252 | ||
252 | ||
252 | ||
F-1 |
i
This prospectus includes forward-looking statements regarding, among other things, our plans, strategies and prospects, both business and financial. These statements are based on the beliefs and assumptions of our management. Although we believe that our plans, intentions and expectations reflected in or suggested by these forward-looking statements are reasonable, we cannot assure you that we will achieve or realize these plans, intentions or expectations. Forward-looking statements are inherently subject to risks, uncertainties and assumptions. Generally, statements that are not historical facts, including statements concerning our possible or assumed future actions, business strategies, events or results of operations, are forward-looking statements. These statements may be preceded by, followed by or include the words believes, expects, anticipates, intends, plans, estimates or similar expressions.
Forward-looking statements are not guarantees of performance. You should not put undue reliance on these statements. You should understand that the following important factors, in addition to those discussed in Risk Factors and elsewhere in this prospectus, could affect our future results and could cause those results or other outcomes to differ materially from those expressed or implied in our forward-looking statements:
| trends and developments affecting the collectibility of accounts receivable; |
| government legislative and budget developments that could continue to affect reimbursement levels; |
| potential reductions in reimbursement rates by government and third-party payors; |
| the effectiveness of our operating systems and controls; |
| healthcare reform and the effect of federal and state healthcare regulations; |
| economic and political events, international conflicts and natural disasters; |
| our ability to implement our outsourcing and other cost savings initiatives and to realize the projected benefits of these initiatives; |
| acquisition-related risks; and |
| the items discussed under Risk Factors in this prospectus. |
All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the foregoing cautionary statements. We undertake no obligations to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.
Information included in this prospectus about the healthcare industry, including our general expectations concerning this industry, is based on estimates prepared using data from various sources and on assumptions made by us. We believe data regarding this industry are inherently imprecise, but based on our understanding of the market in which we compete, we believe that such data are generally indicative of this industry. Our estimates, in particular as they relate to our general expectations concerning this industry, involve risks and uncertainties and are subject to change based on various factors, including those discussed under the caption Risk Factors. Accordingly, you should not place undue reliance on the market and industry data included in this prospectus.
This prospectus contains some of our trademarks, trade names and service marks. Each one of these trademarks, trade names or service marks is either (i) our registered trademark, (ii) a trademark for which we have a pending application, (iii) a trade name or service mark for which we claim common law rights or (iv) a registered trademark or application for registration which we have been licensed by a third party to use. All other trademarks, trade names or service marks of any other company appearing in this prospectus belong to their respective owners.
ii
As used in this prospectus, unless otherwise noted or the context otherwise requires, references to Company, we, us, and our are to Apria Healthcare Group Inc., a Delaware corporation, and its subsidiaries; references to Apria and the Issuer are to Apria Healthcare Group Inc., exclusive of its subsidiaries; references to Merger Sub are to Sky Merger Sub Corporation, a Delaware corporation; references to Holdings are to Apria Holdings LLC, a Delaware limited liability company, exclusive of its subsidiaries; references to Sky Acquisition are to Sky Acquisition LLC, a Delaware limited liability company, exclusive of its subsidiaries; references to Blackstone and the Sponsor are to Blackstone Capital Partners V L.P.; references to the Investor Group are, collectively, to Blackstone and certain funds affiliated with Blackstone, Dr. Norman C. Payson and certain other members of our management; and references to home medical equipment, durable medical equipment and DME are used synonymously.
The term outstanding notes refers to the outstanding 11.25% Senior Secured Notes due 2014 (Series A-1) and 12.375% Senior Secured Notes due 2014 (Series A-2). The term exchange notes refers to the 11.25% Senior Secured Notes due 2014 (Series A-1) and 12.375% Senior Secured Notes due 2014 (Series A-2), as registered under the Securities Act. The term Series A-1 Notes refers collectively to the outstanding Series A-1 Notes and the exchange Series A-1 Notes; the term Series A-2 Notes refers collectively to the outstanding Series A-2 Notes and the exchange Series A-2 Notes; and the term Notes refers collectively to the outstanding notes and the exchange notes.
We completed the acquisition of Coram, Inc. (Coram) on December 3, 2007. Historical financial information of the Company presented herein includes the results of Coram from the date of the acquisition and does not include the results of Coram prior to the date of the acquisition.
On June 18, 2008, Sky Acquisition and Merger Sub entered into an agreement and plan of merger with Apria (the Merger Agreement). Pursuant to the Merger Agreement, on October 28, 2008, Merger Sub merged with and into Apria, with Apria being the surviving corporation following the merger (the Merger). As a result of the Merger, the Investor Group beneficially owns all of Aprias issued and outstanding capital stock.
The initial borrowings under Aprias senior secured bridge credit agreement dated October 28, 2008 (the senior secured bridge credit agreement) and the credit agreement governing our senior secured asset-based revolving credit facility, dated October 28, 2008 (as amended from time to time, the ABL Facility), the equity investment by the Investor Group and the repayment of all outstanding indebtedness under our senior secured revolving credit facility, dated November 23, 2004, as amended (the 2004 senior secured revolving credit facility), and Aprias credit facility, dated June 18, 2008 (the Interim Facility), are collectively referred to in this prospectus as the Original Financing. The offerings of outstanding notes, the repayment of approximately $1,010.0 million of borrowings under Aprias senior secured bridge credit agreement, plus accrued and unpaid interest, and the payment of related fees and expenses with the proceeds of the offerings of the outstanding notes, together with cash on hand, are collectively referred to in this prospectus as the Refinancing. The Merger, the Original Financing and the Refinancing are collectively referred to in this prospectus as the Transactions. For a more complete description of the Transactions, see The Transactions and Description of Other Indebtedness.
The term Successor refers to the Company following the Merger and the term Predecessor refers to the Company prior to the Merger.
Unless the context otherwise requires, the financial information presented herein is the financial information of Apria on a consolidated basis together with its subsidiaries.
iii
This summary highlights information about us and the exchange offers contained in greater detail elsewhere in this prospectus. This summary is not complete and may not contain all of the information that may be important to you. You should carefully read the entire prospectus, especially the information presented under the headings Risk Factors and Managements Discussion and Analysis of Financial Condition and Results of Operations, before participating in the exchange offers.
Our Company
General
We are a quality, cost-efficient provider of home healthcare products and services in the United States, offering a comprehensive range of home respiratory therapy, home infusion therapy and home medical equipment services to over two million patients annually in all 50 states through approximately 500 locations. We hold market-leading positions across all of our major service linesmaking us a leader in the homecare market. By targeting the managed care segment of the population, we are better positioned than many of our competitors to minimize risks associated with changes in Medicare/Medicaid reimbursement rates. We are focused on being the industrys highest-quality provider of homecare services, while maintaining our commitment to being a low-cost operator. Our integrated product and service offerings, combined with our national scale and strong reputation, provide us with a strategic advantage in attracting clients, which include almost all of the national and regional managed care and government payors in the United States, and in retaining our referral base of more than 70,000 physicians, discharge planners, hospitals and third-party payors. For the year ended December 31, 2009 and for the six months ended June 30, 2010 our net revenues were $2,094.6 million and $1,027.1 million, respectively.
We have two operating segments, (1) home respiratory therapy and home medical equipment and (2) home infusion therapy. Within the two operating segments there are three core service lines: home respiratory therapy, home medical equipment and home infusion therapy. Through these service lines we provide patients with a variety of clinical and administrative support services and related products and supplies, most of which are prescribed by a physician as part of a care plan. We provide substantial benefits to both patients and payors by allowing patients to receive necessary care and services in the comfort of their own home while reducing the cost of treatment. Our services include:
| providing in-home clinical respiratory care, infusion nursing and pharmaceutical management services; |
| educating patients and caregivers about health conditions or illnesses and providing written instructions about home safety, self-care and the proper use of equipment; |
| monitoring patients individualized treatment plans; |
| reporting patient progress and status to the physician and/or managed care organization; |
| providing in-home delivery, set-up and maintenance of equipment and/or supplies; and |
| processing claims to third-party payors and billing/collecting patient co-pays and deductibles. |
Home Respiratory Therapy and Home Medical Equipment ($1,169.6 million and $551.4 million, or 55.8% and 53.7%, of our net revenues for the year ended December 31, 2009 and the six months ended June 30, 2010, respectively)
Home Respiratory Therapy
We are the largest provider of home respiratory therapies in the United States to the managed care market serving approximately 1.5 million patients annually through our nationwide distribution platform that includes
1
approximately 400 locations. We offer a full range of home respiratory therapy products and services, from the simplest nebulizer and oxygen concentrator to the most complex ventilator. Our services offer a compelling relative cost advantage to our patients and payors. For example, in-home oxygen treatment costs for a Medicare patient are on average less than $7 per day. Patients utilize our products to treat a variety of conditions, including:
| chronic obstructive pulmonary diseases (COPD), such as emphysema and chronic bronchitis (the fourth leading cause of death in the U.S.); |
| respiratory conditions associated with nervous system disorders or injuries, such as Lou Gehrigs disease and quadriplegia; |
| congestive heart failure; and |
| lung cancer. |
By focusing our efforts primarily on the managed care population, we limit our exposure to the highly-regulated Medicare respiratory business, which is subject to changes in coverage, payment and pricing guidelines. As an example, Medicare oxygen accounted for less than 10% of our total net revenues for the year ended December 31, 2009 and six months ended June 30, 2010.
We employ a nationwide clinical staff of more than 800 respiratory care professionals, including home respiratory therapists who provide direct patient care, monitoring and 24-hour support services under physician-directed treatment plans and in accordance with our proprietary acuity program. We derive revenues from the provision of oxygen systems, ventilators, respiratory assist devices, and Continuous Positive Airway Pressure (CPAP) and bi-level devices, as well as from the provision of infant apnea monitors, nebulizers, home-delivered respiratory medications and related services.
We are also the largest provider of sleep apnea devices, including CPAP/bi-level devices, and patient support services in the United States. The incidence and diagnosis of Obstructive Sleep Apnea (OSA) continues to increase in the United States. We believe that the strength of our position in this market is partly due to our significant presence in the managed care market, since OSA largely affects adults between the ages of 35 and 55 rather than the population served by Medicare. To manage our significant new and recurring patient volumes in a cost-effective, clinically sound manner, we developed an innovative care model called the CPAP Center at Apria Healthcare. This branch-based model allows Aprias respiratory care practitioners to educate, on a timely and efficient basis, newly-diagnosed patients about their condition, the equipment and accessories their physician has prescribed for them, and the long-term importance of complying with the physicians order. The model includes both one-on-one patient education and teaching performed in group settings, depending on the geographic area of the country and the patients payors contractual preferences.
Home Medical Equipment
As the leading provider of home medical equipment in the United States, we supply a wide range of products to help improve the quality of life for patients with special needs. Our integrated service approach allows patients, hospital and physician referral sources and managed care organizations accessing either our home respiratory or home infusion therapy services to also access needed home medical equipment through a single source. The use of home medical equipment provides a significant relative cost advantage to our patients and payors. For example, on average, it costs $50 per day to create an in-home hospital room versus approximately $1,500 per day for in-patient hospital care, according to the Centers for Medicare and Medicaid Services (CMS). Basic categories of equipment are:
| manual wheelchairs and ambulatory equipment, such as canes, crutches and walkers; |
| hospital room equipment, such as hospital beds and bedside commodes; |
2
| bathroom equipment, such as bath and shower benches, elevated toilet seats and toilet, tub or wall grab bars; |
| phototherapy systems, such as blankets, wraps or treatment beds for babies with jaundice; and |
| support surfaces, such as pressure pads and mattresses, for patients at risk for developing pressure sores or decubitus ulcers. |
In May 2008, we announced a preferred provider agreement with Smith & Nephew plc, a leading provider of negative pressure wound therapy (NPWT), to provide NPWT services and products in the United States. NPWT is a topical treatment intended to promote healing in acute and chronic wounds affected by conditions including diabetes, arterial insufficiency and venous insufficiency.
Home Infusion Therapy ($925.0 million and $475.6 million, or 44.2% and 46.3%, of our net revenues for the year ended December 31, 2009 and six months ended June 30, 2010, respectively)
Through our acquisition of Coram in December 2007, we are the leading provider of home infusion therapy services in the United Statesserving approximately 100,000 patients annually through 72 infusion pharmacy locations nationwide. We provide patients with intravenous and injectable medications and clinical services at home or in one of our 62 ambulatory infusion suites nationwide. We employ nursing clinicians who assess patients before their discharge from the hospital whenever possible, and then develop, in conjunction with the physician, a plan of care. Our home infusion products offer a compelling relative cost advantage to our patients and payors. For example, we believe that a home intravenous antibiotic program in a Medicare managed care plan costs significantly less than the cost to provide that service in a hospital setting.
Home infusion therapy is used to administer drugs and other therapeutic agents directly into the body through various types of catheters or tubing. Our services are frequently used to treat patients with infectious diseases, cancer, gastrointestinal diseases, chronic or acute pain syndromes, immune deficiencies, cardiovascular disease or chronic genetic diseases, and those who require therapies associated with bone marrow or solid organ transplantation. We employ licensed pharmacists and registered nurses who specialize in the delivery of home infusion therapy. They are able to respond to emergencies and questions regarding therapy 24 hours a day, seven days a week and provide initial and ongoing training and education to the patient and caregiver. Other support services include supply replenishment, pump management, preventive maintenance, assistance with insurance questions and outcome reporting.
We believe we are also a leading provider of enteral nutrition in the United States. Enteral nutrition, or tube feeding, is prescribed to patients whose gastrointestinal system is malfunctioning or who suffer from neurological conditions, swallowing disorders or malnutrition attributable to stroke, cancer or other conditions. In recent years, advances in enteral nutrition have enabled more adults and children to have their nutritional and caloric needs met by tube feeding, as opposed to more invasive and expensive therapies.
Recent Developments
Outsourcing Initiatives Review
In August 2010, based on a review of key outsourcing initiatives, we refined our initial decisions concerning certain billing, collections and other administrative functions presently outsourced or designated to be outsourced to third parties. Based on our review, it was determined that certain of such functions should instead be performed by the Company. Accordingly, we expect to transition certain services presently outsourced to third parties back to the Company by March 31, 2011 and to incur the associated one-time costs presently estimated
3
not to exceed $10 million. Further consolidation and outsourcing of billing, collections and other administrative functions will be re-evaluated in 2011. As a result of the adjustments made to our outsourcing strategy, we presently expect that our targeted annual cost savings will be approximately $169 million, instead of $198 million targeted as of March 31, 2010. We continue to explore additional cost savings initiatives which may increase our expected cost savings in the future.
Announcement of Single Payment Amounts (SPAs) and Initiation of Contract Offer Process Related to Round 1 Rebid of the Medicare Durable Medical Equipment, Prosthetics, Orthotics and Supplies (DMEPOS) Competitive Bidding Program
In early July 2010, CMS announced the new SPAs for each of the product categories included in the Round 1 Rebid. CMS then began the contracting process with suppliers by issuing contract offer letters to qualified providers. We received contract offers for a substantial majority of the bids we submitted. We did not receive contract offers for certain product categories in certain competitive bidding areas (CBAs), but the process will not be completed until September 2010. Approximately $21 million of our net revenues for the fiscal year ended December 31, 2009 was generated by the products and CBAs included in the Round 1 Rebid. We estimate that the initial results of the Round 1 Rebid would reduce our net revenues in the fiscal year ending December 31, 2011 by approximately $8 million, assuming the current contract offers and no changes in volume. Assuming that Round 2 would include the same product categories and bidding rules and the markets currently being proposed by CMS, we estimate that approximately $110 million of our net revenues for the fiscal year ending December 31, 2011 would be subject to competitive bidding. Although the bidding process for Round 2 is currently scheduled to commence in 2011, the new Round 2 rates and guidelines are not scheduled to take effect until January 2013. Therefore, we cannot estimate the impact of potential Round 2 rate reductions on our business until more specific information is published by CMS and its contractors.
Enactment of a Comprehensive Healthcare Reform Package
In March 2010, the Federal government enacted a comprehensive healthcare reform package (the Reform Package) which consists of the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010. See Risks Relating to Our BusinessContinued Reductions in Medicare and Medicaid Reimbursement Rates and the Comprehensive Healthcare Reform Package Could Have a Material Adverse Effect on Our Results of Operations and Financial Condition.
Reorganization of the Senior Leadership Structure of our Home Respiratory Therapy and Home Medical Equipment Segment
In February 2010, we finalized a decision to reorganize the senior leadership structure of the home respiratory therapy and home medical equipment segment. As part of this reorganization, Lawrence A. Mastrovich, President, Home Respiratory Therapy and Home Medical Equipment segment, resigned and his responsibilities were assumed by other senior executives.
Industry Overview
The home healthcare market, which is projected to generate revenues of approximately $75 billion in the United States in 2010, comprises a broad range of products and servicesincluding respiratory therapy, home infusion therapy, home medical equipment, home healthcare nursing, orthotics and prosthetics and general medical suppliesand is expected to grow at a compounded annual growth rate of 7.4% from 2008 through 2013 according to CMS. The markets that we servehome respiratory therapy (14% of the home healthcare market), infusion therapy (9%) and home medical equipment (5%)accounted for approximately $15 billion in revenues in 2008 according to the 2008 IBISWorld Industry Report. Our industry is highly-fragmented and is served by approximately 12,000 competitors.
4
We benefit from the following trends within the home healthcare market:
| Favorable industry dynamics. Favorable demographic trends and the continued shift to in-home healthcare have resulted in patient volume growth across our core service lines and are expected to continue to drive growth. As the baby boomer population ages and life expectancy increases, the elderlywho comprise the vast majority of our patientswill represent a higher percentage of the overall population. According to a 2008 U.S. Census Bureau projection, the U.S. population aged 55 and over is expected to grow at approximately twice the average rate of population growth from 76.5 million, or 25% of the population, in 2010 to 112 million, or 30% of the population, by 2030. An aging population, the continued prevalence of smoking, increasing obesity rates and higher diagnosis rates have collectively driven growth across our service lines (including Coram) from 2005 to 2008home respiratory therapy (patient growth of 14%), sleep apnea (patient growth of 21%) and infusion (patient growth of 14%, excluding enteral). |
| Compelling in-home economics. By 2017, the nations healthcare spending is projected to increase to $4.3 trillion, growing at an average annual rate of 6.7%, according to CMS. The rising cost of healthcare has caused many payors to look for ways to contain costs and home healthcare is increasingly sought out as an attractive, cost-effective, clinically appropriate alternative to expensive facility-based care. For example, in-home oxygen treatment costs for a Medicare patient are on average less than $7 per day. |
| Increased prevalence of in-home treatments. Improved technology has resulted in a wider variety of treatments being administered in patients homes. These improvements have allowed for earlier patient discharge and have lengthened the portion of the recuperation period spent outside of an institutional setting. In addition, medical advancements have also made medical equipment more simple, adaptable and cost-effective for use in the home. |
| Preference for in-home care. Many patients prefer the convenience and typical cost advantages of home healthcare over institutional care as it provides patients with greater independence, increased responsibility and improved responsiveness to treatment. A December 2007 national telephone survey conducted by Harris Interactive found that over 82% of the respondents expressed a preference for homecare over institutional care, and that preference is even more prevalent among the age 55+ population (91%). The same poll found that 74% of adults surveyed agreed that homecare is part of the solution to the problem of rapidly increasing Medicare spending for seniors in the United States. |
| Development of new infused and injectable drugs. There is a significant number of new infusion or injectable drugs in the development pipeline. We believe this proliferation of medications, many of which are for chronic conditions that require long-term treatment, will drive further increases in home infusion therapy utilization and referrals to our ambulatory infusion suites. |
Our Competitive Strengths
Leading Market Positions with a Compelling Value Proposition
With approximately 11,400 employees and a national distribution footprint of approximately 500 locations that serve patients in all 50 states, we are the largest provider of home healthcare services in the United States. We are the market leader in infusion therapy and sleep apnea devices, the leading respiratory provider to the managed care market and the leading provider of home medical equipment. We believe that our national platform, comprehensive product line and leading reputation provide us with a greater opportunity than our competitors to attract more customers as our industry continues to grow. Our national presence and scale enables us to frequently obtain preferred provider status from other national and regional managed care payors, negotiate better terms with vendors and leverage our fixed overhead costs. For example, we are a preferred provider for a comprehensive list of home respiratory and medical equipment products and services to many managed care organizations and, for some of these payors, we are the exclusive provider. We believe we are better suited to
5
service large managed care accounts due to our extensive branch network, state of the art logistics systems, national coverage of payors members, competitive pricing, comprehensive product line, accreditation from The Joint Commission and the Accreditation Commission for Health Care (the ACHC and, together with The Joint Commission, the Commissions), and our ability to connect electronically with payors systems. We have leveraged this competitive advantage to gain share in the managed care market.
Our acquisition of Coram in December 2007 has allowed us to further penetrate the specialty infusion market. With a significant number of new infusion drugs in the pipeline and an increasing use of specialty infusion treatments, this market is expected to grow over the next few years. We are well-positioned in specialty infusion services, and have aggressively established relationships with pharmaceutical and biotech companies to obtain early access to drugs in various stages of clinical trials. We believe there are other cross-selling opportunities and synergies to be achieved by offering a diverse mix of services. We also believe that an integrated approach allows us to offer patients, hospital and physician referral sources and managed care organizations a highly-valued single source for respiratory therapy, specialty home infusion and home medical equipment.
Diversified Product and Customer Mix
We have one of the most comprehensive product lines and diversified customer mixes among our peers. Our broad product offering has affirmed our status as a leading provider in each market and has made us a more attractive partner to referral sources and payors, as we provide a one-stop solution for homecare products and services.
We contract with a substantial majority of the national managed care organizationsincluding United HealthCare Services, Aetna Health Management, Humana Health Plans and Kaiser Foundation Health Plan, as well as a large number of regional and local payors. All of our contracted managed care organizations combined service over 217 million people.
The Coram acquisition enabled us to both expand our product offering in specialty infused drugs and rebalance our payor mix by reducing reliance on government payors such as Medicare and Medicaid while expanding relationships with managed care organizations. Managed care payors contributed approximately 71% and 72% of our net revenues for the six months ended June 30, 2010 and June 30, 2009, respectively, with no single contract accounting for more than 8% of net revenues during the same periods.
Proven Ability to Execute Cost Savings
We have successfully implemented a number of operational efficiency initiatives historically, which have helped to reduce our costs and significantly offset ongoing Medicare reimbursement changes. We launched a substantial cost reduction plan in late 2007 across a number of identified initiatives presently targeting approximately $169 million in expected annual savings, of which we have realized approximately $135 million through June 30, 2010.
Scalable and Diversified Platform for Home Healthcare Delivery
We currently provide service to more than two million patients through a national infrastructure that enables us to deliver services to patients in their homes. Through approximately 500 locations, we are able to deliver a wide variety of cost-effective products and services to various patient groups. We have successfully leveraged this distribution platform across a number of product and service offerings including CPAP/bi-level, enteral nutrition and NPWT devices, and we are using our nursing capacity to provide infusion services through our growing network of ambulatory infusion suites.
6
We historically supplied CPAP/bi-level devices to a large number of patients, but provided related accessories and supplies primarily on an as-needed basis. Patients who rely on CPAP and bi-level devices periodically require replacement accessories to ensure that they remain compliant to the therapy prescribed by their physician. These accessories include masks, tubing and supplies. Now in operation for over five years, a centralized customer care center for CPAP and bi-level patients provides support and information to patients so that they know what their payors cover in terms of replacement accessories and understand the health value of remaining compliant to their therapy over the long-term. Accessory net revenues were $155.9 million and $68.8 million and represented 47% and 46% of our total CPAP/bi-level net revenues for the year ended December 31, 2009 and the six months ended June 30, 2010, respectively.
In May 2008, we announced a preferred provider agreement with Smith & Nephew plc to provide NPWT products, thus leveraging our existing branch delivery infrastructure and clinical expertise. Centralized patient intake and coordination of care is provided using the same service and systems platform as is used for the CPAP/bi-level direct marketing service program. Although the program is still in its developing stage, interest has been strong from managed care customers who would like to add the NPWT service to our existing contracts with them.
Experienced Management Team
We have a strong and experienced senior management team with over 200 years of combined experience spanning nearly every segment of the healthcare industry, including managed care, manufacturing, supply chain, procurement, home healthcare, acute care, skilled nursing and long-term care. With an average tenure of 20 years within the healthcare industry, this team possesses in-depth knowledge of our industry and the regulatory environment in which we operate, as well as our portfolio of home healthcare services.
Our Business Strategy
Our strategy is to position ourselves in the marketplace as a high-quality provider of a broad range of healthcare services and patient care management programs to our customers. The specific elements of our strategy are to:
| Grow profitable revenue and market share. We are focused on growing profitable revenues and increasing market share in our core home infusion therapy and home respiratory therapy service lines. We have undertaken a series of steps towards this end. Through our acquisition of Coram in December 2007, we considerably increased our home infusion capabilities and expanded our platform for further cross- selling opportunities. Since January 1, 2007, we have expanded our home respiratory therapy and home medical equipment sales force by 37%. This focus has allowed us to more effectively market our products and services to physicians, hospital discharge planners and managed care organizations. |
| Continue to participate in the managed care market. We participate in the managed care market as a long-term strategic customer group because we believe that our scale, expertise, nationwide presence and array of home healthcare products and services will enable us to sign preferred provider agreements with managed care organizations. Managed care represented approximately 71% of our total net revenues for the six months ended June 30, 2010. |
| Leverage our national distribution infrastructure. With approximately 500 locations and a robust platform supporting shared national services, we believe that we can efficiently add products, services and patients to our systems to grow our revenues and leverage our cost structure. For example, we have successfully leveraged this distribution platform across a number of product and service offerings, including a CPAP/bi-level supply replenishment program, enteral nutrition and NPWT services, and we are using our nursing capacity to provide infusion services through our growing network of ambulatory infusion suites. We seek to achieve margin improvements through operational initiatives focused on the continual reduction of costs |
7
and delivery of incremental efficiencies. At the same time, we believe that it is essential to consistently deliver superior customer service in order to increase referrals and retain existing patients. Performance improvement initiatives are underway in all aspects of our operations including customer service, patient satisfaction, logistics, supply chain, clinical services and billing/collections. We believe that by being responsive to the needs of our patients and payors we can provide ourselves with opportunities to take market share from our competitors. |
| Continue to lead the industry in accreditation. The Medicare Improvement for Patients Act of 2008 (MIPPA) made accreditation mandatory for Medicare providers of DMEPOS effective October 1, 2009, per CMS regulation. We were the first durable medical equipment provider to seek and obtain voluntary accreditation from The Joint Commission. All of our locations are currently accredited by The Joint Commission and our home infusion therapy service line is also accredited by the ACHC. In 2007, we completed a nationwide independent triennial accreditation renewal process conducted by The Joint Commission and we have more than 15 years of continuous accreditation by The Joint Commissionlonger than any other homecare provider. In late June 2010, The Joint Commission completed its most recent triennial survey of our respiratory/home medical equipment and infusion locations and is expected to renew our accreditation for another three years. |
| Execute our strategic initiatives to drive profitability. For the past several years, we have successfully engaged in a range of cost savings initiatives to ease pressure on our revenue that has been and continues to be caused by Medicare and Medicaid reimbursement changes. These initiatives are designed to improve customer service, delivery and vehicle routing services, streamline the billing and payment process, effectively manage purchasing costs and improve the overall experience of the patients we serve. We launched a substantial cost reduction plan in late 2007. To date, we have made significant progress across a number of the identified initiatives presently targeting expected annual savings of approximately $169 million, of which we realized approximately $135 million through June 30, 2010. |
Regulatory Overview
We are subject to extensive government regulation, including numerous laws that regulate reimbursement of products and services under various government programs. There are a number of legislative and regulatory activities in Congress, including the March 2010 passage of the Reform Package, and at the Department of Health and Human Services (HHS) and CMS, the federal government agency responsible for administering the Medicare and Medicaid programs, that affect or may affect government reimbursement policies for our products and services.
Healthcare Reform Package. In March 2010, the Federal government enacted the comprehensive healthcare Reform Package. Among many other provisions, the Reform Package expands the Medicaid program, mandates extensive insurance market reforms, creates new health insurance access points (e.g., insurance exchanges), provides certain insurance subsidies (e.g., premiums and cost sharing), imposes individual and employer health insurance requirements and makes a number of changes to the U.S. Internal Revenue Code of 1986, as amended (the Code).
There are a number of provisions in the Reform Package that may affect us. For example, the Reform Package requires certain pharmaceutical and medical device manufacturers to pay an excise tax to the government, which may, in turn, increase our costs for these products. The Reform Package also provides for cuts in some Medicare payments made to certain providers and to Medicare Part C (Medicare Advantage) plans, through which we contract to provide services to Medicare beneficiaries. Also included in the Reform Package is (i) an expansion of the Recovery Audit Contractor Program, (ii) certain fraud and abuse prevention measures and (iii) expanded regulatory authority concerning the types of conduct that can result in additional
8
fines and penalties for those healthcare providers who do not comply with applicable laws and regulations. Furthermore, the Reform Package grants the Secretary of HHS authority to set a date by which certain providers and suppliers will be required to establish a compliance program.
The Reform Package makes a number of changes to how certain of our products and services will be reimbursed by Medicare. The Reform Package also makes changes to the Medicare durable medical equipment consumer price index adjustment for 2011 and each subsequent year based upon the Consumer Price Index (the CPI) reduced by a new productivity adjustment which may result in negative updates and includes changes to the Medicare DMEPOS competitive bidding program. Significantly, Round 2 of the competitive bidding program has been expanded from 70 to 91 of the largest metropolitan statistical areas (MSAs). The Reform Package also gives the Secretary of HHS the authority to apply competitive bid pricing to non-bid areas, but details of that process are unlikely to be understood until after CMS issues guidance or completes a related rulemaking process.
In an effort to further strengthen the integrity of the Medicare program, the Reform Package includes additional requirements concerning physician enrollment and certain mandatory face-to-face patient/physician visits in conjunction with the ordering of durable medical equipment. These provisions are likely to be the subject of rulemaking and are a high priority for the American Association for Homecare and other industry representative organizations. We expect the Obama Administration to continue to enhance its oversight efforts, and we strive to incorporate any necessary changes into our overall corporate compliance and internal audit programs on a regular basis.
The effective dates of the various provisions within the Reform Package are staggered over the next several years, with some changes occurring immediately. Much of the interpretation of what the Reform Package requires will be subject to administrative rulemaking, the development of agency guidance and court interpretations.
Capped Rentals and Oxygen Equipment. The Deficit Reduction Act of 2005 (DRA) converted Medicare reimbursement for oxygen equipment from an ongoing rental method to a capped rental and rent-to-purchase methodology and limited reimbursement for rental of oxygen equipment to the current 36-month maximum. The DRA mandated that, after the 36-month rental period, the ownership of the equipment would transfer to the Medicare beneficiary.
MIPPA, which became law on July 15, 2008, while maintaining the 36-month rental cap, eliminated the mandatory title transfer for oxygen equipment. As a result, the equipment will continue to be owned by the oxygen provider for as long as the patients medical need exists, after which time it will be returned to the oxygen provider. Accordingly, because the 36-month rental period was retroactively applied to January 1, 2006, Medicare services provided on or after January 1, 2009 were the first Medicare claims for which the rental cap impacted Apria. In November 2008, CMS revised its regulations in order to be consistent with the provisions of the DRA and MIPPA. These regulations also set forth that CMS will not pay for any non-routine maintenance, oxygen tubing, cannulas and supplies after the 36-month rental period and that CMS will pay for certain routine maintenance and servicing activities after the 36-month rental cap. There may be future initiatives to implement a reduction to the capped rentals and/or monthly payment rate, but it is uncertain if such initiatives would ultimately be approved.
Competitive Bidding. The Medicare Prescription Drug, Improvement and Modernization Act of 2003 (MMA) mandated implementation of a competitive bidding program for certain DMEPOS. By statute, CMS was required to implement the competitive bidding program over time, with the first phase (Round 1) of competition occurring in 10 of the MSAs in 2007, launch of the program in 2008 and in 70 additional markets in 2009, and in additional markets after 2009. In 2007 and 2008, CMS accepted and reviewed bids to begin Round 1 of the competitive bidding program. Winning contract suppliers began providing services under Round 1 on July 1, 2008.
9
With the enactment of MIPPA in July 2008, the competitive bidding program was delayed and all contracts awarded under Round 1 were immediately terminated. The contracting process was restarted through the re-bidding process in October 2009 (the Round 1 Rebid). CMS also announced in June 2009 that the new payment rates resulting from the bid process will go into effect in the CBAs in January 2011. Currently, all beneficiaries in the fee-for-service Medicare program may use any provider in any geographic area to obtain durable medical equipment and oxygen therapy services and products. In addition to the delay of the competitive bidding program, MIPPA requires a number of programmatic reforms prior to re-launching the program. To offset the cost of, or pay for, the delay in the roll-out of the competitive bidding program, Congress adopted an average nationwide 9.5% payment reduction in the durable medical equipment fee schedule for product categories included in Round 1, effective January 1, 2009.
The Reform Package makes changes to the competitive bidding program. Significantly, Round 2 of the competitive bidding program has been expanded from 70 to 91 of the largest MSAs. CMS has announced that the effective date of the Round 2 pricing will be January 1, 2013; additional details concerning products to be included and other aspects of implementing Round 2 will not be fully known until after CMS completes a rulemaking process, which is currently scheduled for the summer or fall of 2010. The Reform Package also gives the Secretary of HHS the authority to apply competitive bid pricing to non-bid areas, but details of that process are unlikely to be understood until after CMS issues guidance or completes a related rulemaking process.
At a March 2010 Program Advisory and Oversight Committee (PAOC) meeting, CMS briefed the PAOC regarding the next round of the DMEPOS competitive bidding program. With review of Round 1 Rebid bids underway in March 2010, the briefing focused on certain aspects of Round 2, which is mandated by MIPPA to begin in 2011. In late June 2010, CMS published a proposed rule containing several provisions related to the competitive bidding program. The proposed rule included the proposed list of 21 additional MSAs to be included in Round 2, as well as provisions relating to the diabetic supply category. Those provisions include a proposed definition of mail order and non-mail order items and a proposal for providers to supply a minimum level of product choices to patients. The public comment period on the proposed rule will close in August and a final rule is expected in the fall of 2010. CMS expects to make additional changes to the program through the rulemaking process and anticipates that another proposed rule will be published in the summer of 2010, with a final rule to be published in the fall of 2010. Also, during the fall of 2010, CMS plans to announce the Round 2 product categories and begin pre-bidding supplier education. CMS anticipates that it will announce the Round 2 bidding schedule and begin the bidding process, with bidder registration, in the winter of 2011. CMS plans to complete the bid evaluation process, announce the SPAs and begin the contract process for Round 2 in the spring of 2012. In addition, CMS plans to announce the Round 2 contract suppliers in the summer of 2012. The new SPAs for Round 2 markets will take effect in January 2013.
In early July 2010, CMS announced the new SPAs for each of the product categories and each of the CBAs included in the Round 1 Rebid. CMS then began the contracting process with suppliers by issuing contract offer letters to qualified providers. This process is expected to take approximately two months, and CMS expects to announce the list of winners publicly in September 2010.
Reimbursement for Inhalation and Infusion Therapy Drugs. Beginning January 2005, Medicare Part B reimbursement for most drugs, including inhalation drugs, became based upon the manufacturer-reported average sales price (ASP) (subject to adjustment each quarter), plus 6%, plus a separate dispensing fee per patient episode. The Medicare reimbursement methodology for non-compounded, infused drugs administered through durable medical equipment, such as infusion pumps, was not affected by this MMA change and remains based upon either 95% of the October 1, 2003 Average Wholesale Price (AWP) or, for those drugs whose AWPs were not published in the applicable 2003 compendia, at 95% of the first published AWP.
10
In 2007 and 2008, changes were made by CMS to the reimbursement methodology for certain inhalation drugs. Beginning in the third quarter of 2007, CMS reimbursement for Xopenex® and albuterol was based on a blended ASP for these two products. Additionally, the Medicare, Medicaid, and State Childrens Health Insurance Program Extension Act of 2007 partially reversed the CMS regulatory decision regarding Xopenex and albuterol. As a result, beginning on April 1, 2008, Medicare began to reimburse providers for Xopenex by blending the ASP of Xopenex and albuterol, but it no longer reimbursed providers for albuterol at the blended price. Rather, albuterol is reimbursed using an albuterol-only ASP.
Since the financial impact of changes in Medicare reimbursement that have been enacted to date began on or before January 1, 2009, our results of operations for the year ended December 31, 2009 and for the six months ended June 30, 2009 and June 30, 2010 include operations after the Medicare reimbursement changes took effect.
The Transactions
On June 18, 2008, Apria, Sky Acquisition and Merger Sub entered into the Merger Agreement, pursuant to which, on October 28, 2008, Merger Sub merged with and into Apria, with Apria being the surviving corporation following the Merger. The Investor Group beneficially owns all of Aprias issued and outstanding capital stock.
The initial borrowings under our senior secured bridge credit agreement and our ABL Facility, the equity investment by the Investor Group and the repayment of all outstanding indebtedness under our 2004 senior secured revolving credit facility and the Interim Facility are collectively referred to in this prospectus as the Original Financing. The offerings of the outstanding Series A-1 Notes and the outstanding Series A-2 Notes in May 2009 and August 2009, respectively, the repayment of approximately $1,010.0 million of borrowings under our senior secured bridge credit agreement, plus accrued and unpaid interest, and the payment of related fees and expenses with the proceeds of the offerings of the outstanding Series A-1 Notes and the outstanding Series A-2 Notes, together with cash on hand, are collectively referred to in this prospectus as the Refinancing. The Merger, the Original Financing and the Refinancing are collectively referred to in this prospectus as the Transactions. For a more complete description of the Transactions, see The Transactions and Description of Other Indebtedness.
11
The following chart summarizes our organizational structure, equity ownership and our principal indebtedness as of the date of this prospectus. This chart is provided for illustrative purposes only and does not represent all legal entities of Apria and its consolidated subsidiaries or all obligations of such entities.
(1) | Consists of a $673.3 million cash equity investment by the Investor Group in membership interests of our parent entities, which investment includes Dr. Paysons co-investment. The proceeds of such investment were contributed to Merger Sub, which used such proceeds, together with other sources of funds, to fund the Merger and the related transactions. |
(2) | Our ABL Facility is secured, subject to certain exceptions and permitted liens, (i) on a first-priority lien basis, by substantially all of our personal property consisting of accounts receivable, inventory, intercompany notes and intangible assets to the extent attached to the foregoing, and certain related assets and proceeds of the foregoing and (ii) on a second-priority lien basis, by all tangible and intangible assets that secure the Notes on a first-priority basis. See Description of Other IndebtednessSenior Secured Asset-Based Revolving Credit Facility. |
(3) | At the closing of the Merger, we borrowed an aggregate of $1,010.0 million under our senior secured bridge credit agreement. Apria used the proceeds of the offerings of the outstanding Series A-1 Notes and the outstanding Series A-2 Notes in May 2009 and August 2009, respectively, together with cash on hand, to repay all borrowings under the senior secured bridge credit agreement, plus accrued and unpaid interest, and to pay related fees and expenses. Our senior secured bridge credit agreement was terminated concurrently with the closing of the outstanding Series A-2 Notes offering. |
(4) | The Notes and the related guarantees are secured by our assets, including (i) on a first-priority lien basis (subject to certain exceptions and permitted liens) by substantially all the tangible and intangible assets of Apria and its subsidiaries that are guarantors of the Series A-2 Notes (other than the collateral which secures our ABL Facility on a first-priority lien basis) and (ii) on a second-priority lien basis (subject to certain exceptions and permitted liens) by the collateral securing our ABL Facility on a first-priority lien basis. The Series A-1 Notes are entitled to a priority of payment over the Series A-2 Notes in certain circumstances. |
(5) | The Notes are guaranteed on a senior secured basis by all of our existing wholly-owned domestic subsidiaries that guarantee the obligations under the ABL Facility and will be guaranteed by our future wholly-owned domestic subsidiaries, subject to certain exceptions. See Description of NotesGuarantees. |
12
We are incorporated in the State of Delaware. Our principal executive offices are located at 26220 Enterprise Court, Lake Forest, California 92630 and our telephone number is (949) 639-2000.
The Blackstone Group
The Blackstone Group, one of the worlds leading global investment and advisory firms, was founded in 1985. Through its different businesses, as of June 30, 2010, Blackstone had total fee-earning assets under management of approximately $101.4 billion. Blackstones alternative asset management businesses include the management of corporate private equity funds, real estate funds, funds of hedge funds, credit-oriented funds, collateralized loan obligation vehicles (CLOs) and closed-end mutual funds. Blackstone also provides various financial advisory services, including mergers and acquisition advisory, restructuring and reorganization advisory, and fund placement services.
13
The Exchange Offers
General |
On May 27, 2009 and August 13, 2009, respectively, the Issuer issued an aggregate of $700.0 million principal amount of 11.25% Senior Secured Notes due 2014 (Series A-1) and $317.5 million principal amount of 12.375% Senior Secured Notes due 2014 (Series A-2) in private offerings. In connection with the private offerings, the Issuer and the guarantors entered into registration rights agreements with the initial purchasers in which they agreed, among other things, to deliver this prospectus to you and to complete the exchange offers within 450 days after the date of issuance and sale of the outstanding Series A-2 Notes. |
You are entitled to exchange in the exchange offers your outstanding notes for exchange notes which are identical in all material respects to the outstanding notes except: |
| the exchange notes have been registered under the Securities Act; |
| the exchange notes are not entitled to any registration rights which are applicable to the outstanding notes under the registration rights agreements; and |
| certain additional interest rate provisions are no longer applicable. |
The Exchange Offers |
The Issuer is offering to exchange: |
| $700.0 million principal amount of 11.25% Senior Secured Notes due 2014 (Series A-1), which have been registered under the Securities Act, for any and all of its outstanding 11.25% Senior Secured Notes due 2014 (Series A-1); and |
| $317.5 million principal amount of 12.375% Senior Secured Notes due 2014 (Series A-2), which have been registered under the Securities Act, for any and all of its outstanding 12.375% Senior Secured Notes due 2014 (Series A-2). |
You may only exchange outstanding notes in a principal amount of $2,000 or in integral multiples of $1,000 in excess thereof. |
Resale |
Based on an interpretation by the staff of the Securities and Exchange Commission (the SEC) set forth in no-action letters issued to third parties, the Issuer believes that the exchange notes issued pursuant to the exchange offers in exchange for outstanding notes may be offered for resale, resold and otherwise transferred by you (unless you are our affiliate within the meaning of Rule 405 under the Securities Act) without compliance with the registration and prospectus delivery provisions of the Securities Act, provided that: |
| you are acquiring the exchange notes in the ordinary course of your business; and |
14
| you have not engaged in, do not intend to engage in, and have no arrangement or understanding with any person to participate in, a distribution of the exchange notes. |
If you are a broker-dealer and receive exchange notes for your own account in exchange for outstanding notes that you acquired as a result of market-making activities or other trading activities, you must acknowledge that you will deliver this prospectus in connection with any resale of the exchange notes. See Plan of Distribution. |
Any holder of outstanding notes who: |
| is our affiliate; |
| does not acquire exchange notes in the ordinary course of its business; or |
| tenders its outstanding notes in the exchange offers with the intention to participate, or for the purpose of participating, in a distribution of exchange notes; |
cannot rely on the position of the staff of the SEC enunciated in Morgan Stanley & Co. Incorporated (available June 5, 1991) and Exxon Capital Holdings Corporation (available May 13, 1988), as interpreted in the SECs letter to Shearman & Sterling (available July 2, 1993), or similar no-action letters and, in the absence of an exemption therefrom, must comply with the registration and prospectus delivery requirements of the Securities Act in connection with any resale of the exchange notes. |
Expiration Date |
The exchange offers will expire at 5:00 p.m., New York City time, on September 15, 2010, which is the 21st business day after the date of this prospectus, unless extended by us. The Issuer does not currently intend to extend the expiration date. |
Withdrawal |
You may withdraw the tender of your outstanding notes at any time prior to the expiration of the applicable exchange offer. The Issuer will return to you any of your outstanding notes that are not accepted for any reason for exchange, without expense to you, promptly after the expiration or termination of the exchange offers. |
Interest on the exchange notes and the outstanding notes |
Each exchange note will bear interest at their respective rate per annum set forth on the cover page of this prospectus from the most recent date to which interest has been paid on the outstanding notes. The interest will be payable semi-annually on May 1 and November 1. No interest will be paid on outstanding notes following their acceptance for exchange. |
Conditions to the Exchange Offers |
The exchange offers are subject to customary conditions, which the Issuer may waive. See The Exchange OffersConditions to the Exchange Offers. |
15
Procedures for Tendering Outstanding Notes |
If you wish to participate in the exchange offers, you must complete, sign and date the accompanying letter of transmittal, or a facsimile of such letter of transmittal, according to the instructions contained in this prospectus and the letter of transmittal. You must then mail or otherwise deliver the letter of transmittal, or a facsimile of such letter of transmittal, together with the outstanding notes and any other required documents, to the exchange agent at the address set forth on the cover page of the letter of transmittal. |
If you hold outstanding notes through The Depository Trust Company (DTC) and wish to participate in the exchange offers, you must comply with the Automated Tender Offer Program procedures of DTC, by which you will agree to be bound by the letter of transmittal. By signing, or agreeing to be bound by, the letter of transmittal, you will represent to us that, among other things: |
| you are not our affiliate within the meaning of Rule 405 under the Securities Act or, if you are our affiliate, that you will comply with any applicable registration and prospectus delivery requirements of the Securities Act; |
| you do not have an arrangement or understanding with any person or entity to participate in the distribution of the exchange notes; |
| you are acquiring the exchange notes in the ordinary course of your business; and |
| if you are a broker-dealer that will receive exchange notes for your own account in exchange for outstanding notes that were acquired as a result of market-making activities, that you will deliver a prospectus, as required by law, in connection with any resale of such exchange notes. |
Special Procedures for Beneficial Owners |
If you are a beneficial owner of outstanding notes that are registered in the name of a broker, dealer, commercial bank, trust company or other nominee, and you wish to tender those outstanding notes in the exchange offers, you should contact the registered holder promptly and instruct the registered holder to tender those outstanding notes on your behalf. If you wish to tender on your own behalf, you must, prior to completing and executing the letter of transmittal and delivering your outstanding notes, either make appropriate arrangements to register ownership of the outstanding notes in your name or obtain a properly completed bond power from the registered holder. The transfer of registered ownership may take considerable time and may not be able to be completed prior to the expiration date. |
16
Guaranteed Delivery Procedures |
If you wish to tender your outstanding notes and your outstanding notes are not immediately available or you cannot deliver your outstanding notes, the letter of transmittal or any other required documents, or you cannot comply with the applicable procedures under DTCs Automated Tender Offer Program for transfer of book-entry interests, prior to the expiration date, you must tender your outstanding notes according to the guaranteed delivery procedures set forth in this prospectus under The Exchange OfferGuaranteed Delivery Procedures. |
Effect on Holders of Outstanding Notes |
As a result of the making of, and upon acceptance for exchange of all validly tendered outstanding notes pursuant to the terms of the exchange offers, the Issuer and the guarantors will have fulfilled a covenant under the applicable registration rights agreement. Accordingly, there will be no increase in the interest rate on the outstanding notes under the circumstances described in the registration rights agreements. If you do not tender your outstanding notes in the exchange offers, you will continue to be entitled to all the rights and limitations applicable to the outstanding notes as set forth in the indenture, except the Issuer and the guarantors will not have any further obligation to you to provide for the exchange and registration of the outstanding notes under the applicable registration rights agreement. To the extent that outstanding notes are tendered and accepted in the exchange offers, the trading market for remaining outstanding notes that are not so tendered and exchanged could be adversely affected. |
Consequences of Failure to Exchange |
All untendered outstanding notes will continue to be subject to the restrictions on transfer set forth in the outstanding notes and in the indenture. In general, the outstanding notes may not be offered or sold unless registered under the Securities Act, except pursuant to an exemption from, or in a transaction not subject to, the Securities Act and applicable state securities laws. Other than in connection with the exchange offers, the Issuer and the guarantors do not currently anticipate that they will register the outstanding notes under the Securities Act. |
Certain U.S. Federal Income Tax Considerations |
The exchange of outstanding notes in the exchange offers will not be a taxable event for United States federal income tax purposes. See Certain U.S. Federal Income Tax Considerations. |
Use of Proceeds |
The Issuer will not receive any cash proceeds from the issuance of exchange notes in the exchange offers. See Use of Proceeds. |
Exchange Agent |
U.S. Bank National Association is the exchange agent for the exchange offers. The addresses and telephone numbers of the exchange agent are set forth in the section captioned The Exchange OffersExchange Agent of this prospectus. |
17
The Exchange Notes
The terms of the exchange notes are identical in all material respects to the terms of the outstanding notes, except that the exchange notes will not contain terms with respect to transfer restrictions or additional interest upon a failure to fulfill certain of our obligations under the registration rights agreement. The exchange notes will evidence the same debt as the outstanding notes. The exchange notes will be governed by the same indenture under which the outstanding notes were issued. The following summary is not intended to be a complete description of the terms of the exchange notes. For a more detailed description of the Notes, see Description of Notes.
Issuer |
Apria Healthcare Group Inc. |
Notes Offered |
$700.0 million aggregate principal amount of 11.25% Senior Secured Notes due 2014 (Series A-1) and $317.5 million aggregate principal amount of 12.375% Senior Secured Notes due 2014 (Series A-2). |
Maturity Date |
The exchange notes will mature on November 1, 2014. |
Interest |
The exchange Series A-1 Notes and the exchange Series A-2 Notes will bear interest at a rate of 11.25% and 12.375% per annum, respectively, payable on May 1 and November 1 of each year. |
Guarantees |
The exchange notes will be fully and unconditionally guaranteed on a senior secured basis, by all of our existing wholly-owned subsidiaries organized in the United States that guarantee the obligations under the ABL Facility and the outstanding notes, subject to certain limitations described herein. |
If any of our wholly-owned restricted subsidiaries guarantee certain of our other debt, such subsidiaries shall also guarantee the exchange notes. |
Under certain circumstances, subsidiaries may be released from these guarantees without the consent of the holders of the exchange notes. |
See Description of NotesGuarantees. |
Collateral |
The exchange notes and the related guarantees will be secured by (1) a first-priority lien (subject to certain exceptions and permitted liens) on substantially all the tangible and intangible assets of the Issuer and the guarantors, including all of the capital stock of the Issuer, of each guarantor and of any material subsidiary of the Issuer (which, in the case of foreign subsidiaries, will be limited to 65% of the stock of each first-tier foreign subsidiary), other than the collateral securing the ABL Facility on a first-priority lien basis and (2) a second-priority lien on accounts receivable arising from the sale of inventory and other goods and services (including related contracts and contract rights, inventory, cash, deposit accounts, other bank accounts and securities accounts), inventory, intercompany notes and intangible assets to the extent attached to the foregoing, and the proceeds thereof, which secures the ABL Facility on a first-priority lien basis. |
18
The collateral securing the exchange notes on a first-priority lien basis will not include (i) the collateral securing the ABL Facility on a first priority lien basis, (ii) certain excluded assets and (iii) those assets as to which the collateral agent representing the holders of the exchange notes reasonably determines that the costs of obtaining such a security interest are excessive in relation to the value of the security to be afforded thereby. |
See Description of NotesSecurity for the Notes.
Ranking |
The exchange notes and the related guarantees will be our senior secured obligations. The indebtedness evidenced by the exchange notes and the guarantees will rank: |
| equal with all of the Issuers and the guarantors existing and future senior indebtedness, including any indebtedness under the ABL Facility and the outstanding notes; |
| senior to all of the Issuers and the guarantors existing and future subordinated indebtedness; |
| junior in priority as to collateral that secures the ABL Facility on a first-priority lien basis with respect to the Issuers and the guarantors obligations under the ABL Facility, any other debt incurred after the issue date that has a priority security interest relative to the Notes in the collateral that secures the ABL Facility and all cash management and hedging obligations incurred with any lender under the ABL Facility or any affiliate of any such lender; and |
| equal in priority as to collateral that secures the Notes and the guarantees on a first-priority lien basis with respect to the Issuers and the guarantors obligations under our notes and any other pari passu lien obligations incurred after the issue date; provided that the Series A-1 Notes are entitled to a priority of payment over the Series A-2 Notes in certain circumstances, including upon any acceleration of the obligations under the Notes or any bankruptcy or insolvency event of default. |
The Notes will also be effectively junior to the liabilities of any non-guarantor subsidiaries. |
As of June 30, 2010: |
| we had $1,017.5 million in aggregate principal amount of senior secured indebtedness outstanding under the outstanding notes; |
| we had $16.1 million of drawn letters of credit under the ABL Facility and availability of $133.9 million under the ABL Facility, which are secured on a first-priority lien basis by substantially all of our personal property consisting of accounts receivable, inventory, intercompany notes and intangible assets to the extent attached to the foregoing, and certain related assets and proceeds of the foregoing; and |
19
| we had $2.8 million in aggregate principal amount of other senior indebtedness outstanding (excluding the ABL Facility, the outstanding notes and guarantees of the foregoing). |
See Description of NotesRanking and Description of NotesPriorities of Payment as between Series A-2 Debt (including the Series A-2 Notes) and Series A-1 Notes. |
Optional Redemption |
We may, at our option, redeem some or all of the exchange notes at 100% of the principal amount thereof plus a make-whole premium at any time and from time to time prior to November 1, 2011. |
We may, at our option, redeem some or all of the exchange notes, at any time and from time to time after November 1, 2011, at the redemption prices listed under Description of NotesOptional Redemption.
In addition, prior to November 1, 2011, we may at our option redeem up to 35% of the exchange Series A-1 Notes at a redemption price of 111.25% of their principal amount, and up to 35% of the exchange Series A-2 Notes at a redemption price of 112.375% of their principal amount, plus accrued and unpaid interest, if any, to the date of redemption, from the proceeds of certain equity offerings. See Description of the NotesOptional Redemption.
Mandatory Repurchase Offer |
If we experience specific types of changes of control, we must offer to repurchase the exchange notes at a price equal to 101% of the principal amount thereof, plus accrued and unpaid interest to the date of purchase, subject to the rights of holders of exchange notes on the relevant record date to receive interest due on the relevant payment date. |
Certain Covenants |
The exchange notes will be governed by the same indenture under which the outstanding notes were issued. The indenture governing the exchange notes contains covenants that, among other things, will limit our ability and the ability of our restricted subsidiaries to: |
| incur additional debt; |
| pay dividends and make other distributions; |
| make certain investments; |
| repurchase our stock; |
| incur certain liens; |
| enter into transactions with affiliates; |
| merge or consolidate; |
| enter into agreements that restrict the ability of our subsidiaries to make dividends or other payments to us; and |
| transfer or sell assets. |
20
These covenants are subject to important exceptions and qualifications. See Description of NotesCertain Covenants. |
Use of Proceeds |
We will not receive any proceeds from the exchange offers. See Use of Proceeds. |
No Prior Market |
The exchange notes will generally be freely transferable (subject to certain restrictions discussed in The Exchange Offers) but will be a new issue of securities for which there will not initially be a market. Accordingly, there can be no assurance as to the development or liquidity of any market for the exchange notes. The initial purchasers in the private offering of the outstanding notes have advised us that they currently intend to make a market for the exchange notes, as permitted by applicable laws and regulations. However, they are not obligated to do so and may discontinue any such market making activities at any time without notice. We do not intend to apply for a listing of the exchange notes on any securities exchange or automated dealer quotation system. |
Risk Factors
You should carefully consider the information set forth under the caption Risk Factors beginning on page 24 of this prospectus before participating in the exchange offers.
21
Summary Historical Consolidated Financial Data
Our summary historical consolidated financial data set forth below should be read in conjunction with The Transactions, Selected Historical Consolidated Financial Data and Managements Discussion and Analysis of Financial Condition and Results of Operations and our financial statements and accompanying notes contained herein. We derived the summary historical consolidated financial data for the year ended December 31, 2007, the periods from January 1, 2008 to October 28, 2008 and October 29, 2008 to December 31, 2008, the year ended December 31, 2009 and as of December 31, 2008 and 2009 from our audited consolidated financial statements which are included in this prospectus. We derived the summary historical consolidated financial data for the year ended December 31, 2006 and as of December 31, 2006 and 2007 from our audited consolidated financial statements which are not included in this prospectus. The historical results presented are not necessarily indicative of future results. Our audited consolidated financial statements for each of the years in the two-year period ended December 31, 2007, the periods from January 1, 2008 to October 28, 2008 and October 29, 2008 to December 31, 2008 and the year ended December 31, 2009 have been audited by Deloitte & Touche LLP, an independent registered public accounting firm.
Our summary historical consolidated financial data for the six months ended June 30, 2009 and as
of and for the six months ended June 30, 2010 have been derived from our unaudited condensed consolidated
financial statements, which are included in this prospectus. We derived the summary historical consolidated financial data as of June 30, 2009 from our unaudited condensed consolidated financial statements, which are not included in this prospectus. The unaudited condensed consolidated financial statements were prepared on a basis consistent with our audited consolidated financial statements. In our opinion, the unaudited condensed consolidated financial statements include all adjustments, consisting of normal recurring accruals, necessary for the fair presentation of those statements. Our results for the six months ended June 30, 2010 should not be considered indicative of the results for the full fiscal year ending December 31, 2010.
Year Ended |
Period January 1, 2008 to October 28, 2008 |
Period October 29, 2008 to December 31, 2008 |
Year Ended December 31, 2009 |
Six Months Ended June 30, 2009 |
Six Months Ended June 30, 2010 | |||||||||||||||||
2007 | ||||||||||||||||||||||
(Predecessor) | (Predecessor) | (Successor) | (Successor) | (Successor) | (Successor) | |||||||||||||||||
(dollars in thousands) | ||||||||||||||||||||||
Statement of Operations Data: |
||||||||||||||||||||||
Net revenues |
$ | 1,631,801 | $ | 1,773,289 | $ | 356,665 | $ | 2,094,561 | $ | 1,038,959 | $ | 1,027,054 | ||||||||||
Cost and expenses: |
||||||||||||||||||||||
Total cost of net revenues |
564,992 | 691,337 | 137,760 | 867,459 | 410,510 | 410,924 | ||||||||||||||||
Provision for doubtful accounts |
43,138 | 33,626 | 14,329 | 57,919 | 25,504 | 28,820 | ||||||||||||||||
Selling, distribution and administrative |
862,062 | 924,536 | 179,362 | 1,050,134 | 526,392 | 516,581 | ||||||||||||||||
Amortization of intangible assets |
3,079 | 3,461 | 1,008 | 3,716 | 2,955 | 2,742 | ||||||||||||||||
Total costs and expenses |
1,473,271 | 1,652,960 | 332,459 | 1,979,228 | 965,361 | 959,067 | ||||||||||||||||
Operating income |
158,530 | 120,329 | 24,206 | 115,333 | 73,598 | 67,987 | ||||||||||||||||
Interest expense and other, net |
20,493 | 29,684 | 25,441 | 127,591 | 64,078 | 64,930 | ||||||||||||||||
Income (loss) from continuing operations before taxes |
138,037 | 90,645 | (1,235 | ) | (12,258 | ) | 9,520 | 3,057 | ||||||||||||||
Income tax expense (benefit) |
51,998 | 34,192 | 659 | (8,438 | ) | 5,982 | 494 | |||||||||||||||
Net income (loss) from continuing operations |
$ | 86,039 | $ | 56,453 | $ | (1,894 | ) | $ | (3,820 | ) | $ | 3,538 | $ | 2,563 | ||||||||
22
Year
Ended December 31, 2007 |
Period January 1, 2008 to October 28, 2008 |
Period October 29, 2008 to December 31, 2008 |
Year
Ended December 31, 2009 |
Six Months Ended June 30, 2009 |
Six Months Ended June 30, 2010 |
|||||||||||||||||||||
(Predecessor) | (Predecessor) | (Successor) | (Successor) | (Successor) | (Successor) | |||||||||||||||||||||
(dollars in thousands) | ||||||||||||||||||||||||||
Cash Flow Data: |
||||||||||||||||||||||||||
Net cash provided by operating activities |
$ | 294,006 | $ | 297,937 | $ | 63,337 | $ | 169,426 | $ | 60,471 | $ | 34,718 | ||||||||||||||
Net cash used in investing activities |
(483,235 | ) | (154,493 | ) | (75,466 | ) | (168,656 | ) | (71,160 | ) | (40,044 | ) | ||||||||||||||
Net cash (used in) provided by financing activities |
203,023 | (123,682 | ) | 131,934 | (10,625 | ) | (13,155 | ) | (36,365 | ) | ||||||||||||||||
Capital expenditures |
128,759 | 157,183 | 26,217 | 150,597 | 73,598 | 55,783 |
As of December 31, | As of June 30, 2010 | |||||||||||||
2007 | 2008 | 2009 | ||||||||||||
(Predecessor) | (Successor) | (Successor) | (Successor) | |||||||||||
(dollars in thousands) | ||||||||||||||
Balance Sheet Data: |
||||||||||||||
Cash and cash equivalents |
$ | 28,451 | $ | 168,018 | $ | 158,163 | $ | 116,472 | ||||||
Short-term investments |
| | 23,673 | 6,076 | ||||||||||
Goodwill and intangible assets |
822,992 | 1,292,403 | 1,341,456 | 1,340,974 | ||||||||||
Total assets |
1,597,802 | 2,210,813 | 2,309,047 | 2,266,211 | ||||||||||
Total debt |
687,283 | 1,022,233 | 1,021,146 | 1,020,279 | ||||||||||
Stockholders equity |
512,025 | 672,820 | 678,731 | 683,419 |
23
You should carefully consider the following risks, in addition to the other information contained in this prospectus, before participating in the exchange offers. The risks described below are not the only risks we face. Any of the following risks, as well as other risks and uncertainties not currently known to us or that we currently deem to be immaterial, could materially adversely affect our business, financial condition or results of operations.
Risks Associated with the Exchange Offers
If you choose not to exchange your outstanding notes in the exchange offers, the transfer restrictions currently applicable to your outstanding notes will remain in force and the market price of your outstanding notes could decline.
If you do not exchange your outstanding notes for exchange notes in the exchange offers, then you will continue to be subject to the transfer restrictions on the outstanding notes as set forth in the offering memorandum distributed in connection with the private offering of the outstanding notes. In general, the outstanding notes may not be offered or sold unless they are registered or exempt from registration under the Securities Act and applicable state securities laws. Except as required by the registration rights agreement, we do not intend to register resales of the outstanding notes under the Securities Act.
The tender of outstanding notes under the exchange offers will reduce the remaining principal amount of the outstanding notes, which may have an adverse effect upon and increase the volatility of, the market price of the outstanding notes due to reduction in liquidity.
Your ability to transfer the notes may be limited by the absence of an active trading market, and an active trading market may not develop for the notes.
The exchange notes are a new issue of securities for which there is no established trading market. We do not intend to have the exchange notes listed on a national securities exchange or to arrange for quotation on any automated quotation system. The initial purchasers have advised us that they intend to make a market in the exchange notes, as permitted by applicable laws and regulations; however, the initial purchasers are not obligated to make a market in the exchange notes, and they may discontinue their market-making activities at any time without notice. Therefore, we cannot assure you as to the development or liquidity of any trading market for the exchange notes. The liquidity of any market for the exchange notes will depend on a number of factors, including:
| the number of holders of exchange notes; |
| our operating performance and financial condition; |
| the market for similar securities; |
| the interest of securities dealers in making a market in the exchange notes; and |
| prevailing interest rates. |
Historically, the market for non-investment grade debt has been subject to disruptions that have caused substantial volatility in the prices of securities similar to the exchange notes. The market, if any, for the exchange notes may face similar disruptions that may adversely affect the prices at which you may sell your exchange notes. Therefore, you may not be able to sell your exchange notes at a particular time and the price that you receive when you sell may not be favorable.
24
Risks Relating to Our Business
Continued Reductions in Medicare and Medicaid Reimbursement Rates and the Comprehensive Healthcare Reform Package Could Have a Material Adverse Effect on Our Results of Operations and Financial Condition.
There are ongoing legislative and regulatory efforts to reduce or otherwise adversely affect Medicare reimbursement rates for products and services we provide. For example, the regulations implementing the mandates under the MMA, the DRA and MIPPA reduced the reimbursement for a number of products and services we provide and established a competitive bidding program for certain durable medical equipment under Medicare Part B. The Medicare DMEPOS competitive bidding program is intended to further reduce reimbursement for certain products as well as decrease the number of companies permitted to serve Medicare beneficiaries. In July 2008, MIPPA was passed and included a delay to the competitive bidding program. In order to ensure that the delay would achieve the same level of savings projected for the DMEPOS competitive bidding program, Congress adopted a nationwide average payment reduction of 9.5% in the DMEPOS fee schedule for those product categories included in Round 1, effective January 1, 2009. MIPPA called for those DMEPOS items that were not subject to Round 1 competitive bidding to receive a CPI update each year from 2009 to 2013. The CPI for 2009 for these items was 5%. For 2010, the CPI was -1.4%, however, the annual DMEPOS updates cannot be negative. The Reform Package made changes to the CPI adjustment for 2011 and each subsequent year based upon the CPI reduced by a new productivity adjustment which may result in negative updates.
In January 2009, CMS released an interim final rule implementing certain MIPPA provisions requiring CMS to conduct a second Round 1 competition in 2009 (the Round 1 Rebid) and mandated certain changes for both the Round 1 Rebid and subsequent rounds of the program. Despite industry advocacy and Congressional efforts to further delay CMS implementation of the program, the final rule took effect on April 18, 2009. In early July 2010, CMS announced the new SPAs for each of the product categories and each of the CBAs included in the Round 1 Rebid. CMS then began the contracting process with suppliers by issuing contract offer letters to qualified providers. We received contract offers for a substantial majority of the bids we submitted. We did not receive contract offers for certain product categories in certain CBAs, but the process will not be completed until September 2010. Approximately $21 million of our net revenues for the fiscal year ended December 31, 2009 was generated by the products and CBAs included in the Round 1 Rebid. We estimate that the initial results of the Round 1 Rebid would impact our net revenues in the fiscal year ending December 31, 2011 by approximately $8 million, assuming the current contract offers and no changes in volume. CMS expects to announce the winners in the fall of 2010 and the new rates will take effect in January 2011. The Reform Package also made changes to the competitive bidding program. Significantly, Round 2 of the competitive bidding program has been expanded from 70 to 91 of the largest MSAs. CMS has announced that the effective date of the Round 2 pricing will be January 1, 2013; additional details concerning products to be included and other aspects of implementing Round 2 will not be fully known until after CMS completes a rulemaking process, which is currently scheduled for the summer or fall of 2010. Assuming that Round 2 would include the same product categories, bidding rules and markets currently being proposed by CMS, we estimate that approximately $110 million of our net revenues for the fiscal year ending December 31, 2011 would be subject to competitive bidding. Although the bidding process for Round 2 is currently scheduled to commence in 2011, the effective date of new Round 2 rates and guidelines would take effect in January 2013 at the earliest. Therefore, we cannot estimate the impact of potential Round 2 rate reductions on our business until more specific information is published by CMS and its contractors. The Reform Package also gives the Secretary of Health and Human Services the authority to apply competitive bid pricing to non-bid areas, but details of that process are unlikely to be understood until after CMS issues guidance or completes a related rulemaking process. At this time, we cannot quantify what negative impact, if any, the revised program will have upon our revenue or operations when the program is reinitiated, but such impact could be material.
Further, the DRA resulted in reduced reimbursement rates for certain durable medical equipment, including the home oxygen equipment and services we provide, a reduced period for rental revenue, and potential increased
25
costs to us associated with replacement of certain patient-owned equipment. There have been various administrative and legislative proposals to further reduce the maximum capped rental period for oxygen equipment below the 36-month level mandated by the DRA to 13 and 18 months, respectively, and/or to reduce the monthly payment rates for oxygen equipment. In 2009, the Medicare Home Oxygen Therapy Act of 2009 was introduced in the House of Representatives and subsequently offered and withdrawn as an amendment to healthcare reform legislation being debated in the House Energy and Commerce Committee. This bill would, among other things, have amended the current statutory language surrounding the provision of home oxygen therapy. It defined covered services to be provided by all oxygen providers, established criteria for a qualified home oxygen provider to meet, aligned the oxygen equipment provided more directly with patient need, eliminated the 36-month cap, provided for certain cost transparency and would be implemented in a budget neutral manner. While these proposals have not been enacted, the home oxygen industry continues to work with Congress on oxygen benefit reform measures, and similar proposals may be raised in the future.
In addition to these activities, certain other proposed legislative and regulatory activities may affect reimbursement policies and rates for other items and services we provide. For example, in March 2010, Congress enacted the Reform Package which includes comprehensive healthcare reform. Among many other provisions, the Reform Package expands the Medicaid program, mandates extensive insurance market reforms, creates new health insurance access points (e.g., insurance exchanges), provides certain insurance subsidies (e.g., premiums and cost sharing), imposes individual and employer health insurance requirements and makes a number of changes to the Code.
There are various provisions in the Reform Package that impact our business. For example, the Reform Package requires certain pharmaceutical and medical device manufacturers to pay an excise tax to the government, which may, in turn, increase our costs for these products. The Reform Package also provides for cuts in some Medicare payments made to certain providers and substantial cuts to Medicare Advantage plans, through which we contract to provide services to Medicare beneficiaries. Also included in the Reform Package are (i) an expansion of the Recovery Audit Contractor Program, (ii) certain fraud and abuse prevention measures and (iii) expanded regulatory authority concerning the types of conduct that can result in additional fines and penalties for those healthcare providers who do not comply with applicable laws and regulations. Furthermore, the Reform Package grants the Secretary of Health and Human Services authority to set a date by which certain providers and suppliers will be required to establish a compliance program.
The Reform Package makes a number of changes to how certain of the Companys products will be reimbursed by Medicare. The Reform Package also makes changes to the Medicare durable medical equipment CPI adjustment for 2011 and each subsequent year based upon the CPI reduced by a new productivity adjustment which may result in negative updates and, as noted above, includes changes to the Medicare DMEPOS competitive bidding program.
In an effort to further strengthen the integrity of the Medicare program, the Reform Package includes additional requirements concerning physician enrollment and certain mandatory face-to-face patient/physician visits in conjunction with the ordering of durable medical equipment. These provisions are likely to be the subject of rulemaking and are a high priority for the American Association for Homecare and other industry representative organizations. We expect the Obama Administration to continue to enhance its oversight efforts and the Company strives to incorporate any necessary changes into its overall corporate compliance and internal audit programs on a regular basis.
The effective dates of the various provisions within the Reform Package are staggered over the next several years, with some changes occurring immediately. Much of the interpretation of what the Reform Package requires will be subject to administrative rulemaking, the development of agency guidance and court interpretations. We cannot currently predict the adverse impact, if any, that these and other Reform Package changes might have on our operations, cash flow and capital resources, but such impact could be material. In addition, other legislative and regulatory changes could have a material adverse effect on our business, financial condition, results of operations, cash flow, capital resources and liquidity.
26
There are also ongoing state and federal legislative and regulatory efforts to reduce or otherwise adversely affect Medicaid reimbursement rates for products and services we provide. For a number of years, some states have adopted alternative pricing methodologies for certain drugs, biologicals and home medical equipment reimbursed under the Medicaid program. In a number of states, the changes reduced the level of reimbursement we received for these items without a corresponding offset or increase to compensate for the service costs we incurred. For example, Californias Medicaid program (Medi-Cal) adopted a regulation that limits the amounts a provider can bill for certain durable medical equipment and medical supplies. In March 2009, the California Association of Medical Product Suppliers (CAMPS) initiated a lawsuit to invalidate this regulation as having been adopted in violation of Californias Administrative Procedure Act. On August 3, 2009, the court entered a decision denying CAMPS petition. CAMPS has appealed the courts decision. If the regulation is ultimately upheld, it could result in our making refunds and other payments to Medi-Cal and our future revenues from Medi-Cal may be reduced. In addition to this Medi-Cal regulation, we currently are examining other similar Medicaid program rules to confirm whether we have complied with the particular states Medicaid reimbursement methodologies. The review could result in our making refunds and other payments to these state Medicaid programs and our future revenues may be reduced. Historically, when we have learned that states have adopted such alternative reimbursement methodologies, we have sometimes elected to stop accepting new Medicaid patient referrals for the affected drugs, biologicals and home medical equipment. We are currently evaluating the possibility of stopping or reducing our Medicaid business in a number of states with reimbursement policies that make it difficult for us to conduct operations profitably. Moreover, the Reform Package increases Medicaid enrollment over a number of years and imposes additional requirements on states, which could further strain state budgets and therefore result in additional policy changes or rate reductions. In addition, changes to the federal regulations pertaining to prescription drug pricing may also impact the Medicaid reimbursement available to us. We cannot currently predict the adverse impact, if any, that any such changes to or reduction in our Medicaid business might have on our operations, cash flow and capital resources, but such impact could be material. In addition, we cannot predict whether other states will consider similar or other reimbursement reductions or whether any such changes could have a material adverse effect on our results of operations, cash flow and capital resources.
We cannot estimate the ultimate impact of all legislated and contemplated Medicare and Medicaid reimbursement changes or provide assurance to investors that additional reimbursement reductions will not be made or will not have a material adverse effect on our business, financial condition, results of operations, cash flow, capital resources and liquidity.
For further information, see BusinessGovernment RegulationMedicare and Medicaid Revenues and BusinessGovernment RegulationMedicare Reimbursement.
We Believe That Continued Pressure to Reduce Healthcare Costs Could Have a Material Adverse Effect on Us.
As the result of continuing reductions in payor reimbursement, we, like many other healthcare companies, are making substantial efforts to reduce our costs in providing healthcare services and products. Certain managed care organizations and larger insurers also regularly attempt to seek reductions in the prices at which we provide services to them and their patients. We have a large number of contractual arrangements with managed care organizations and other parties, which represented approximately 71% and 72% of our total net revenues for the six months ended June 30, 2010 and June 30, 2009, respectively, and we expect that we will continue to enter into more of these contractual arrangements. Also, the Reform Package significantly reduces the governments payment rates to Medicare Advantage plans. Other provisions impose minimum medical-loss ratios, state and federal premium review procedures and benefit requirements on insurers. There can be no assurance that we will retain or obtain Medicare Advantage or other such managed care contracts or that such plans will not attempt to further reduce the rates they pay to providers. In addition, if we are unable to successfully reduce our costs, we may be unable to continue to provide services directly to patients of certain payors or through these contractual arrangements. This would have a material adverse effect on our business, financial condition, results of operations, cash flow, capital resources and liquidity.
27
The segment of the healthcare market in which we operate is highly competitive. In each of our service lines, there are a number of national providers and numerous regional and local providers. Other types of healthcare providers, including industrial gas manufacturers, individual hospitals and hospital systems, home health agencies and health maintenance organizations, have entered and may continue to enter the market to compete with our various service lines. With access to significantly greater financial and market resources than what is available to us, some of these competitors may be better positioned to compete in the market. This may increase pricing pressure and limit our ability to maintain or increase our market share and may have a material adverse effect on our business, financial condition, results of operations, cash flow, capital resources and liquidity.
Non-Compliance With Laws and Regulations Applicable to Our Business and Future Changes in Those Laws and Regulations Could Have a Material Adverse Effect on Us.
We are subject to many stringent and frequently changing laws and regulations, and interpretations thereof, at both the federal and state levels, requiring compliance with burdensome and complex billing and payment, substantiation and record-keeping requirements. On an ongoing basis, we have implemented policies and procedures designed to meet the various documentation requirements of government payors as they have been interpreted and applied. Examples of such documentation requirements are contained in the Durable Medical Equipment Medicare Administrative Contractor (DMEMAC) Supplier Manuals which provide that clinical information from the patients medical record is required to justify the medical necessity for the provision of DME. An auditor for one of the DMEMACs has recently taken the position, among other things, that the patients medical record refers not to documentation maintained by the DME supplier but instead to documentation maintained by the patients physician, healthcare facility, or other clinician, and that clinical information created by the DME suppliers personnel and confirmed by the patients physician is not sufficient to establish medical necessity. Other government auditors have recently taken the same or a similar position. It may be difficult, and sometimes impossible, for us to obtain such documentation from other healthcare providers. If these or other burdensome positions continue to be adopted by auditors, DMEMACs, other contractors or CMS in administering the Medicare program, we have the right to challenge these positions as being contrary to law. If these interpretations of the documentation requirements are ultimately upheld, however, it could result in our making significant refunds and other payments to Medicare and our future revenues from Medicare would likely be substantially reduced. We cannot currently predict the adverse impact, if any, that these new, more burdensome interpretations of the Medicare documentation requirements might have on our operations, cash flow and capital resources, but such impact could be material.
The federal False Claims Act imposes civil and criminal liability on individuals or entities that submit false or fraudulent claims for payment to the government. The federal government and a number of courts also have taken the position that claims presented in violation of certain other statutes, including the federal anti-kickback statute or the Omnibus Budget Reconciliation Act of 1993 (the Stark Law), can be considered a violation of the federal False Claims Act. Violations of the federal civil False Claims Act may result in treble damages, civil monetary penalties and exclusion from the Medicare, Medicaid and other federally funded healthcare programs. If certain criteria are satisfied, the federal civil False Claims Act allows a private individual to bring a qui tam suit on behalf of the government and, if the case is successful, to share in any recovery. Federal False Claims Act suits brought directly by the government or private individuals against healthcare providers, like us, are increasingly common and are expected to continue to increase.
The Reform Package also includes certain fraud and abuse prevention measures and expands regulatory authorities concerning the types of conduct that can result in additional fines and penalties for those healthcare providers who do not comply with applicable laws and regulations.
Financial relationships between us and physicians and other referral sources are also subject to strict limitations under laws such as the Stark Law and anti-kickback laws. In addition, strict licensure, accreditation, safety and marketing requirements apply to the provision of services, pharmaceuticals and medical equipment.
28
Violations of these laws and regulations could subject us to civil and criminal enforcement actions; licensure revocation, suspension or non-renewal; severe fines; facility shutdowns; repayment of amounts received from third party payors and possible exclusion from participation in federal healthcare programs such as Medicare and Medicaid. We cannot assure you that we are in compliance with all applicable existing laws and regulations or that we will be able to comply with any new laws or regulations that may be enacted in the future. In addition, from time to time, we may be the subject of investigations or audits or be a party to additional litigation which alleges violations of law. If any of those matters were successfully asserted against us, there could be a material adverse effect on our business, financial condition, results of operations, cash flow, capital resources, liquidity or prospects.
Changes in public policy, healthcare law, new interpretations of existing laws, or changes in payment methodology may have a significant effect on our business, financial condition, results of operations, cash flow, capital resources and liquidity.
Our Business and Financial Performance May Be Adversely Affected By Our Inability to Effectively Execute and Implement Cost Savings Initiatives.
We launched a substantial cost reduction plan in late 2007 across a number of identified initiatives presently targeting pre-tax savings of approximately $169 million on an annualized basis, of which we have realized approximately $135 million through June 30, 2010. The programs related to the remaining targeted annualized savings of $34 million to be realized include customer service and billing center centralization, purchasing cost reduction initiatives, outsourcing certain functions of our information technology department, a branch optimization program, outsourced equipment pickups and exchanges and document imaging. Projected costs and savings associated with these initiatives are subject to a variety of risks, including:
| the contemplated costs to effect these initiatives may exceed estimates; |
| the initiatives we are contemplating may require consultation with various customers, employees, labor representatives or regulators, and such consultations may influence the timing, costs and extent of expected savings; |
| the loss of skilled employees in connection with the initiatives; and |
| the projected savings contemplated under these programs may fall short of targets. |
While we have begun and expect to continue to implement these cost savings initiatives, there can be no assurance that we will be able to do so successfully or that we will realize the projected benefits of these and other restructuring and cost savings initiatives. If we are unable to realize these anticipated cost savings initiatives, our business may be adversely affected. Moreover, our continued implementation of cost savings initiatives may have a material adverse effect on our business, results of operations and financial condition, including but not limited to the loss of revenue, increases in accounts receivable and reserves and/or write-offs of accounts receivable. Also, in response to changing business conditions, we may discontinue or significantly adjust our cost savings initiatives which would affect our ability to achieve future cost savings.
Our Failure to Successfully Design, Modify and Implement Computer and Other Process Changes to Maximize Productivity and Ensure Compliance Could Ultimately Have a Significant Negative Impact on Our Results of Operations and Financial Condition.
We have identified a number of areas throughout our operations where we intend to modify the current processes or systems in order to attain a higher level of productivity or ensure compliance. The ultimate cost savings expected from the successful design and implementation of such initiatives will be necessary to help offset the impact of Medicare and Medicaid reimbursement reductions and continued downward pressure on pricing. Additionally, Medicare and Medicaid often change their documentation requirements. The DMEPOS competitive bidding program, once fully implemented, will also impose new reporting requirements on
29
contracted providers. Perot Systems Corporation, our outsourcing partner for certain information systems functions, was acquired by Dell Inc. in late 2009; new management could make operational, leadership or other changes that could impact our plans and cost-savings goals. Our failure to successfully design and implement system or process modifications could have a significant impact on our operations and financial condition. Further, the implementation of these system or process changes could have a disruptive effect on related transaction processing and operations.
Our Failure to Maintain Controls and Processes Over Billing and Collections or to Execute the Outsourcing Effectively, the Deterioration of the Financial Condition of Our Payors or Disputes With Third Parties Could Have a Significant Negative Impact on Our Results of Operations and Financial Condition.
The collection of accounts receivable is one of our most significant challenges and requires constant focus and involvement by management and ongoing enhancements to information systems and billing center operating procedures. For example, we have recently experienced an increase in accounts receivable attributable, among other things, to transitioning of some of our billing and collection functions to our outsourcing partner and to changes in payment practices by some of our payors and their intermediaries. While we believe that a portion of this increase is temporary, there can be no assurance that we will be able to return to or maintain our current levels of collectibility and days sales outstanding in future periods. Further, some of our payors and/or patients may experience financial difficulties, or may otherwise not pay accounts receivable when due, resulting in increased write-offs. If we are unable to properly bill and collect our accounts receivable, our results will be adversely affected. In addition, from time to time we are involved in disputes with various parties, including our payors and their intermediaries regarding their performance of various contractual or regulatory obligations. These disputes sometimes lead to legal and other proceedings and cause us to incur costs or experience delays in collections or loss of revenue. In addition, in the event such disputes are not resolved in our favor or cause us to terminate our relationships such parties, there may be an adverse impact on our results of operations or financial condition.
Our Outsourcing and Offshoring Activities Subject Us to Risks That Could Have a Significant Negative Impact on Our Results of Operations and Financial Condition.
We are pursuing an outsourcing strategy with respect to certain business functions. We are in the process of outsourcing certain billing, collections and other administrative and clerical services to Intelenet Global Services Private Limited (Intelenet) and certain information systems functions to Dell Services (formerly Perot Systems Corporation). See BusinessOutsourcing Activities and Certain Relationships and Related Party TransactionsIntelenet Agreement. There is intense competition around the world for skilled business process and technical professionals and we expect that competition to increase, which could result in our outsourcing strategy not having the favorable economic impact currently projected. Operations in other parts of the world involve certain regional geopolitical risks that are different than operating in the United States, including the possibility of civil unrest, terrorism and substantial regulation by the individual governments. In addition, federal and state regulators have expressed concerns regarding the impact of offshoring on American business in general, including, for example, job loss, security and privacy concerns. These factors may cause disruptions in our business processes which could have a material adverse impact on our operations. We also may experience negative reactions from federal and state regulators, payors, patients and referral sources as a result of the actual or perceived concerns caused by the outsourcing of portions of our business operations including increases in accounts receivables or reserves, write-offs of accounts receivables and/or loss of revenues.
Non-Compliance With the Requirements of Corams Certification of Compliance Agreement Could Result in the Imposition of Significant Penalties and Sanctions.
As part of our acquisition of Coram, we assumed Corams obligations including those imposed on Coram as part of its three-year Certification of Compliance Agreement with the U.S. Department of Health and Human Services (HHS) Office of Inspector General (OIG), which requires Coram to maintain a compliance
30
program, monitor and ensure compliance with federal healthcare program requirements and submit timely reports to the government regarding the same. The year 2009 marked the second year of the three-year agreement; in both 2008 and 2009, the OIG accepted our annual certification documents as filed. Violation of the terms of the Compliance Agreement could result in the imposition of significant penalties and sanctions, including disqualification from Medicare and other reimbursement programs.
Our Failure to Maintain Required Licenses Could Impact Our Operations.
We are required to maintain a significant number of state and/or federal licenses for our operations and facilities. Certain employeesprimarily those with clinical expertise in pharmacy, nursing, respiratory therapy and nutritionare required to maintain licenses in the states in which they practice. We manage the facility licensing function centrally. In addition, individual clinical employees are responsible for obtaining, maintaining and renewing their professional licenses and we also have processes in place designed to notify branch or pharmacy managers of renewal dates for the clinical employees under their supervision. State and federal licensing requirements are complex and often open to subjective interpretation by various regulatory agencies. In addition, from time to time, we may become subject to new or different licensing requirements due to legislative or regulatory requirements developments or changes in our business, and such developments may cause us to make further changes in our business, the results of which may be material. Although we believe we have the right systems in place to monitor licensure, violations of licensing requirements may occur and our failure to acquire or maintain appropriate licensure for our operations, facilities and clinicians could result in interruptions in our operations, refunds to state and/or federal payors, sanctions or fines, which could have an adverse material impact on our business, financial condition, results of operation, cash flow, capital resources and liquidity.
Our Failure to Maintain Accreditation Could Impact Our Operations.
Accreditation is required by most of our managed care payors and is a mandatory requirement for all Medicare DMEPOS providers effective October 1, 2009. In late June 2010, The Joint Commission completed its triennial survey cycle and we expect it to renew our three-year accreditation. If we or any of our branches lose accreditation, or if any of our new branches are unable to become accredited, our failure to maintain accreditation or become accredited could have a material adverse effect on our business, financial condition, results of operations, cash flow, capital resources and liquidity.
Political and Economic Conditions and the Recent Financial Turmoil in the United States and Global Capital and Credit Markets As Well As Significant Global or Regional Developments Such As Economic and Political Events, International Conflicts and Natural Disasters That are Out of Our Control Could Adversely Affect Our Revenue and Results of Operations and Overall Financial Growth and Could Have a Material Adverse Effect on Us.
Our business can be affected by a number of factors that are beyond our control such as general geopolitical, economic and business conditions, conditions in the financial services markets, and general political and economic developments. For example, the costs of military and security activities, government expenditures to support or bail out financial institutions or the U.S. credit markets in light of recent significant declines and volatility in the financial markets, or prolonged relief efforts in response to a natural disaster could increase pressure to reduce government expenditures for other purposes, including government-funded programs such as Medicare and Medicaid. In addition, reductions in reimbursement from Medicare and Medicaid programs could result if there is a significant change in government spending priorities. Any such reimbursement reductions could have a material adverse effect on our business, financial condition, results of operations, cash flow, capital resources and liquidity.
Recent turmoil in the financial markets, including in the capital and credit markets, the present economic slowdown and the uncertainty over its breadth, depth and duration may continue to put pressure on the global economy and could have a negative effect on our business. Further, the recent worldwide financial and credit
31
turmoil has reduced the availability of liquidity and credit to fund the continuation and expansion of business operations worldwide. The shortage of liquidity and credit combined with recent substantial losses in worldwide equity markets could extend the economic recession in the United States or worldwide. As widely reported, financial markets in the United States, Europe and Asia have experienced extreme disruption, including, among other things, extreme volatility in security prices, severely diminished liquidity and credit availability, rating downgrades of certain investments and declining valuations of others. Governments have taken unprecedented actions intended to address extreme market conditions that include severely restricted credit and declines in real estate values. There can be no assurance that the deterioration in financial markets will not impair our ability to obtain financing in the future, including, but not limited to, our ability to draw on funds under our ABL Facility and our ability to incur additional indebtedness. If conditions in the global economy, U.S. economy or other key vertical or geographic markets remain uncertain or weaken further, we could experience material adverse impacts on our business, financial condition, results of operations, cash flow, capital resources and liquidity.
Our Strategic Growth Plan, Which Involves the Acquisition of Other Companies, May Not Succeed.
Our strategic growth plan involves, in part, the acquisition of other companies such as our 2007 acquisition of Coram. Such growth involves a number of risks, including:
| difficulties related to combining previously separate businesses into a single unit, including product and service offerings, distribution and operational capabilities and business cultures; |
| availability of financing to the extent needed to fund acquisitions; |
| customer loss and other general business disruption; |
| managing the integration process while completing other independent acquisitions or dispositions; |
| diversion of managements attention from day-to-day operations; |
| assumption of liabilities of an acquired business, including unforeseen or contingent liabilities or liabilities in excess of the amounts estimated; |
| failure to realize anticipated benefits and synergies, such as cost savings and revenue enhancements; |
| potentially substantial costs and expenses associated with acquisitions and dispositions; |
| failure to retain and motivate key employees; |
| coordinating research and development activities to enhance the introduction of new products and services; and |
| difficulties in applying our internal control over financial reporting and disclosure controls and procedures to an acquired business. |
We May Not Be Able to Realize Anticipated Cost Savings, Revenue Enhancements or Synergies From the Transactions or From Our Acquisitions.
We may not be able to realize the potential cost savings, synergies and revenue enhancements that we anticipate from the Transactions or from our acquisitions, either in the amount or within the time frame that we expect, and the costs of achieving these benefits may be higher than, and the timing may differ from, what we expect. Our ability to realize anticipated cost savings, synergies and revenue enhancements may be affected by a number of factors, including, but not limited to, the following:
| the use of more cash or other financial resources on integration and implementation activities than we expect; |
| increases in other expenses unrelated to the Transactions or our acquisitions, which may offset the cost savings and other synergies from those transactions; |
32
| our ability to eliminate effectively duplicative back office overhead and overlapping and redundant selling, general and administrative functions; and |
| our ability to avoid labor disruptions in connection with any integration, particularly in connection with any headcount reduction. |
In addition, estimated cost savings are only estimates and may not actually be achieved in the timeframe anticipated or at all. If we fail to realize anticipated cost savings, synergies or revenue enhancements, our financial results will be adversely affected, and we may not generate the cash flow from operations that we anticipated, or that is sufficient to repay our indebtedness.
There is an Inherent Risk of Liability in the Provision of Healthcare Services; Damage to Our Reputation or Our Failure to Adequately Insure Against Losses Could Have a Material Adverse Effect on Our Operations, Financial Condition or Prospects.
There is an inherent risk of liability in the provision of healthcare services. As participants in the healthcare industry, we expect to periodically be subject to lawsuits, some of which may involve large claims and significant costs to defend. In that case, the coverage limits under our insurance programs may not be adequate to protect us. We also cannot be assured that we will be able to maintain this insurance on acceptable terms in the future. A successful claim in excess of our coverage could have a material adverse effect upon our business, financial condition, results of operations, cash flow, capital resources and liquidity. Even where our insurance is adequate to cover claims against us, damage to our reputation in the event of a judgment against us could have an adverse effect on our business, financial condition, results of operations, cash flow, capital resources, liquidity or prospects.
We Experience Competition From Numerous Other Home Respiratory/Home Medical Equipment and Home Infusion Therapy Service Providers, and This Competition Could Adversely Affect Our Revenues and Our Business.
The home respiratory/home medical equipment and home infusion therapy markets are highly competitive and include a large number of providers, some of which are national providers, but most of which are either regional or local providers. We believe that the primary competitive factors are quality considerations such as responsiveness, the technical ability of the professional staff and the ability to provide comprehensive services. These markets are very fragmented. Some of our competitors may now or in the future have greater financial or marketing resources than we do. In addition, in certain markets, competitors may have more effective sales and marketing activities. Our largest national home respiratory/home medical equipment provider competitors are American HomePatient, Inc., Lincare Holdings, Inc. and Rotech Healthcare Inc. Our largest competitors in the home infusion therapy service market are Walgreens/OptionCare and Accredo/Critical Care Systems. The rest of the market in the United States consists of several medium-size competitors, as well as numerous small (under $3.5 million in revenues) local operations. There are relatively few barriers to entry in local home healthcare markets. We cannot assure you that the competitive nature of the homecare environment will not adversely affect our revenues and our business.
Our Business Operations are Labor Intensive. Difficulty Hiring Enough Additional Management and Other Employees, Increasing Costs of Compensation or Employee Benefits, and the Potential Impact of Unionization and Organizing Activities Could Have an Adverse Effect on Our Costs and Results of Operations.
The success of our business depends upon our ability to attract and retain highly motivated, well-qualified management and other employees. One of our largest costs is in the payment of salaries and benefits to our approximately 11,400 employees. We face significant competition in the recruitment of qualified employees, which has caused increased salary and wage rates among certain employee groups. If we are unable to recruit or
33
retain a sufficient number of qualified employees, or if the costs of compensation or employee benefits increase substantially, our ability to deliver services effectively could suffer and our profitability would likely be adversely affected. The Reform Package may materially increase our cost of providing health benefits to our employees and their dependents. In addition, union organizing activities have occurred in the past and may occur in the future, and the adverse impact of unionization and organizing activities on our costs and operating results could be substantial.
We are Highly Dependent Upon Senior Management; Our Failure to Attract and Retain Key Members of Senior Management Could Have a Material Adverse Effect on Us.
We are highly dependent on the performance and continued efforts of our senior management team. Our future success is dependent on our ability to continue to attract and retain qualified executive officers and senior management. Any inability to manage our operations effectively could have a material adverse effect on our business, financial condition, results of operations, cash flow, capital resources and liquidity.
Our Reliance on Relatively Few Suppliers for the Majority of Our Patient Service Equipment, Pharmaceuticals and Supplies and New Excise Taxes Which Are To Be Imposed on Certain Manufacturers of Such Items Could Adversely Affect Our Ability to Operate.
We currently rely on a relatively small number of suppliers to provide us with the majority of our patient service equipment, pharmaceuticals and supplies. Significant price increases, or disruptions in the ability to obtain such equipment, pharmaceuticals and supplies from existing suppliers, may force us to use alternative suppliers. Additionally, the Reform Package calls for significant new excise taxes to be imposed on manufacturers of certain medical equipment and pharmaceuticalstaxes which they could attempt to pass on to customers such as us. Such manufacturers may be forced to make other changes to their products or manufacturing processes that are unacceptable to us, resulting in our desire to change suppliers. Any change in suppliers we use could cause delays in the delivery of such products and possible losses in revenue, which could adversely affect our results of operations. In addition, alternative suppliers may not be available, or may not provide their products and services at similar or favorable prices. If we cannot obtain the patient service equipment, pharmaceuticals and supplies we currently use, or alternatives at similar or favorable prices, our ability to provide such products may be severely impacted, which could have an adverse effect on our business, financial condition, results of operations, cash flow, capital resources and liquidity.
Our Failure to Establish and Maintain Relationships With Hospital and Physician Referral Sources May Cause Our Revenue to Decline.
Our success is partly dependent on referrals from hospital and physician sources. If we are unable to successfully establish new referral sources and maintain strong relationships with our current referral sources, or if efforts to increase the skill level and effectiveness of our sales force fail, our revenues may decline.
Changes in Medical Equipment Technology and Development of New Treatments May Cause Our Current Equipment or Services to Become Obsolete.
We evaluate changes in home medical equipment technology and treatments on an ongoing basis for purposes of determining the feasibility of replacing or supplementing items currently included in the patient service equipment inventory and services that we offer our customers. The selection of medical equipment and services we offer is formulated on the basis of a variety of factors, including overall quality, functional reliability, availability of supply, payor reimbursement policies, product features, labor costs associated with the technology, acquisition, repair and ownership costs and overall patient and referral source demand, as well as patient therapeutic and lifestyle benefits. Manufacturers continue to invest in research and development to introduce new products to the marketplace. It is possible that major changes in available technology, payor benefit or coverage policies related to those changes, or the preferences of patients and referral sources may cause our current
34
product offerings to become less competitive or obsolete, and it will be necessary for us to adapt to those changes. We endeavor to anticipate industry trends and initiate new product offerings in a way that minimizes the financial impact of increased cost of goods sold, equipment replacement costs and other expenses associated with changes in technology and demand. For example, Medicare DMEPOS competitive bidding regulations contain policies relating to the provision of products covered by the program. However, unanticipated changes could cause us to incur increased capital expenditures and accelerated equipment write-offs, and could force us to alter our sales, operations and marketing strategies.
Our Operations Involve the Transport of Compressed and Liquid Oxygen, Which Carries an Inherent Risk of Rupture or Other Accidents With the Potential to Cause Substantial Loss.
Our operations are subject to the many hazards inherent in the transportation of medical gas products and compressed and liquid oxygen, including ruptures, leaks and fires. These risks could result in substantial losses due to personal injury or loss of life, severe damage to and destruction of property and equipment and pollution or other environmental damage and may result in curtailment or suspension of our related operations. If a significant accident or event occurs, it could adversely affect our financial position and results of operations.
Our Medical Gas Facilities and Operations are Subject to Extensive Regulation by Federal and State Authorities and There Can Be No Assurance That Our Medical Gas Facilities Will Achieve and Maintain Compliance With Such Regulations.
We have a number of medical gas facilities in several states subject to federal and state regulatory requirements. Our medical gas facilities and operations are subject to extensive regulation by the Food and Drug Administration (FDA) and other federal and state authorities. The FDA regulates medical gases, including medical oxygen, pursuant to its authority under the federal Food, Drug and Cosmetic Act (FFDCA). Among other requirements, the FDAs current Good Manufacturing Practice (cGMP) regulations impose certain quality control, documentation and recordkeeping requirements on the receipt, processing and distribution of medical gas. Further, in each state in which we do business, our medical gas facilities are subject to regulation under state health and safety laws, which vary from state to state. The FDA and state authorities conduct periodic, unannounced inspections at medical gas facilities to assess compliance with the cGMP and other regulations, and we expend significant time, money and resources in an effort to achieve substantial compliance with the cGMP regulations and other federal and state law requirements at each of our medical gas facilities. In the fourth quarter of 2009, the FDA changed its methodology for medical gas providers to register their sites with the agency; we complied with the regulation. There can be no assurance, however, that these efforts will be successful and that our medical gas facilities will achieve and maintain compliance with federal and state law regulations. Our failure to achieve and maintain regulatory compliance at our medical gas facilities could result in enforcement action, including warning letters, fines, product recalls or seizures, temporary or permanent injunctions, or suspensions in operations at one or more locations, and civil or criminal penalties which would materially harm our business, financial condition, results of operations, cash flow, capital resources and liquidity.
We have in the Past Identified a Material Weakness in Our Internal Controls Over Financial Reporting as it Relates to the Calculation of Accounts Receivable Reserves. If We Do Not Maintain Effective Internal Controls Over Financial Reporting, We Could Fail to Accurately Report Our Financial Results.
We have in the past identified a material weakness in our internal control over financial reporting. In light of this material weakness in internal control over financial reporting, we also concluded that our disclosure controls and procedures were not effective as of certain dates in 2007 and 2008.
A material weakness is defined by the standards issued by the Public Company Accounting Oversight Board as a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected. We did not effectively design and perform control activities to prevent or detect material misstatements that might exist in our reserve for uncollectible accounts receivable. Specifically, we did not
35
perform an analysis with a sufficient level of detail to support managements estimate of the reserve for uncollectible accounts receivable.
During 2008, we implemented a remediation program designed to address such material weakness. In the fourth quarter of 2008, we concluded that our remediation program was operating effectively and as of December 31, 2008, management concluded that the material weakness was remediated and did not exist as of that date. If our remediation efforts are insufficient to address the material weaknesses, or if additional material weaknesses in our internal controls are discovered in the future, they may adversely affect our ability to record, process, summarize and report financial information timely and accurately and, as a result, our financial statements may contain material misstatements or omissions.
We have completed a number of acquisitions in the past several years, and may continue to pursue growth through strategic acquisitions. Among the risks associated with acquisitions are the risks of control deficiencies that result from the integration of the acquired business.
It is possible that control deficiencies could be identified by our management or by our independent auditing firm in the future or may occur without being identified. Such a failure could result in regulatory scrutiny, cause investors to lose confidence in our reported financial condition, lead to a default under our indebtedness and otherwise materially adversely affect our business and financial condition.
Affiliates of the Sponsor Own Substantially All of the Equity Interests in Us and May Have Conflicts of Interest With Us or the Holders of the Notes in the Future.
As a result of the Merger, investment funds affiliated with the Sponsor collectively own a substantial majority of our capital stock, and the Sponsor designees hold a majority of the seats on our Board of Directors. As a result, affiliates of the Sponsor have control over our decisions to enter into any corporate transaction and have the ability to prevent any transaction that requires the approval of stockholders regardless of whether holders of our Notes believe that any such transactions are in their own best interests. For example, affiliates of the Sponsor could collectively cause us to make acquisitions that increase the amount of our indebtedness or to sell assets, or could cause us to issue additional capital stock or declare dividends. So long as investment funds affiliated with the Sponsor continue to indirectly own a significant amount of the outstanding shares of our common stock, affiliates of the Sponsor will continue to be able to strongly influence or effectively control our decisions. The indenture governing the Notes and the credit agreement governing our ABL Facility permit us to pay advisory and other fees, dividends and make other restricted payments to the Sponsor under certain circumstances and the Sponsor or its affiliates may have an interest in our doing so. In addition, the Sponsor has no obligation to provide us with any additional debt or equity financing.
Additionally, the Sponsor is in the business of making investments in companies and may from time to time acquire and hold interests in businesses that compete directly or indirectly with us or that supply us with goods and services. For example, the Sponsor controls Intelenet, an Indian company with which we contracted in 2009 to assist us with the outsourcing of certain revenue management functions. The Sponsor may also pursue acquisition opportunities that may be complementary to our business and, as a result, those acquisition opportunities may not be available to us. The holders of the Notes should consider that the interests of the Sponsor and other members of the Investor Group may differ from their interests in material respects. See Security Ownership of Principal Shareholders and Management, Certain Relationships and Related Party Transactions, Description of Notes, and Description of Other Indebtedness.
Proposed Federal Legislation, If Passed, Would Encourage Greater Unionization and Could Materially Impact Our Labor Costs and Customer Service Provided to Patients.
It is possible that the U.S. Congress will pass the Employee Free Choice Act, legislation which would change existing laws concerning union representation. The proposed Employee Free Choice Act would in certain circumstances eliminate the secret ballot voting process, shorten the time window in which a contract negotiation
36
between an employee and a labor union must take place and mandate arbitration of contract terms if a negotiated contract is not met within certain timeframes. While the ultimate outcome of this legislation is still unclear, any increased union representation within the homecare industry or mandatory arbitration of contract terms would potentially increase labor and other operating expenses. Additional unionization could also negatively impact our ability to provide high quality service to patients in the event of a strike or other work stoppage.
Our Ability to Retain Certain Hospital-Based Referral Revenue is Contingent on the Quality of Our Referral Process and Patient Service.
For over a decade, we have implemented a contractual business model with a number of hospitals which facilitates continuity of care and quality for patients who are being discharged from those hospitals to the homecare setting. We discontinued most of these arrangements in 2009. In these cases, we continue to work closely with the hospitals to accept discharges for their patients who require our services. However, the dissolution of the contractual relationship may result in the decision by hospitals to refer patients to our competitors in lieu of or in addition to us. We are not able to predict whether the discontinuance of these hospital arrangements will have a material impact on our overall operational and financial results.
Our Payor Contracts are Subject to Renegotiation or Termination Which Could Result in a Decrease in Our Revenue and Profits.
From time to time, our payor contracts are amended, renegotiated or terminated altogether. Sometimes in the renegotiation process, certain lines of business may not be renewed or a payor may enlarge its provider network or otherwise adversely change the way it conducts its business with us. In other cases, a payor may reduce its provider network in exchange for lower payment rates. Our revenue from a payor may also be adversely affected if the payor alters its administrative procedures for payments and audits or changes its order of preference among the providers to which it refers business. We cannot assure you that our payor contracts will not be terminated or altered in ways that are unfavorable to us as a result of renegotiation or such administrative changes.
Risks Relating to the Notes
Our Substantial Indebtedness Could Adversely Affect Our Financial Condition and Prevent Us From Fulfilling Our Obligations Under the Notes.
We have a substantial amount of debt, which requires significant interest and principal payments. As of June 30, 2010, we had approximately $1,020.3 million of total debt outstanding. Subject to the limits contained in the credit agreement governing our ABL Facility, the indenture governing the Notes and our other debt instruments, we may be able to incur substantial additional debt from time to time to finance working capital, capital expenditures, investments or acquisitions, or for other purposes. If we do so, the risks related to our high level of debt could intensify. Specifically, our high level of debt could have important consequences to the holders of the Notes, including the following:
| making it more difficult for us to satisfy our obligations with respect to the Notes and our other debt; |
| limiting our ability to obtain additional financing to fund future working capital, capital expenditures, acquisitions or other general corporate requirements; |
| requiring a substantial portion of our cash flows to be dedicated to debt service payments instead of other purposes, thereby reducing the amount of cash flows available for working capital, capital expenditures, acquisitions and other general corporate purposes; |
| increasing our vulnerability to general adverse economic and industry conditions; |
| exposing us to the risk of increased interest rates as certain of our borrowings may be at variable rates of interest; |
37
| limiting our flexibility in planning for and reacting to changes in the industry in which we compete; |
| placing us at a disadvantage compared to other, less leveraged competitors; and |
| increasing our cost of borrowing. |
Our Variable Rate Indebtedness Subjects Us to Interest Rate Risk, Which Could Cause Our Indebtedness Service Obligations to Increase Significantly.
Borrowings under our ABL Facility are at variable rates of interest and expose us to interest rate risk. If interest rates increase, our debt service obligations on the variable rate indebtedness would increase even though the amount borrowed remained the same, and our net income and cash flows, including cash available for servicing our indebtedness, would correspondingly decrease.
We May Be Unable to Service Our Indebtedness, Including the Notes.
Our ability to make scheduled payments on and to refinance our indebtedness, including the Notes, depends on and is subject to our financial and operating performance, which in turn is affected by general and regional economic, financial, competitive, business and other factors beyond our control, including the availability of financing in the international banking and capital markets. We cannot assure you that our business will generate sufficient cash flow from operations or that future borrowings will be available to us in an amount sufficient to enable us to service our debt, including the Notes, to refinance our debt or to fund our other liquidity needs. If we are unable to meet our debt service obligations or to fund our other liquidity needs, we will need to restructure or refinance all or a portion of our debt, including the Notes, which could cause us to default on our debt obligations and impair our liquidity. Any refinancing of our indebtedness could be at higher interest rates and may require us to comply with more onerous covenants that could further restrict our business operations.
The Indenture Governing the Notes and the Credit Agreement Governing Our ABL Facility Impose Significant Operating and Financial Restrictions on Our Company and Our Subsidiaries, Which May Prevent Us From Capitalizing on Business Opportunities.
The indenture governing the Notes and the credit agreement governing our ABL Facility impose significant operating and financial restrictions on us. These restrictions will limit our ability, among other things, to:
| incur additional indebtedness or enter into sale and leaseback obligations; |
| pay certain dividends or make certain distributions on our capital stock or repurchase or redeem our capital stock; |
| make certain capital expenditures; |
| make certain loans, investments or other restricted payments; |
| place restrictions on the ability of our subsidiaries to pay dividends or make other payments to us; |
| engage in transactions with stockholders or affiliates; |
| sell certain assets or engage in mergers, acquisitions and other business combinations; |
| amend or otherwise alter the terms of our indebtedness; |
| alter the business that we conduct; |
| guarantee indebtedness or incur other contingent obligations; and |
| create liens. |
Our ABL Facility also includes financial covenants. Our ability to comply with these covenants is dependent on our future performance, which will be subject to many factors, some of which are beyond our control.
38
As a result of these covenants and restrictions, we are limited as to how we conduct our business and we may be unable to raise additional debt or equity financing to compete effectively or to take advantage of new business opportunities. The terms of any future indebtedness we may incur could include more restrictive covenants. We cannot assure you that we will be able to maintain compliance with these covenants in the future and, if we fail to do so, that we will be able to obtain waivers from the lenders and/or amend the covenants.
Our failure to comply with the restrictive covenants described above as well as other terms of our existing indebtedness and/or the terms of any future indebtedness from time to time could result in an event of default, which, if not cured or waived, could result in our being required to repay these borrowings before their due date. If we are forced to refinance these borrowings on less favorable terms, our results of operations and financial condition could be adversely affected.
Claims of Holders of the Series A-2 Notes Will Be Effectively Subordinated to Claims of Lenders Under the ABL Facility to the Extent of the Value of the Collateral Securing the ABL Facility on a First-Priority Lien Basis.
The Series A-2 Notes are secured on a first-priority lien basis by the Notes Collateral (as defined below) and on a second-priority lien basis by the ABL Collateral (as defined below). The Series A-2 Notes and the related guarantees will be effectively subordinated in right of payment to all of our and our subsidiary guarantors secured indebtedness under the ABL Facility to the extent of the value of the collateral securing the ABL Facility on a first-priority lien basis. In the event of a bankruptcy, liquidation, dissolution, reorganization or similar proceeding against us, the assets that are securing indebtedness under the ABL Facility on a first-priority lien basis must first be used to pay the first-priority claims under the ABL Facility in full before these assets may be used to make any payments on the Series A-2 Notes. After claims of the lenders under the ABL Facility have been satisfied in full, to the extent of the value of the collateral securing the ABL Facility on a first-priority lien basis, there may be no assets remaining under the ABL Collateral that may be applied to satisfy the claims of holders of the Series A-2 Notes.
Claims of Holders of the Notes Will Be Structurally Subordinated to Claims of Creditors of Certain of Our Subsidiaries That Will Not Guarantee the Notes.
The Notes may not be guaranteed by certain of our future subsidiaries, including all of our non-U.S. subsidiaries. Accordingly, claims of holders of the Notes will be structurally subordinated to the claims of creditors of these non-guarantor subsidiaries, including trade creditors. All obligations of our non-guarantor subsidiaries will have to be satisfied before any of the assets of such subsidiaries would be available for distribution, upon a liquidation or otherwise, to us or a guarantor of the Notes. The indenture governing the Notes will permit these subsidiaries to incur certain additional debt and will not limit their ability to incur other liabilities that are not considered indebtedness under the indenture.
Our Failure to Comply With the Agreements Relating to Our Outstanding Indebtedness, Including as a Result of Events Beyond Our Control, Could Result in an Event of Default That Could Materially and Adversely Affect Our Results of Operations and Our Financial Condition.
If there were an event of default under any of the agreements relating to our outstanding indebtedness, the holders of the defaulted debt could cause all amounts outstanding with respect to that debt to be due and payable immediately. We cannot assure you that our assets or cash flow would be sufficient to fully repay borrowings under our outstanding debt instruments if accelerated upon an event of default. Further, if we are unable to repay, refinance or restructure our indebtedness under our secured debt, the holders of such debt could proceed against the collateral securing that indebtedness. In addition, any event of default or declaration of acceleration under one debt instrument could also result in an event of default under one or more of our other debt instruments.
39
Federal and State Statutes May Allow Courts, Under Specific Circumstances, to Void the Notes and the Guarantees, Subordinate Claims in Respect of the Notes and the Guarantees and/or Require Holders of the Notes to Return Payments Received From Us.
Under the federal bankruptcy laws and comparable provisions of state fraudulent transfer laws, the Notes and the guarantees could be voided, or claims in respect of the Notes and the guarantees could be subordinated to all of our other debt, if the issuance of the Notes or a guarantee was found to have been made for less than their reasonable equivalent value and we, at the time we incurred the indebtedness evidenced by the Notes:
| were insolvent or rendered insolvent by reason of such indebtedness; |
| were engaged in, or about to engage in, a business or transaction for which our remaining assets constituted unreasonably small capital; or |
| intended to incur, or believed that we would incur, debts beyond our ability to pay such debts as they mature. |
A court might also void the issuance of Notes or a guarantee, without regard to the above factors, if the court found that we issued the Notes or the guarantors entered into their respective guarantees with actual intent to hinder, delay or defraud our or their respective creditors.
A court would likely find that we or a guarantor did not receive reasonably equivalent value or fair consideration for the Notes or the guarantees, respectively, if we or a guarantor did not substantially benefit directly or indirectly from the issuance of the Notes. If a court were to void the issuance of the Notes or the guarantees, you would no longer have a claim against us or the guarantors. Sufficient funds to repay the Notes may not be available from other sources, including the remaining guarantees, if any. In addition, the court might direct you to repay any amounts that you already received from us or the guarantors with respect to the Notes.
In addition, any payment by us pursuant to the Notes made at a time we were found to be insolvent could be voided and required to be returned to us or to a fund for the benefit of our creditors if such payment is made to an insider within a one-year period prior to a bankruptcy filing or within 90 days for any outside party and such payment would give the creditors more than such creditors would have received in a distribution under Title 11 of the United States Code, as amended (the Bankruptcy Code).
The measures of insolvency for purposes of these fraudulent transfer laws will vary depending upon the law applied in any proceeding to determine whether a fraudulent transfer has occurred. Generally, however, we would be considered insolvent if:
| the sum of our debts, including contingent liabilities, were greater than the fair saleable value of all our assets; |
| the present fair saleable value of our assets were less than the amount that would be required to pay our probable liability on existing debts, including contingent liabilities, as they become absolute and mature; or |
| we could not pay our debts as they become due. |
In addition, although each guarantee will contain a provision intended to limit that guarantors liability to the maximum amount that it could incur without causing the incurrence of obligations under its guarantee to be a fraudulent transfer, this provision may not be effective to protect those guarantees from being voided under fraudulent transfer law, or may reduce that guarantors obligation to an amount that effectively makes its guarantee worthless.
Finally, as a court of equity, the bankruptcy court may subordinate the claims in respect of the Notes to other claims against us under the principle of equitable subordination, if the court determines that: (i) the holder of the Notes engaged in some type of inequitable conduct; (ii) such inequitable conduct resulted in injury to our
40
other creditors or conferred an unfair advantage upon the holder of the Notes; and (iii) equitable subordination is not inconsistent with the provisions of the Bankruptcy Code.
Holders of the Notes May Not Be Able to Fully Realize the Value of Their Liens.
The security interests and liens for the benefit of holders of the Notes may be released without such holders consent in specified circumstances. In particular, the security documents governing the Notes and our ABL Facility generally provide for an automatic release of all liens on any asset securing our ABL Facility on a first-priority basis and that is disposed of in compliance with the provisions of our ABL Facility and the indenture governing the Notes. As a result, we cannot assure holders of the Notes that the Notes will continue to be secured by a substantial portion of our assets. In addition, the capital stock of our subsidiaries will be excluded from the collateral to the extent liens thereon would trigger reporting obligations under Rule 3-16 of Regulation S-X, which requires financial statements from any company whose securities are collateral if its book value or market value, whichever is greater, would exceed 20% of the principal amount of the Notes secured thereby.
The Collateral May Not Be Valuable Enough to Satisfy All the Obligations Secured by Such Collateral.
The Notes are secured on a first-priority lien basis (subject to certain exceptions) by substantially all of our and the guarantors assets (other than accounts receivable, inventory and cash and proceeds and products of the foregoing and certain assets related thereto) (the Notes Collateral) and such collateral may be shared in certain circumstances with our future creditors; provided that the Series A-1 Notes are entitled to a priority of payment over our Series A-2 Notes in certain circumstances, including upon any acceleration of the obligations under the Notes or any bankruptcy or insolvency event of default with respect to the Issuer or any guarantor. The actual value of the Notes Collateral at any time will depend upon market and other economic conditions. The Notes are also secured on a second-priority lien basis (subject to certain exceptions) by our and each guarantors accounts receivable, inventory and cash and proceeds and products of the foregoing and certain assets related thereto (the ABL Collateral). The ABL Collateral will be subject to a first-priority security interest for the benefit of the lenders under our ABL Facility, and may be shared with our future creditors. Although the holders of obligations secured by first-priority liens on the ABL Collateral and the holders of obligations secured by second-priority liens on the ABL Collateral, including the Notes, will share in the proceeds of the ABL Collateral, the holders of obligations secured by first-priority liens in the ABL Collateral will be entitled to receive proceeds from any realization of the ABL Collateral to repay the obligations held by them in full before the holders of the Notes and the holders of other obligations secured by second-priority liens in the ABL Collateral receive any such proceeds.
In addition, the asset sale covenant and the definition of asset sale in the indenture governing the Notes have a number of significant exceptions pursuant to which we will be able to sell Notes Collateral without being required to reinvest the proceeds of such sale into assets that will comprise Notes Collateral or to make an offer to the holders of the Notes to repurchase the Notes.
All indebtedness under our ABL Facility will be secured by first-priority liens on the ABL Collateral (subject to certain exceptions). In addition, under the terms of the indenture governing the Notes, we may grant certain additional liens on any property or asset that constitutes ABL Collateral. Any grant of additional liens on the ABL Collateral would further dilute the value of the second-priority lien on the ABL Collateral securing the Notes. Further, as discussed above, we will be permitted under the terms of the indenture governing the Notes to sell all assets that constitute ABL Collateral and not apply the proceeds to invest in additional assets that will secure the Notes or repay outstanding indebtedness. The value of the pledged assets in the event of a liquidation will depend upon market and economic conditions, the availability of buyers and similar factors. No independent appraisals of any of the pledged property have been prepared by or on behalf of us in connection with the Notes. Accordingly, we cannot assure holders of the Notes that the proceeds of any sale of the pledged assets following an acceleration to maturity with respect to the Notes would be sufficient to satisfy, or would not be substantially less than, amounts due on the Notes and the other debt secured thereby. If the proceeds of any sale of the pledged assets were not sufficient to repay all amounts due on the Notes, the holders of the Notes (to the extent their Notes were not repaid from the proceeds of the sale of the
41
pledged assets) would have only an unsecured claim against our remaining assets. By their nature, some or all of the pledged assets may be illiquid and may have no readily ascertainable market value. Likewise, we cannot assure holders of the Notes that the pledged assets will be saleable or, if saleable, that there will not be substantial delays in their liquidation. To the extent that liens, rights and easements granted to third parties encumber assets located on property owned by us or constitute subordinate liens on the pledged assets, those third parties may have or may exercise rights and remedies with respect to the property subject to such encumbrances (including rights to require marshalling of assets) that could adversely affect the value of the pledged assets located at that site and the ability of the collateral agent to realize or foreclose on the pledged assets at that site.
In addition, the indenture governing the Notes permits us to issue additional secured debt, including debt secured equally and ratably by the same assets pledged for the benefit of the holders of the Notes and entitled to a priority of payment over the Series A-2 Notes to the same extent as the Series A-1 Notes. For example, we are permitted to issue additional Series A-1 Notes ($150.0 million at any time and an additional $150.0 million for acquisitions under certain circumstances), and we are permitted to incur up to an additional $200.0 million of debt which ranks equally and ratably with the Series A-1 Notes. This could reduce amounts payable to holders of the Series A-2 Notes from the proceeds of any sale of the collateral.
The Rights of Holders of the Notes With Respect to the ABL Collateral Will Be Substantially Limited by the Terms of the Intercreditor Agreement.
Under the terms of the intercreditor agreement which was entered into in connection with our ABL Facility, at any time that obligations that have the benefit of the first-priority liens on the ABL Collateral are outstanding, any actions that may be taken in respect of the ABL Collateral, including the ability to cause the commencement of enforcement proceedings against the ABL Collateral and to control the conduct of such proceedings, and the approval of amendments to, releases of ABL Collateral from the lien of, and waivers of past defaults under, the security documents, will be at the direction of the holders of the obligations secured by the first-priority liens. Neither the trustee nor the collateral agent, on behalf of the holders of the Notes, will have the ability to control or direct such actions, even if the rights of the holders of the Notes are adversely affected, subject to certain exceptions. See Description of NotesSecurity for the Notes and Description of NotesAmendment, Supplement and Waiver. Under the terms of the intercreditor agreement, at any time that obligations that have the benefit of the first-priority liens on the ABL Collateral are outstanding, if the holders of such indebtedness release the ABL Collateral for any reason whatsoever, including, without limitation, in connection with any sale of assets, the second-priority security interest in such ABL Collateral securing the Notes will be automatically and simultaneously released without any consent or action by the holders of the Notes, subject to certain exceptions. The ABL Collateral so released will no longer secure our and the guarantors obligations under the Notes. In addition, because the holders of the indebtedness secured by first-priority liens in the ABL Collateral control the disposition of the ABL Collateral, such holders could decide not to proceed against the ABL Collateral, regardless of whether there is a default under the documents governing such indebtedness or under the indenture governing the Notes. In such event, the only remedy available to the holders of the Notes would be to sue for payment on the Notes and the related guarantees under the indenture. In addition, the intercreditor agreement gives the holders of first-priority liens on the ABL Collateral the right to access and use the collateral that secures the Notes to allow those holders to protect the ABL Collateral and to process, store and dispose of the ABL Collateral.
The Rights of the Holders of the Notes With Respect to the Notes Collateral Will Be Substantially Limited by the Terms of the Intercreditor and Collateral Agency Agreement.
The relationship among the Series A-1 Notes and the Series A-2 Notes will be governed by an intercreditor and collateral agency agreement that was entered into in connection with the issuance of the Series A-1 Notes. This agreement describes, among other things, the obligations, powers and duties of the Notes Collateral Agent, actions and voting by the Series A-1 Notes and the Series A-2 Notes, the exercise of remedies, and the application of collateral proceeds. Pursuant to this agreement, the holders of the Series A-1 Notes (and certain
42
other secured indebtedness we are permitted under the indenture to incur) will be entitled to a priority of payment over the holders of the Series A-2 Notes in respect of any amounts received from the Company or any guarantor (or from the proceeds of any Notes Collateral or ABL Collateral) following any acceleration of the obligations under the Notes or any bankruptcy or insolvency event of default with respect to the Company or any significant subsidiary under the Notes, whether received from the proceeds of an asset sale, reorganization, liquidation, sale pursuant to section 363 of the bankruptcy code, any adequate protection payments, or otherwise. Pursuant to this priority waterfall, the holders of the Series A-1 Notes must receive an amount equal to all obligations, including accrued and unpaid interest outstanding on or prior to the acceleration or filing date, owing to them in respect of the Series A-1 Notes on the date of any payment or other distribution or other receipt of proceeds (other than amounts calculated in respect of postpetition interest, including amounts payable as adequate protection) before the holders of the Series A-2 Notes are entitled to receive any distribution on account of the obligations owing to them in respect of the Series A-2 Notes. In a situation in which the priority waterfall is in effect, if the Notes Collateral was fully liquidated and the proceeds of collateral distributed to the holders of the Series A-1 Notes were not sufficient to repay in full all obligations owing to them in respect of the Series A-1 Notes, then there would not be sufficient collateral proceeds to provide a recovery to holders of the Series A-2 Notes. In such event, holders of the Series A-2 Notes would have only an unsecured claim against our remaining assets.
The Value of the Collateral Securing the Notes May Not Be Sufficient to Secure Post-Petition Interest.
In the event of a bankruptcy, liquidation, dissolution, reorganization or similar proceeding against us, holders of the Notes will only be entitled to post-petition interest under the Bankruptcy Code to the extent that the value of their security interest in the collateral is greater than their pre-bankruptcy claim. Holders of the Notes that have a security interest in collateral with a value equal or less than their pre-bankruptcy claim will not be entitled to post-petition interest under the Bankruptcy Code. No appraisal of the fair market value of the collateral has been prepared in connection with the Notes and we therefore cannot assure you that the value of the noteholders interest in the collateral equals or exceeds the principal amount of the Notes. In addition, the ability of the holders of the Notes to receive post-petition interest may be further limited by the intercreditor agreement that was entered into in connection with the offering of the Series A-1 Notes that defines the relative rights of the Notes. In particular, the provisions relating to the priority of payments of the Series A-1 Notes over the Series A-2 Notes in certain circumstances also provide that the holders of the Series A-2 Notes are entitled to postpetition interest only after all obligations, including any accrued and unpaid pre-petition interest, in respect of the Series A-1 Notes are satisfied in full. See The Collateral May Not Be Valuable Enough to Satisfy All the Obligations Secured by Such Collateral and Description of NotesPriorities of Payment as between Series A-2 Debt (including the Series A-2 Notes) and Series A-1 NotesWaterfall of Payment Following Acceleration or in Bankruptcy.
The Waiver in the Intercreditor Agreement of Rights of Marshaling May Adversely Affect the Recovery Rates of Holders of the Notes in a Bankruptcy or Foreclosure Scenario.
The Notes and the guarantees are secured on a second-priority lien basis by the ABL Collateral. The intercreditor agreement provides that, at any time that obligations that have the benefit of the first-priority liens on the ABL Collateral are outstanding, the holders of the Notes, the trustee under the indenture governing the Notes and the collateral agent for the Notes may not assert or enforce any right of marshaling accorded to a junior lienholder, as against the holders of such indebtedness secured by first-priority liens in the ABL Collateral. Without this waiver of the right of marshaling, holders of such indebtedness secured by first-priority liens in the ABL Collateral would likely be required to liquidate collateral on which the Notes did not have a lien, if any, prior to liquidating the ABL Collateral, thereby maximizing the proceeds of the ABL Collateral that would be available to repay our obligations under the Notes. As a result of this waiver, the proceeds of sales of the ABL Collateral could be applied to repay any indebtedness secured by first-priority liens in the ABL Collateral before applying proceeds of other collateral securing indebtedness, and the holders of the Notes may recover less than they would have if such proceeds were applied in the order most favorable to the holders of the Notes.
43
In the Event of a Bankruptcy of Us or Any of the Guarantors, Holders of the Notes May Be Deemed to Have an Unsecured Claim to the Extent That Our Obligations in Respect of the Notes Exceed the Fair Market Value of the Collateral Securing the Notes.
In any bankruptcy proceeding with respect to us or any of the guarantors, it is possible that the bankruptcy trustee, the debtor-in-possession or competing creditors will assert that the fair market value of the collateral with respect to the Notes on the date of the bankruptcy filing was less than the then-current principal amount of the Notes. Upon a finding by the bankruptcy court that the Notes are under-collateralized, the claims in the bankruptcy proceeding with respect to the Notes would be bifurcated between a secured claim and an unsecured claim, and the unsecured claim would not be entitled to the benefits of security in the collateral. Other consequences of a finding of under-collateralization would be, among other things, a lack of entitlement on the part of the Notes to receive post-petition interest and a lack of entitlement on the part of the unsecured portion of the Notes to receive other adequate protection under federal bankruptcy laws. In addition, if any payments of post-petition interest had been made at the time of such a finding of under-collateralization, those payments could be recharacterized by the bankruptcy court as a reduction of the principal amount of the secured claim with respect to the Notes.
Because Each Guarantors Liability Under its Guarantees May Be Reduced to Zero, Avoided or Released Under Certain Circumstances, You May Not Receive Any Payments From Some or All of the Guarantors.
You have the benefit of the guarantees of the guarantors. However, the guarantees by the guarantors are limited to the maximum amount that the guarantors are permitted to guarantee under applicable law. As a result, a guarantors liability under its guarantee could be reduced to zero, depending upon the amount of other obligations of such guarantor. Further, under the circumstances discussed more fully above, a court under federal and state fraudulent conveyance and transfer statutes could void the obligations under a guarantee or further subordinate it to all other obligations of the guarantor. SeeFederal and State Statutes May Allow Courts, Under Specific Circumstances, to Void the Notes and the Guarantees, Subordinate Claims in Respect of the Notes and the Guarantees and/or Require Holders of the Notes to Return Payments Received From Us. In addition, you will lose the benefit of a particular guarantee if it is released under certain circumstances described under Description of NotesGuarantees.
Bankruptcy Laws May Limit the Ability of Holders of the Notes to Realize Value From the Collateral.
The right of the collateral agent to repossess and dispose of the pledged assets upon the occurrence of an event of default under the indenture governing the Notes is likely to be significantly impaired by applicable bankruptcy law if a bankruptcy case were to be commenced by or against us before the collateral agent repossessed and disposed of the pledged assets. For example, under the Bankruptcy Code, pursuant to the automatic stay imposed upon the bankruptcy filing, a secured creditor is prohibited from repossessing its security from a debtor in a bankruptcy case, or from disposing of security repossessed from such debtor, or taking other actions to levy against a debtor, without bankruptcy court approval. Moreover, the Bankruptcy Code permits the debtor to continue to retain and to use collateral even though the debtor is in default under the applicable debt instruments, provided that the secured creditor is given adequate protection. The meaning of the term adequate protection may vary according to circumstances (and is within the discretion of the bankruptcy court), but it is intended in general to protect the value of the secured creditors interest in the collateral and may include cash payments or the granting of additional security, if and at such times as the court in its discretion determines, for any diminution in the value of the collateral as a result of the automatic stay of repossession or disposition or any use of the collateral by the debtor during the pendency of the bankruptcy case. Generally, adequate protection payments, in the form of interest or otherwise, are not required to be paid by a debtor to a secured creditor unless the bankruptcy court determines that the value of the secured creditors interest in the collateral is declining during the pendency of the bankruptcy case. In addition, the bankruptcy court may determine not to provide cash payments as adequate protection to the holders of the Notes if, among other possible reasons, the bankruptcy court determines that the fair market value of the collateral with respect to the Notes on the date of
44
the bankruptcy filing was less than the then-current principal amount of the Notes. Furthermore, due to the imposition of the automatic stay, the lack of a precise definition of the term adequate protection and the broad discretionary powers of a bankruptcy court, it is impossible to predict (1) how long payments under the Notes could be delayed following commencement of a bankruptcy case, (2) whether or when the collateral agent could repossess or dispose of the pledged assets or (3) whether or to what extent holders of the Notes would be compensated for any delay in payment or loss of value of the pledged assets through the requirement of adequate protection.
The Collateral is Subject to Casualty Risks.
We are obligated under our ABL Facility to at all times cause all the pledged assets to be properly insured and kept insured against loss or damage by fire or other hazards to the extent that such properties are usually insured by corporations operating in the same or similar business. There are, however, some losses, including losses resulting from terrorist acts, that may be either uninsurable or not economically insurable, in whole or in part. As a result, we cannot assure holders of the Notes that the insurance proceeds will compensate us fully for our losses. If there is a total or partial loss of any of the pledged assets, we cannot assure holders of the Notes that the proceeds received by us in respect thereof will be sufficient to satisfy all the secured obligations, including the Notes. In the event of a total or partial loss to any of the mortgaged facilities, certain items of equipment and inventory may not be easily replaced. Accordingly, even though there may be insurance coverage, the extended period needed to manufacture replacement units or inventory could cause significant delays.
Rights of Holders of the Notes in the Collateral May Be Adversely Affected by the Failure to Perfect Security Interests in the Collateral.
Applicable law requires that a security interest in certain tangible and intangible assets can only be properly perfected and its priority retained through certain actions undertaken by the secured party. The liens in the collateral securing the Notes may not be perfected with respect to the claims of the Notes if the collateral agent is not able to take the actions necessary to perfect any of these liens on or prior to the date of the issuance of the Notes.
In addition, applicable law requires that certain property and rights acquired after the grant of a general security interest, such as real property, equipment subject to a certificate of title and certain proceeds, can only be perfected at the time such property and rights are acquired and identified. We and the guarantors have limited obligations to perfect the security interest of the holders of the Notes in specified collateral. There can be no assurance that the trustee or the collateral agent for the Notes will monitor, or that we will inform such trustee or collateral agent of, the future acquisition of property and rights that constitute collateral, and that the necessary action will be taken to properly perfect the security interest in such after-acquired collateral. Neither the trustee nor the collateral agent for the Series A-2 Notes has an obligation to monitor the acquisition of additional property or rights that constitute collateral or the perfection of any security interest. Such failure may result in the loss of the security interest in the collateral or the priority of the security interest in favor of the Notes against third parties.
Any future pledge of collateral in favor of the holders of the Notes might be voidable in bankruptcy. Any future pledge of collateral in favor of the holders of the Notes, including pursuant to security documents delivered after the date of the indenture governing the Notes, might be voidable by the pledgor (as debtor in possession) or by its trustee in bankruptcy if certain events or circumstances exist or occur, including, under the Bankruptcy Code, if the pledgor is insolvent at the time of the pledge, the pledge permits the holders of the Notes to receive a greater recovery than if the pledge had not been given and a bankruptcy proceeding in respect of the pledgor is commenced with 90 days following the pledge, or, in certain circumstances, a longer period.
45
The Indenture Provides That the Notes Will Be Treated Under the Indenture as a Single Class for Purposes of Most Amendments and Waivers. Moreover, the Series A-1 Notes Are Entitled to a Priority in Payment Over the Series A-2 Notes Following Acceleration or a Bankruptcy Event of Default With Respect to Then Payable Principal and Interest.
The indenture provides that the Notes will be treated under the indenture as a single class for purposes of most amendments and waivers, other than certain matters that only affect the Series A-1 Notes or the Series A-2 Notes. Moreover, most accelerations of the Series A-1 Notes or Series A-2 Notes following an event of default will require action by the holders of 25% of the Notes combined. This may make it more difficult for the holders of the Series A-1 Notes or Series A-2 Notes to accelerate the Notes absent the concurrence of some of the other holders. In addition, for amendments or waivers that require a majority consent, even if a majority of the holders of the Series A-1 Notes or Series A-2 Notes voted in favor of an amendment or waiver, the amendment or waiver may not become effective unless a majority of both the series of Notes collectively vote in favor of the amendment or waiver. The indenture also provides that the Series A-1 Notes are entitled to a priority in payment over the Series A-2 Notes being issued in this offering following acceleration or a bankruptcy event of default with respect to then payable principal and interest, as further described in Description of NotesPriorities of Payment as between Series A-2 Debt (including the Series A-2 Notes) and Series A-1 Notes. This priority applies only following acceleration or a bankruptcy event of default. Further, this priority applies to principal and interest already due, but does not apply to post-petition interest. Post-petition interest, if any, would be paid to the holders of Notes only after the holders of Notes have received their principal and pre-petition interest. Finally, although bankruptcy courts in general honor intercreditor agreements entered into prior to the bankruptcy filing, there can be no assurance that the intercreditor arrangements between the Notes would not be modified, changed or rejected during the course of a bankruptcy proceeding, including a determination that the Notes should be considered separate classes for purposes of the bankruptcy proceeding.
The Series A-1 Notes Were Issued With Original Issue Discount (OID) for U.S. Federal Income Tax Purposes.
Since the stated redemption price at maturity of the Series A-1 Notes exceeds their issue price (both as described below under Certain U.S. Federal Income Tax Considerations) by more than a statutory de minimis threshold, the Series A-1 Notes are considered to have been issued with OID for U.S. federal income tax purposes in an amount equal to such excess. U.S. holders (as defined in Certain U.S. Federal Income Tax Considerations) of Series A-1 Notes will be required to include such OID in income as it accrues, in advance of the receipt of cash attributable to such income. For a discussion of the tax consequences of an investment in the Series A-1 Notes, see Certain U.S. Federal Income Tax Considerations.
We May Not Be Able to Finance a Change of Control Offer Required by the Indenture.
Upon a change of control, as defined under the indenture governing the Notes, you will have the right to require us to offer to purchase all of the Notes then outstanding at a price equal to 101% of the principal amount of the Notes, plus accrued interest. In order to obtain sufficient funds to pay the purchase price of the outstanding Notes, we expect that we would have to refinance the Notes. We cannot assure you that we would be able to refinance the Notes on reasonable terms, if at all. Our failure to offer to purchase all outstanding Notes or to purchase all validly tendered Notes would be an event of default under the indenture. Such an event of default may cause the acceleration of our other debt. Our future debt also may contain restrictions on repayment requirements with respect to specified events or transactions that constitute a change of control under the indenture.
46
As used in this prospectus, the term Transactions means, collectively, the Merger, the Original Financing and the Refinancing described below.
The Merger and the Original Financing
On June 18, 2008, Apria, Sky Acquisition and Merger Sub entered into the Merger Agreement, pursuant to which, on October 28, 2008, Merger Sub merged with and into Apria, with Apria being the surviving corporation following the Merger. The Investor Group beneficially owns all of Aprias issued and outstanding capital stock.
The Investor Group made a $673.3 million cash equity investment in membership interests of Sky Acquisition and its parent entity, which investment includes Dr. Paysons co-investment. The proceeds of such investment were contributed to Merger Sub, which used such proceeds, together with other sources of funds, to fund the Merger and the related transactions.
Following the closing of the Merger, Sky Acquisition and its parent entity adopted equity incentive arrangements for directors, executives and other senior management employees. Consistent with these arrangements, certain members of our management team have purchased and/or received, and may, from time to time, purchase and/or receive, equity interests or profit interests in one of our direct or indirect parent entities. Such purchases or awards of equity interests or profit interests may represent a substantial portion of the equity or profits of such parent entity.
In addition to the Merger Agreement, the parties entered into various ancillary agreements governing relationships between the parties after the Merger. See Certain Relationships and Related Party Transactions.
Concurrently with the signing of the Merger Agreement, Apria entered into a $280.0 million credit facility pursuant to a credit agreement with Banc of America Bridge LLC, Barclays Capital, the investment banking division of Barclays Bank PLC, Wells Fargo Securities, LLC (formerly known as Wachovia Capital Markets, LLC) and the lenders named therein (the Interim Facility). The loans under the Interim Facility bore interest at a rate of 11% per year with a maturity date of March 1, 2009. Proceeds of the Interim Facility were used to fund repurchases of $249.8 million of Aprias 3.375% Convertible Senior Notes due 2033 (the convertible senior notes) in September 2008. We repaid all amounts outstanding under the Interim Facility and terminated it at the closing of the Merger.
The following financing transactions occurred in connection with the closing of the Merger:
| a cash investment made by the Investor Group totaling $673.3 million in membership interests of a parent entity of Sky Acquisition (which, in turn, contributed the proceeds of such investment to Sky Acquisition, which, in turn, contributed the proceeds of such investment to Merger Sub); |
| borrowings by Apria of $30.0 million under its $150.0 million ABL Facility; and |
| borrowings by Apria of $1,010.0 million under its senior secured bridge credit agreement. |
In addition, on the closing date of the Merger, we terminated all commitments and repaid all outstanding borrowings under the 2004 senior secured revolving credit facility and the Interim Facility, totaling $553.8 million as of October 28, 2008, and paid all accrued and unpaid interest thereon.
47
The sources and uses of the funds used in connection with the Merger and the Original Financing are shown in the table below.
Sources |
Uses |
|||||||
(dollars in millions) | ||||||||
ABL Facility(1) |
$ | 30.0 | Purchase of equity(4) | $ | 946.4 | |||
Senior secured bridge credit agreement(2) |
1,010.0 | Repayment of existing indebtedness(5): 2004 senior secured revolving credit facility |
305.1 | |||||
Equity investment(3) |
673.3 | Interim facility | 251.9 | |||||
Increase in cash(6) | 110.8 | |||||||
Fees and expenses(7) | 99.1 | |||||||
Total sources |
$ | 1,713.3 | Total uses |
$ | 1,713.3 | |||
(1) | Upon the closing of the Merger, we entered into a $150.0 million senior secured asset-based revolving credit facility, which has a five-year maturity. We borrowed $30.0 million under the ABL Facility on the closing date of the Merger. See Description of Other IndebtednessSenior Secured Asset-Based Revolving Credit Facility for more information. |
(2) | Upon the closing of the Merger, we entered into a senior secured bridge credit agreement, which has a six-year maturity. We borrowed an aggregate of $1,010.0 million under the senior secured bridge credit agreement on the closing date of the Merger. See Managements Discussion and Analysis of Financial Condition and Results of OperationsLiquidity and Capital ResourcesIndebtednessPost-TransactionsSenior Secured Bridge Credit Agreement for more information. |
(3) | Represents the cash equity contributed by the Investor Group. |
(4) | Represents the amount of total consideration paid to holders of approximately 43.9 million of outstanding shares of Aprias common stock, approximately 0.9 million of outstanding shares of restricted stock and approximately 0.8 million of outstanding options to acquire Aprias common stock with a net option value of approximately $5.1 million, which is based upon an average exercise price of $14.46 per share. At the effective time of the Merger, each share of Aprias common stock issued and outstanding immediately prior to the effective time (other than dissenting shares, shares held in treasury or shares held by Sky Acquisition, Merger Sub or any wholly-owned subsidiary of Apria) was converted into a right to receive $21.00 in cash, without interest and less any applicable withholding taxes. |
(5) | Represents (i) $304.0 million of outstanding borrowings under our 2004 senior secured revolving credit facility and $1.1 million of accrued and unpaid interest related thereto and (ii) $249.8 million of outstanding borrowings under the Interim Facility and $2.1 million of accrued and unpaid interest related thereto, repaid in connection with the Merger. In September 2008, we were required pursuant to the terms of the indenture governing our convertible senior notes to repurchase $249.8 million of the convertible senior notes at a redemption price equal to 100% of the principal amount of the convertible senior notes properly tendered and not withdrawn plus accrued and unpaid interest to the redemption date. We funded the repurchase by borrowing $249.8 million under the Interim Facility. In addition, in December 2008, holders of $151,000 of the remaining outstanding $0.2 million of the convertible senior notes exercised their right to require us to repurchase their notes following the Merger. Approximately $77,000 of the convertible senior notes remain outstanding. |
(6) | Represents an increase of $110.8 million in cash on hand upon the completion of the Merger and the Original Financing, which is expected to be used for general corporate purposes. |
(7) | Includes commitment, accounting, legal and other professional fees, including the lenders fees and transaction fees paid to affiliates of the Sponsor. |
The Refinancing
We used the proceeds from the offerings of our outstanding Series A-1 Notes and the outstanding Series A-2 Notes in May 2009 and August 2009, respectively, together with cash on hand, to repay all of the outstanding borrowings under our senior secured bridge credit agreement and to pay related fees and expenses. The senior secured bridge credit agreement was terminated concurrently with the closing of the outstanding Series A-2 Notes offering. The sources and uses of the funds in connection with the Refinancing are shown in the table below.
Sources |
Uses | |||||||
(dollars in millions) | ||||||||
Repayment of the senior secured bridge | ||||||||
Series A-1 Notes |
$ | 700.0 | credit agreement(1) |
$ | 1,027.2 | |||
Series A-2 Notes |
317.5 | Fees and expenses | 19.1 | |||||
Cash required for the Refinancing |
28.8 | |||||||
Total Sources |
$ | 1,046.3 | Total Uses | $ | 1,046.3 | |||
(1) | Represents $1,010.0 million outstanding under the senior secured bridge credit agreement prior to the offering of the outstanding Series A-1 Notes and $17.2 million of accrued and unpaid interest on the $1,010.0 million outstanding under the senior secured bridge credit agreement from May 1, 2009 until May 26, 2009 and $310.0 million outstanding under the senior secured bridge credit agreement from May 27, 2009 to August 12, 2009. |
48
We will not receive any proceeds from the issuance of the exchange notes in the exchange offers. The exchange offers are intended to satisfy our obligations under the registration rights agreements that we entered into in connection with the private offerings of the outstanding notes. As consideration for issuing the exchange notes as contemplated in this prospectus, we will receive in exchange a like principal amount of outstanding notes, the terms of which are identical in all material respects to the exchange notes, except that the exchange notes will not contain terms with respect to transfer restrictions or additional interest upon a failure to fulfill certain of our obligations under the registration rights agreements. The outstanding notes that are surrendered in exchange for the exchange notes will be retired and cancelled and cannot be reissued. As a result, the issuance of the exchange notes will not result in any change in our capitalization.
49
The following table sets forth our consolidated cash and cash equivalents and capitalization as of June 30, 2010.
You should read this table in conjunction with Prospectus SummarySummary Historical Consolidated Financial Data, Use of Proceeds, Selected Historical Consolidated Financial Data, Managements Discussion and Analysis of Financial Condition and Results of Operations and our historical consolidated financial statements and the related notes thereto included elsewhere in this prospectus.
The outstanding notes that are surrendered in exchange for the exchange notes will be retired and cancelled and cannot be reissued. As a result, the issuance of the exchange notes will not result in any change in our capitalization.
As of June 30, 2010 | |||
(dollars in thousands) | |||
Cash and cash equivalents |
$ | 116,472 | |
Total debt: |
|||
ABL Facility(1) |
| ||
Series A-1 Notes |
700,000 | ||
Series A-2 Notes |
317,500 | ||
Other debt |
2,779 | ||
Total debt |
1,020,279 | ||
Total stockholders equity |
683,419 | ||
Total capitalization |
$ | 1,703,698 | |
(1) | Upon the closing of the Merger, we entered into a $150.0 million senior secured asset-based revolving credit facility, which has a five-year maturity. We had no outstanding borrowings and approximately $16.1 million of drawn letters of credit under the ABL Facility as of June 30, 2010. See Description of Other IndebtednessSenior Secured Asset-Based Revolving Credit Facility for more information. |
50
SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data set forth below should be read in conjunction with Managements Discussion and Analysis of Financial Condition and Results of Operations and our historical financial statements and accompanying notes contained herein. We derived the selected consolidated financial data for the year ended December 31, 2007, the periods from January 1, 2008 to October 28, 2008 and October 29, 2008 to December 31, 2008 and the year ended December 31, 2009 and as of December 31, 2008 and 2009 from our consolidated financial statements, which have been audited and are included in this prospectus. We derived the selected consolidated financial data for the years ended December 31, 2005 and 2006 and as of December 31, 2005, 2006 and 2007 from our consolidated financial statements that have been audited and are not included in this prospectus. The historical results presented are not necessarily indicative of future results. The audited consolidated financial statements for each of the years in the three-year period ended December 31, 2007, the periods from January 1, 2008 to October 28, 2008 and October 29, 2008 to December 31, 2008 and the year ended December 31, 2009 have been audited by Deloitte & Touche LLP, an independent registered public accounting firm.
Our selected historical condensed consolidated financial data for the six months ended June 30, 2009 and as of and for the six months ended June 30, 2010 have been derived from our condensed consolidated financial statements, which are included in this prospectus. We derived the selected historical consolidated financial data as of June 30, 2009 from our unaudited condensed consolidated financial statements, which are not included in this prospectus. The unaudited condensed consolidated financial statements were prepared on a basis consistent with our audited consolidated financial statements. In our opinion, the unaudited condensed consolidated financial statements include all adjustments, consisting of normal recurring accruals, necessary for the fair presentation of those statements. Our results for the six months ended June 30, 2010 should not be considered indicative of the results for the full fiscal year ending December 31, 2010.
Year Ended December 31, | Period January 1, 2008 to October 28, 2008 |
Period October 29, 2008 to December 31, 2008 |
Year Ended December 31, 2009 |
Six
Months Ended June 30, 2009 |
Six
Months Ended June 30, 2010 |
|||||||||||||||||||||||||||||
2005 | 2006 | 2007 | ||||||||||||||||||||||||||||||||
(Predecessor) | (Predecessor) | (Predecessor) | (Predecessor) | (Successor) | (Successor) | (Successor) | (Successor) | |||||||||||||||||||||||||||
(dollars in thousands) |
||||||||||||||||||||||||||||||||||
Statement of Operations Data: |
||||||||||||||||||||||||||||||||||
Net revenues |
$ | 1,475,670 | $ | 1,516,691 | $ | 1,631,801 | $ | 1,773,289 | $ | 356,665 | $ | 2,094,561 | $ | 1,038,959 | $ | 1,027,054 | ||||||||||||||||||
Cost and expenses: |
||||||||||||||||||||||||||||||||||
Total cost of net revenues |
479,213 | 521,580 | 564,992 | 691,337 | 137,760 | 867,459 | 410,510 | 410,924 | ||||||||||||||||||||||||||
Provision for doubtful accounts |
46,948 | 38,723 | 43,138 | 33,626 | 14,329 | 57,919 | 25,504 | 28,820 | ||||||||||||||||||||||||||
Selling, distribution and administrative |
792,031 | 804,285 | 862,062 | 924,536 | 179,362 | 1,050,134 | 526,392 | 516,581 | ||||||||||||||||||||||||||
Qui tam settlement and related costs |
19,258 | | | | | | | | ||||||||||||||||||||||||||
Amortization of intangible assets |
6,941 | 5,080 | 3,079 | 3,461 | 1,008 | 3,716 | 2,955 | 2,742 | ||||||||||||||||||||||||||
Total costs and expenses |
1,344,391 | 1,369,668 | 1,473,271 | 1,652,960 | 332,459 | 1,979,228 | 965,361 | 959,067 | ||||||||||||||||||||||||||
Operating income |
131,279 | 147,023 | 158,530 | 120,329 | 24,206 | 115,333 | 73,598 | 67,987 | ||||||||||||||||||||||||||
Interest expense and other, net |
22,119 | 29,463 | 20,493 | 29,684 | 25,441 | 127,591 | 64,078 | 64,930 | ||||||||||||||||||||||||||
Write-off of deferred debt issuance costs |
| | | | | | | | ||||||||||||||||||||||||||
Income (loss) from continuing operations before taxes |
109,160 | 117,560 | 138,037 | 90,645 | (1,235 | ) | (12,258 | ) | 9,520 | 3,057 | ||||||||||||||||||||||||
Income tax expense (benefit) |
40,677 | 43,297 | 51,998 | 34,192 | 659 | (8,438 | ) | 5,982 | 494 | |||||||||||||||||||||||||
Net income (loss) from continuing operations |
$ | 68,483 | $ | 74,263 | $ | 86,039 | $ | 56,453 | $ | (1,894 | ) | $ | (3,820 | ) | $ | 3,538 | $ | 2,563 | ||||||||||||||||
Cash Flow Data: |
||||||||||||||||||||||||||||||||||
Net cash provided by operating activities |
$ | 206,299 | $ | 280,914 | $ | 294,006 | $ | 297,937 | $ | 63,337 | $ | 169,426 | $ | 60,471 | $ | 34,718 | ||||||||||||||||||
Net cash used in investing activities |
(223,571 | ) | (132,932 | ) | (483,235 | ) | (154,493 | ) | (75,466 | ) | (168,656 | ) | (71,160 | ) | (40,044 | ) | ||||||||||||||||||
Net cash provided by (used in) financing activities |
1,177 | (156,629 | ) | 203,023 | (123,682 | ) | 131,934 | (10,625 | ) | |
(13,155 |
) |
(36,365 | ) | ||||||||||||||||||||
Capital expenditures |
118,867 | 125,628 | 128,759 | 157,183 | 26,217 | 150,597 | 73,598 | 55,783 |
51
As of December 31, | As of June 30, 2010 | |||||||||||||||||||
2005 | 2006 | 2007 | 2008 | 2009 | ||||||||||||||||
(Predecessor) | (Predecessor) | (Predecessor) | (Successor) | (Successor) | (Successor) | |||||||||||||||
(dollars in thousands) | ||||||||||||||||||||
Balance Sheet Data: |
||||||||||||||||||||
Total assets |
$ | 1,198,461 | $ | 1,154,636 | $ | 1,597,802 | $ | 2,210,813 | $ | 2,309,047 | $ | 2,266,211 | ||||||||
Goodwill and intangible assets |
551,565 | 545,738 | 822,992 | 1,292,403 | 1,341,456 | 1,340,974 | ||||||||||||||
Long-term debt, including current maturities |
645,320 | 487,145 | 687,283 | 1,022,233 | 1,021,146 | 1,020,279 | ||||||||||||||
Stockholders equity |
311,651 | 399,693 | 512,025 | 672,820 | 678,731 | 683,419 |
Year Ended December 31, | Period January 1, 2008 to October 28, 2008 |
Period October 29, 2008 to December 31, 2008 |
Year
Ended December 31, 2009 |
Six Months Ended June 30, | ||||||||||||||||||||||||
2005 | 2006 | 2007 | 2009 | 2010 | ||||||||||||||||||||||||
(Predecessor) | (Predecessor) | (Predecessor) | (Predecessor) | (Successor) | (Successor) | (Successor) | (Successor) | |||||||||||||||||||||
Other Data: |
||||||||||||||||||||||||||||
Ratio of earnings to fixed charges(1) |
2.5x | 2.5x | 2.9x | 2.2x | .97x | 0.9x | 1.1x | 1.0x | ||||||||||||||||||||
Earnings deficiency to cover fixed charges |
$ | | $ | | $ | | $ | | $ | (1,235 | ) | $ | (12,258 | ) | $ | | $ |
|
(1) | Computed by dividing pre-tax net income before fixed charges by fixed charges. Fixed charges means the sum of the following: net interest expense, amortized premiums, discounts and capitalized expenses related to indebtedness, and an estimate of the interest within rental expense. Net interest expense excludes any interest related to tax liabilities, which is recorded as income tax expense. |
52
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
This Managements Discussion and Analysis of Financial Condition and Results of Operations is intended to assist in understanding and assessing the trends and significant changes in our results of operations and financial condition. Historical results may not be indicative of future performance. Our forward-looking statements reflect our current views about future events, are based on assumptions and are subject to known and unknown risks and uncertainties such as the current global economic uncertainty, including the tightening of the credit markets and the recent significant declines and volatility in our global financial markets, that could cause actual results to differ materially from those contemplated by these statements. Factors that may cause differences between actual results and those contemplated by forward-looking statements include, but are not limited to, those discussed in the Risk Factors and Forward-Looking Statements sections of this prospectus. This Managements Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our consolidated financial statements and the related notes and other information included in this prospectus.
Overview
We have three core service lines: home respiratory therapy, home medical equipment and home infusion therapy. In these core service lines, we offer a variety of patient care management programs, including clinical and administrative support services, products and supplies, most of which are prescribed by a physician as part of a care plan. We provide these services to patients through approximately 500 locations throughout the United States. We have two reportable operating segments:
| home respiratory therapy and home medical equipment; and |
| home infusion therapy. |
Strategy
Our strategy is to position ourselves in the marketplace as a high-quality provider of a broad range of healthcare services and patient care management programs to our customers. The specific elements of our strategy are to:
| Grow profitable revenue and market share. We are focused on growing profitable revenues and increasing market share in our core home infusion therapy and home respiratory therapy service lines. We have undertaken a series of steps towards this end. Through our acquisition of Coram in December 2007, we considerably increased our home infusion capabilities and expanded our platform for further cross-selling opportunities. Since January 1, 2007, we have expanded our home respiratory therapy and home medical equipment sales force by 37%. This focus has allowed us to more effectively market our products and services to physicians, hospital discharge planners and managed care organizations. |
| Continue to participate in the managed care market. We participate in the managed care market as a long-term strategic customer group because we believe that our scale, expertise, nationwide presence and array of home healthcare products and services will enable us to sign preferred provider agreements with managed care organizations. Managed care represented approximately 71% of our total net revenues for the six months ended June 30, 2010. |
| Leverage our national distribution infrastructure. With approximately 500 locations and a robust platform supporting shared national services, we believe that we can efficiently add products, services and patients to our systems to grow our revenues and leverage our cost structure. For example, we have successfully leveraged this distribution platform across a number of product and service offerings, including a CPAP/bi-level supply replenishment program, enteral nutrition and NPWT services, and we are using our nursing capacity to provide infusion services through our growing network of ambulatory infusion suites. We seek to achieve margin improvements through operational initiatives focused on the continual reduction of costs and delivery of incremental efficiencies. At the same time, we believe that it is essential to consistently deliver superior customer service in order to increase referrals and retain existing patients. Performance improvement initiatives are underway in all aspects of our operations |
53
including customer service, patient satisfaction, logistics, supply chain, clinical services and billing/collections. We believe that by being responsive to the needs of our patients and payors we can provide ourselves with opportunities to take market share from our competitors. |
| Continue to lead the industry in accreditation. MIPPA made accreditation mandatory for Medicare providers of DMEPOS, effective October 1, 2009, per CMS regulation. We were the first durable medical equipment provider to seek and obtain voluntary accreditation from The Joint Commission. All of our locations are currently accredited by The Joint Commission and our home infusion therapy service line is also accredited by the ACHC. In 2007, we completed a nationwide independent triennial accreditation renewal process conducted by The Joint Commission and we have more than 15 years of continuous accreditation by The Joint Commissionlonger than any other homecare provider. In late June 2010, The Joint Commission completed its most recent triennial survey of our respiratory/home medical equipment and infusion locations and is expected to renew our accreditation for another three years. |
| Execute our strategic initiatives to drive profitability. For the past several years, we have successfully engaged in a range of cost savings initiatives to ease pressure on our revenue that has been and continues to be caused by Medicare and Medicaid reimbursement changes. These initiatives are designed to improve customer service, delivery and vehicle routing services, streamline the billing and payment process, effectively manage purchasing costs and improve the overall experience of the patients we serve. We launched a substantial cost reduction plan in late 2007. To date, we have made significant progress across a number of identified initiatives presently targeting expected annual savings of approximately $169 million, of which we realized approximately $135 million through June 30, 2010. |
Recent Developments
Outsourcing Initiatives Review. In August 2010, based on a review of key outsourcing initiatives, we refined our initial decisions concerning certain billing, collections and other administrative functions presently outsourced or designated to be outsourced to third parties. Based on our review, it was determined that certain of such functions should instead be performed by the Company. Accordingly, we expect to transition certain services presently outsourced to third parties back to the Company by March 31, 2011 and to incur the associated one-time costs presently estimated not to exceed $10 million. Further consolidation and outsourcing of billing, collections and other administrative functions will be re-evaluated in 2011. As a result of the adjustments made to our outsourcing strategy, we presently expect that our targeted annual cost savings will be approximately $169 million, instead of $198 million targeted as of March 31, 2010. We continue to explore additional cost savings initiatives which may increase our expected cost savings in the future.
Announcement of SPAs and Initiation of Contract Offer Process Related to Round 1 Rebid of the Medicare DMEPOS Competitive Bidding Program. In early July 2010, CMS announced the new SPAs for each of the product categories included in the Round 1 Rebid. CMS then began the contracting process with suppliers by issuing contract offer letters to qualified providers. We received contract offers for a substantial majority of the bids we submitted. We did not receive contract offers for certain product categories in CBAs, but the process will not be completed until September 2010. Approximately $21 million of our net revenues for the fiscal year ended December 31, 2009 was generated by the products and CBAs included in the Round 1 Rebid. We estimate that the initial results of the Round 1 Rebid would reduce our net revenues in the fiscal year ending December 31, 2011 by approximately $8 million, assuming the current contract offers and no changes in volume. Assuming that Round 2 would include the same product categories and bidding rules and the markets currently being proposed by CMS, we estimate that approximately $110 million of our net revenues for the fiscal year ending December 31, 2011 would be subject to competitive bidding. Although the bidding process for Round 2 is currently scheduled to commence in 2011, the new Round 2 rates and guidelines are not scheduled to take effect until January 2013. Therefore, we cannot estimate the impact of potential Round 2 rate reductions on our business until more specific information is published by CMS and its contractors.
Enactment of a Comprehensive Healthcare Reform Package. In March 2010, the Federal government enacted a comprehensive healthcare Reform Package which consists of the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010. See Risk FactorsRisks
54
Relating to Our BusinessContinued Reductions in Medicare and Medicaid Reimbursement Rates and the Comprehensive Healthcare Reform Package Could Have a Material Adverse Effect on Our Results of Operations and Financial Condition.
Reorganization of the Senior Leadership Structure of our Home Respiratory Therapy and Home Medical Equipment Segment. In February 2010, we finalized a decision to reorganize the senior leadership structure of the home respiratory therapy and home medical equipment segment. As part of this reorganization, Lawrence A. Mastrovich, President, Home Respiratory Therapy and Home Medical Equipment segment, resigned and his responsibilities were assumed by other senior executives.
Critical Accounting Policies
We consider the accounting policies that govern revenue recognition and the determination of the net realizable value of accounts receivable to be the most critical in relation to our consolidated financial statements. These policies require the most complex and subjective judgments of management. Additionally, the accounting policies related to goodwill, long-lived assets, share-based compensation and income taxes require significant judgment.
Revenue and Accounts Receivable. Revenues are recognized under fee for service/product arrangements for equipment we rent to patients, sales of equipment, supplies, pharmaceuticals and other items we sell to patients and under capitation arrangements with third party payors for services and equipment we provide to the patients of these payors. Revenue generated from equipment that we rent to patients is recognized over the rental period, typically one month, and commences on delivery of the equipment to the patients. Revenue related to sales of equipment, supplies and pharmaceuticals is recognized on the date of delivery to the patients. Revenues derived from capitation arrangements were approximately 8%, 8%, 8%, 8%, and 10% of total net revenues for the six months period ended June 30, 2010, the year ended December 31, 2009, the period October 29, 2008 to December 31, 2008, the period January 1, 2008 to October 28, 2008, and the year ended December 31, 2007, respectively. Capitation revenue is earned as a result of entering into a contract with a third party to provide its members certain services without regard to the actual services provided, therefore revenue is recognized in the period that the beneficiaries are entitled to health care services. All revenues are recorded at amounts estimated to be received under reimbursement arrangements with third-party payors, including private insurers, prepaid health plans, Medicare and Medicaid.
In our business, there are multiple services and products delivered to patients. These arrangements involve equipment that is rented and related supplies that may be sold that cannot be returned. In arrangements with multiple deliverables, revenue is recognized when each deliverable is provided to the patient. For example, revenues from equipment rental supplies sales are recognized upon confirmation of delivery of the products, as the supplies sold are considered a separate unit of accounting.
Included in accounts receivable are earned but unbilled receivables of $49.9 million, $44.6 million and $48.2 million at June 30, 2010, December 31, 2009 and 2008, respectively. Delays ranging from a day up to several weeks between the date of service and billing can occur due to delays in obtaining certain required payor-specific documentation from internal and external sources. Earned but unbilled receivables are aged from date of service and are considered in the analysis of historical performance and collectibility.
Due to the nature of the industry and the reimbursement environment in which we operate, certain estimates are required to record total net revenues and accounts receivable at their net realizable values. Inherent in these estimates is the risk that they will have to be revised or updated as additional information becomes available. Specifically, the complexity of many third-party billing arrangements and the uncertainty of reimbursement amounts for certain services from certain payors may result in adjustments to amounts originally recorded. Such adjustments are typically identified and recorded at the point of cash application, claim denial or account review.
Management performs periodic analyses to evaluate accounts receivable balances to ensure that recorded amounts reflect estimated net realizable value. Specifically, management considers historical realization data,
55
accounts receivable aging trends, other operating trends, the extent of contracted business and business combinations. Also considered are relevant business conditions such as governmental and managed care payor claims processing procedures and system changes. Additionally, focused reviews of certain large and/or problematic payors are performed. Due to continuing changes in the healthcare industry and third-party reimbursement, it is possible that managements estimates could change in the near term, which could have an impact on operations and cash flows.
Accounts receivable are reduced by an allowance for doubtful accounts which provides for those accounts from which payment is not expected to be received, although services were provided and revenue was earned. Upon determination that an account is uncollectible, it is written-off and charged to the allowance.
Goodwill and Long-Lived Assets. Goodwill arising from business combinations represents the excess of the purchase price over the estimated fair value of the net assets of the acquired business. Goodwill and indefinite-lived intangible assets are tested annually for impairment or more frequently if circumstances indicate the potential for impairment. We have selected October 1 to perform our annual impairment test. Also, we test for impairment of our intangible assets and long-lived assets on an ongoing basis, whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Our goodwill impairment test is conducted at a reporting unit level and compares each reporting units fair value to its carrying value. We have determined that our two operating segments are reporting units. As such, we have two reporting units, home respiratory therapy/home medical equipment and home infusion therapy. The measurement of fair value for each reporting unit is based on an evaluation of future discounted cash flows. In projecting our reporting units cash flows, we consider industry growth rates and trends, known and potential reimbursement reductions, cost structure changes and local circumstances specific to a service line. Goodwill and indefinite-lived intangible assets were tested for impairment on October 1, 2009 and resulted in no impairment. If an asset had been deemed impaired, an impairment loss would have been recognized to the extent the carrying value of the asset exceeded its estimated fair market value.
Long-lived assets, including property and equipment and purchased intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. Significant judgment is required in determining whether a potential indicator of impairment of long-lived assets exists and in estimating future cash flows for any necessary impairment tests. Recoverability of assets to be held and used is measured by the comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. If such an asset is considered to be impaired, the impairment to be recognized is measured as the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. As of June 30, 2010, December 31, 2009 and 2008, there was no impairment.
Share-Based Compensation. We measure and recognize compensation expense for all share-based payment awards made to employees and non-employee directors based on estimated fair values on the date of grant. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service period in our consolidated financial statements. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. We recognize share-based compensation expense on a straight-line basis over the requisite service period. Prior to the Merger, we estimated fair value of our share-based payment awards using the Black-Scholes valuation model. Subsequent to the Merger, the estimate of fair value of share-based awards on the date of grant is determined through the allocation of all outstanding securities to a business enterprise valuation. The enterprise valuation is based upon a combination of the income approach and the market approach. The income approach is based on discounted cash flows. The market approach uses a selection of comparable companies in determining value. This determination of fair value is affected by assumptions regarding a number of highly complex and subjective variables. Changes in the subjective assumptions can materially affect the estimate of their fair value.
Income Taxes. Deferred income tax assets and liabilities are computed for differences between the carrying amounts of assets and liabilities for financial statement and tax purposes. Deferred income tax assets are required to be reduced by a valuation allowance when it is determined that it is more likely than not that all or a portion of
56
a deferred tax asset will not be realized. In determining the necessity and amount of a valuation allowance, management considers our current and past performance, the market environment in which we operate, tax planning strategies and the length of tax benefit carryforward periods.
Our provision for income taxes is based on expected income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Significant management estimates and judgments are required in determining the provision for income taxes. We are routinely under audit by federal, state or local authorities regarding the timing and amount of deductions, allocation of income among various tax jurisdictions and compliance with federal, state and local tax laws. Tax assessments related to these audits may not arise until several years after tax returns have been filed. Although predicting the outcome of such tax assessments involves uncertainty, we believe that the recorded tax liabilities appropriately reflect our potential obligations.
Capitalized Software. Internally developed and purchased software are capitalized and amortized over periods that the assets are expected to provide benefit. Capitalized costs include direct costs of materials and services incurred in developing or obtaining internal-use software and payroll and benefit costs for employees directly involved in the development of internal-use software. In connection with the Merger in 2008, we evaluated our information technology strategy and concluded it was no longer advisable to implement a new enterprise-wide information system. As a result of this change in strategy, we wrote off approximately $65.0 million of capitalized information systems assets as part of our purchase accounting adjustments that were made in connection with the Merger in 2008.
Government Regulation
We are subject to extensive government regulation, including numerous laws directed at regulating reimbursement of our products and services under various government programs and preventing fraud and abuse. We maintain certain safeguards intended to reduce the likelihood that we will engage in conduct or enter into arrangements in violation of these restrictions. Corporate contract services and legal department personnel review and approve written contracts subject to these laws. We also maintain various educational and audit programs designed to keep our managers updated and informed regarding developments on these topics and to reinforce to employees our policy of strict compliance in this area. Federal and state laws require that we obtain facility and other regulatory licenses and that we enroll as a supplier with federal and state health programs. Under various federal and state laws, we are required to make filings or submit notices in connection with transactions that might be defined as a change of control of the Company. We are aware of these requirements and routinely make such filings with, and seek such approvals from, the applicable regulatory agencies. Notwithstanding these measures, due to changes in and new interpretations of such laws and regulations, and changes in our business, violations of these laws and regulations may still occur, which could subject us to civil and criminal enforcement actions; licensure revocation, suspension or non-renewal; severe fines and penalties; the repayment of amounts previously paid to us and even the termination of our ability to provide services, including those provided under certain government programs such as Medicare and Medicaid. See Risk FactorsRisks Relating to Our BusinessContinued Reductions in Medicare and Medicaid Reimbursement Rates and the Comprehensive Healthcare Reform Package Could Have a Material Adverse Effect on Our Results of Operations and Financial Condition and Risk FactorsRisk Factors Risks Relating to Our BusinessOur Failure To Maintain Required Licenses Could Impact Our Operations.
For additional information about government regulation of our business and industry, see BusinessGovernment Regulation.
Results of Operations
Six Months Ended June 30, 2010 Compared to the Six Months Ended June 30, 2009
Net Revenues. Net revenues decreased $11.9 million, or 1.1%, to $1,027.1 million in the six months ended June 30, 2010 from $1,039.0 million in the six months ended June 30, 2009. The decrease in revenue was due primarily to the non-renewal or termination of, or changes to, certain payor contracts. We or the payor terminated
57
or did not renew certain contracts during 2009 and expect to continue to strategically evaluate our payor contracts. The revenue decrease was partially offset by increases in home infusion therapy revenue. In addition, revenue in the six months ended June 30, 2010 was positively impacted by the recognition of monthly rental revenue previously deferred for services that were initiated prior to certain 2009 Medicare reimbursement reductions.
We also expect to continue to face pricing pressures from Medicare and Medicaid as well as from our managed care customers as these payors seek to lower costs by obtaining more favorable pricing from providers such as us. In addition to the pricing reductions, such changes could cause us to provide reduced levels of certain products and services in the future, resulting in a corresponding reduction in revenue. See BusinessGovernment Regulation.
Gross Profit. Gross profit margin is defined as total net revenues less total costs of total net revenues divided by total net revenues. The gross profit margin in the six months ended June 30, 2010 was 60.0%, compared to 60.5% in the six months ended June 30, 2009. This decline is due to the favorable impact of certain cost of goods sold adjustments in the six months ended June 30, 2009. Excluding the favorable impact of these certain cost of goods sold adjustments, the overall gross profit margin percentage for the six months ended June 30, 2009 would have been 60.0%. In addition to these certain cost of goods sold adjustments in the six months ended June 30, 2009, the decline is due to the impact of an increase in the revenue of the home infusion therapy segment as a percent of total company revenue. Our home infusion therapy segment has a lower gross profit margin as a percentage of net revenues than the home respiratory therapy and home medical equipment segment. This decline in the gross profit margin percentage is offset by our ability to obtain favorable pricing on the purchase of products and the termination of certain low margin or unprofitable payor contracts during 2009.
Provision for Doubtful Accounts. The provision for doubtful accounts is based on managements estimate of the net realizable value of accounts receivable after considering actual write-offs of specific receivables. Accounts receivable estimated to be uncollectible are provided for by computing a required reserve using estimated future cash receipts based on historical cash receipts collections as a percentage of revenue. In addition, management may adjust for changes in billing practices, cash collection protocols or practices, or changes in general economic conditions, contractual issues with specific payors, new markets or products. The provision for doubtful accounts, expressed as a percentage of total net revenues, was 2.8% and 2.5% in the six months ended June 30, 2010 and the six months ended June 30, 2009, respectively. The increased provision for doubtful accounts in 2010 is primarily the result of unfavorable collections experience occurring in 2010 compared to 2009.
Selling, Distribution and Administrative Expenses. Selling, distribution and administrative expenses are comprised of expenses incurred in direct support of operations and those associated with administrative functions. Expenses incurred by the operating locations include salaries and other expenses in the following functional areas: selling, distribution, clinical services, warehousing and repair. Many of these operating costs are directly variable with revenue growth patterns. Some are also very sensitive to market-driven price fluctuations such as facility lease and fuel costs. The administrative expenses include overhead costs incurred by the operating locations, regional and corporate support functions. These expenses are generally less sensitive to fluctuations in revenue growth than operating costs.
Selling, distribution and administrative expenses, expressed as a percentage of total net revenues was 50.3% for the six months ended June 30, 2010 compared to 50.7% for the six months ended June 30, 2009.
Selling, distribution and administrative expenses decreased by $9.8 million for the six months ended June 30, 2010 over the six months ended June 30, 2009. The decrease was comprised of a $28.1 million decrease in labor and other related expenses offset by an increase in other operating expenses of $18.3 million. The decrease in labor and other related expenses was due to reduced salaries and wages as a result of headcount reductions due primarily to the outsourcing of certain functions relating to documentation, billing, reimbursement, information technology and other services, and lower management incentive compensation program expense as a result of not meeting certain targets in 2010. These decreases were partially offset by an increase in labor expenses due to increases in our home respiratory therapy and home medical equipment sales
58
force. The increases in other operating expenses of $18.3 million were primarily due to an increase in professional fees and expenses related to the outsourcing of certain functions relating to billing, collections and other administrative and clerical services, information technology and other services, an increase in travel expense related to sales and operations training, a gain in 2009 on the sale of assets to a third party payor which did not recur in 2010, an increase in our sponsor management fee and an increase in depreciation related to information technology assets. The increases in other operating expenses were partially offset by debt offering and other legal costs in 2009 that did not recur at the same amount in 2010.
Amortization of Intangible Assets. Amortization of intangible assets was $2.7 million in the six months ended June 30, 2010 and $2.9 million in the six months ended June 30, 2009. The amortization expense primarily results from the revaluation of intangible assets as a result of the Merger, including the finalization of the intangible asset valuation in 2009.
Interest Expense. Interest expense increased $0.7 million, or 1.0%, to $65.2 million in the six months ended June 30, 2010 from $64.5 million in the six months ended June 30, 2009. This increase is primarily due to higher amortization of deferred debt costs related to the $700.0 million of our 11.25% Senior Secured Notes due 2014 (Series A-1) and $317.5 million of our 12.375% Senior Secured Notes due 2014 (Series A-2).
Interest Income and Other. Interest income and other decreased $0.2 million, or 37.9%, to $0.3 million in the six months ended June 30, 2010 from $0.5 million in the six months ended June 30, 2009.
Income Tax Expense. Our effective tax rate was 16.2% for the six months ended June 30, 2010 compared with 62.8% for the six months ended June 30, 2009.
The 16.2% effective tax rate for the six months ended June 30, 2010 was lower than federal and state statutory tax rates primarily due to the release of tax contingency accruals resulting from the completion of certain state tax audits.
The 62.8 % effective tax rate for the six months ended June 30, 2009 was higher than federal and state statutory tax rates primarily due to the relationship between non-deductible equity compensation as a percentage of our pre-tax income. The relative size of non-deductible items as a percentage of pre-tax income can cause significant fluctuations in our effective tax rate.
Our provision for income taxes is based on expected income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Significant management estimates and judgments are required in determining the provision for income taxes. We are routinely under audit by federal, state or local authorities regarding the timing and amount of deductions, allocation of income among various tax jurisdictions and compliance with federal, state and local tax laws. Tax assessments related to these audits may not arise until several years after tax returns have been filed. Although predicting the outcome of such tax assessments involves uncertainty, we believe that the recorded tax liabilities appropriately reflect our potential obligations under generally accepted accounting principles.
Segment Net Revenues and Earnings Before Interest and Taxes (EBIT)
The following table sets forth a summary of results of operations by segment:
(dollars in thousands) |
Six Months
Ended June 30, 2010 |
Percentage of Net Revenues |
Six Months Ended June 30, 2009 |
Percentage of Net Revenues |
||||||||
Net revenues: |
||||||||||||
Home respiratory therapy and home medical equipment |
$ | 551,443 | 53.7 | % | $ | 587,175 | 56.5 | % | ||||
Home infusion therapy |
475,611 | 46.3 | 451,784 | 43.5 | ||||||||
Total net revenues |
$ | 1,027,054 | 100.0 | % | $ | 1,038,959 | 100.0 | % | ||||
59
EBIT is a measure used by our management to measure operating performance. EBIT is defined as net income (loss) plus interest expense and income taxes. EBIT is not a recognized term under Generally Accepted Accounting Principles (GAAP) and does not purport to be an alternative to net income as a measure of operating performance or to cash flows from operating activities as a measure of liquidity.
Six Months Ended June 30, 2010 | |||||||||||||||
(dollars in thousands) | Home
Respiratory Therapy and Home Medical Equipment |
Percentage of Segment Net Revenues |
Home Infusion Therapy |
Percentage of Segment Net Revenues |
Total | ||||||||||
EBIT |
$ | 13,307 | 2.4 | % | $ | 54,758 | 11.5 | % | $ | 68,065 |
Six Months Ended June 30, 2009 | |||||||||||||||
(dollars in thousands) | Home
Respiratory Therapy and Home Medical Equipment |
Percentage of Segment Net Revenues |
Home Infusion Therapy |
Percentage of Segment Net Revenues |
Total | ||||||||||
EBIT |
$ | 48,627 | 8.3 | % | $ | 25,073 | 5.5 | % | $ | 73,700 |
We allocate certain expenses that are not directly attributable to a product line based upon segment headcount. For a reconciliation of net income (loss) to EBIT, see the table under Results of OperationsEBIT at the end of this section.
Home Respiratory Therapy and Home Medical Equipment Segment. For the home respiratory therapy and home medical equipment segment total net revenues decreased $35.7 million, or 6.1%, to $551.4 million in the six months ended June 30, 2010 from $587.2 million in the six months ended June 30, 2009. Revenues for the home respiratory therapy and home medical equipment segment decreased to 53.7% of total revenue in the six months ended June 30, 2010 from 56.5% in the six months ended June 30, 2009.
Home respiratory therapy revenues are derived primarily from the provision of oxygen systems, home ventilators, obstructive sleep apnea equipment, nebulizers, respiratory medications and related services. Revenues from the home respiratory therapy service line decreased by 6.0% in the six months ended June 30, 2010 compared to the six months ended June 30, 2009. The decrease in revenue resulted primarily from decreases in oxygen, sleep apnea and other respiratory revenue, due to the termination of or changes to certain payor contracts, as well as the impact of revenue recognized in the three months ended March 31, 2009 that was previously deferred for services performed prior to certain Medicare reimbursement reductions.
Home medical equipment revenues are derived from the rental and sale of equipment to assist patients with ambulation, safety and general care in and around the home. Home medical equipment revenues decreased by 6.7% in the six months ended June 30, 2010 compared to the six months ended June 30, 2009. The decrease was primarily due to the termination of or changes to certain payor contracts.
EBIT for the home respiratory and home medical equipment segment in the six months ended June 30, 2010 was $13.3 million compared to $48.6 million in the six months ended June 30, 2009. EBIT was 2.4% of segment net revenues in the six months ended June 30, 2010 compared to the 8.3% of segment net revenues in the six months ended June 30, 2009. This decrease in EBIT as a percentage of segment net revenues was primarily due to the unfavorable collection experience in the six months ended June 30, 2010 compared to the six months ended June 30, 2009 and an increase in sales, distribution and administrative costs as a percentage of net segment revenues due to a reduction in net segment revenues in the six months ended June 30, 2010 compared to the six months ended June 30, 2009.
Home Infusion Therapy Segment. For the home infusion therapy segment, total net revenues increased $23.8 million, or 5.3% to $475.6 million for the six months ended June 30, 2010 from $451.8 million in the six months ended June 30, 2009. Revenues for the home infusion therapy segment increased to 46.3% of total revenue in the six months ended June 30, 2010 from 43.5% in the six months ended June 30, 2009.
60
The home infusion therapy segment involves the administration of drugs or nutrients directly into the body intravenously through a needle or catheter. Infusion therapy services also include administering enteral nutrients directly into the gastrointestinal tract through a feeding tube. The growth in home infusion therapy revenue resulted primarily from an increase in the overall volume of specialty drugs, core drugs, non-core revenue and enteral nutrients. These increases were partially offset by a decrease in revenue due to the termination of certain payor contracts.
EBIT for the home infusion therapy segment in the six months ended June 30, 2010 was $54.8 million compared to $25.1 million in the six months ended June 30, 2009. EBIT was 11.5% of segment net revenues in the six months ended June 30, 2010 compared to 5.5% of segment net revenues in the six months ended June 30, 2009. This increase in EBIT as a percentage of segment net revenues was primarily due to improvements in the gross profit margin, sales, distribution and administrative costs and the provision for doubtful accounts as a percentage of net segment revenues in the six months ended June 30, 2010 compared to the six months ended June 30, 2009.
Year Ended December 31, 2009 Results Compared to the Period October 29, 2008 to December 31, 2008 Results
The following table compares year ended December 31, 2009 results with the period October 29, 2008 to December 31, 2008.
(in thousands) |
Year
Ended December 31, 2009 |
Percentage of Net Revenues |
Period October 29, 2008 to December 31, 2008 |
Percentage of Net Revenues |
||||||||||
Net revenues: |
||||||||||||||
Fee for service arrangements |
$ | 1,930,464 | 92.2 | % | $ | 328,005 | 92.0 | % | ||||||
Capitation |
164,097 | 7.8 | 28,660 | 8.0 | ||||||||||
TOTAL NET REVENUES |
2,094,561 | 100.0 | 356,665 | 100.0 | ||||||||||
Costs and expenses: |
||||||||||||||
Cost of net revenues: |
||||||||||||||
Product and supply costs |
638,452 | 30.5 | 105,120 | 29.5 | ||||||||||
Patient service equipment depreciation |
101,681 | 4.9 | 17,539 | 4.9 | ||||||||||
Amortization of intangible assets |
44,000 | 2.1 | | | ||||||||||
Home respiratory therapy services |
34,700 | 1.7 | 6,270 | 1.8 | ||||||||||
Nursing services |
36,345 | 1.7 | 6,276 | 1.8 | ||||||||||
Other |
12,281 | 0.6 | 2,555 | 0.7 | ||||||||||
TOTAL COST OF NET REVENUES |
867,459 | 41.4 | 137,760 | 38.6 | ||||||||||
Provision for doubtful accounts |
57,919 | 2.8 | 14,329 | 4.0 | ||||||||||
Selling, distribution and administrative |
1,050,134 | 50.1 | 179,362 | 50.3 | ||||||||||
Amortization of intangible assets |
3,716 | 0.2 | 1,008 | 0.3 | ||||||||||
TOTAL COSTS AND EXPENSES |
1,979,228 | 94.5 | 332,459 | 93.2 | ||||||||||
OPERATING INCOME |
115,333 | 5.5 | 24,206 | 6.8 | ||||||||||
Interest expense |
129,200 | 6.2 | 26,167 | 7.3 | ||||||||||
Interest income and other |
(1,609 | ) | (0.1 | ) | (726 | ) | (0.2 | ) | ||||||
LOSS BEFORE TAXES |
(12,258 | ) | (0.6 | ) | (1,235 | ) | (0.3 | ) | ||||||
Income tax (benefit) expense |
(8,438 | ) | (0.4 | ) | 659 | 0.2 | ||||||||
NET LOSS |
$ | (3,820 | ) | (0.2 | )% | $ | (1,894 | ) | (0.5 | )% | ||||
61
Net Revenues. Net revenues in the year ended December 31, 2009 were $2,094.6 million compared to $356.7 million in the period October 29, 2008 to December 31, 2008. Revenue for the year ended December 31, 2009 increased due to more operating days in the year ended December 31, 2009 compared to the period October 29, 2008 to December 31, 2008. In the year ended December 31, 2009 revenue was impacted by Medicare reimbursement reductions of $108.7 million that did not occur in the period October 29, 2008 to December 31, 2008. The Medicare reimbursement reductions primarily related to:
| respiratory drug reimbursement reductions effective April 1, 2008; |
| changing the maximum rental period of oxygen equipment from an unlimited rental period to 36 months (the regulation effective date was January 2006; revenue was therefore impacted beginning in January 2009); and |
| MIPPA legislation authorized an average of 9.5% payment reduction in the DMEPOS fee schedule effective January 2009. |
We expect to continue to face pricing pressures from Medicare and Medicaid as well as from our managed care customers as these payers seek to lower costs by obtaining more favorable pricing from providers such as us. In addition to the pricing reductions, such changes could cause us to provide reduced levels of certain products and services in the future, resulting in a corresponding reduction in revenue. See Business Government Regulation. For the year ended December 31, 2009 and the period October 29, 2008 to December 31, 2008, revenues reimbursed under arrangements with Medicare and Medicaid were approximately 28% and 31%, respectively, as a percentage of total revenues. In the year ended December 31, 2009 and the period October 29, 2008 to December 31, 2008, no other third-party payor group represented more than 8% of our revenues. In fee for service arrangement revenue, rental and sale revenues comprise approximately $654.6 million or 33.9% and $1,275.9 million or 66.1% and $125.7 million or 38.3% and $202.3 or 61.7% in the year ended December 31, 2009 and the period October 29, 2008 to December 31, 2008.
Gross Profit. Gross profit margin is defined as total net revenues less total costs of total net revenues divided by total net revenues. The gross profit margin for the year ended December 31, 2009 was 58.6%, compared to 61.4% in the period October 29, 2008 to December 31, 2008. Included in cost of revenue for the year ended December 31, 2009 is $44.0 million of amortization related to our patient backlog intangible asset which was provisional in the period October 29, 2008 to December 31, 2008. In addition, this decrease in gross profit margin was primarily due to the negative impact of the Medicare reimbursement reductions. Excluding the intangible asset amortization and the impact of Medicare reimbursement reductions, the overall gross profit margin percentage for the year ended December 31, 2009 would have been 62.4%, compared to 61.4% in the period October 29, 2008 to December 31, 2008. This improvement in the gross profit margin was due to a shift in product mix to a higher volume of products with lower costs as a percentage of revenue in our home respiratory therapy service line and our ability to obtain favorable pricing on the purchase of products and supplies in our all three of our service lines. These improvements in the gross profit margin were partially offset by a decrease in the gross profit margin in our home infusion therapy service line as a result of a shift in product mix to more specialty drugs, which have a higher product cost as a percentage of revenue.
Provision for Doubtful Accounts. The provision for doubtful accounts is based on managements estimate of the net realizable value of accounts receivable after considering actual write-offs of specific receivables. Accounts receivable estimated to be uncollectible are provided for by computing a required reserve using estimated future cash receipts based on historical cash receipts collections as a percentage of revenue. In addition, management may adjust for changes in billing practices, cash collection protocols or practices, or changes in general economic conditions, contractual issues with specific payors, new markets or products. The provision for doubtful accounts, expressed as a percentage of total net revenues, was 2.8% and 4.0% in the year ended December 31, 2009 and the period October 29, 2008 to December 31, 2008, respectively. The decrease in the provision for doubtful accounts in 2009 is primarily the result of favorable collections experience occurring in the year ended December 31, 2009 as a percentage compared to the period October 29, 2008 to December 31, 2008.
Selling, Distribution and Administrative Expenses. Selling, distribution and administrative expenses are comprised of expenses incurred in direct support of operations and those associated with administrative
62
functions. Expenses incurred by the operating locations include salaries and other expenses in the following functional areas: selling, distribution, clinical services, warehousing and repair. Many of these operating costs are directly variable with revenue growth patterns. Some are also very sensitive to market-driven price fluctuations such as facility lease and fuel costs. The administrative expenses include overhead costs incurred by the operating locations and regional and corporate support functions. These expenses are generally less sensitive to fluctuations in revenue growth than operating costs.
Selling, distribution and administrative expenses, expressed as a percentage of total net revenues were 50.1% for the year ended December 31, 2009 compared to 50.3% for the period October 29, 2008 to December 31, 2008. Adjusted for Medicare reimbursement reductions of $108.7 million in the year ended December 31, 2009, the selling, distribution and administrative expense percentage for 2009 would have been 47.7% of revenue in the year ended December 31, 2009.
In the year ended December 31, 2009 and the period October 29, 2008 to December 31, 2008 labor and other related expenses as a percentage of total net revenues were 33.0% and 32.9%, respectively. For the year ended December 31, 2009 when adjusting for the impact of Medicare reimbursement reductions, labor and related costs were 31.4% of total revenue. The decrease in labor and other related expenses was primarily due to reduced salaries and wages as a result of headcount reductions in 2009 and lower outside labor. These decreases were partially offset by increases due to higher management incentive compensation program expense, as a result of meeting the targets in 2009 and not in 2008, and higher termination and retention expense due to the projects to outsource certain billing, collection and information technology functions.
In the year ended December 31, 2009 and the period October 29, 2008 to December 31, 2008 other operating expenses as a percentage of total net revenues were 17.1% and 17.4%, respectively. For the year ended December 31, 2009 when adjusting for the impact of Medicare reimbursement reductions, other operating expenses were 16.3% of total revenue. The decreases in other operating expenses were primarily due to delivery costs, principally lower fuel prices and lower freight costs due to renegotiation of a contract with a vendor. These decreases were partially offset by expenses incurred in 2009 associated with our projects to outsource certain billing, collection and information technology functions that did not exist in 2008, professional fees incurred in connection with the sale of our outstanding Series A-1 Notes and Series A-2 Notes and expenses associated with other corporate initiative projects in 2009.
Amortization of Intangible Assets. Amortization of intangible assets was 0.2% and 0.3% of total net revenues in the year ended December 31, 2009 and the period October 29, 2008 to December 31, 2008, respectively. The amortization expense primarily results from the revaluation of intangible assets as a result of the Merger, including the finalization of the intangible asset valuation in 2009.
Interest Expense. Interest expense as a percentage of total net revenues was 6.2% for the year ended December 31, 2009. Adjusted for the impact of Medicare reimbursement reductions interest expense was 5.9% of total net revenues in the year ended December 31, 2009. Interest expense for the period October 29, 2008 to December 31, 2008 was 7.3% of revenue. This decrease is primarily due to higher interest expense in the two month period due to higher borrowing on the ABL facility and higher deferred debt costs in 2008 related to the Predecessor Revolving Credit Facility and Senior Secured Bridge Credit Agreement.
Interest Income and Other. Interest income and other was 0.1% as a percentage of total net revenues for the year ended December 31, 2009 compared to 0.2% as a percentage of total net revenues for the period October 29, 2008 to December 31, 2008. This decrease is due to a decrease in interest rates earned on invested cash.
Income Tax Benefit. The income tax benefit as a percentage of total net revenues for the year ended December 31, 2009 was 0.4% compared to a tax expense as a percentage of total net revenues of 0.2% for the period October 29, 2008 to December 31, 2008. The effective tax rate was 68.8% at December 31, 2009 compared to 53.4% for the period October 29, 2008 to December 31, 2008. The income tax benefit in the year ended December 31, 2009 resulted from (1) a reduction in our valuation allowances related to state net operating losses and other state deferred tax assets and (2) a decrease in our tax reserves due to settlements with state tax agencies and the expiration of statute of limitations.
63
Segment Net Revenues and EBIT
The following table sets forth a summary of results of operations by segment:
(in thousands) |
Year Ended December 31, 2009 |
Percentage of Net Revenues |
Period October 29, 2008 to December 31, 2008 |
Percentage of Net Revenues |
||||||||
Net revenues: |
||||||||||||
Home respiratory therapy and home medical equipment |
$ | 1,169,609 | 55.8 | % | $ | 209,567 | 58.8 | % | ||||
Home infusion therapy |
924,952 | 44.2 | 147,098 | 41.2 | ||||||||
Total net revenues |
$ | 2,094,561 | 100.0 | % | $ | 356,665 | 100.0 | % | ||||
(in thousands) |
Year Ended December 31, 2009 | ||||||||||||||
Home
Respiratory Therapy and Home Medical Equipment |
Percentage of Segment Net Revenues |
Home Infusion Therapy |
Percentage of Segment Net Revenues |
Total | |||||||||||
EBIT |
$ | 50,167 | 4.3 | % | $ | 65,667 | 7.1 | % | $ | 115,834 |
(in thousands) |
Period October 29, 2008 to December 31, 2008 | |||||||||||||||
Home
Respiratory Therapy and Home Medical Equipment |
Percentage of Segment Net Revenues |
Home Infusion Therapy |
Percentage of Segment Net Revenues |
Total | ||||||||||||
EBIT |
$ | 26,255 | 12.5 | % | $ | (1,740 | ) | (1.2 | )% | $ | 24,515 |
We allocate certain expenses that are not directly attributable to a product line based upon segment headcount. For a reconciliation of net income (loss) to EBIT, see the table under Results of OperationsEBIT at the end of this section.
Home Respiratory Therapy and Home Medical Equipment Segment. Net revenues for the home respiratory therapy and home medical equipment segment in the year ended December 31, 2009 was $1,169.6 million compared to $209.6 million in the period October 29, 2008 to December 31, 2008. Revenues for the home respiratory therapy and home medical equipment segment decreased to 55.8% of total revenue in the year ended December 31, 2009 from 58.8% in the period October 29, 2008 to December 31, 2008.
Home respiratory therapy revenues are derived primarily from the provision of oxygen systems, home ventilators, obstructive sleep apnea equipment, nebulizers, respiratory medications and related services. Revenues from the respiratory therapy service line decreased to 48.4% of total revenue in the year ended December 31, 2009 compared to 51.5% in the period October 29, 2008 to December 31, 2008. The majority of Medicare reimbursement reductions discussed above impacted the home respiratory therapy services line. Such reductions were $104.0 million for the year ended December 31, 2009. Adjusted for the Medicare reimbursement reductions, respiratory therapy revenues for 2009 would have been 50.7%. Home respiratory therapy revenues as a percentage of total revenue decreased as a result of increased sales as a percentage of total revenue in our home infusion therapy service line.
Home medical equipment revenues are derived from the rental and sale of equipment to assist patients with ambulation, safety and general care in and around the home. Home medical equipment revenues were 7.5% of total revenue in the year ended December 31, 2009 compared to 7.3% of total revenue in the period October 29, 2008 to December 31, 2008. During the year ended December 31, 2009, $1.9 million of the Medicare reimbursement reductions impacted this service line. Excluding the impact of the Medicare reimbursement reductions, home medical equipment revenue would have been 7.2% of total revenues in the year ended December 31, 2009.
64
EBIT for the home respiratory therapy and home medical equipment segment in the year ended December 31, 2009 was $50.2 million compared to $26.3 million in the period October 29, 2008 to December 31, 2008. EBIT was 4.3% of segment net revenues in the year ended December 31, 2009 compared to 12.5% of segment net revenues in the period October 28, 2008 to December 31, 2008. This decrease in EBIT as a percentage of segment net revenues was primarily due to the negative impact of the Medicare reimbursement reductions. This decrease in the EBIT was partially offset by a shift in product mix to a higher volume of products with lower costs as a percentage of segment net revenues in our home respiratory therapy service line and our ability to obtain favorable pricing on the purchase of products and supplies.
Home Infusion Therapy Segment. For the home infusion therapy segment total net revenues increased $777.9 million, or 528.8%, to $925.0 million in the year ended December 31, 2009 from $147.1 million in the period October 29, 2008 to December 31, 2008. Revenues for the home infusion therapy segment increased to 44.2% of total revenue in the year ended December 31, 2009 from 41.2% in the period October 29, 2008 to December 31, 2008.
Home infusion therapy involves the administration of drugs or nutrients directly into the body intravenously through a needle or catheter. Infusion therapy services also include administering enteral nutrients directly into the gastrointestinal tract through a feeding tube. Home infusion therapy revenues as a percentage of total revenue increased to 44.2% in the year ended December 31, 2009 compared to 41.2% in the period October 29, 2008 to December 31, 2008. The growth in revenue in the year ended December 31, 2009 resulted primarily from an increase in volume of specialty drugs, core drugs and enteral nutrients. The increase in these drugs was offset by a decrease in revenue due to the termination of a payor contract, and a decrease in volume of non-core revenue. As a result of increasing volume, specialty drug revenue also increased as a percentage of total home infusion therapy revenue. During the year ended December 31, 2009, Medicare reimbursement reductions impacted this service line by $2.8 million. Excluding the impact of Medicare reimbursement reductions, home infusion therapy revenue would have been 42.1% as a percentage of total revenue for the year ended December 31, 2009.
EBIT for the home infusion therapy segment in the year ended December 31, 2009 was $65.7 million compared to $(1.7) million in the period October 28, 2008 to December 31, 2008. EBIT was 7.1% of segment net revenues in the year ended December 31, 2009 compared to (1.2)% of segment net revenues in the period October 29, 2008 to December 31, 2008. This increase in EBIT was primarily due to our ability to obtain favorable pricing on the purchase of products and supplies and our ability to reduce our selling distribution and administrative costs as a percentage of segment net revenues partially offset by a decrease in the gross profit margin as a result of a shift in product mix to more specialty drugs, which have a higher product cost as a percentage of segment net revenues.
65
Year Ended December 31, 2009 Results Compared to Pro forma Year Ended December 31, 2008 Results
The following table compares the year ended December 31, 2009 results to the pro forma results for the year ended December 31, 2008 to reflect the Merger if it had occurred on January 1, 2008. We are providing a comparison of the year ended December 31, 2009 to the pro forma year ended December 31, 2008 for illustrative purposes only to facilitate the comparison of the results of the full year 2008 with the full year 2009.
Year Ended December 31, 2009 |
Period October 29, 2008 to December 31, 2008 |
Period January 1, 2008 to October 28, 2008 |
Adjustments for the Transactions |
Year
Ended December 31, 2008 Pro forma |
Year Ended December 31, 2009 Compared to Pro forma Year Ended December 31, 2008 |
||||||||||||||||||||||||
(in thousands) |
Increase/ Decrease |
Percentage Change |
|||||||||||||||||||||||||||
(Successor) | (Successor) | (Predecessor) | |||||||||||||||||||||||||||
Net revenues: |
|||||||||||||||||||||||||||||
Fee for service arrangements |
$ | 1,930,464 | $ | 328,005 | $ | 1,630,767 | $ | | $ | 1,958,772 | $ | (28,308 | ) | (1.4 | )% | ||||||||||||||
Capitation |
164,097 | 28,660 | 142,522 | | 171,182 | (7,085 | ) | (4.1 | ) | ||||||||||||||||||||
TOTAL NET REVENUES |
2,094,561 | 356,665 | 1,773,289 | | 2,129,954 | (35,393 | ) | (1.7 | ) | ||||||||||||||||||||
Costs and expenses: |
|||||||||||||||||||||||||||||
Cost of net revenues: |
|||||||||||||||||||||||||||||
Product and supply costs |
638,452 | 105,120 | 526,610 | | 631,730 | 6,722 | 1.1 | ||||||||||||||||||||||
Patient service equipment depreciation |
101,681 | 17,539 | 89,246 | | 106,785 | (5,104 | ) | (4.8 | ) | ||||||||||||||||||||
Amortization of intangible assets |
44,000 | | | 42,920 | (a) | 42,920 | 1,080 | 2.5 | |||||||||||||||||||||
Home respiratory therapy services |
34,700 | 6,270 | 31,893 | | 38,163 | (3,463 | ) | (9.1 | ) | ||||||||||||||||||||
Nursing services |
36,345 | 6,276 | 29,773 | | 36,049 | 296 | 0.8 | ||||||||||||||||||||||
Other |
12,281 | 2,555 | 13,815 | | 16,370 | (4,089 | ) | (25.0 | ) | ||||||||||||||||||||
TOTAL COST OF NET REVENUES |
867,459 | 137,760 | 691,337 | 42,920 | 872,017 | (4,558 | ) | (0.5 | ) | ||||||||||||||||||||
Provision for doubtful accounts |
57,919 | 14,329 | 33,626 | | 47,955 | 9,964 | 20.8 | ||||||||||||||||||||||
Selling, distribution and administrative |
1,050,134 | 179,362 | 924,536 | (22,613 | )(b) | 1,081,285 | (31,151 | ) | (2.9 | ) | |||||||||||||||||||
Amortization of intangible assets |
3,716 | 1,008 | 3,461 | (796 | )(c) | 3,673 | 43 | 1.2 | |||||||||||||||||||||
TOTAL COSTS AND EXPENSES |
1,979,228 | 332,459 | 1,652,960 | 19,511 | 2,004,930 | (25,702 | ) | (1.3 | ) | ||||||||||||||||||||
OPERATING INCOME |
115,333 | 24,206 | 120,329 | (19,511 | ) | 125,024 | (9,691 | ) | (7.8 | ) | |||||||||||||||||||
Interest expense |
129,200 | 26,167 | 31,838 | 74,270 | (d) | 132,275 | (3,075 | ) | (2.3 | ) | |||||||||||||||||||
Interest income and other |
(1,609 | ) | (726 | ) | (2,154 | ) | | (2,880 | ) | 1,271 | (44.1 | ) | |||||||||||||||||
(LOSS) INCOME BEFORE TAXES |
(12,258 | ) | (1,235 | ) | 90,645 | (93,781 | ) | (4,371 | ) | (7,887 | ) | 180.4 | |||||||||||||||||
Income tax (benefit) expense |
(8,438 | ) | 659 | 34,192 | (36,829 | )(e) | (1,978 | ) | (6,460 | ) | 326.6 | ||||||||||||||||||
(LOSS) INCOME |
$ | (3,820 | ) | $ | (1,894 | ) | $ | 56,453 | $ | (56,952 | ) | $ | (2,393 | ) | $ | (1,427 | ) | 59.6 | % | ||||||||||
(a) | Reflects amortization expense of patient backlog intangible assets with finite lives that were identified as a result of the Merger, as set forth below: |
(in thousands) |
Gross Carrying Amount at December 31, 2009 |
Life | Annual Amortization Expense | |||||
Patient backlog |
$ | 44,000 | 1.1 | $ | 42,920 |
66
The adjustment was calculated as follows:
(in thousands) |
Year Ended December 31, 2008 | ||
Amortization expense as a results of the Merger |
$ | 42,920 | |
Less: historical amortization expense |
| ||
Total adjustment |
$ | 42,920 | |
(b) | Represents adjustments to expenses as set forth below. |
(in thousands) |
Year Ended December 31, 2008 |
|||
Legal, accounting and other expenses directly attributable to the Merger |
$ | (4,458 | ) | |
Management fee(i) |
5,773 | |||
Accelerated stock option vesting (ii) |
(22,328 | ) | ||
Executive bonus payments (iii) |
(1,600 | ) | ||
Total adjustments to expenses |
$ | (22,613 | ) | |
(i) | Reflects an annual management fee of $7.0 million payable to an affiliate of the Sponsor under the transaction and management fee agreement. |
The adjustments for the management fee were calculated as follows:
(in thousands) |
Year Ended December 31, 2008 |
|||
Management fee |
$ | 7,000 | ||
Less: management fee recorded for the periods shown |
(1,227 | ) | ||
Total adjustment |
$ | 5,773 | ||
(ii) | Reflects accelerated compensation expense due to the vesting and payout of all stock-based awards as a result of the Merger. |
(iii) | Represents incremental bonuses paid as a result of the Merger to certain executive officers pursuant to change in control provisions in their employment agreements. |
(c) | Reflects the amortization expense of intangible assets with finite lives that were identified as a result of the Merger, as set forth below. |
(in thousands) |
Gross Carrying Amount at December 31, 2009 |
Life | Annual Amortization Expense | |||||
Capitated relationships |
$ | 40,000 | 20 | $ | 2,000 | |||
Payor relationships |
11,000 | 20 | 550 | |||||
Net favorable leasehold interest |
3,553 | 3.2 | 1,123 | |||||
Total intangible assets with finite lives |
$ | 54,553 | $ | 3,673 | ||||
The adjustments were calculated as follows:
(in thousands) |
Year Ended December 31, 2008 |
|||
Amortization expense as a results of the Merger |
$ | 3,673 | ||
Less: historical amortization expense |
(4,469 | ) | ||
Total adjustment |
$ | (796 | ) | |
67
(d) | Reflects interest expense resulting from our new capital structure (using current applicable LIBOR rates) as set forth below. |
(in thousands) |
Balance | Assumed Rate |
Interest Expense Year Ended December 31, 2008 |
|||||||
Senior Secured Bridge Credit Agreement(1) |
$ | 1,010,000 | 12.00 | % | $ | 121,200 | ||||
ABL Facility(2) |
150,000 | 1.20 | % | 1,803 | ||||||
Ongoing interest on other existing debt to be retained(3) |
4,733 | 1,869 | ||||||||
Total cash interest expense |
124,872 | |||||||||
Amortization of capitalized debt issuance costs related to the Merger(4) |
57,678 | 7,403 | ||||||||
Total pro forma interest expense related to the Merger |
132,275 | |||||||||
Less: historical interest expense |
(58,005 | ) | ||||||||
Total adjustment to pro forma interest expense related to the Merger |
74,270 | |||||||||
Total pro forma interest expense |
$ | 132,275 | ||||||||
(1) | Represents $1,010.0 million borrowed under the Senior Secured Bridge Credit Agreement entered into in October 2008, which bears interest at the rate of 12.00% per annum. |
(2) | Reflects $16.1 million of drawn letters of credit, no borrowings and the undrawn portion in the amount of $133.9 million under the ABL Facility. The interest rate on the ABL Facility used to compute pro format interest expense is an assumed blended interest rate of the letters of credit and the undrawn portion of the ABL Facility. The interest rate on borrowings under the ABL Facility is variable and had there been borrowings under the ABL Facility, the interest rate on the borrowed portion would have been determined using a three-month LIBOR rate of 0.25% plus an assumed applicable margin of 2.75%, based upon an assumed average excess availability of $133.9 million. The pro forma fee expense for letters of credit is assumed at 2.75% to 3.25%, depending on the average excess availability, with the lowest average excess availability resulting in the highest letters of credit fees and applicable margin. The ABL Facility also requires a fee for undrawn amounts ranging from 0.50% to 1.00% depending on the utilization percentage, with the lowest utilization rate resulting in the highest fee rate. The pro forma interest expense assumes a utilization fee of 1.00%. See Liquidity and Capital Resources for more information. A 0.125% variance in the assumed blended interest rate for the ABL Facility would amount to a change in total annual pro forma interest expense of $0.2 million. |
(3) | Represents $4.7 million of capital leases, deferred compensation and certain other indebtedness that we retained following the Refinancing. On going interest amounts for debt that were retained after the Transactions are based upon actual interest amounts recorded during each of the pro forma periods. Includes interest expense recorded in relation to accretion of the Companys deferred compensation plan of approximately $0.1 million and $1.0 million for the historical period of October 29, 2008 to December 31, 2008 and the historical period of January 1, 2008 to October 28, 2008. |
(4) | Debt issuance costs related to the Merger. Amortization is calculated using the effective interest method over the terms of the related debt. |
68
(e) | Reflects the estimated tax impact relating to the adjustments for the Merger, calculated at estimated statutory rates as set forth below. |
(in thousands) |
Year Ended December 31, 2008 |
|||
Total adjustments for the Merger |
$ | (93,781 | ) | |
Adjustments without tax benefit |
2,377 | |||
Adjustments resulting in tax benefit |
(96,158 | ) | ||
Statutory tax rate |
38.3 | % | ||
Tax effect of the adjustments for the Merger |
$ | (36,829 | ) | |
Net Revenues. Net revenues decreased $35.4 million, or 1.7%, to $2,094.6 million in the year ended December 31, 2009 from $2,130.0 million in the pro forma year ended December 31, 2008. The revenue decline for the year ended December 31, 2009 was impacted by Medicare reimbursement reductions of $108.7 million. Had those reductions not been implemented, revenues for 2009 would have increased by 3.4%. The Medicare reimbursement reductions primarily related to:
| respiratory drug reimbursement reductions effective April 1, 2008; |
| changing the maximum rental period of oxygen equipment from an unlimited rental period to 36 months (regulation effective date of January 2006); and |
| MIPPA legislation authorized an average of 9.5% payment reduction in the DMEPOS fee schedule effective January 2009. |
We expect to continue to face pricing pressures from Medicare and Medicaid as well as from our managed care customers as these payers seek to lower costs by obtaining more favorable pricing from providers such as us. In addition to the pricing reductions, such changes could cause us to provide reduced levels of certain products and services in the future, resulting in a corresponding reduction in revenue. See BusinessGovernment Regulation.
Gross Profit. Gross profit margin is defined as total net revenues less total costs of total net revenues divided by total net revenues. The gross profit margin in the year ended December 31, 2009 was 58.6%, compared to 59.1% in the pro forma year ended December 31, 2008. Included in cost of revenue is amortization related to our patient backlog intangible asset of $44.0 million during the year ended December 31, 2009 and $42.9 million during the pro forma year ended December 31, 2008. As of December 31, 2009, the patient backlog intangible asset was fully amortized. Excluding the impact of the intangible asset amortization discussed above, the overall gross profit margin percentage for the year ended December, 31, 2009 would have been 60.7%, compared to 61.1% in the pro forma year ended December 31, 2008. This decrease of 0.4% in gross profit margin was primarily due to the negative impact of the Medicare reimbursement reductions. Excluding the intangible asset amortization and the impact of Medicare reimbursement reductions, the overall gross profit margin percentage for the year ended December 31, 2009 would have been 62.4%, compared to 61.1% in the pro forma year ended December 31, 2008. This improvement was primarily the result of a shift in product mix to a higher volume of products with lower cost as a percentage of revenue in our home respiratory service line; our ability to obtain favorable pricing on the purchase of products and supplies in all three of our service lines and the sale of the rehabilitation product line in June 2008. These favorable items were partially offset by a decrease in rental revenue with no corresponding decrease in fixed costs in our home medical equipment service line and a decrease in gross profit margin, as the result of the shift in product mix in our infusion therapy drugs to more specialty drugs, which have a higher product cost as a percentage of net revenues.
Provision for Doubtful Accounts. The provision for doubtful accounts is based on managements estimate of the net realizable value of accounts receivable after considering actual write-offs of specific receivables.
69
Accounts receivable estimated to be uncollectible are provided for by computing a required reserve using estimated future cash receipts based on historical cash receipts collections as a percentage of revenue. In addition, management may adjust for changes in billing practices, cash collection protocols or practices, or changes in general economic conditions, contractual issues with specific payors, new markets or products. The provision for doubtful accounts, expressed as a percentage of total net revenues, was 2.8% and 2.3% in the year ended December 31, 2009 and the pro forma year ended December 31, 2008, respectively. The increased provision for doubtful accounts in 2009 is primarily the result of favorable collections experience occurring in 2008 compared to 2009.
Selling, Distribution and Administrative Expenses. Selling, distribution and administrative expenses are comprised of expenses incurred in direct support of operations and those associated with administrative functions. Expenses incurred by the operating locations include salaries and other expenses in the following functional areas: selling, distribution, clinical services, warehousing and repair. Many of these operating costs are directly variable with revenue growth patterns. Some are also very sensitive to market-driven price fluctuations such as facility lease and fuel costs. The administrative expenses include overhead costs incurred by the operating locations, regional and corporate support functions. These expenses are generally less sensitive to fluctuations in revenue growth than operating costs.
Selling, distribution and administrative expenses, expressed as a percentage of total net revenues was 50.1% for the year ended December 31, 2009 compared to 50.8% for the pro forma year ended December 31, 2008. Adjusted for Medicare reimbursement reductions of $108.7 million, the selling, distribution and administrative expense percentage for 2009 would have been 47.7% of revenue.
Selling, distribution and administrative expenses decreased by $31.2 million for the year ended December 31, 2009 over the pro forma year ended December 31, 2008. The $31.2 million decrease was composed of a $12.9 million decrease in labor and other related expenses and by a decrease in other operating expenses of $18.3 million. The decrease in labor and other related expenses was primarily due to reduced salaries and wages as a result of headcount reductions in 2009, the sale of our rehabilitation product line in July 2008, the reduction in expenses related to equity incentive awards, and lower outside labor. These decreases were partially offset by increases due to higher management incentive compensation program expense as a result of meeting the targets in 2009 and not in 2008, and higher termination and retention expense due to the projects to outsource certain billing, collection and information technology functions, and the Merger. The decreases in other operating expenses of $18.3 million were primarily due to delivery costs, principally lower fuel prices, lower freight costs due to renegotiation of a contract with a vendor, reduction in expenses due to sale of our rehabilitation product line in July 2008 and lower depreciation on information technology assets. These decreases were partially offset by expenses incurred in 2009 associated with our projects to outsource certain billing, collection and information technology functions that did not exist in 2008, professional fees incurred in connection with the sale of our outstanding Series A-1 Notes and Series A-2 Notes and expenses associated with other corporate initiative projects in 2009.
Amortization of Intangible Assets. Amortization of intangible assets was $3.7 million in the year ended December 31, 2009 and in the pro forma year ended December 31, 2008. The amortization expense primarily results from the revaluation of intangible assets as a result of the Merger, including the finalization of the intangible asset valuation in 2009.
Interest Expense. Interest expense decreased $3.1 million, or 2.3%, to $129.2 million in the year ended December 31, 2009 from $132.3 million in the pro forma year ended December 31, 2008. This decrease is primarily due to a lower interest rate of 11.8% in the year ended December 31, 2009 as compared to 12.0% for the pro forma year ended December 31, 2008.
Interest Income and Other. Interest income and other decreased $1.3 million, or 44.1%, to $1.6 million in the year ended December 31, 2009 from $2.9 million in the pro forma year ended December 31, 2008.
70
Income Tax Benefit. Income tax benefit increased $6.5 million to $(8.4) million in the year ended December 31, 2009 from $(1.9) million in the pro forma year ended December 31, 2008. The increase in income tax benefit in the year ended December 31, 2009 from the pro forma year ended December 31, 2008 resulted from (1) a reduction in our valuation allowances related to state net operating losses and other state deferred tax assets and (2) a decrease in our tax reserves due to settlements with state tax agencies and the expiration of statute of limitations. The reductions in our valuation allowances and tax reserves resulted in a 68.8% effective tax benefit for the year ended December 31, 2009 compared with 45.3% for the pro forma year ended December 31, 2008.
Segment Net Revenues and EBIT
The following table sets forth a summary of results of operations by segment:
(in thousands) |
Year Ended December 31, 2009 |
Percentage of Net Revenues |
Pro Forma Year Ended December 31, 2008 |
Percentage of Net Revenues |
||||||||
Net revenues: |
||||||||||||
Home respiratory therapy and home medical equipment |
$ | 1,169,609 | 55.8 | % | $ | 1,284,278 | 60.3 | % | ||||
Home infusion therapy |
924,952 | 44.2 | 845,676 | 39.7 | ||||||||
Total net revenues |
$ | 2,094,561 | 100.0 | % | $ | 2,129,954 | 100.0 | % | ||||
Year Ended December 31, 2009 | |||||||||||||||
(in thousands) |
Home
Respiratory Therapy and Home Medical Equipment |
Percentage of Segment Net Revenues |
Home Infusion Therapy |
Percentage of Segment Net Revenues |
Total | ||||||||||
EBIT |
$ | 50,167 | 4.3 | % | $ | 65,667 | 7.1 | % | $ | 115,834 |
Pro Forma Year Ended December 31, 2008 | |||||||||||||||
(in thousands) |
Home Respiratory Therapy and Home Medical Equipment |
Percentage of Segment Net Revenues |
Home Infusion Therapy |
Percentage of Segment Net Revenues |
Total | ||||||||||
EBIT |
$ | 111,708 | 8.7 | % | $ | 14,188 | 1.7 | % | $ | 125,896 |
We allocate certain expenses that are not directly attributable to a product line based upon segment headcount. For a reconciliation of net income (loss) to EBIT, see the table under Results of OperationsEBIT at the end of this section.
Home Respiratory Therapy and Home Medical Equipment Segment: For the home respiratory therapy and home medical equipment segment total net revenues decreased $114.7 million, or 8.9%, to $1,169.6 million in the year ended December 31, 2009 from $1,284.3 million in the pro forma year ended December 31, 2008. Revenues for the home respiratory therapy and home medical equipment segment decreased to 55.8% of total revenue in the year ended December 31, 2009 from 60.3% in the pro forma year ended December 31, 2008.
Home respiratory therapy revenues are derived primarily from the provision of oxygen systems, home ventilators, obstructive sleep apnea equipment, nebulizers, respiratory medications and related services. Revenues from the home respiratory therapy service line decreased by 7.6% in the year ended December 31, 2009 compared to the pro forma year ended December 31, 2008. The majority of Medicare reimbursement reductions discussed above impacted the home respiratory therapy services line. Such reductions were $104.0 million for year ended December 31, 2009. Adjusted for the Medicare reimbursement reductions, respiratory therapy revenues for 2009 would have increased by 1.9%. The increase in revenue, excluding the Medicare reimbursement reductions, resulted primarily from increases in oxygen, sleep apnea, and ventilator revenue, partially offset by decreases in respiratory medication revenue and nebulizer revenue.
71
Home medical equipment revenues are derived from the rental and sale of equipment to assist patients with ambulation, safety and general care in and around the home. Home medical equipment revenues decreased by 16.6% in the year ended December 31, 2009 compared to the pro forma year ended December 31, 2008. The decrease was primarily due to the sale of our rehabilitation product line in July 2008. In 2009, $1.9 million of the Medicare reimbursement reductions impacted this service line. Excluding the impact of the Medicare reimbursement reductions, home medical equipment revenues would have decreased 15.6% for the year ended December 31, 2009.
EBIT for the home respiratory and home medical equipment segment in the year ended December 31, 2009 was $50.2 million compared to $111.7 million in the pro forma year ended December 31, 2008. EBIT was 4.3% of segment net revenues in the year ended December 31, 2009 compared to the 8.7% of segment net revenues in the pro forma year ended December 31, 2008. This decrease in EBIT as a percentage of segment net revenues was primarily due to the negative impact of the Medicare reimbursement reductions and a decrease in rental revenue with no corresponding decrease in fixed costs in our home medical equipment service line. These decreases were partially offset by an improvement in gross profit margin as a result of a shift in product mix to a higher volume of products with lower cost as a percentage of segment net revenues in our home respiratory therapy service line; our ability to obtain favorable pricing on the purchase of products and supplies; and the sale of the rehabilitation product line in June 2008.
Home Infusion Therapy Segment. For the home infusion therapy segment total net revenues increased $79.3 million, or 9.4%, to $925.0 million in the year ended December 31, 2009 from $845.7 million in the pro forma year ended December 31, 2008. Revenues for the home infusion therapy segment increased to 44.2% of total revenue in the year ended December 31, 2009 from 39.7% in the pro forma year ended December 31, 2008.
The home infusion therapy segment involves the administration of drugs or nutrients directly into the body intravenously through a needle or catheter. Infusion therapy services also include administering enteral nutrients directly into the gastrointestinal tract through a feeding tube. Home infusion therapy revenues increased by 9.4% in the year ended December 31, 2009. The growth in revenue in the year ended December 31, 2009 resulted primarily from an increase in volume of specialty drugs, core drugs and enteral nutrients. The increase in these drugs was offset by a decrease in revenue due to the termination of a payor contract, and a decrease in volume of non-core revenue. As a result of increasing volume, specialty drug revenue also increased as a percentage of total home infusion therapy revenue. During the year ended December 31, 2009, Medicare reimbursement reductions impacted this service line by $2.8 million. Excluding the impact of Medicare reimbursement reductions, home infusion therapy revenue would have increased by 9.7%.
EBIT for the home infusion therapy segment in the year ended December 31, 2009 was $65.7 million compared to $14.2 million in the pro forma year ended December 31, 2008. EBIT was 7.1% of segment net revenues in the year ended December 31, 2009 compared to 1.7% of segment net revenues in the pro forma year ended December 31, 2008. This increase in EBIT was due to the increase in segment net revenues and the result of favorable product costs on our enteral nutrients and our ability to reduce our selling distribution and administrative costs as a percentage of segment net revenues. This favorability was partially offset by a decrease in gross profit margin, as the result of shift in product mix in our infusion therapy drugs to more specialty drugs, which have a higher product cost as a percentage of segment net revenues.
72
The Period January 1, 2008 to October 28, 2008 Results Compared to Year Ended December 31, 2007 Results
(in thousands) |
Period January 1, 2008 to October 28, 2008 |
Percentage of Net Revenues |
Year Ended December 31, 2007 |
Percentage of Net Revenues |
||||||||||
Net revenues: |
||||||||||||||
Fee for service arrangements |
$ | 1,630,767 | 92.0 | % | $ | 1,465,303 | 89.8 | % | ||||||
Capitation |
142,522 | 8.0 | 166,498 | 10.2 | ||||||||||
TOTAL NET REVENUES |
1,773,289 | 100.0 | 1,631,801 | 100.0 | ||||||||||
Costs and expenses: |
||||||||||||||
Cost of net revenues: |
||||||||||||||
Product and supply costs |
526,610 | 29.7 | 386,496 | 23.7 | ||||||||||
Patient service equipment depreciation |
89,246 | 5.0 | 110,775 | 6.8 | ||||||||||
Amortization of intangible assets |
| | | | ||||||||||
Home respiratory therapy services |
31,893 | 1.8 | 38,886 | 2.4 | ||||||||||
Nursing services |
29,773 | 1.7 | 11,353 | 0.7 | ||||||||||
Other |
13,815 | 0.8 | 17,482 | 1.1 | ||||||||||
TOTAL COST OF NET REVENUES |
691,337 | 39.0 | 564,992 | 34.6 | ||||||||||
Provision for doubtful accounts |
33,626 | 1.9 | 43,138 | 2.6 | ||||||||||
Selling, distribution and administrative |
924,536 | 52.1 | 862,062 | 52.8 | ||||||||||
Amortization of intangible assets |
3,461 | 0.2 | 3,079 | 0.2 | ||||||||||
TOTAL COSTS AND EXPENSES |
1,652,960 | 93.2 | 1,473,271 | 90.3 | ||||||||||
OPERATING INCOME |
120,329 | 6.8 | 158,530 | 9.7 | ||||||||||
Interest expense |
31,838 | 1.8 | 22,447 | 1.4 | ||||||||||
Interest income and other |
(2,154 | ) | (0.1 | ) | (1,954 | ) | (0.1 | ) | ||||||
INCOME BEFORE TAXES |
90,645 | 5.1 | 138,037 | 8.5 | ||||||||||
Income tax expense |
34,192 | 1.9 | 51,998 | 3.2 | ||||||||||
NET INCOME |
$ | 56,453 | 3.2 | % | $ | 86,039 | 5.3 | % | ||||||
Net Revenues. Net revenues increased $141.5 million, or 8.7%, to $1,773.3 million in the period January 1, 2008 to October 28, 2008 from $1,631.8 million in the year ended December 31, 2007. The increase in revenue was primarily in our infusion service line, due to service line growth subsequent to our acquisition of Coram in December 2007, offset by the fact that the period January 1, 2008 to October 28, 2008 had approximately two months less than the year ended December 31, 2007. The revenue growth rate for the period January 1, 2008 to October 28, 2008 was impacted by incremental Medicare reimbursement reductions of $18.6 million due to reimbursement reductions imposed in 2007 and 2008. The Medicare reimbursement reductions in 2008 related to respiratory drug reimbursement reductions, which were effective April 1, 2008.
We expect to continue to face pricing pressures from Medicare and Medicaid as well as from our managed care customers as these payers seek to lower costs by obtaining more favorable pricing from providers such as us. In addition to the pricing reductions, such changes could cause us to provide reduced levels of certain products and services in the future, resulting in a corresponding reduction in revenue. However, given our high volume of managed care business, we are well-positioned among our competitors with respect to serving the managed care market with a diversified array of services. See BusinessGovernment Regulation.
Gross Profit. Gross profit margin is defined as total net revenues less total costs of total net revenues divided by total net revenues. The gross profit margin for the period January 1, 2008 to October 28, 2008 was 61.0% compared to 65.4% for the year ended December 31, 2007. The decrease in gross margin is due to the acquisition of the Coram home infusion therapy business being included in the entire period of January 1, 2008 to October 31, 2008 and only in one month in the year end December 31, 2007. The Coram home infusion therapy business has a lower gross profit margin due to the nature of the infusion business compared to our home respiratory therapy and home medical equipment service lines. Excluding the Coram acquisition, the gross profit
73
margin was 67.6% for the period January 1, 2008 to October 28, 2008 compared to 65.4% for the year ended December 31, 2007. This increase in the gross profit margin percentage resulted from our ability to secure favorable pricing on the purchases of products and supplies and lower depreciation expense.
Provision for Doubtful Accounts. The provision for doubtful accounts is based on managements estimate of the net realizable value of accounts receivable after considering actual write-offs of specific receivables. Management considers historical realization data, accounts receivable aging trends, other operating trends, the extent of contracted business and business combinations. Also considered are relevant business conditions such as governmental and managed care payor claims processing procedures and system changes. Additionally, focused reviews of certain large and/or problematic payors are performed. The provision for doubtful accounts, expressed as a percentage of net revenues, was 1.9% in the period January 1, 2008 to October 28, 2008 and 2.6% for the year ended December 31, 2007. The decrease in the period January 1, 2008 to October 28, 2008 from the 2007 levels resulted primarily from a decrease in the aging of our accounts receivable.
Selling, Distribution and Administrative Expenses. Selling, distribution and administrative expenses are comprised of expenses incurred in direct support of operations and those associated with administrative functions. Expenses incurred by the operating locations include salaries and other expenses in the following functional areas: selling, distribution, clinical services, warehousing and repair. Many of these operating costs are directly variable with revenue growth patterns. Some are also very sensitive to market-driven price fluctuations such as facility lease and fuel costs. The administrative expenses include overhead costs incurred by the operating locations, regional and corporate support functions. These expenses do not fluctuate with revenue growth as closely as do operating costs.
Selling, distribution and administrative expenses, expressed as a percentage of total net revenues, was 52.1% for the period January 1, 2008 to October 28, 2008 compared to 52.8% for the year ended December 31, 2007. Selling, distribution and administrative expenses increased by $62.5 million for the period January 1, 2008 to October 28, 2008 compared to the year ended December 31, 2007. For period January 1, 2008 to October 28, 2008 labor and related expenses were 34.4% of net revenues compared to 35.1% for the year ended December 31, 2007. The decrease in labor and related expenses were due to the realization of certain synergies associated with the Coram transaction, lower management incentive compensation programs, lower salaries due to the sale of our rehab business and decreases due to changes in estimates related to health benefits. These decreases were partially offset by increases in labor and related expenses due to stock compensation expense from the change in control vesting due to the Merger and higher bonus and commission expenses, due to the revenue management teams higher collection efforts and sale incentives being met above targeted amounts. Other operating expenses for the period January 1, 2008 to October 28, 2008 were 17.7% of net revenues compared to 17.8% for the year ended December 31, 2007. The decrease in other operating expenses was due to cost savings programs and lower delivery costs (primarily fuel and vehicle lease cost). These decreases were partially offset by the increases in expenses incurred related to the sale of the Company, which resulted in the Merger Agreement with Blackstone, costs incurred in support of our enterprise wide information system project, expenses incurred related to the sale of the rehabilitation product line in July 2008, and professional fees related to our accounts receivable reserve work.
Amortization of Intangible Assets. Amortization of intangible assets increased $0.4 million, or 12.4%, to $3.5 million in the period January 1, 2008 to October 28, 2008 from $3.1 million in year ended December 31, 2007. The increase in amortization expense in the period January 1, 2008 to October 28, 2008, when compared to the year ended December 31, 2007, resulted from our acquisition of Coram intangible assets in December 2007, offset by customer lists and covenants not to compete that became fully amortized in 2008.
Interest Expense. Interest expense increased $9.4 million, or 41.8%, to $31.8 million in the period January 1, 2008 to October 28, 2008 from $22.4 million in the year ended December 31, 2007. The increase in interest expense is partially offset by the fact that the period January 1, 2008 to October 28, 2008 had approximately two months less than the year ended December 31, 2007. The increase in interest expense in the
74
period January 1, 2008 to October 28, 2008 is due to the funding fee of $5.6 million related to the $280 million credit facility, entered into on June 18, 2008 (the Interim Facility), increased costs due to the amortization of debt issuance costs related to the Interim Facility and the corresponding increase in our interest rate on the Interim Facility. These increases were in addition to the impact of the $359.0 million we borrowed to purchase Coram in December 2007 and the write-off of the remaining deferred debt issuance costs related to the prior credit agreement. See Liquidity and Capital ResourcesIndebtednessPre-Transactions below.
Interest Income. Interest income increased $0.2 million, or 10.2%, to $2.1 million in the period January 1, 2008 to October 28, 2008 from $1.9 million in the year ended December 31, 2007. The increase in interest income is partially offset by the fact that the period January 1, 2008 to October 28, 2008 had approximately two months less than the year ended December 31, 2007.
Income Tax Expense. Income tax expense decreased $17.8 million, or 34.2%, to $34.2 million in the period January 1, 2008 to October 28, 2008 from $52.0 million in the year ended December 31, 2007. The decrease in the period January 1, 2008 to October 28, 2008 from the year ended December 31, 2007 resulted from lower pre-tax earnings; thus, decreasing our income tax expense. This income tax expense decrease was partially off-set by various unfavorable tax expense increases including higher non-deductible expenses in the period January 1, 2008 to October 28, 2008 as compared to the year ended December 31, 2007.
Segment Net Revenues and EBIT
The following table sets forth a summary of results of operations by segment:
(in thousands) |
Period January 1, 2008 to October 28, 2008 |
Percentage of Net Revenues |
Year Ended December 31, 2007 |
Percentage of Net Revenues |
|||||||||||
Net revenues: |
|||||||||||||||
Home respiratory therapy and home medical equipment |
$ | 1,074,711 | 60.6 | % | $ | 1,297,619 | 79.5 | % | |||||||
Home infusion therapy |
698,578 | 39.4 | 334,182 | 20.5 | |||||||||||
Total net revenues |
$ | 1,773,289 | 100.0 | % | $ | 1,631,801 | 100.0 | % | |||||||
Period January 1, 2008 to October 28, 2008 | |||||||||||||||
(in thousands) |
Home
Respiratory Therapy and Home Medical Equipment |
Percentage of Segment Net Revenues |
Home Infusion Therapy |
Percentage of Segment Net Revenues |
Total | ||||||||||
EBIT |
$ | 102,927 | 9.6 | % | $ | 17,965 | 2.6 | % | $ | 120,892 | |||||
Year Ended December 31, 2007 | |||||||||||||||
(in thousands) |
Home
Respiratory Therapy and Home Medical Equipment |
Percentage of Segment Net Revenues |
Home Infusion Therapy |
Percentage of Segment Net Revenues |
Total | ||||||||||
EBIT |
$ | 118,242 | 9.1 | % | $ | 40,288 | 12.1 | % | $ | 158,530 |
We allocate certain expenses that are not directly attributable to a product line based upon segment headcount. For a reconciliation of net income (loss) to EBIT, see the table under Results of OperationsEBIT at the end of this section.
Home Respiratory Therapy and Home Medical Equipment Segment: Net revenues for the home respiratory therapy and home medical equipment segment decreased $222.9 million, or 17.2%, to $1,074.7 million in the period January 1, 2008 to October 28, 2008 from the $1,297.6 million in the year ended December 31, 2007.
75
Home respiratory therapy revenues are derived primarily from the provision of oxygen systems, home ventilators, sleep apnea equipment, nebulizers, respiratory medications and related services. Revenues from the respiratory therapy service line decreased by 16.0% in the period January 1, 2008 to October 28, 2008 compared to the year ended December 31, 2007. The decrease is primarily due to the period January 1, 2008 to October 28, 2008 having approximately two months less than the year ended December 31, 2007. The majority of the Medicare reimbursement reductions discussed above impacted the respiratory therapy line. Such reductions were $17.3 million in the period January 1, 2008 to October 28, 2008. The growth in revenue dollars for the period January 1, 2008 to October 28, 2008 resulted primarily from an increase in revenue from oxygen equipment rental revenue and an increase in the sale of Bi-level devices and related supplies. These increases were offset by a decrease in respiratory drug revenue, primarily as a result of the Medicare reimbursement reductions in this area. This was offset by the fact that there were approximately two less months in the period January 1, 2008 to October 28, 2008 compared to the year ended December 31, 2007.
Home medical equipment revenues are derived from the rental and sale of equipment to assist patients with ambulation, safety and general care in and around the home. Home medical equipment revenues decreased by 23.1% in the period January 1, 2008 to October 28, 2008 compared to the year ended December 31, 2007. The decrease is primarily due to the period January 1, 2008 to October 28, 2008 having approximately two months less than the year ended December 31, 2007. In the period January 1, 2008 to October 28, 2008, $1.3 million of the Medicare reimbursement reductions impacted this service line. Excluding the impact of the Medicare reimbursement reductions home medical equipment revenue would have decreased by 6.5%. The decrease in revenue dollars for the period January 1, 2008 to October 31, 2008 primarily resulted from the sale of our rehabilitation product line in July 2008.
EBIT for the home respiratory therapy and home medical equipment segment in the period January 1, 2008 to October 28, 2008 was $102.9 million compared to $118.2 million in the year ended December 31, 2007. EBIT was 9.6% of segment net revenues for the period January 1, 2008 to October 28, 2008 compared to 9.1% of segment net revenues in the year ended December 31, 2007. The increase in EBIT as a percentage of segment net revenues was due to the sale of our rehabilitation product line in July 2008 and securing favorable pricing on the purchases of products and supplies.
Home Infusion Therapy Segment. For the home infusion therapy segment total net revenues increased $364.4 million, or 109.0%, to $698.6 million in the period January 1, 2008 to October 28, 2008 from $334.2 million in the year ended December 31, 2007. Revenues for the home infusion therapy segment increased to 39.4% of total revenue in the period January 1, 2008 to October 28, 2008 from 20.5% in the year ended December 31, 2007.
Home infusion therapy involves the administration of drugs or nutrients directly into the body intravenously through a needle or catheter. Infusion therapy services also include administering enteral nutrients directly into the gastrointestinal tract through a feeding tube. Home infusion therapy revenues increased by 109.0% in the period January 1, 2008 to October 28, 2008 compared to the year ended December 31, 2007. The increase in infusion revenue was due to our acquisition of Coram in December 2007.
EBIT for the home infusion therapy segment in the period January 1, 2008 to October 28, 2008 was $18.0 million compared to $40.3 million in the year ended December 31, 2007. EBIT was 2.6% of segment net revenues in the period January 1, 2008 to October 28, 2008 compared to 12.1% of segment net revenues in the year ended December 31, 2007. The decrease in EBIT is due to the inclusion of the results of our acquisition of Coram in December 2007, as it was in all periods from January 1, 2008 to October 28, 2008 and only in one month in the year ended December 31, 2007. The decrease in the EBIT as a percentage of segment net revenues that occurred in the period January 1, 2008 to October 28, 2008 as compared to the year ended December 31, 2007 was also due to the Coram acquisition. The Coram infusion business has a lower margin compared to the infusion business that existed in the first eleven months of the year ended December 31, 2007.
76
EBIT
EBIT is a measure used by our management to measure operating performance. EBIT is defined as net income (loss) plus interest expense and income taxes. EBIT is not a recognized term under GAAP and does not purport to be an alternative to net income as a measure of operating performance or to cash flows from operating activities as a measure of liquidity.
The following table provides a reconciliation from net income (loss) to EBIT:
(in thousands) | Year Ended December 31, 2007 | Pro Forma Year Ended December 31, 2008 |
|||||||||||||||||||
Home Respiratory Therapy and Home Medical Equipment |
Home Respiratory Therapy and Home Medical Equipment |
Home Respiratory Therapy and Home Medical Equipment |
Home Respiratory Therapy and Home Medical Equipment |
Home Infusion Therapy |
Total | ||||||||||||||||
Net income (loss) |
$ | 86,039 | $ | (2,393 | ) | ||||||||||||||||
Interest expense, |
20,493 | 130,267 | |||||||||||||||||||
Income tax (benefit) expense |
51,998 | (1,978 | ) | ||||||||||||||||||
EBIT |
$ | 118,242 | $ | 40,288 | $ | 158,530 | $ | 111,708 | $ | 14,188 | $ | 125,896 | |||||||||
(in thousands) | Period January 1, 2008 to October 28, 2008 |
Period October 29, 2008
to December 31, 2008 |
|||||||||||||||||||
Home Respiratory Therapy and Home Medical Equipment |
Home Infusion Therapy |
Total | Home Respiratory Therapy and Home Medical Equipment |
Home Infusion Therapy |
Total | ||||||||||||||||
Net income (loss) |
$ | 56,453 | $ | (1,894 | ) | ||||||||||||||||
Interest expense, |
30,247 | 25,750 | |||||||||||||||||||
Income tax (benefit) expense |
34,192 | 659 | |||||||||||||||||||
EBIT |
$ | 102,927 | $ | 17,965 | $ | 120,892 | $ | 26,255 | $ | (1,740 | ) | $ | 24,515 | ||||||||
(in thousands) | Year Ended December 31, 2009 | ||||||||||||||||||||
Home Respiratory Therapy and Home Medical Equipment |
Home Infusion Therapy |
Total | |||||||||||||||||||
Net loss |
$ | (3,820 | ) | ||||||||||||||||||
Interest expense, |
128,092 | ||||||||||||||||||||
Income tax (benefit) expense |
(8,438 | ) | |||||||||||||||||||
EBIT |
$ | 50,167 | $ | 65,667 | $ | 115,834 | |||||||||||||||
77
(in thousands) | Six Months Ended June 30, 2009 | Six Months Ended June 30, 2010 | ||||||||||||||||
Home Respiratory Therapy and Home Medical Equipment |
Home Infusion Therapy |
Total | Home Respiratory Therapy and Home Medical Equipment |
Home Infusion Therapy |
Total | |||||||||||||
Net income |
$ | 3,538 | $ | 2,563 | ||||||||||||||
Interest expense, net (a) |
64,180 | 65,008 | ||||||||||||||||
Income tax expense |
5,982 | 494 | ||||||||||||||||
EBIT |
$ | 48,627 | $ | 25,073 | $ | 73,700 | $ | 13,307 | $ | 54,758 | $ | 68,065 | ||||||
(a) | Reflects $22.4 million of interest expense, net of $1.9 million in interest income for 2007. Reflects $132.3 million of interest expense, net of $2.0 million in interest income for the pro forma year ended December 31, 2008. Reflects $31.8 million of interest expense, net of $1.6 million of interest income for the period January 1, 2008 to October 28, 2008. Reflects $26.2 million of interest expense, net of $0.4 million of interest income for the period October 29, 2008 to December 31, 2008. Reflects $129.2 million of interest expense, net of $1.1 million of interest income for 2009. Reflects $64.6 million of interest expense, net of $0.4 million of interest income for the six months ended June 30, 2009. Reflects $65.2 million of interest expense, net of $0.2 million of interest income for the six months ended June 30, 2010. |
We allocate certain expenses that are not directly attributable to a product line based upon segment headcount.
Impact of Inflation and Changing Prices
We experience pricing pressures in the form of continued reductions in reimbursement rates, particularly from managed care organizations and from governmental payors such as Medicare and Medicaid. We are also impacted by rising costs for certain inflation-sensitive operating expenses such as labor and employee benefits, facility and equipment leases, and vehicle fuel. However, we generally do not believe these impacts are material to our revenues or net income.
Liquidity and Capital Resources
Our principal source of liquidity is our operating cash flow, which is supplemented by our ABL Facility, which provides for revolving credit of up to $150.0 million, subject to borrowing base availability. See Description of Other IndebtednessSenior Secured Asset-Based Revolving Credit Facility. In recent years, we have generated operating cash flows in excess of our operating needs, which has afforded us the ability to pursue acquisitions and fund patient service equipment purchases to support revenue growth. We believe that our operating cash flow, together with our existing cash, cash equivalents, investments and ABL Facility, will continue to be sufficient to fund our operations and growth strategies for at least the next 12 months.
Our short-term investments consist of certificates of deposit with maturities greater than three months from our purchase date. As of June 30, 2010, the carrying value of our short-term investments approximates fair value and such investments do not individually exceed FDIC insurance limits.
Prior to the Merger we had initiated a project to implement a new enterprise-wide information system. The overall objective of the project was to deliver the necessary technology and automation across the organization to enable improvements in service, productivity and access to information. Development on certain modules commenced in 2006 and continued in 2007 and 2008. In connection with the Merger, we evaluated our information technology strategy and concluded that it was no longer advisable to implement a new enterprise- wide information system. As a result of this change in strategy, we wrote off approximately $65.0 million of capitalized information systems assets as part of our purchase accounting adjustments that were made in connection with the Merger.
78
In the six months ended June 30, 2010, our free cash flow was $(21.1) million. For the six months ended June 30, 2009 our free cash flow was $(13.1) million. We use free cash flow as a performance metric which is not calculated in accordance with GAAP. Free cash flow is defined as cash provided by operating activities less purchases of patient service equipment and property, equipment and improvements, exclusive of effects of acquisitions. It is presented as a supplemental performance measure and is not intended as an alternative to any other cash flow measure calculated in accordance with GAAP. Further, free cash flow may not be comparable to similarly titled measures used by other companies. A table reconciling free cash flow to net cash provided by operating activities is presented below.
(in thousands) |
Six Months Ended June 30, 2010 |
Six Months Ended June 30, 2009 |
||||||
Reconciliation Free Cash Flow: | ||||||||
Net income |
$ | 2,563 | $ | 3,538 | ||||
Non-cash items |
112,971 | 101,996 | ||||||
Change in operating assets and liabilities |
(80,816 | ) | (45,063 | ) | ||||
Net cash provided by operating activities |
34,718 | 60,471 | ||||||
Less: Purchases of patient service equipment and property, equipment and improvements |
(55,783 | ) | (73,598 | ) | ||||
Free cash flow |
$ | (21,065 | ) | $ | (13,127 | ) | ||
Cash Flow. The following table presents selected data from our consolidated statement of cash flows:
(in thousands) |
Six Months Ended June 30, 2010 |
Six Months Ended June 30, 2009 |
||||||
Net cash provided by operating activities |
$ | 34,718 | $ | 60,471 | ||||
Net cash used in investing activities |
(40,044 | ) | (71,160 | ) | ||||
Net cash used in financing activities |
(36,365 | ) | (13,155 | ) | ||||
Net decrease in cash and equivalents |
(41,691 | ) | (23,844 | ) | ||||
Cash and equivalents at beginning of period |
158,163 | 168,018 | ||||||
Cash and equivalents at end of period |
$ | 116,472 | $ | 144,174 | ||||
The Six Months Ended June 30, 2010 Results Compared to the Six Months Ended June 30, 2009
Net cash provided by operating activities in the six months ended June 30, 2010 was $34.7 million compared to $60.5 million in the six months ended June 30, 2009, a decrease of $25.8 million. The decrease in net cash provided by operating activities resulted from a $10.0 million increase in income before non-cash items to $115.5 million in 2010 from $105.5 million in 2009, offset by a $35.7 million increase in the cash used related to the change in operating assets and liabilities to a $80.8 million use of cash in 2010 from a $45.1 million use of cash in 2009.
The $35.7 million increase in cash used related to the change in operating assets and liabilities consisted primarily of the following:
| $50.4 million increase in cash used by accounts receivable to a $76.3 million use of cash in the six months ended June 30, 2010 from a $25.9 million use of cash in the six months ended June 30, 2009. The increase is primarily related to delays in collections due to the initial outsourcing of our billing and collections process. |
Offset by:
| $5.9 million increase in cash provided by inventories to a $7.9 million provision of cash in the six months ended June 30, 2010 from a $2.0 million provision of cash in the six months ended June 30, 2009. The increase is primarily due to a decrease in our infusion and respiratory therapy and home medical equipment inventories. |
79
| $2.3 million increase in cash provided by deferred revenue, net of expenses, to a $0.5 million provision of cash in the six months ended June 30, 2010 from a $1.8 million use of cash in the six months ended June 30, 2009. The increase is due primarily to the recognition of revenue in the six months ended June 30, 2009 that was previously deferred for services initiated prior to certain 2009 Medicare reimbursement reductions. |
| $12.9 million decrease in cash used by accounts payable to a $7.2 million use of cash in the six months ended June 30, 2010 from a $20.1 million use of cash in the six months ended June 30, 2009. The decrease is primarily due to the timing of payment of invoices. |
Net cash used in investing activities in the six months ended June 30, 2010 was $40.0 million, compared to $71.2 million in the six months ended June 30, 2009. The primary use of funds in 2010 was $55.8 million to purchase patient service equipment and property equipment and improvements; $42.0 million related to patient service equipment and $13.8 million related to property, equipment and improvements, primarily due to additions to our information systems hardware and software. Additionally, $25.7 million related to short-term investments that matured during the period which was partially offset by purchases of $8.1 million during this same period. The primary use of funds in 2009 was approximately $73.6 million to purchase patient service equipment and property equipment and improvements; $58.8 million related to patient service equipment and $14.8 million related to property, equipment and improvements, primarily due to additions to our information systems hardware and software and leasehold improvements on new facilities.
Net cash used in financing activities in the six months ended June 30, 2010 was $36.4 million compared to $13.2 million in the six months ended June 30, 2009. Net cash used in financing activities in the six months ended June 30, 2010 primarily reflected the use of $32.5 million to pay down the book cash overdraft reported in accounts payable and debt issuance costs and other registration fees of $2.9 million incurred during the period. Net cash used in financing activities in the six months ended June 30, 2009 primarily reflected the issuance of our Series A-1 Notes, the repayment of our senior secured bridge credit agreement, the repayment of $6.5 million of indebtedness under our ABL Facility and debt issuance costs related to our Series A-1 Notes.
The Year Ended December 31, 2009 Results
Our cash and equivalents were $158.2 million at December 31, 2009. Net cash from operating activities was $169.4 million for the year ended December 31, 2009. Cash provided by operating activities was primarily the result of our net loss for the year ended December 31, 2009 adjusted for non-cash items, principally our provision for doubtful accounts, depreciation and amortization of intangible assets. These amounts were offset by changes in operating assets, primarily decreases in accounts receivable and accounts payable. Net cash used in investing activities was $168.7 million primarily due to $150.6 million of capital expenditures for normal course of business purchases primarily related to patient service and net, short-term investment purchases of $23.7 million. Our net cash used in financing activities were $10.6 million in the year ended December 31, 2009. This was primarily due to incurring debt issuance costs in connection with the sale of our outstanding Series A-1 Notes and Series A-2 Notes. As a result of the Merger on October 28, 2008, the Company has concluded that a comparison of the year ended December 31, 2009 to the period October 29, 2008 to December 31, 2008 does not provide a meaningful comparison and has chosen to discuss only the year ended December 31, 2009.
The Period October 29, 2008 to December 31, 2008 Results
Our cash increased to $168.0 million at December 31, 2008 from $48.2 million at October 29, 2008. Net cash from operating activities was $63.3 million for the period October 29, 2008 to December 31, 2008. Net cash used in investing activities was $75.5 million primarily due to $49.3 million of Merger-related costs and capital expenditures of $26.2 million for normal course of business purchases primarily related to patient service equipment. Our net cash provided by financing activities increased by $131.9 million in the period due to Merger related activities. Overall, the net increase in cash was $119.8 million.
80
The Period January 1, 2008 to October 28, 2008 Results Compared to the Year Ended December 31, 2007 Results
Net cash provided by operations in the period January 1, 2008 to October 28, 2008 was $297.9 million compared to $294.0 million in the year ended December 31, 2007, an increase of $3.9 million. Changes in cash provided by operations from the period January 1, 2008 to October 28, 2008 from the year ended December 31, 2007 is partially due to the fact that the period January 1, 2008 to October 28, 2008 had approximately two less months. Net cash provided by operations for the ten months ended October 31, 2007 was $237.7 million. The increase in net cash provided by operations for the period January 1, 2008 to October 28, 2008 compared to the ten months ended October 31, 2007, resulted from a $29.8 million increase in the cash used by the change in operating assets and liabilities to a $17.6 million use of cash in the period January 1, 2008 to October 28, 2008 from a $12.2 million provision of cash in the ten months ended October 31, 2007, offset by a $90.0 million increase in income before non-cash items to $315.5 million in 2008 from $225.5 million in 2007.
The $29.8 million increase in cash used by the change in operating assets and liabilities consisted primarily of the following:
| $23.8 million increase in cash used by income taxes payable to a $3.5 million use of cash in the period January 1, 2008 to October 28, 2008 from a $20.3 million provision of cash in the ten months ended October 31, 2007. The net increase in cash used was primarily due to a reduction in taxable income for the period of January 1, 2008 to October 28, 2008 as compared to the ten months ended October 31, 2007. The reduction in taxable income was caused by lower comparative pre-tax earnings, usage of Corams net operating loss carryforwards during 2008 and certain favorable tax deductions in the period of January 1, 2008 to October 28, 2008. This increase in cash used was off-set by a net increase in cash provided by income taxes payable which was primarily due to the receipt of significant tax refunds in 2008 resulting from certain favorable 2007 tax return to tax provision adjustments. |
| $16.1 million increase in cash used by accrued payroll and related taxes and benefits to a $13.5 use of cash in the period January 1, 2008 to October 28, 2008 from a $2.6 million source in the ten months ended October 31, 2007. The increase was primarily due to an $11.7 million increase for management incentive compensation programs. |
| $4.7 million was due to an increase in cash used by the change in inventories, to a $1.2 million use of cash in the period January 1, 2008 to October 28, 2008 from a $3.5 million provision of cash in the ten months ended October 31, 2007, primarily due to a purchase of inventory to be utilized over a ten-month period. |
Offset by:
| $13.7 million decrease in cash used in accounts receivable, to a $8.9 million use of cash in the period January 1, 2008 to October 28, 2008 from a $22.6 million use of cash in the ten months ended October 31, 2007. This decrease in use of cash was primarily due to a net increase in accounts receivable primarily related to the Coram acquisition. |
| $3.0 million increase in cash provided by prepaid expenses and other current assets to a $4.5 million provision of cash in the period January 1, 2008 to October 31, 2008 from a $1.5 million provision of cash in the ten months ended October 31, 2007. The increase was primarily due to prepaid inventory of $6.2 million due to a change in payment terms, offset by a decrease in prepaid insurance of $3.6 million. |
Investing activities used $154.5 million in the period January 1, 2008 to October 28, 2008 compared to $483.2 million in the year ended December 31, 2007. Investing activities used $90.5 million in the ten months ended October 31, 2007. The primary use of funds in 2008 was approximately $157.2 million to purchase patient service equipment and property equipment and improvements; $104.6 million related to patient service equipment and $52.6 million related to property, plant and equipment, primarily due to additions to our information systems hardware and software, which was subsequently adjusted due to a change in strategy. The
81
primary use of funds in the year ended December 31, 2007 was $350.0 million to purchase Coram in December 2007 and $128.8 million to purchase patient service equipment and property, equipment and improvements. The primary use of funds in the ten months ended October 31, 2007 was approximately $90.8 million to purchase patient service equipment for $62.5 million and property, equipment and improvements of $28.3 million.
Net cash used in financing activities in the period January 1, 2008 to October 28, 2008 was $123.7 million compared to net cash provided by financing activities of $203.0 million in the year ended December 31, 2007. Net cash used in financing activities in the ten months ended October 31, 2007 was $131.6 million. In the period January 1, 2008 to October 28, 2008, net cash used in financing activities primarily reflected our borrowing of $250.0 million in proceeds from the Interim Facility and $18.3 million under the Predecessor Revolving Credit Facility, offset by $138.3 million in repayments on the Predecessor Revolving Credit Facility, defined below, and $249.8 million in cash used for the redemption of our convertible senior notes. Net cash used in financing activities for the ten months ended October 31, 2007 reflected our repayment of $150.0 million on the Predecessor Revolving Credit Facility, offset by the issuance of common stock for $17.0 million in connection with the granting of equity awards and the exercises of stock options.
Contractual Cash Obligations. The following table summarizes the long-term cash payment obligations as of December 31, 2009 to which we are contractually bound. The years presented below represent 12-month periods ending December 31.
Less than 1 Year |
1-3 Years |
3-5 Years |
More than 5 Years |
Totals | |||||||||||
(in millions) | |||||||||||||||
Series A-1 Notes |
$ | | $ | | $ | 700 | $ | | $ | 700 | |||||
Series A-2 Notes |
| | 318 | | 318 | ||||||||||
ABL Facility(1) |
| | | | | ||||||||||
Interest Payments on Series A-1 Notes(2) |
79 | 158 | 157 | | 394 | ||||||||||
Interest Payments on Series A-2 Notes(3) |
39 | 79 | 78 | | 196 | ||||||||||
Fees on ABL Facility(1)(4) |
2 | 3 | 1 | | 6 | ||||||||||
Operating Leases |
62 | 93 | 32 | 10 | 197 | ||||||||||
Capitalized Leases |
2 | 1 | | | 3 | ||||||||||
Purchase Obligations(5) |
46 | 65 | 64 | 102 | 277 | ||||||||||
Unrecognized Tax Benefits(6) |
| | | | | ||||||||||
Total Contractual Cash Obligations |
$ | 230 | $ | 399 | $ | 1,350 | $ | 112 | $ | 2,091 | |||||
(1) | Borrowings under the ABL Facility bear interest at a rate per annum equal to, at our option, either (a) a base rate determined by reference to the higher of (1) the prime rate of Bank of America, N.A. and (2) the federal funds effective rate plus 1/2 of 1%, plus an applicable margin of 2.00% or (b) a LIBOR rate determined by reference to LIBOR, adjusted for statutory reserve requirements, plus an applicable margin of 3.00%. The applicable margin for borrowings under our ABL Facility is subject to step ups and step downs based on average excess availability under the ABL Facility. The actual amounts of interest and fee payments under the ABL Facility will ultimately depend on the amount of debt and letters of credit outstanding and the interest rates in effect during each period. We are also required to pay customary letter of credit fees equal to the applicable margin on LIBOR loans and certain agency fees. |
(2) | Represents aggregate interest payments on $700.0 million of the Series A-1 Notes that are paid semi-annually in May and November. Interest payments on the Series A-1 Notes will total approximately $78 million annually until the Series A-1 Notes mature on November 1, 2014. The Series A-1 Notes bear interest at 11.25% per annum. |
(3) | Represents aggregate interest payments on $317.5 million of the Series A-2 Notes that are paid semi-annually in May and November. Interest payments on the Series A-2 Notes will total approximately $39 million annually until the Series A-2 Notes mature on November 1, 2014. The Series A-2 Notes bear interest at 12.375% per annum. |
(4) | The fees payable on the ABL Facility are based on an assumed fee for undrawn amounts of 1.00%, which represents the fees payable under the ABL Facility assuming no borrowings or drawn letters of credit. We are required to pay a commitment fee on the ABL Facility, in respect of the unutilized commitments there under, ranging from 0.50% to 1.00% per annum, which fee is determined based on the utilization of our ABL Facility (increasing when utilization is low and decreasing when utilization is high). The fees also include an administrative fee of $31,250 which is paid quarterly. |
82
(5) | The purchase obligations primarily relate to: (i) approximately $71 million due under the Intelenet Agreement (as described under BusinessOutsourcing Activities below), pursuant to which we outsource to Intelenet certain functions relating to billing, collections and other administrative and clerical services and (ii) approximately $203 million due under an agreement with Dell Services (formerly Perot Systems Corporation), pursuant to which we outsource to Dell Services (formerly Perot Systems Corporation) certain information technology functions. |
(6) | Gross unrecognized tax benefits of $22.8 million are included within Income Taxes Payable and Other Non-current Liabilities in the total liabilities section of our June 30, 2010 consolidated balance sheet. The entire $22.8 million amount is not reflected in the contractual cash obligations table above since we cannot make a reliable estimate of the period in which cash payments will occur. |
Accounts Receivable. Accounts receivable before allowance for doubtful accounts increased to $346.9 million as of June 30, 2010 from $292.1 million at December 31, 2009. Days sales outstanding (calculated as of each period-end by dividing accounts receivable, less allowance for doubtful accounts, by the rolling average of total net revenues) were 53 days at June 30, 2010, compared to 43 days at December 31, 2009. The increase in accounts receivable and days sales outstanding is a direct result of the delays in cash collections due to the outsourcing of our billing and collections process.
Accounts aged in excess of 180 days expressed as percentages of total receivables for certain major payor categories, and in total, are as follows:
June 30, 2010 |
December 31, 2009 |
|||||
Total |
18.5 | % | 18.3 | % | ||
Medicare |
16.0 | % | 18.0 | % | ||
Medicaid |
28.0 | % | 19.5 | % | ||
Patient Self pay |
24.6 | % | 31.3 | % | ||
Managed care/other |
17.0 | % | 16.6 | % |
Included in accounts receivable are earned but unbilled receivables of $49.9 million and $44.6 million at June 30, 2010 and December 31, 2009, respectively. Delays, ranging from a day up to several weeks, between the date of service and billing can occur due to delays in obtaining certain required payor-specific documentation from internal and external sources. Earned but unbilled receivables are aged from date of service and are considered in our analysis of historical performance and collectibility.
Inventories and Patient Service Equipment. Inventories consist primarily of pharmaceuticals and disposable products used in conjunction with patient service equipment. Patient service equipment consists of respiratory and home medical equipment that is provided to in-home patients for the course of their care plan, normally on a rental basis, and subsequently returned to us for redistribution after cleaning and maintenance is performed.
The branch locations serve as the primary point from which inventories and patient service equipment are delivered to patients. Certain products and services, such as infusion therapy and respiratory medications, bypass the respiratory/home medical equipment branches and are provided directly to patients from pharmacies or other central locations. The branches are supplied with inventory and equipment from central warehouses that service specific areas of the country. Such warehouses are also responsible for repairs and scheduled maintenance of patient service equipment, which adds to the frequent movement of equipment between locations. Further, the majority of our patient service equipment is located in patients homes. While utilization varies widely between equipment types, on the average, approximately 86% of equipment is on rent at any given time. Inherent in this asset flow is the fact that losses will occur. Depending on the product type, we perform physical inventories on an annual or quarterly basis. Inventory and patient service equipment balances in the financial records are adjusted to reflect the results of these physical inventories. Inventory and patient service equipment losses for the six months ended June 30, 2010 and 2009 were $0.5 million and $1.8 million, respectively.
83
IndebtednessPre-Transactions
2004 Senior Secured Revolving Credit Facility. On November 23, 2004, we entered into a senior secured revolving credit facility with Bank of America and a syndicate of lenders that was amended effective June 23, 2006. The amendment extended the maturity date from November 23, 2009 to June 23, 2011 and lowered the applicable interest rate margins and commitment fees. The 2004 senior secured credit agreement was structured as a $500 million revolving credit facility. In connection with the Merger on October 28, 2008, we repaid all outstanding indebtedness under our 2004 senior secured revolving credit facility.
Convertible Senior Notes. In August 2003, we issued 3.375% Convertible Senior Notes due 2033 in the aggregate principal amount of $250 million under an indenture between us and U.S. Bank National Association in a private placement. Holders of our convertible senior notes had the right to require us to redeem on September 1, 2008 some or all of their notes at a price equal to 100% of the principal amount thereof plus accrued and unpaid interest. The holders of substantially all of the convertible senior notes exercised this right. On September 2, 2008, proceeds of the Interim Facility (described below) were used to fund repurchases of $249.8 million of our convertible senior notes. In addition, holders of the remaining $0.2 million of the convertible senior notes had the right, as a result of the change of control resulting from the Merger, to cause us to repurchase the convertible senior notes at a price equal to 100% of the principal amount thereof plus accrued and unpaid interest. Pursuant to this right, holders of $151,000 of convertible senior notes exercised their option in December 2008. Approximately $77,000 of convertible senior notes remain outstanding in accordance with the terms of the indenture governing the convertible senior notes.
Interim Facility. On June 18, 2008, we entered into a $280 million Interim Facility pursuant to the credit agreement with Banc of America Bridge LLC, Barclays Capital, the investment banking division of Barclays Bank PLC, Wells Fargo Securities, LLC (formerly known as Wachovia Capital Markets, LLC) and the lenders named therein. On September 2, 2008, proceeds of the Interim Facility were used to fund repurchases of our convertible senior notes as described above. The loans under the Interim Facility bore interest at a rate of 11% per year with a maturity date of March 1, 2009. In addition, we paid usual and customary bank fees in connection with entering into the Interim Facility. In connection with the Merger, all borrowings under the Interim Facility were paid off on October 28, 2008 using a portion of the proceeds from the Original Financing.
IndebtednessPost-Transactions
After the consummation of the Merger we became, and we continue to be, highly leveraged. As of June 30, 2010, our total indebtedness was $1,020.3 million, and we would have had an additional $133.9 million of available borrowings under our ABL Facility, less any limitations on borrowing resulting from actual collateral availability. As of June 30, 2010, the additional availability under our ABL Facility based on the borrowing base as of such date was $133.9 million.
Our liquidity requirements are and will be significant, primarily due to debt service requirements. Our net cash interest expense for the six months ended June 30, 2010 and the year ended December 31, 2009 was $59.8 million and $120.1 million, respectively.
We believe that our existing cash, plus the amounts we expect to generate from operations and amounts available through our ABL Facility, will be sufficient to meet our operating needs for the next twelve months, including working capital requirements, capital expenditures, debt repayment obligations and potential new acquisitions.
While we currently are in compliance with all of the financial covenants included in our ABL Facility, there is no assurance that we will continue to be able to do so in the future or that, if we do not, we will be able to obtain from our lenders waivers of default or amendments to the credit agreement governing our ABL Facility in the future.
84
As market conditions warrant, we and our major equityholders, including the Sponsor and its affiliates, may from time to time, depending upon market conditions, seek to repurchase debt securities that we have issued or loans that we have borrowed, including the Notes and the ABL Facility, in privately negotiated or open market transactions, by tender offer or otherwise.
ABL Facility. In connection with the Merger on October 28, 2008, we entered into the ABL Facility with Bank of America, N.A., as administrative agent and collateral agent, Wachovia Bank, National Association and Barclays Capital, the investment banking division of Barclays Bank PLC, as syndication agents, and The Bank of Nova Scotia, as documentation agent, and a syndicate of financial institutions and institutional lenders. Banc of America Securities LLC and Wells Fargo Securities, LLC (formerly known as Wachovia Capital Markets, LLC) acted as joint lead arrangers and Banc of America Securities LLC, Wells Fargo Securities, LLC (formerly known as Wachovia Capital Markets, LLC) and Barclays Capital, the investment banking division of Barclays Bank PLC, acted as joint bookrunners. Set forth below is a summary of the terms of our ABL Facility.
Our ABL Facility provides for revolving credit financing of up to $150.0 million, subject to borrowing base availability, with a maturity of five years, including both a letter of credit and swingline loan sub-facility. The borrowing base at any time is equal to the sum (subject to certain reserves and other adjustments) of 85% of eligible receivables and the lesser of (a) 85% of the net orderly liquidation value of eligible inventory and (b) $20.0 million.
Our ABL Facility includes borrowing capacity available for letters of credit and for borrowings on same-day notice, referred to as swingline loans.
Borrowings under our ABL Facility are subject to the satisfaction of customary conditions, including absence of a default and accuracy of representations and warranties.