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USMD > SEC Filings for USMD > Form 10-Q on 15-May-2013All Recent SEC Filings

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Form 10-Q for USMD HOLDINGS, INC.


15-May-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

This section should be read in conjunction with the accompanying condensed consolidated financial statements. As used in this Quarterly Report on Form 10-Q, the terms "Holdings," the "Company," "we," "us" and "our" refer to USMD Holdings, Inc. and its consolidated subsidiaries (collectively, "Holdings"). The purpose of this section, Management's Discussion and Analysis of Financial Condition and Results of Operations, is to provide a narrative explanation of our financial statements that enables investors to better understand our business, to enhance our overall financial disclosures, to provide the context within which our financial information may be analyzed and to provide information about the quality of, and potential variability of, our financial condition, results of operations and cash flows.

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains, and from time to time management may make, statements that may constitute "forward-looking statements" within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not historical facts but instead represent management's current expectations regarding future events, many of which, by their nature, are inherently uncertain and outside its control. The forward-looking statements contained in this Quarterly Report are based on information as of the date of this Quarterly Report. Many of these forward-looking statements relate to future industry trends, actions, future performance or results of current and anticipated initiatives and the outcome of contingencies and other uncertainties that may have a significant impact on our business, future operating results and liquidity. Whenever possible, we identify these statements by using words such as "anticipate," "believe," "estimate," "continue," "intend," "expect," "plan," "forecast," "project" and similar expressions, for future-tense or conditional constructions ("will," "may," "should," "could," etc.). We caution you that these statements are only predictions and are not guarantees of future performance. These forward-looking statements and our actual results, developments and business are subject to certain risks and uncertainties that could cause actual results and events to differ materially from those anticipated by these statements. By identifying these statements for you in this manner, we are alerting you to the possibility that our actual results may differ, possibly materially, from the anticipated results indicated in these forward-looking statements. We assume no obligation to update or revise any forward-looking statements, whether as a result of new information or future events, except as required by law. Many factors that could cause actual results to differ from those in the forward-looking statements including, among others, those discussed under "Risk Factors," in our Registration Statement on Form S-4 and those described elsewhere in this Quarterly Report on Form 10-Q and from time to time in our future reports filed with the Securities and Exchange Commission (the "SEC").

Executive Overview

Background

USMD Holdings, Inc., a Delaware corporation, was formed on May 7, 2010 to facilitate the business combination of USMD Inc., a Texas corporation ("USMD"), Urology Associates of North Texas, L.L.P., a Texas limited liability partnership ("UANT"), and UANT Ventures, L.L.P., a Texas limited liability partnership ("Ventures"). On August 19, 2010, Holdings, USMD, Ventures and UANT entered into a Contribution and Purchase Agreement (such agreement, the "Original Contribution Agreement") pursuant to which the entities would combine into a single integrated health services company (such transaction, the "Contribution"). Immediately prior to the Contribution, a subsidiary of Ventures would merge into UANT, resulting in UANT's becoming a wholly owned subsidiary of Ventures, and certain of the USMD shareholders would contribute all or a portion of their shares of USMD common stock to Ventures in exchange for partnership interests in Ventures. When the Contribution was consummated, Ventures would contribute its assets, which would include its equity interests in USMD and UANT, and the remaining USMD shareholders would contribute their USMD shares, to Holdings in exchange for shares of Holdings common stock. Holdings described the Contribution in its Registration Statement on Form S-4 filed with the SEC on December 23, 2010 and declared effective by the SEC on July 25, 2011. On August 23, 2011, the shareholders of USMD and the partners of Ventures voted on and approved the Original Contribution Agreement.

Prior to the consummation of the Contribution, on December 1, 2011, Ventures and Holdings entered into a merger agreement with The Medical Clinic of North Texas, P.A., a Texas professional association ("MCNT"), and on December 15, 2011, Ventures and Holdings entered into a merger agreement with Impel Management Services, L.L.C., a Texas limited liability company ("Impel"). These merger agreements provided that subsidiaries of Ventures would merge into each of MCNT and Impel, resulting in these businesses becoming wholly owned subsidiaries of Ventures prior to the closing of the Contribution. As a result of these merger agreements, on February 9, 2012, Holdings, USMD, UANT and Ventures executed an amendment to the Original Contribution Agreement (the "Amendment") to reflect, among other changes, that Ventures would contribute to Holdings, in addition to its equity interests in USMD and UANT, its equity interests in MCNT and Impel as part of the Contribution. Holdings described these transactions in a post-effective amendment to its Registration Statement on Form S-4 filed with the SEC on February 10, 2012, which was declared effective on April 30, 2012. On May 21, 2012, Ventures, Holdings, MCNT and Impel executed corresponding amendments to the merger agreements. On May 29, 2012, the equity holders of USMD, Ventures, MCNT and Impel voted on and approved the Amendment. On August 31, 2012, Holdings and the other parties consummated the Contribution, inclusive of the mergers.

For accounting purposes, the Contribution qualifies as a business combination and was accounted for as a reverse acquisition by USMD into Holdings, previously a business combination related shell company. Under reverse acquisition accounting, the financial statements are issued in the name of the legal parent
(Holdings), but represent a continuation of the accounting acquirer's (USMD)
financial statements, with an adjustment to retroactively restate USMD's legal capital to reflect the legal capital of Holdings. The assets and liabilities of USMD continue at their pre-Contribution carrying values. The assets and liabilities of Holdings are recorded at fair value at the acquisition date, which, for Holdings, equaled their carrying values. The assets acquired and liabilities assumed from Ventures, UANT, MCNT and Impel (collectively, the "acquired businesses") are recorded at their respective fair values at the acquisition date. Holdings' statements of operations, comprehensive income and cash flows for the three months ended March 31, 2012 only include the historical results, comprehensive income and cash flows of USMD for that period.


Table of Contents

The Business of Holdings

The Contribution created an innovative physician-led integrated health system committed to maintaining the vital doctor-patient relationship that we believe results in higher quality and more affordable patient care. Our focus and the focus of our healthcare providers is to deliver higher quality, more convenient, cost effective health care to our patients. We believe our model brings primary care and specialist physicians together and places them in their proper role as leaders of health care delivery, and that this important shift brings quality and patient satisfaction back to the forefront where it belongs by making our providers responsible for patient outcomes and the overall clinical experience.

We intend to expand our business in the North Texas service area by developing or acquiring complementary physician group practices and building or acquiring ancillary healthcare service providers. We also intend to expand our business in other strategic service areas by developing strategic alliances with large integrated practices. We believe that developing or acquiring targeted physician group practices and ancillary healthcare service providers will permit us to pursue more innovative compensation arrangements with health care consumers, such as risk contracting, and will place us in a position to achieve our goal of becoming a national fully integrated health services company. Risk contracting, or full risk capitation, refers to a model where we would receive from the third party payer a defined amount per person per month in a population (a full dollar premium) in order to manage the healthcare of that population. In such a model, we would then be responsible for all cost of care of the population. This differs from the fee-for-service model in which we currently participate where we are paid based on specific services performed.

In the three months ending March 31, 2013, we had the following:

                       Patient encounters (i)      226,958
                       New patients (ii)            11,471
                       RVUs(iii)                   366,785
                       Lab tests (iv)              220,990
                       Imaging procedures (iv)      16,494

For the three months ended March 31, 2013 and 2012, we had the following:

                                                               March 31,
                                                           2013         2012
        Cancer treatment center fractions treated (iv)     13,994       19,406
        Lithotripsy cases (iv)                              2,280        2,174

(i) A patient encounter is registered when a patient sees their physician.

(ii) New patients are registered for patients not previously seen by a service provider within the Holdings system.

(iii) Relative Value Units ("RVUs") are equivalent to physician work RVUs as defined by the Medicare Physician Fee Schedule. RVUs reflect the relative level of time, skill, training and intensity required of a physician to provide a given service. We use RVUs as measures of physician performance and utilization and RVUs are also a component of physician compensation.

(iv) Lab tests, imaging procedures, cancer treatment center fractions and lithotripsy cases are all production metrics based on Current Procedural Terminology codes.

We use various evidence-based quality metrics such as specific cancer screenings to measure how well our physicians manage their panel of patients. We believe our quality criteria have enabled us to reduce the total medical cost of care of our managed patients, including reductions in emergency room visits and hospital readmissions. We use these and other metrics to measure the performance of our business.

Results of Operations

Three Months Ended March 31, 2013 Compared to Three Months Ended March 31, 2012

As a result of the August 31, 2012 Contribution, which was accounted for as a reverse acquisition by USMD into Holdings, results of operations and cash flows have limited comparability to prior periods. Our results of operations and cash flows for the three months ended March 31, 2013 include the results of operations and cash flows of the consolidated post-Contribution Holdings. Our results of operations and cash flows for the three months ended March 31, 2012 include only the historical results and cash flows of USMD for that period.


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The following table summarizes our results of operations for the periods indicated and is used in the discussions that follow (dollars in thousands):

                                                                                                    Three Months
                                                   Three Months Ended March 31,                       Variance
                                                 2013                       2012                   2013 vs. 2012
                                          Amount        Ratio        Amount        Ratio        Amount        Ratio
Revenues:
Net patient service revenue              $ 45,631         80.2 %    $    -            0.0 %    $ 45,631           n/a
Management services revenue                 5,982         10.5 %       6,020         53.6 %         (38 )        -0.6 %
Lithotripsy revenue                         5,279          9.3 %       5,205         46.4 %          74           1.4 %

Net operating revenue                      56,892        100.0 %      11,225        100.0 %      45,667         406.8 %

Operating expenses:
Salaries, wages and employee benefits      37,459         65.8 %       5,476         48.8 %      31,983         584.1 %
Medical supplies and services expense       5,280          9.3 %         102          0.9 %       5,178        5076.5 %
Rent expense                                3,399          6.0 %         130          1.2 %       3,269        2514.6 %
Provision for doubtful accounts               (36 )       -0.1 %          36          0.3 %         (72 )      -200.0 %
Other operating expenses                    6,514         11.4 %       1,891         16.8 %       4,623         244.5 %
Depreciation and amortization               1,943          3.4 %         265          2.4 %       1,678         633.2 %

                                           54,559         95.9 %       7,900         70.4 %      46,659         590.6 %

Income from operations                      2,333          4.1 %       3,325         29.6 %        (992 )       -29.8 %
Other income, net                             563          1.0 %         111          1.0 %         452         407.2 %

Income before provision for income
taxes                                       2,896          5.1 %       3,436         30.6 %        (540 )       -15.7 %
Provision for income taxes                    356          0.6 %         327          2.9 %          29           8.9 %

Net income                                  2,540          4.5 %       3,109         27.7 %        (569 )       -18.3 %
Less: net income attributable to
noncontrolling interests                   (2,484 )       -4.4 %      (2,726 )      -24.3 %         242          -8.9 %

Net income attributable to USMD
Holdings, Inc.                           $     56          0.1 %    $    383          3.4 %    $   (327 )       -85.4 %

Revenues

Net operating revenue increased 407% to $56.9 million for the three months ended March 31, 2013 as compared to the same period in 2012, due primarily to increases in net patient service revenue related to businesses acquired in the Contribution.

Management services revenue includes revenue earned through the provision of management and staffing services to our managed entities and decreased 0.6% to $6.0 million for the three months ended March 31, 2013. Hospital management services revenue increased $0.1 million primarily as a result of inflation adjustments to the reimbursable management costs at USMD Hospital at Arlington, L.P. ("USMD Arlington") and USMD Hospital at Fort Worth L.P. ("USMD Fort Worth"). Lithotripsy management services revenue decreased $0.1 million. Cancer treatment center management services revenue decreased $0.3 million in 2013 as compared to 2012 due primarily to a decline in revenues in the managed Florida locations. In April 2013, the Company was informed by the owner of the Florida facilities it manages that the owner intended to terminate the management agreements that were in place. Management believes that the growth opportunities in our other managed cancer treatment centers will offset any future decline from the loss of our Florida locations. The remaining $0.3 million increase is related to businesses acquired in the Contribution.

Lithotripsy revenue consists of revenue of the consolidated lithotripsy entities, which increased 1.4% to $5.3 million for the three months ended March 31, 2013 from $5.2 million for the same period in 2012. Lithotripsy entity case counts increased 4.9% in 2013 as compared to 2012.

Operating Expenses

Salaries, wages and employee benefits increased 584% to $37.5 million for the three months ended March 31, 2013 from $5.5 million in 2012 due primarily to businesses acquired in the Contribution. Additional increases have occurred due to the expansion of corporate overhead departments. The salaries, wages and employee benefits of the acquired businesses used to generate net patient service revenue have a higher relative cost than our historical salaries, wages and employee benefits. This higher cost of revenue accounted for the majority of the increase in salaries, wages and employee benefits as a percentage of net operating revenue to 65.8% in 2013 from 48.8% in 2012.

Medical supplies and services expense increased due to the nature of businesses acquired in the Contribution. The businesses provide health care services to patients in physician clinics and other health care facilities and utilize significant medical supplies and services in the provision of those services.

Rent expense increased related to businesses acquired in the Contribution. The acquired businesses provide their primary healthcare services in rented facilities.

Other operating expenses consist primarily of professional fees, purchased services, repairs & maintenance, travel expense and other expense. Other operating expenses increased 245% to $6.5 million for the three months ended March 31, 2013 from $1.9 million in 2012. The net increase is primarily related to expenses of businesses acquired in the Contribution.

Depreciation and amortization expense increased 633% to $1.9 million for the three months ended March 31, 2013 from $0.3 million in 2012. The increase is due primarily to increases in depreciation and amortization of $1.2 million and $0.4 million, respectively, related to property and equipment and intangible assets acquired and recorded at fair value in the Contribution.


Table of Contents

Other Income, net

Other income, net increased 407% to $0.6 million for the three months ended March 31, 2013 from $0.1 million in 2012 due primarily to a $0.5 million increase in equity in income of nonconsolidated affiliates. Increased ownership interests in USMD Arlington and USMD Fort Worth, as a result of the Contribution, accounted for a $1.0 million increase offset by a $0.5 million decrease in equity in income of nonconsolidated affiliates as a result of decreased profitability at USMD Arlington related to an interest rate swap novation. Net interest expense increased $0.1 million as a result of the net increase in borrowings related to the Contribution, offset by an overall reduction in borrowing rates.

Provision for Income Taxes

Holdings' effective tax rates were 12.3% and 9.5% for the three months ended March 31, 2013 and 2012, respectively. The increase in the effective rate is primarily due to the out of period adjustment resulting in an additional income tax provision of $0.2 million during the first quarter of 2013, offset by the decline of net income attributable to noncontrolling interests.

Net Income Attributable to Noncontrolling Interests

Noncontrolling interests eliminate the income or loss attributable to non-Holdings ownership interests in our consolidated entities. Net income attributable to noncontrolling interests decreased $0.2 million to $2.5 million for the three months ended March 31, 2013 from $2.7 million in 2012. The net decrease is primarily related to Holdings' increased ownership interest in three of the consolidated lithotripsy entities as a result of the Contribution.

Liquidity and Capital Resources

We primarily rely on cash flows from operations to fund our operating activity cash requirements. At March 31, 2013, we had available cash of $3.6 million, which is net of $1.7 million of consolidated lithotripsy entity cash that is unavailable for wholly owned entity cash flow operating activities.
Additionally, on February 28, 2013, we renewed our revolving credit facility for one year from the renewal date to February 28, 2014. The revolving credit facility is available for working capital needs. Cash flows associated with the Contribution have resulted in a significant drain on our cash balance. Under the credit agreement entered into contemporaneously with the Contribution, we are required to maintain a $5.0 million restricted cash balance. In addition, we began making principal payments under the credit facility in December 2012. Current liabilities assumed in the Contribution have become due and payable faster than we have been able to monetize the current assets acquired. In addition, we have incurred increased cash outflows associated with integration and strategic planning and execution efforts. During April 2013, we borrowed $3.0 million under the revolving credit facility. As cash flow activity normalizes, we expect that our cash flows from operations will increase in the second half of 2013; however, as we continue to incur integration and infrastructure improvement costs, we may be required to borrow additional funds under the revolving credit facility ($7.0 million available to borrow at April 30, 2013). At this time we do not anticipate borrowing additional funds under the revolving credit facility, but a decline in projected collections may also necessitate accessing those funds. Although the business combination of three management platforms and existing infrastructures and two physician practices creates an opportunity for cost synergies, we don't expect to benefit from significant cost synergies until 2014.

Our near term business plan contemplates expansion in the North Texas service area by developing or acquiring complementary physician group practices and building or acquiring ancillary healthcare service providers. We also plan to expand our count of primary care physicians and specialists in our areas of focus and areas that expand our integrated health system offerings. Execution of these activities and of our broader strategic plan will likely require additional capital, which we may seek through public or private financings or through other arrangements. In such an event, adequate funds may not be available when needed or may be available only on terms which could have a negative impact on our business and results of operations. In addition, if we raise additional funds by issuing equity or convertible securities, dilution to then existing stockholders may result.


Table of Contents

The following table summarizes our cash flows for the periods indicated and is used in the discussions that follow (in thousands):

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