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USMD > SEC Filings for USMD > Form 10-K on 15-Apr-2014All Recent SEC Filings

Show all filings for USMD HOLDINGS, INC.

Form 10-K for USMD HOLDINGS, INC.


15-Apr-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The purpose of this section, Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A"), is to provide a narrative explanation of our financial statements from the perspective of our management 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. The MD&A should be read in conjunction with the accompanying consolidated financial statements and related notes included in this Annual Report on Form 10-K.

Executive Overview

The Contribution created an innovative early-stage 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. An integrated health system is considered early-stage when it has not yet established all the components necessary to be considered a fully integrated health system. 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 operate in one physician-led integrated health system segment and provide healthcare services to patients in physician clinics, hospitals and other healthcare facilities, primarily in the Dallas-Fort Worth, Texas metropolitan area. We provide management and/or operational services to six cancer treatment centers in five states and 21 lithotripsy service providers (i.e., kidney stone treatment) primarily located in the South-Central United States.

Key Developments

On June 1, 2013, WNI-DFW commenced operations and we began recording capitation revenue and associated expenses, including incurred but not recorded medical expense. Currently, WNI-DFW is a cornerstone of our physician-led integrated health system and establishes our presence in the North Texas Medicare Advantage market.


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Effective September 1, 2013, we issued convertible subordinated notes in the aggregate principal amount of $24.3 million (the "Convertible Subordinated Notes") to certain limited partners of USMD Arlington to acquire their limited partnership interests in USMD Arlington. Our investment in USMD Arlington increased by $24.3 million and our ownership percentage in USMD Arlington increased to 46.4% from 28.4%. Our allocable share of net income or loss from USMD Arlington will increase commensurate with our increased ownership.

Opportunities and Challenges

We are focused on expanding our physician-led integrated health system through the growth of our physician and patient base as well as by increasing the service offerings within our system. We intend to increase our patient base by increasing the number of primary care and specialist physicians in our system, including increasing the number of specialists in our current areas of focus as well as in specialties not currently within our system. We may achieve this through hiring efforts or through the acquisition of or affiliations with physician practices or other healthcare practices that share our vision of patient-first care. Inherent in expansion of our physician-led integrated health system is a build out of our imaging, clinical and pathological laboratory offerings and implementation of a more efficient clinical care model.

A significant component of our growth plan is an increase in the number of Medicare Advantage patients currently served through WNI-DFW. From the commencement of operations in June 2013 through December 2013, WNI-DFW had an average of approximately 1,640 Medicare Advantage member patients. Beginning January 1, 2014, following the annual Medicare enrollment process, WNI-DFW had nearly 5,200 Medicare Advantage member patients. We believe the care coordination and population health infrastructure we have installed will enhance the clinical outcomes and eliminate wasteful costs for our Medicare Advantage patients. Our WNI-DFW agreement calls for receipt of 85% of the premium for that Medicare Advantage population, which has provided us the resources needed to develop the care management infrastructure necessary to achieve these results. As we increase investment in our care coordination and population management infrastructure, we anticipate near-term margin pressures as we identify opportunities to appropriately manage the health of our Medicare Advantage patient population. We believe effective management of that population will generate positive long-term returns.

In December 2013, our physician practice was selected by CMS to participate in the Medicare ACO Shared Savings Program. Doctors, hospitals and health care providers establish ACOs in order to work together to provide higher-quality coordinated care to patient populations specified by Medicare, with the intent to produce savings as a result of improved quality and operational efficiency. Since passage of the Affordable Care Act, more than 360 ACOs have been established, serving over 5.3 million Americans with Medicare. ACOs share with Medicare any savings generated from lowering the growth in health care costs when they meet standards for high quality care. The ACOs must meet quality standards to ensure that savings are achieved through improving care coordination and providing care that is appropriate, safe, and timely. CMS evaluates ACO quality performance using 33 quality measures on patient and caregiver experience of care, care coordination and patient safety, appropriate use of preventive health services, and improved care for at-risk populations.

Increasing physician counts and the expansion of service offerings may have a near-term negative impact on margins as we develop our physician-led integrated health system. Designing and implementing a physician compensation model that properly incentivizes physicians in a value-based care paradigm is integral to our future success. We will face operational and cultural challenges in integrating new physicians and components of our patient-centric model, which continues to evolve and is expected to offer numerous opportunities for improving healthcare delivery and growing our business. In addition, the continued development of our physician-led integrated health system will likely require additional capital infusions or other financing.

Selected Operating Statistics

At December 31, 2013, USMD Physician Services operated out of 58 clinics and
other healthcare facilities and employed 128 primary care and pediatric
physicians and 84 physician specialists.

For the periods presented, we had the following:



                                          Years Ended December 31,           Four Months Ended December 31,
                                             2013             2012             2013                  2012
Patient encounters (i)                         882,295        271,320             290,499               271,320
New patients (ii)                               93,699         13,668              29,712                13,668
RVU's (iii)                                  1,455,479        474,095             478,783               474,095
Lab tests (iv)                               1,183,829        340,416             391,797               340,416
Imaging procedures (iv)                         44,743         11,975              14,476                11,975

For the years ended December 31, 2013 and 2012, we had the following:

                                                           2013         2012
        Cancer Treatment Center fractions treated (iv)     52,726       60,707
        Lithotripsy cases (iv)                              9,342        9,348

i. A patient encounter is registered when a patient sees his or her physician.

ii. New patients are registered for patients not previously seen by a service provider within our 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 productivity 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.


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We use various evidence-based quality metrics such as specific cancer screenings to measure how well our physicians manage their patient panels. 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.

Industry Trends

Healthcare Reform

In March 2010, the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010 (collectively, the "Healthcare Reform Law") was enacted. The Healthcare Reform Law is intended to expand health insurance coverage to uninsured individuals and reform the healthcare delivery system with the objectives of improving quality and lowering the overall cost of providing healthcare. Many provisions within the Healthcare Reform Law could impact us in the future, resulting in potential variances in third-party reimbursement rates, payer mix and patient encounter volumes. The most significant provisions of the Health Reform Law that seek to decrease the number of uninsured individuals mostly became effective January 1, 2014. However, the shared responsibility provisions that require companies with 50-99 or greater than 100 employees to provide health insurance or pay fines has been delayed until January 1, 2015 and 2016, respectively. Because of the many variables involved and the staggered implementation timeline, we cannot predict with any assurance the ultimate effect of the Healthcare Reform Law and related regulations and interpretive legislation on our business. We believe that we are well positioned to respond effectively to the opportunities and challenges presented by this important legislation as a result of our physician-led, high quality, patient-centered care model.

One provision of the Health Reform Law required CMS to establish a Medicare Shared Savings Program (MSSP) that promotes accountability and coordination of care through the creation of ACOs. The program allows certain healthcare providers to voluntarily form ACOs and work together along with other ACO participants to invest in infrastructure and redesign delivery processes to achieve high quality and efficient delivery of services. Our physician practice was recently selected as an ACO by HHS. As an ACO, we will strive to improve the clinical outcomes of our Medicare fee for service patients participating in the ACO and to achieve those improved outcomes at a reduced relative cost. We will have the opportunity to share with CMS in any financial savings created.

Value-Based Care and Patient-Centered Medical Home

We believe the U.S. healthcare system continues to evolve in a manner that favors integrated healthcare systems and value-based care, with an increasing focus on population management. As government and commercial payers strive to control healthcare costs and improve healthcare outcomes, we believe payment methodologies and reimbursement trends will continue to evolve, including payment bundling, value-based payment methodologies linked to the quality and coordination of care as well as risk-sharing arrangements such as capitated payments.

We also believe that patient-centered medical home models, in which a primary care or specialty physician serves as the care coordinator will grow in prominence. We believe our focus on developing a clinically integrated, comprehensive healthcare delivery network, our commitment to patient-centered care, our collaborations such as those with WNI-DFW, other commercial payors and our experienced management team position us well to respond to these emerging trends and to manage the changing healthcare regulatory and reimbursement environment.

Electronic Health Records

The American Recovery and Reinvestment Act of 2009 provides for incentive payments under the Medicare and Medicaid programs for certain hospitals and physicians that demonstrate meaningful use of certified EHR technology. Physicians and other professionals may be eligible for either Medicare or Medicaid incentive payments, but not both. We anticipate that nearly all of our physicians will participate in the meaningful use program in 2014. We have incurred and will continue to incur both capital expenditures and operating expenses in order to implement EHR technology and meet the meaningful use requirements; the timing of recognition of EHR incentive income does not correlate with those expenditures and expenses. We believe that the operational benefits of EHR technology, including anticipated improved clinical outcomes and increased operational and administrative efficiencies, will contribute to development of our integrated health system and our ability to meet targeted quality objectives.

Results of Operations

Year ended December 31, 2013 Compared to Year Ended December 31, 2012

As a result of the August 31, 2012 Contribution, which was accounted for as a reverse acquisition by USMD into Holdings, previously a business combination related shell company, results of operations and cash flows have limited comparability between periods. Our results of operations and cash flows for the year ended December 31, 2013 include a full year of results of operations and cash flows of post-Contribution Holdings. Our results of operations and cash flows for the year ended December 31, 2012 include eight months of results of operations and cash flows of pre-Contribution USMD and four-months of results of operations and cash flows of post-Contribution Holdings.


Table of Contents

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

                                                     Years Ended December 31,                       Annual Variance
                                                 2013                        2012                    2013 vs. 2012
                                         Amount         Ratio        Amount         Ratio        Amount         Ratio
Revenues:
Net patient service revenue             $ 178,286         76.0 %    $  59,420         56.2 %    $ 118,866         200.0 %
Capitated revenue                           9,524          4.1 %          656          0.6 %        8,868        1351.8 %
Management and other services revenue      25,536         10.9 %       23,400         22.1 %        2,136           9.1 %
Lithotripsy revenue                        21,381          9.1 %       22,226         21.0 %         (845 )        -3.8 %

Net operating revenue                     234,727        100.0 %      105,702        100.0 %      129,025         122.1 %

Operating expenses:
Salaries, wages and employee benefits     153,999         65.6 %       62,694         59.3 %       91,305         145.6 %
Medical supplies and services expense      29,199         12.4 %        7,060          6.7 %       22,139         313.6 %
Rent expense                               15,034          6.4 %        5,086          4.8 %        9,948         195.6 %
Provision for doubtful accounts                70          0.0 %          107          0.1 %          (37 )       -34.6 %
Other operating expenses                   27,464         11.7 %       15,711         14.9 %       11,753          74.8 %
Electronic Health Record incentive
income                                     (1,643 )       -0.7 %         (474 )       -0.4 %       (1,169 )       246.6 %
Depreciation and amortization               7,626          3.2 %        3,302          3.1 %        4,324         131.0 %

                                          231,749         98.7 %       93,486         88.4 %      138,263         147.9 %

Income from operations                      2,978          1.3 %       12,216         11.6 %       (9,238 )       -75.6 %
Other income (expense), net                 7,823          3.3 %        3,024          2.9 %        4,799         158.7 %

Income before provision for income
taxes                                      10,801          4.6 %       15,240         14.4 %       (4,439 )       -29.1 %
Provision for income taxes                     71          0.0 %        1,487          1.4 %       (1,416 )       -95.2 %

Net income                                 10,730          4.6 %       13,753         13.0 %       (3,023 )       -22.0 %
Less: net income attributable to
noncontrolling interests                   (9,751 )       -4.2 %      (11,653 )      -11.0 %        1,902         -16.3 %

Net income attributable to USMD
Holdings, Inc.                          $     979          0.4 %    $   2,100          2.0 %    $  (1,121 )       -53.4 %

Revenues

The following table summarizes our net operating revenues for the periods
indicated and is used in the revenue discussions that follow (in thousands):



                                                         Years Ended December 31,                      Annual Variance
                                                     2013                       2012                    2013 vs. 2012
                                              Amount        Ratio        Amount        Ratio        Amount         Ratio
Net patient service revenue:
Physician clinics                            $ 143,373        61.1 %    $  47,446        44.9 %    $  95,927         202.2 %
Imaging                                          3,891         1.7 %        1,460         1.4 %        2,431         166.5 %
Diagnostic laboratories                         14,260         6.1 %        4,674         4.4 %        9,586         205.1 %
Cancer treatment center                         13,364         5.7 %        4,506         4.3 %        8,858         196.6 %

Total patient encounter based clinic NPSR      174,888        74.5 %       58,086        55.0 %      116,802         201.1 %
Other physician revenue                          3,398         1.4 %        1,334         1.3 %        2,064         154.7 %

                                               178,286        76.0 %       59,420        56.2 %      118,866         200.0 %
Capitated revenue                                9,524         4.1 %          656         0.6 %        8,868        1351.8 %

Total net patient service revenue              187,810        80.0 %       60,076        56.8 %      127,734         212.6 %

Management and other services revenue:
Hospital management revenue                     14,573         6.2 %       13,898        13.1 %          675           4.9 %
Lithotripsy management revenue                   1,631         0.7 %        1,425         1.3 %          206          14.5 %
Cancer treatment center management revenue       5,343         2.3 %        7,179         6.8 %       (1,836 )       -25.6 %
Other services revenue                           3,989         1.7 %          898         0.8 %        3,091         344.2 %

                                                25,536        10.9 %       23,400        22.1 %        2,136           9.1 %


Lithotripsy revenue                             21,381         9.1 %       22,226        21.0 %         (845 )        -3.8 %


Net operating revenue                        $ 234,727       100.0 %    $ 105,702       100.0 %    $ 129,025         122.1 %


Table of Contents

- Net Patient Service Revenue ("NPSR")

Our net patient service revenue is driven by a patient encounter at one of our physician clinics. A patient sees the physician at one of our clinics and the physician may prescribe services that may be performed at one of our imaging centers, diagnostic laboratories, cancer treatment center or other affiliated or unaffiliated healthcare facility. The net patient service revenue earned at our imaging centers, diagnostic laboratories and cancer treatment center are almost exclusively derived from the physician clinic patient encounter. Our imaging centers, diagnostic laboratories and cancer treatment center only nominally serve patients or conduct tests not derived from our physician clinic patient encounter. For these reasons, we focus on the overall net patient service revenue per patient encounter metric.

Certain volume statistics are used internally as productivity measures (lab tests, imaging procedures, fractions treated) and we present these volume statistics within MD&A. Therefore, the ensuing MD&A discussion regarding net patient service revenue related metrics is consistent with our business structure.

The clinic patient encounter results in the direct provision of healthcare services and the prescription of diagnostic (imaging and laboratory services) and other therapeutic services (i.e. radiation treatments) that may be performed at our diagnostic laboratories, imaging centers and cancer treatment center. Patient encounter based clinic net patient service revenue increased $116.8 million or 201.1% while patient encounters and RVUs increased by 225.2% and 207.0%, respectively, for the year ended December 31, 2013 as compared to the year ended December 31, 2012, due primarily to the inclusion of a full year of activity related to businesses acquired in the Contribution. Net patient service revenue per patient encounter decreased 7.4% in 2013 as compared to 2012. The decrease is primarily attributable to the composition of the periods compared. The 2012 metric includes four post-Contribution months and 2013 includes an entire annual period. The four-month 2012 period includes back-to-school and flu immunization seasons, which are generally beneficial to net patient service revenue due to the drug component of the patient encounter.

Other physician revenue represents non-clinic physician premium payments for quality measures, medical home, on-call pay and physician recruit guarantee revenues and increased to $3.4 million for the year ended December 31, 2013 from $1.3 million in 2012. The increase is primarily attributable to the composition of the periods compared and the accumulation of activities spanning four months of 2012, compared to twelve months of activity in 2013.

The following table presents our net patient service revenue for the year-over-year comparative periods that include net patient service revenue (in thousands):

                                                    Four Months Ended December 31,                Four Months Variance
                                                    2013                      2012                    2013 vs. 2012
                                             Amount       Ratio        Amount       Ratio         Amount           Ratio
Net patient service revenue:
Physician clinics                           $ 48,341        75.0 %    $ 47,446        79.0 %    $      895            1.9 %
Imaging                                        1,094         1.7 %       1,460         2.4 %          (366 )        -25.1 %
Diagnostic laboratories                        4,678         7.3 %       4,674         7.8 %             4            0.1 %
Cancer treatment center                        4,125         6.4 %       4,506         7.5 %          (381 )         -8.5 %

Total patient encounter based clinic NPSR     58,238        90.4 %      58,086        96.7 %           152            0.3 %
Other physician revenue                        1,140         1.8 %       1,334         2.2 %          (194 )        -14.5 %

                                              59,378        92.1 %      59,420        98.9 %           (42 )         -0.1 %

Capitated revenue                              5,069         7.9 %         656         1.1 %         4,413          672.7 %

Total net patient service revenue           $ 64,447       100.0 %    $ 60,076       100.0 %    $    4,371            7.3 %

Patient encounter based clinic net patient service revenue increased $0.2 million or less than 1% for September - December 2013 as compared to September - December 2012. This increase was driven by a 7.1% increase in patient encounters for the year over year period. However, net patient service revenue per patient encounter decreased 6.2%, resulting from a shift to an overall lower acuity case
mix. This shift in acuity is reflected in an approximately 8% decline in RVUs per charge, which generally garners lower reimbursement per patient encounter. Also contributing to the decline in net patient service revenue per patient encounter was a 2% decrease in higher reimbursing commercial payer sources and a corresponding 2% rise in government payer sources from 36% to 38% of charges.

- Capitated Revenue

In June 2013, WNI-DFW began operations and we began recording capitated revenue associated with the consolidated operations of WNI-DFW. Capitated revenue increased $8.8 million to $9.5 million for the year ended December 31, 2013 from $0.7 million in 2012. The commencement of operations at WNI-DFW accounted for $7.4 million of the increase and $1.4 million of the increase is due to the inclusion of a full year of activity related to businesses acquired in the Contribution. The following table presents, as of December 31, 2013, the total number of capitated members to whom WNI-DFW provides healthcare services to and the associated aggregate member months. Member months represent the aggregate number of months of healthcare services WNI-DFW has provided to capitated members.

                                                              Member
                                                Members       Months
                 WNI-DFW capitated membership      1,752       11,484

Effective January 1, 2014, the WNI-DFW member count increased to 5,188. We anticipate increasing our capitated member counts through WNI-DFW or other entities focused on the Medicare Advantage market as we execute our strategy to move from an early-stage integrated health system to a fully integrated health system.

- Management and Other Services Revenue

Management services revenue includes revenue earned through the provision of management and support services to our nonconsolidated managed entities. Management services revenue increased 9.1% to $25.5 million for the year ended December 31, 2013 from $23.4 million in 2012.

Hospital management revenue earned from USMD Arlington and USMD Fort Worth increased $0.7 million or 4.9%. Hospital management revenue earned per surgical case at the hospitals increased 4.7%. A contractual 4.4 % inflation adjustment to reimbursable management and support costs contributed $0.3 million of the year over year increase in hospital management revenue. The hospitals expect to receive annual inflation adjustments to reimbursable management and support costs equivalent to the Bureau of Labor and Statistics Healthcare Services . . .

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