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IPCM > SEC Filings for IPCM > Form 10-Q on 30-Oct-2012All Recent SEC Filings

Show all filings for IPC THE HOSPITALIST COMPANY, INC.

Form 10-Q for IPC THE HOSPITALIST COMPANY, INC.


30-Oct-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following management's discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and the notes thereto included in this Quarterly Report. In addition, reference is made to our audited consolidated financial statements and notes thereto and related Management's Discussion and Analysis of Financial Condition and Results of Operations included in our most recent Annual Report on Form 10-K for the year ended December 31, 2011 filed with the Securities and Exchange Commission (SEC) on February 23, 2012.

The following discussion contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 regarding future events and the future results of IPC that are based on management's current expectations, estimates, projections, and assumptions about our business. Words such as "may," "will," "could," "should," "target," "potential," "project," "expects," "anticipates," "intends," "plans," "believes," "sees," "estimates" and variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements due to numerous factors, including, but not limited to, those discussed in our most recent Annual Report on Form 10-K, including the section entitled "Risk Factors," as well as those discussed from time to time in the Company's other SEC filings and reports. In addition, such statements could be affected by general industry and market conditions. Such forward-looking statements speak only as of the date of this Quarterly Report or, in the case of any document incorporated by reference, the date of that document, and we do not undertake any obligation to update any forward-looking statement to reflect events or circumstances after the date of this Report, or for changes made to this document by wire services or internet service providers. If we update or correct one or more forward-looking statements, investors and others should not conclude that we will make additional updates or corrections with respect to other forward-looking statements.

Overview and Recent Developments

We are a leading provider of hospitalist services in the United States. Hospitalist medicine is organized around inpatient care, primarily delivered in acute hospitals, but also in post-acute facilities, and is focused on providing, managing and coordinating the care of patients in facility based care settings. We believe we are the largest dedicated hospitalist company in the United States based on revenues, patient encounters and number of affiliated hospitalists. Our early entry into the emerging hospitalist industry has permitted us to establish a reputation and leadership position that we believe is closely identified with hospitalist medicine.

Acquisitions

During the nine months ended September 30, 2012, we acquired the assets of seven hospitalist physician practices for a total estimated purchase price of $32,819,000. In connection with these acquisitions, we recorded goodwill of $32,142,000 and identifiable intangible assets of $677,000. Total transaction costs of $209,000 for our acquisition activities during the nine months ended September 30, 2012 were expensed as incurred.

In connection with these acquisitions, we recorded liabilities of $15,155,000 representing the fair value of future contingent considerations to be paid based upon the estimated achievement of certain operating results of the acquired practices as of certain measurement dates. The fair value of such contingent considerations is re-evaluated on a quarterly basis based on changes in our estimate of the operating results of future payments. The changes, if any, in fair value are recognized in our results of operations.

Subsequent to September 30, 2012, we acquired the assets of two hospitalist physician practices.

Rate Changes by Government Sponsored Programs

The Medicare program reimburses for our services based upon the rates in the Medicare Physician Fee Schedule, and each year the Medicare program updates the Physician Fee Schedule reimbursement rates based on a formula approved by Congress in the Balanced Budget Act of 1997. Many private payors use the Medicare fee schedule to determine their own reimbursement rates.

The Medicare law requires the Centers for Medicare and Medicaid Services (CMS) to adjust the Physician Fee Schedule payment rates annually based on an update formula which includes application of the Sustainable Growth Rate (SGR) that was adopted in the Balanced Budget Act of 1997. This formula has yielded negative updates every year beginning in 2002, and numerous subsequent administrative and legislative actions since then have either delayed, modified or overrode the SGR formula to prevent the reimbursement reductions each year through 2012. CMS has determined that, effective January 1, 2012,


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the SGR formula results in a payment cut of approximately 27 percent. Congress, however, enacted the Temporary Payroll Tax Cut Continuation Act of 2011, which blocked this cut through the end of February 2012. In February 2012, Congress passed the Middle Class Tax Relief and Job Creation Act of 2012, which blocks the cut through the end of 2012. While Congress has repeatedly intervened to mitigate the negative reimbursement impact associated with the SGR formula, there is no guarantee that Congress will continue to do so in the future. Moreover, the existing methodology may result in significant yearly fluctuations in the Physician Fee Schedule amounts, which may be unrelated to changes in the actual costs of providing physician services. Unless Congress enacts a change in the SGR methodology, the uncertainty regarding reimbursement rates and fluctuation will continue to exist.

Another provision that affects physician payments is an adjustment under the Medicare statute to reflect the geographic variation in the cost of delivering physician services, by comparing those costs to the national average. This concerns the "work" component of the Geographic Practice Cost Indices (GPCI). If Congress does not block this adjustment, payments would be decreased to any geographic area with an index of less than 1.0. Congress, however, enacted the Temporary Payroll Tax Cut Continuation Act of 2011, which blocked this cut through the end of February 2012. In February 2012, Congress passed the Middle Class Tax Relief and Job Creation Act of 2012, which blocks the cut through the end of 2012. Although Congress has extended the work GPCI floor several times, there is no guarantee that Congress will block the adjustment in the future, which could result in a decrease in payments we receive for physician services.

Congress has a strong interest in reducing the federal debt, which may lead to new proposals designed to achieve savings by altering payment policies. The Budget Control Act of 2011 (BCA) established a Joint Select Committee on Deficit Reduction, which was tasked with achieving a reduction in the federal debt level of at least $1.2 trillion. That Committee did not draft a proposal by the BCA's deadline. As a result, automatic cuts in various federal programs are scheduled to take place, beginning in January 2013. Although the Medicare program's eligibility and scope of benefits are generally exempt from these cuts, Medicare payments to providers are not exempt. The BCA does, however, provide that the Medicare cuts to providers may not exceed two percent. In September 2012, President Obama released a report providing estimates regarding the implementation of the BCA's automatic cuts. Although the report did not provide many of the details about the cuts, it did confirm that Medicare payments to providers and health plans will be cut by 2 percent. The report estimated that the total cut to Medicare will be $11.09 billion for fiscal year 2013. At this time it is unclear how this automatic reduction may be applied to various Medicare healthcare programs, including physician reimbursement. Therefore it is not possible at this time to estimate what impact, if any, the BCA will have on our business or results of operations. However, under our provider compensation plan, any decrease in reimbursement rates also reduces our physician incentive payments such that, for example, a 2% net reduction in Medicare reimbursement rates for the codes applicable to the services performed by our affiliated hospitalists could reduce our net income by approximately 0.2%.

Healthcare Reform

In March 2010, the Patient Protection and Affordable Care Act (PPACA) and the Health Care and Education Reconciliation Act of 2010 (collectively the "Healthcare Reform Act") were enacted. The Healthcare Reform Act includes a number of provisions that may affect our Company, although the impact of many of the changes will be unknown until they are implemented, which in some cases will not occur for a couple of years. The impact of some of these provisions may be positive, such as the expansion in the number of individuals with health insurance, the 10% Medicare bonus payment for primary care services (including outpatient and nursing home visits) from 2011 through 2015 to primary care practitioners for whom primary care services represented a minimum of 60% of Medicare allowed charges in a prior period, and the increase in Medicaid rates in 2013 and 2014 for primary care services. The impact of other provisions is unknown at this time, such as the establishment of an Independent Medicare Advisory Board that could recommend changes in payment for physicians under certain circumstances not earlier than January 15, 2014, which the Secretary of Health and Human Services generally would be required to implement unless Congress enacts superseding legislation. Fraud and abuse penalty increases and the expansion in the scope of the reach of the Federal Civil False Claims Act and government enforcement tools may adversely impact entities in the healthcare industry, including our Company.

The impact of certain provisions will depend upon the ultimate method of implementation. For example, the Healthcare Reform Act requires the Secretary of Health and Human Services to develop a budget neutral value-based payment modifier that provides for differential payment under the physician fee schedule for physicians or groups of physicians that is linked to quality of care furnished compared to cost. The Secretary of Health and Human Services has begun implementing the modifier through the proposed physician fee schedule rulemaking for 2013, by, among other things, specifying the proposed initial performance period and how it proposes to apply the proposed upward and downward modifier for certain physicians and physician groups beginning January 1, 2015, as well as all physicians and physician groups starting not later than January 1, 2017. The impact of this payment modifier cannot be determined at this time.

In addition, certain provisions of the Healthcare Reform Act authorize voluntary demonstration projects, which include the development of bundling payments for acute, inpatient hospital services, physician services, and post-acute services for episodes of hospital care beginning no later than 2013. In addition, the Healthcare Reform Act allows providers organized as Accountable Care Organizations that voluntarily meet quality thresholds to share in the cost savings they achieve for the Medicare program. The impact of these projects on our Company cannot be determined at this time.


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Seasonality and Quarterly Fluctuations

We have historically experienced and expect to continue to experience quarterly fluctuations in net revenue and income from operations. Absent the impact and timing of acquisitions, our net revenue has historically been higher in the first and fourth quarters of the year primarily due to the following factors:

the number of physicians we have on staff during the quarter, which may fluctuate based upon the timing of hires due to the end of the academic year for graduating resident physicians, the schedule of the Internal Medicine Board exams and terminations in our existing practices; and

fluctuations in patient encounters, which are impacted by hospital census, which can be volatile, and physician productivity and often reflect seasonality due to the higher occurrence of illnesses such as flu and pneumonia in patient populations in the first quarter.

We have significant fixed operating costs, including physician practice salaries and benefits and, as a result, are highly dependent on patient encounters and the productivity of our affiliated hospitalists to sustain profitability. Additionally, quarterly results may be affected by the timing of practice acquisitions and the hiring and termination of our affiliated hospitalists.

Results of Operations and Operating Data

The following table sets forth operating data and selected consolidated
statements of income information stated as a percentage of net revenue:



                                              Three Months Ended                  Nine Months Ended
                                                 September 30,                      September 30,
                                            2012              2011              2012             2011
Operating data - patient encounters        1,349,000         1,193,000         4,049,000        3,538,000

Net revenue                                    100.0 %           100.0 %           100.0 %          100.0 %
Operating expenses:
Cost of services-physician practice
salaries, benefits and other                    73.3 %            74.2 %            73.2 %           73.3 %
General and administrative                      16.2 %            15.8 %            15.9 %           16.0 %
Net change in fair value of contingent
consideration                                    0.0 %             0.2 %             0.1 %            0.2 %
Depreciation and amortization                    0.8 %             0.6 %             0.8 %            0.6 %

Total operating expenses                        90.3 %            90.8 %            90.0 %           90.1 %

Income from operations                           9.7 %             9.2 %            10.0 %            9.9 %
Investment income                                0.0 %             0.0 %             0.0 %            0.0 %
Interest expense                                (0.1 )%           (0.1 )%            0.0 %           (0.1 )%

Income before income taxes                       9.6 %             9.1 %            10.0 %            9.8 %
Income tax provision                             3.5 %             3.5 %             3.7 %            3.7 %

Net income                                       6.1 %             5.6 %             6.3 %            6.1 %

Three months ended September 30, 2012 compared to three months ended September 30, 2011

Our patient encounters for the three months ended September 30, 2012 increased by 156,000 encounters or 13.1% to 1,349,000, compared to 1,193,000 for the same period in the prior year. Net revenue for the three months ended September 30, 2012 was $127.7 million, an increase of $13.2 million, or 11.5%, from $114.5 million for the three months ended September 30, 2011. Of this $13.2 million increase, 60% was attributable to same-market area growth and 40% was


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attributable to revenue generated from operations in five new markets. Of these new markets, three were entered through acquisitions in 2011, one was from a new hospital contract established in 2011 and one was from a new hospital contract established in 2012. Same-market encounters increased 9.7%, same-market revenue increased 7.0% and same-market patient revenue per encounter decreased 2.4%. The 2.4% decrease was principally due to a shift in service mix from acute to post acute care. Same-market areas are those geographic areas in which we have had operations for the entire current period and the entire comparable prior period. Because in-market area acquisitions are often small practice groups which become subsumed within our existing practice groups and are managed by our existing regional management staff, we consider these as part of our same-market area growth.

Physician practice salaries, benefits and other expenses for the three months ended September 30, 2012 were $93.6 million or 73.3% of net revenue compared to $84.9 million or 74.2% of net revenue for the three months ended September 30, 2011. These costs increased by $8.7 million or 10.2%. The increase in practice costs is largely related to the increase in the number of hospitalists added through hiring and acquisitions during the period and to continued investment in physician leadership initiatives. Same-market area physician costs increased a total of $4.6 million, which was primarily the result of increased costs related to our new hires or acquired physician practices. In addition, $4.1 million of the $8.7 million overall cost increase is attributable to physician costs associated with our entrance into five new markets.

General and administrative expenses include all salaries, benefits and operating expenses not specifically related to the day-to-day operations of our physician group practices, including billing and collections functions, our regional and market-area administrative offices and our corporate management and overhead. General and administrative expenses increased $2.6 million, or 14.4%, to $20.7 million, or 16.2% of net revenue, for the three months ended September 30, 2012, as compared to $18.1 million, or 15.8% of net revenue, for the three months ended September 30, 2011. The increase in expense was primarily the result of increased costs to support the continuing growth of our operations and acquisitions, including new regional office costs and other expenses. Excluding stock based compensation, which increased primarily as a result of the increase in our stock price at the date of various grants, general and administrative expenses were 14.9% of revenue for the three months ended September 30, 2012, compared to 14.7% of revenue for the same period of 2011.

Income from operations increased $1.9 million, or 18.0%, to $12.4 million from $10.5 million for the same period in the prior year. Our operating margin increased to 9.7% for the three months ended September 30, 2012, compared to 9.2% for the three months ended September 30, 2011.

Our effective tax rate for the three months ended September 30, 2012 was 36.6% compared to 38.0% for the three months ended September 30, 2011. The decrease in the effective tax rate is due primarily to a decrease in our effective state tax rate. The effective tax rate differs from the statutory U.S. federal rate of 35.0% due primarily to state income taxes.

Net income for the three months ended September 30, 2012 increased to $7.8 million from $6.5 million for the three months ended September 30, 2011, and our net income margin was 6.1% for the three months ended September 30, 2012, as compared to 5.6% for the same period in the prior year.

Nine months ended September 30, 2012 compared to nine months ended September 30, 2011

Our patient encounters for the nine months ended September 30, 2012 increased by 511,000 encounters or 14.4% to 4,049,000, compared to 3,538,000 for the same period in the prior year. Net revenue for the nine months ended September 30, 2012 was $385.9 million, an increase of $46.3 million, or 13.6%, from $339.6 million for the nine months ended September 30, 2011. Of this $46.3 million increase, 67% was attributable to same-market area growth and 33% was attributable to revenue generated from operations in five new markets. Of these new markets, three were entered through acquisitions in 2011, one was from a new hospital contract established in 2011 and one was from a new hospital contract established in 2012. Same-market encounters increased 11.1%, same-market revenue increased 9.3% and same-market patient revenue per encounter decreased 2.2%. The 2.2% decrease was principally due to a shift in service mix from acute to post acute care.

Physician practice salaries, benefits and other expenses for the nine months ended September 30, 2012 were $282.7 million or 73.2% of net revenue compared to $248.8 million or 73.3% of net revenue for the nine months ended September 30, 2011. These costs increased by $33.9 million or 13.6%. The increase in practice costs is largely related to the increase in the number of hospitalists added through hiring and acquisitions during the period and to continued investment in physician leadership initiatives. Same-market area physician costs increased a total of $22.4 million, which was primarily the result of increased costs related to our new hires or acquired physician practices. In addition, $11.5 million of the $33.9 million overall cost increase is attributable to physician costs associated with our entrance into five new markets.


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General and administrative expenses increased $6.9 million, or 12.7%, to $61.2 million, or 15.9% of net revenue, for the nine months ended September 30, 2012, as compared to $54.3 million, or 16.0% of net revenue, for the nine months ended September 30, 2011. The increase in expense was primarily the result of increased costs to support the continuing growth of our operations and acquisitions, including new regional office costs and other expenses. Excluding stock based compensation, which increased primarily as a result of the increase in our stock price at the date of various grants, general and administrative expenses decreased by 40 basis points to 14.6% of revenue for the nine months ended September 30, 2012, compared to 15.0% of revenue for the same period of 2011.

Income from operations increased $5.2 million, or 15.5%, to $38.7 million from $33.5 million for the same period in the prior year. Our operating margin increased to 10.0% for the nine months ended September 30, 2012, compared to 9.9% for the three months ended September 30, 2011.

Our effective tax rate for the nine months ended September 30, 2012 was 37.2% compared to 38.0% for the nine months ended September 30, 2011. The decrease in the effective tax rate is due primarily to a decrease in our effective state tax rate. The effective tax rate differs from the statutory U.S. federal rate of 35.0% due primarily to state income taxes.

Net income for the nine months ended September 30, 2012 increased to $24.1 million from $20.7 million for the nine months ended September 30, 2011, and our net income margin increased to 6.3% for the nine months ended September 30, 2012, as compared to 6.1% for the same period in the prior year.

Liquidity and Capital Resources

As of September 30, 2012, we had no debt outstanding and approximately $100.0 million in liquidity, which is composed of $25.2 million in cash and cash equivalents and an available line of credit of $74.8 million.

Net cash provided by operating activities for the nine months ended September 30, 2012 was $39.1 million compared to $31.0 million for the same period of 2011. The primary changes in working capital during the nine months ended September 30, 2012 was composed of (i) an increase in accounts receivable of $7.8 million, (ii) a decrease of prepaid expenses and other current assets of $5.1 million, (iii) an increase in accrued compensation of $7.8 million primarily related to timing of payrolls and physician bonus payments, and
(iv) an increase in medical malpractice and self-insurance reserves of $2.0 million.

Our days sales outstanding (DSO), which we use to measure the effectiveness of our collections, was 53 DSO as of September 30, 2012 as compared to 51 DSO as of December 31, 2011. We calculate our DSO using a three-month rolling average of net revenues. The increase in DSO was primarily related to revenues from new contracted facilities and practices acquired in 2012.

Net cash used in investing activities was $36.3 million for the nine months ended September 30, 2012, compared to $21.5 million for the same period in 2011. Cash of $33.3 million was used in the nine months ended September 30, 2012 for physician practice acquisitions and earn-out payments on prior acquisitions, compared to $19.4 million in the same period of the prior year. The remainder of cash used in investing activities was for purchases of computer hardware and software, and office furnishings.

For the nine months ended September 30, 2012, net cash provided by financing activities was $4.7 million, compared to $3.5 million provided by financing activities for the same period in 2011.

Credit Facility and Liquidity

Our secured revolving credit agreement (Credit Facility) provides a revolving line of credit of $75.0 million and contains an "accordion" feature that allows an increase of $25.0 million to the Credit Facility with lender approval. The Credit Facility has a maturity date of August 4, 2016 and is available for working capital, practice acquisitions, capital expenditures and general business expenses. In March 2012, we borrowed $15.0 million under our Credit Facility bearing interest at 1.0% per annum, which was repaid during the second quarter 2012. As of September 30, 2012, we had no borrowings outstanding, letters of credit of $0.2 million outstanding and $74.8 million available under the Credit Facility.

The revolving line of credit is limited by a formula based on a certain multiple times the trailing twelve months of earnings before interest, taxes, depreciation, amortization and certain non-cash items. Interest rate options for each borrowing under the Credit Facility, to be selected by us at the time of each borrowing, include either LIBOR plus 0.75% to 1.25%, or the lender's prime rate plus 0% to 0.25%, both based on a leverage ratio. We pay an unused commitment fee equal to 0.25% per annum on the difference between the revolving line capacity and the average balance outstanding during the year. Outstanding amounts advanced to us under the revolving line of credit are repayable on or before the maturity date.


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The Credit Facility is guaranteed by our subsidiaries and affiliated Professional Medical Corporations and limited liability companies, and is secured by substantially all of our and our guarantors' tangible and intangible assets. The Credit Facility includes various customary financial covenants and restrictions, as well as customary remedies for our lenders following an event of default. As of September 30, 2012, we were in compliance with such financial covenants and restrictions.

We anticipate that funds generated from operations, together with our current cash on hand and funds available under our Credit Facility will be sufficient to finance our working capital requirements and fund anticipated acquisitions, contingent acquisition consideration and capital expenditures.

Off Balance Sheet Arrangements

As of September 30, 2012, we had no off-balance sheet arrangements.

Recently Adopted and New Accounting Principles

See Note 1 to the Consolidated Financial Statements for information regarding recently adopted accounting principles.

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