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HEALTHWAYS, INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations
(Edgar Glimpses Via Acquire Media NewsEdge) Overview
Founded in 1981, Healthways provides specialized, comprehensive solutions to
help people improve physical, emotional and social well-being, thereby improving
their health and productivity and reducing their health-related costs.
We provide highly specific and personalized interventions for each individual in
a population, irrespective of health status, age or payor. Our evidence-based
health, prevention and well-being services are made available to consumers via
phone, mobile devices, direct mail, the Internet, face-to-face consultations and
venue-based interactions.
In North America, our customers include health plans, employers, integrated
healthcare systems, hospitals, physicians, and government entities in all 50
states, the District of Columbia and Puerto Rico. We also provide services to
commercial healthcare businesses and/or government entities in Brazil, Australia
and France. We operate domestic and international well-being improvement centers
staffed with licensed health professionals. Our fitness center network
encompasses approximately 15,000 U.S. locations. We also maintain an extensive
network of over 88,000 complementary, alternative and physical medicine
practitioners, which offers convenient access to the significant number of
individuals who seek health services outside of the traditional healthcare
system.
Our guiding philosophy and approach to market is predicated on the fundamental
belief that healthier people cost less and are more productive. As described
more fully below, our programs are designed to improve well-being by helping
people to adopt or maintain healthy behaviors, reduce health-related risk
factors, and optimize care for identified health conditions.
First, our programs are designed to help people adopt or maintain healthy
behaviors by:
· fostering wellness and disease prevention through total population screening,
well-being assessments and supportive interventions; and
· providing access to health improvement programs, such as fitness solutions,
weight management, chiropractic, and complementary and alternative medicine.
Our prevention programs focus on education, physical fitness, health coaching,
and behavior change techniques and support. We believe this approach improves
the well-being status of member populations and reduces the short- and long-term
health-related costs for participants, including associated costs from the loss
of employee productivity.
Second, our programs are designed to help people reduce health-related risk
factors by:
· promoting the change and improvement of the lifestyle behaviors that lead to
poor health or chronic conditions; and
· providing educational materials and personal interactions with highly trained
nurses and other healthcare professionals to create and sustain healthier
behaviors for those individuals at-risk or in the early stages of chronic
conditions.
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We enable our customers to engage everyone in their covered populations through
specific interactions that are sensitive to each individual's health risks and
needs. Our programs are designed to motivate people to make positive lifestyle
changes and accomplish individual goals, such as increasing physical activity
for seniors through the Healthways SilverSneakers fitness solution, overcoming
nicotine addiction through the QuitNet® on-line smoking cessation community, or
generating sustainable weight-loss through our InnergyTM solution.
Finally, our programs are designed to help people optimize care for identified
health conditions by:
· incorporating the latest, evidence-based clinical guidelines into
interventions to optimize patient health outcomes;
· developing care support plans and motivating members to set attainable goals
for themselves;
· providing local market resources to address acute episodic interventions;
· coordinating members' care with their healthcare providers;
· providing software licensing and management consulting in support of
well-being improvement services; and
· providing high-risk care management for members at risk for hospitalization
due to complex conditions.
Our approach is to use proprietary, analytic models to identify individuals who
are likely to incur future high costs, including those who have specific gaps in
care, and through evidence-based interventions drive adherence to proven
standards of care, medication regimens and physicians' plans of care to reduce
disease progression and related medical spending.
We recognize that each individual plays a variety of roles in his or her pursuit
of health, often simultaneously. By providing the full spectrum of services to
meet each individual's needs, we believe our interventions can be delivered at
scale and in a manner that reflects those unique needs over time. We believe
creating real and sustainable behavior change generates measurable, long-term
cost savings and improved individual and business performance.
Forward-Looking Statements
Management's Discussion and Analysis of Financial Condition and Results of
Operations contains forward-looking statements, which are based upon current
expectations, involve a number of risks and uncertainties, and are subject to
the "safe harbor" provisions of the Private Securities Litigation Reform Act of
1995. Forward-looking statements include all statements that are not historical
statements of fact and those regarding the intent, belief, or expectations of
the Company, including, without limitation, all statements regarding the
Company's future earnings and results of operations, and can be identified by
the use of words like "may," "believe," "will," "expect," "project," "estimate,"
"anticipate," "plan," or "continue" and similar expressions. Those
forward-looking statements may be affected by certain risks and uncertainties,
including, but not limited to:
· our ability to sign and implement new contracts for our solutions;
· our ability to accurately forecast the costs required to successfully
implement new contracts;
· our ability to renew and/or maintain contracts with our customers under
existing terms or restructure these contracts on terms that would not have a
material negative impact on our results of operations;
· our ability to effectively compete against other entities, whose financial,
research, staff, and marketing resources may exceed our resources;
· our ability to accurately forecast the Company's revenues, margins, earnings
and net income, as well as any potential charges that we may incur as a result
of changes in our business;
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· our ability to accurately forecast variables that affect performance and the
timing of revenue recognition under the terms of our customer contracts ahead
of data collection and reconciliation;
· the impact of the Patient Protection and Affordable Care Act, as amended by
the Health Care and Education Reconciliation Act of 2010 ( "PPACA"), on our
operations and/or the demand for our services;
· the impact of any new or proposed legislation, regulations and interpretations
relating to the Medicare Prescription Drug, Improvement, and Modernization Act
of 2003, including the potential expansion to Phase II for Medicare Health
Support programs and any legislative or regulatory changes with respect to
Medicare Advantage;
· our ability to anticipate the rate of market acceptance of our solutions in
potential international markets;
· our ability to accurately forecast the costs necessary to establish a presence
in international markets;
· the risks associated with foreign currency exchange rate fluctuations and our
ability to hedge against such fluctuations;
· the risks associated with deriving a significant concentration of our revenues
from a limited number of customers;
· our ability to achieve and reach mutual agreement with customers with respect
to contractually required performance metrics, cost savings and clinical
outcomes improvements, or to achieve such metrics, savings and improvements
within the time frames contemplated by us;
· our ability to achieve estimated annualized revenue in backlog in the manner
and within the timeframe we expect, which is based on certain estimates
regarding the implementation of our services;
· our ability and/or the ability of our customers to enroll participants and to
estimate their level of enrollment and participation in our programs in a
manner and within the timeframe anticipated by us;
· the ability of our customers to provide timely and accurate data that is
essential to the operation and measurement of our performance under the terms
of our contracts;
· our ability to favorably resolve contract billing and interpretation issues
with our customers;
· our ability to service our debt, make principal and interest payments as those
payments become due, and remain in compliance with our debt covenants;
· the risks associated with changes in macroeconomic conditions, which may
reduce the demand and/or the timing of purchases for our services from
customers or potential customers, reduce the number of covered lives of our
existing customers, or restrict our ability to obtain additional financing;
· counterparty risk associated with our interest rate swap agreements and
foreign currency exchange contracts;
· our ability to integrate acquired businesses, services (including outsourced
services), or technologies into our business and to accurately forecast the
related costs;
· our ability to anticipate and respond to strategic changes, opportunities, and
trends in our industry and/or business and to accurately forecast the related
impact on our earnings;
· the impact of any impairment of our goodwill or other intangible assets;
· our ability to develop new products and deliver outcomes on those products;
· our ability to implement our integrated data and technology solutions platform
within the required timeframe and expected cost estimates and to develop and
enhance this platform and/or other technologies to meet evolving customer and
market needs;
· our ability to obtain adequate financing to provide the capital that may be
necessary to support our operations and to support or guarantee our
performance under new contracts;
· unusual and unforeseen patterns of healthcare utilization by individuals with
diseases or conditions for which we provide services;
· the ability of our customers to maintain the number of covered lives enrolled
in the plans during the terms of our agreements;
· the impact of legal proceedings involving us and/or our subsidiaries;
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· the impact of future state, federal, and international legislation and
regulations applicable to our business, including PPACA, on our ability to
deliver our services and on the financial health of our customers and their
willingness to purchase our services;
· current geopolitical turmoil, the continuing threat of domestic or
international terrorism, and the potential emergence of a health pandemic; and
· other risks detailed in our Annual Report on Form 10-K for the fiscal year
ended December 31, 2011 and other filings with the Securities and Exchange
Commission.
We undertake no obligation to update or revise any such forward-looking
statements.
Contract Terms
Our fees are generally billed on a per member per month ("PMPM") basis or upon
member participation. For PMPM fees, we generally determine our contract fees by
multiplying the contractually negotiated PMPM rate by the number of members
covered by our services during the month. We typically set PMPM rates during
contract negotiations with customers based on the value we expect our programs
to create and a sharing of that value between the customer and the Company. In
addition, some of our services, such as the Healthways SilverSneakers fitness
solution, include fees that are based upon member participation.
Our contracts with health plans generally range from three to five years with
provisions for subsequent renewal; contracts with self-insured employers
typically have one to three-year terms. Some of our contracts allow the customer
to terminate early.
Some of our contracts place a portion of our fees at risk based on achieving
certain performance metrics, cost savings, and/or clinical outcomes improvements
("performance-based"). Approximately 7% of revenues recorded during the nine
months ended September 30, 2012 were performance-based and were subject to final
reconciliation as of September 30, 2012.
Technology
Our solutions require sophisticated analytical, data management, Internet and
computer-telephony solutions based on state-of-the-art technology. These
solutions help us deliver our services to large populations within our customer
base. Our predictive modeling capabilities allow us to identify and stratify
those participants who are most at risk for an adverse health event. We
incorporate behavior-change science with consumer-friendly interactions to
facilitate consumer preferences for engagement and convenience. We use
sophisticated data analytical and reporting solutions to validate the impact of
our programs on clinical and financial outcomes. We continue to invest heavily
in technology, as evidenced by our long-term applications and technology
services outsourcing agreement with HP Enterprise Services, LLC, and are
continually expanding and improving our proprietary clinical, data management,
and reporting systems to continue to meet the information management
requirements of our services. The behavior change techniques and predictive
modeling incorporated in our technology identify an individual's readiness to
change and provide personalized support through appropriate interactions using a
range of methods desired by an individual, including venue-based face-to-face;
print; phone; mobile and remote devices; on-line; emerging modalities; and any
combination thereof to motivate and sustain healthy behaviors.
Business Strategy
The World Health Organization defines health as "…not only the absence of
infirmity and disease, but also a state of physical, mental, and social
well-being."
Our business strategy reflects our passion to enhance health and well-being and,
as a result, reduce
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overall healthcare costs and improve workforce engagement, yielding better
business performance for our customers. Our solutions are designed to improve
well-being by helping people to:
· adopt or maintain healthy behaviors;
· reduce health-related risk factors; and
· optimize care for identified health conditions.
Through our solutions, we work to optimize the health and well-being of entire
populations, one person at a time, domestically and internationally, thereby
creating value by reducing overall healthcare costs and improving productivity
and performance for individuals, families, health plans, governments, employers,
integrated healthcare systems and communities.
We believe it is critical to impact an entire population's underlying health
status and well-being in a long-term, cost effective way. Believing that what
gets measured gets acted upon, in 2008, we entered into an exclusive, 25-year
relationship with Gallup to create a definitive measure and empiric database of
changes in the well-being of the U.S. population, known as the Gallup-Healthways
Well-Being Index® ("WBI"), as well as processes to establish benchmarking for
purposes of comparing the well-being of any subset of the national
population. The responses to the nearly 1.8 million completed WBI surveys to
date have provided Gallup and us with an unmatched database to support our
mutual goal of understanding the causes and effects of well-being for a
population. This relationship was expanded in 2011 with the launch of the
Gallup-Healthways Well-Being Index in the United Kingdom and Germany, indicating
a growing global interest in gaining clear insights for government and business
leaders charged with shaping the policy responses necessary to improve health,
increase individual and organizational performance, lower healthcare costs and
achieve sustained economic growth. In October 2012 we created a global joint
venture with Gallup that will develop the next generation of Gallup-Healthways
individual well-being assessment tools to provide employers, health providers,
insurers and other interested parties with validated tools to assess, measure
and report on changes in the well-being of their employees, patients, members
and customers. Under the joint venture agreement, we will acquire an increasing
equity interest in the joint venture over a five-year period beginning in
January 2013. We have contractual cash obligations of $6.5 million per year for
the first three years of the agreement and between $5.0 million and $8.0 million
for each of the final two years of the agreement (such amounts to be determined
during the fourth quarter of 2015).
To enhance health and well-being within their respective populations, our
current and prospective customers require solutions that focus on the underlying
drivers of healthcare demand, address worsening health status, reverse or slow
unsustainable cost trends, foster healthy behaviors, mitigate health risk
factors, and manage chronic conditions. Our strategy is to deliver programs that
engage individuals and help them enhance their health status and well-being
regardless of their starting point. We believe we can achieve health and
well-being improvements in a population and generate significant cost savings
and increases in productivity by providing effective programs that support the
individual throughout his or her well-being journey.
We are adding and enhancing solutions to extend our reach and effectiveness and
to meet increasing demand for integrated solutions. The flexibility of our
programs allows customers to provide a range of services they deem appropriate
for their organizations. Customers may select from certain single program
options up to a total-population approach, in which all members of a customer's
population are eligible to receive our services. Recently signed contracts have
expanded both the level of integration and breadth of services provided to major
health plans as they develop and implement a number of patient-centered medical
home models. Our services extend beyond chronic care and wellness programs to
include care management and pharmacy benefit management, as well as health
promotion, prevention and quality improvement solutions.
Our strategy includes, as a priority, the ongoing expansion of our value
proposition through our total population management solution. This solution, in
addition to improving individuals' health and reducing direct
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healthcare costs, targets a much larger improvement in employer profitability by
reducing the impact of lost productivity for health-related reasons. With the
success of our total population management solution, we expect to gain an even
greater competitive advantage in responding to employers' needs for a healthier,
higher-performing and less costly workforce.
Our strategy also includes the further enhancement and deployment of our
proprietary next generation technology platform known as Embrace™. This
platform, which is essential to our total population management solution,
enables us to integrate data from the healthcare organizations and other
entities interacting with an individual. Embrace provides for the delivery of
our integrated solutions and ongoing communications between the individual and
his or her medical and health experts, using a range of methods, including
venue-based face-to-face; print; phone; mobile and remote devices; on-line;
emerging modalities; and any combination thereof.
Significant changes in government regulation of healthcare continue to afford us
expanding opportunities to provide services to integrated healthcare systems,
hospitals, and physicians in addition to health plans and employers. In 2011 we
acquired Navvis & Company, a well-established provider of strategic counsel and
change management services enabling its healthcare system clients to become
future-ready clinical enterprises within healthcare's rapidly emerging
value-based reimbursement system. Our strategy includes providing integrated
healthcare systems, hospitals, and physician enterprises both consultative
strategic planning services and a range of capabilities that enable and support
the delivery of Physician-Directed Population Health solutions.
We plan to increase our competitive advantage in delivering our services by
leveraging the scope of our capabilities, including our medical information
content, behavior change processes and techniques, strategic relationships,
health provider networks, and fitness center relationships. We also plan to
continue to scale the delivery of our solutions employing a blend of our
scalable, state-of-the-art well-being improvement centers and proprietary
technologies, modalities, and techniques. We may add new capabilities and
technologies through internal development, strategic alliances with other
entities, and/or selective acquisitions or investments. Examples include our
collaboration with Blue Zones, LLC in delivering a scaled well-being improvement
solution to support the Healthiest State initiative in Iowa; our investment in
our wholly-owned subsidiary MeYou Health, LLC in bringing to market well-being
improvement tools in the social media space through web and personal device
delivery methods; and our recently expanded strategic relationship with Johns
Hopkins Medicine to commercialize the sustained weight loss program Innergy
resulting from a three-year clinical trial conducted by the National Heart, Lung
and Blood Institute.
We anticipate continuing to enhance, expand and integrate additional
capabilities with health plans and integrated healthcare systems and to pursue
opportunities with employers, domestic government entities, and communities, as
well as the public and private sectors of healthcare in international markets.
Critical Accounting Policies
We describe our accounting policies in Note 1 of the Notes to the Consolidated
Financial Statements in our Annual Report on Form 10-K for the fiscal year ended
December 31, 2011. We prepare the consolidated financial statements in
conformity with U.S. GAAP, which requires us to make estimates and judgments
that affect the reported amounts of assets and liabilities and related
disclosures at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results may differ
from those estimates.
We believe the following accounting policies are the most critical in
understanding the estimates and judgments that are involved in preparing our
financial statements and the uncertainties that could impact our consolidated
results of operations, financial condition and cash flows.
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Revenue Recognition
Our fees are generally billed on a per member per month ("PMPM") basis or upon
member participation. For PMPM fees, we generally determine our contract fees by
multiplying the contractually negotiated PMPM rate by the number of members
covered by our services during the month. We typically set PMPM rates during
contract negotiations with customers based on the value we expect our programs
to create and a sharing of that value between the customer and the Company. In
addition, some of our services, such as the Healthways SilverSneakers fitness
solution, include fees that are based upon member participation.
Our contracts with health plans generally range from three to five years with
provisions for subsequent renewal; contracts with self-insured employers
typically have one to three-year terms. Some of our contracts allow the customer
to terminate early.
Some of our contracts place a portion of our fees at risk based on achieving
certain performance metrics, cost savings, and/or clinical outcomes improvements
("performance-based"). Approximately 7% of revenues recorded during the nine
months ended September 30, 2012 were performance-based and were subject to final
reconciliation as of September 30, 2012.
We recognize revenue as follows: 1) we recognize the fixed portion of PMPM fees
and fees for service as revenue during the period we perform our services; and
2) we recognize performance-based revenue based on the most recent assessment of
our performance, which represents the amount that the customer would legally be
obligated to pay if the contract were terminated as of the latest balance sheet
date.
We generally bill our customers each month for the entire amount of the fees
contractually due for the prior month's enrollment, which typically includes the
amount, if any, that is performance-based and may be subject to refund should we
not meet performance targets. Fees for service are typically billed in the month
after the services are provided. Deferred revenues arise from contracts that
permit upfront billing and collection of fees covering the entire contractual
service period, generally 12 months. A limited number of our contracts provide
for certain performance-based fees that cannot be billed until after they are
reconciled with the customer.
We generally assess our level of performance for our contracts based on medical
claims and other data that the customer is contractually required to supply. A
minimum of four to nine months' data is typically required for us to measure
performance. In assessing our performance, we may include estimates such as
medical claims incurred but not reported and a medical cost trend compared to a
baseline year. In addition, we may also provide contractual allowances for
billing adjustments (such as data reconciliation differences) as appropriate.
If data is insufficient or incomplete to measure performance, or interim
performance measures indicate that we are not meeting performance targets, we do
not recognize performance-based fees subject to refund as revenues but instead
record them in a current liability account entitled "contract billings in excess
of earned revenue." Only in the event we do not meet performance levels by the
end of the measurement period, typically one year, are we contractually
obligated to refund some or all of the performance-based fees. We would only
reverse revenues that we had already recognized if performance to date in the
measurement period, previously above targeted levels, subsequently dropped below
targeted levels. Historically, any such adjustments have been immaterial to our
financial condition and results of operations.
During the settlement process under a contract, which generally occurs six to
eight months after the end of a contract year, we settle any performance-based
fees and reconcile healthcare claims and clinical data. As of
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September 30, 2012, cumulative performance-based revenues that have not yet been
settled with our customers but that have been recognized in the current and
prior years totaled approximately $56.2 million, all of which were based on
actual data received from our customers. Data reconciliation differences, for
which we provide contractual allowances until we reach agreement with respect to
identified issues, can arise between the customer and us due to customer data
deficiencies, omissions, and/or data discrepancies.
Performance-related adjustments (including any amounts recorded as revenue that
were ultimately refunded), changes in estimates, or data reconciliation
differences may cause us to recognize or reverse revenue in a current fiscal
year that pertains to services provided during a prior fiscal year. During the
nine months ended September 30, 2012, we recognized a net increase in revenue of
$8.0 million that related to services provided prior to 2012.
Impairment of Intangible Assets and Goodwill
We review goodwill for impairment at the reporting unit level (operating segment
or one level below an operating segment) on an annual basis or more frequently
whenever events or circumstances indicate that the carrying value may not be
recoverable. We may elect to perform a qualitative assessment to determine
whether it is more likely than not that the fair value of a reporting unit is
less than its carrying value. If we conclude during the qualitative assessment
that this is the case, we perform a quantitative review as described below.
Otherwise, we do not perform a quantitative review. If we elect not to perform a
qualitative assessment, then we proceed to the quantitative review described
below.
During a quantitative review of goodwill, we estimate the fair value of each
reporting unit using a combination of a discounted cash flow model and a
market-based approach, and we reconcile the aggregate fair value of our
reporting units to our consolidated market capitalization. Estimating fair value
requires significant judgments, including management's estimate of future cash
flows, which is dependent on internal forecasts, estimation of the long-term
growth rate for our business, the useful life over which cash flows will occur,
and determination of our weighted average cost of capital, as well as relevant
comparable company earnings multiples for the market-based approach. Changes in
these estimates and assumptions could materially affect the estimate of fair
value and potential goodwill impairment for each reporting unit.
If we determine that the carrying value of goodwill is impaired based upon an
impairment review, we calculate any impairment using a fair-value-based goodwill
impairment test as required by U.S. GAAP. The fair value of a reporting unit is
the price that would be received to sell the unit as a whole in an orderly
transaction between market participants at the measurement date.
Except for a certain trade name that has an indefinite life and is not subject
to amortization, we amortize identifiable intangible assets, such as acquired
technologies and customer contracts, using the straight-line method over their
estimated useful lives. We assess the potential impairment of intangible assets
subject to amortization whenever events or changes in circumstances indicate
that the carrying values may not be recoverable. If we determine that the
carrying value of other identifiable intangible assets may not be recoverable,
we calculate any impairment using an estimate of the asset's fair value based on
the estimated price that would be received to sell the asset in an orderly
transaction between market participants.
We review intangible assets not subject to amortization, which consist of a
certain trade name, on an annual basis or more frequently whenever events or
circumstances indicate that the assets might be impaired. We estimate the fair
value of the trade name using a present value technique, which requires
management's estimate of future revenues attributable to this trade name,
estimation of the long-term growth rate for these revenues, and determination of
our weighted average cost of capital. Changes in these estimates and assumptions
could materially affect the estimate of fair value for the trade name.
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Future events could cause us to conclude that impairment indicators exist and
that goodwill and/or other intangible assets are impaired. Any resulting
impairment loss could have a material adverse impact on our financial condition
and results of operations.
Income Taxes
The objectives of accounting for income taxes are to recognize the amount of
taxes payable or refundable for the current year and deferred tax liabilities
and assets for the future tax consequences of events that have been recognized
in an entity's financial statements or tax returns. Accounting for income taxes
requires significant judgment in determining income tax provisions, including
determination of deferred tax assets, deferred tax liabilities, and any
valuation allowances that might be required against deferred tax assets, and in
evaluating tax positions.
We recognize the tax benefit from an uncertain tax position only if it is more
likely than not that the tax position will be sustained on examination by the
taxing authorities, based on the technical merits of the position. The tax
benefits recognized in the financial statements from such a position should be
measured based on the largest benefit that has a greater than 50% likelihood of
being realized upon ultimate settlement. U.S. GAAP also provides guidance on
derecognition of income tax assets and liabilities, classification of current
and deferred income tax assets and liabilities, accounting for interest and
penalties associated with tax positions, and income tax disclosures. Judgment is
required in assessing the future tax consequences of events that have been
recognized in our financial statements or tax returns. Variations in the actual
outcome of these future tax consequences could materially impact our
consolidated financial position, results of operations, or cash flows.
Share-Based Compensation
We measure and recognize compensation expense for all share-based payment awards
based on estimated fair values at the date of grant. Determining the fair value
of stock options at the grant date requires judgment in developing assumptions,
which involve a number of variables. These variables include, but are not
limited to, the expected stock price volatility over the term of the awards and
expected stock option exercise behavior. In addition, we also use judgment in
estimating the number of share-based awards that are expected to be forfeited.
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Results of Operations
The following table shows the components of the consolidated statements of
comprehensive income for the three and nine months ended September 30, 2012 and
2011 expressed as a percentage of revenues.
Three Months Ended Nine Months Ended
September 30, September 30,
2012 2011 2012 2011
Revenues 100.0 % 100.0 % 100.0 % 100.0 %
Cost of services
(exclusive of depreciation
and amortization included 76.1 % 73.5 % 78.9 % 74.2 %
below)
Selling, general and 8.8 % 8.1 % 8.7 % 9.8 %
administrative expenses
Depreciation and 8.0 % 7.1 % 7.6 % 7.3 %
amortization
Operating income 7.1 % 11.3 % 4.8 % 8.7 %
Interest expense 2.0 % 1.8 % 2.2 % 1.9 %
Income before income taxes 5.1 % 9.5 % 2.6 % 6.8 %
Income tax expense 2.1 % 4.1 % 1.1 % 2.9 %
Net income (1) 3.0 % 5.4 % 1.5 % 3.8 %
(1) Figures may not add due to rounding.
Revenues
Revenues decreased $9.6 million and $6.8 million, or 5.5% and 1.3%, for the
three and nine months ended September 30, 2012 compared to the same periods in
2011, primarily due to decreases in revenue from the wind-down of our contract
with CIGNA in advance of the contract's expiration in February 2013, as well as
certain other contract or program terminations with three smaller health plan
customers. These decreases were somewhat offset by the following:
· an increase in participation in our fitness solutions, as well as in the
number of members eligible to participate in such programs;
· the commencement of contracts with new customers; and
· an increase in performance-based revenues due to our ability to measure and
achieve performance targets on certain contracts during the three and nine
months ended September 30, 2012.
Cost of Services
Cost of services (excluding depreciation and amortization) as a percentage of
revenues increased to 76.1% and 78.9% for the three and nine months ended
September 30, 2012, respectively, compared to 73.5% and 74.2% for the three and
nine months ended September 30, 2011, respectively, primarily due to the
following:
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· the wind-down of our contract with CIGNA and certain other contract or program
terminations with three smaller health plan customers to whom we provided
traditional disease management services, all of which carried a lower than
average cost of services as a percentage of revenues;
· increased costs related to the launch of new business in the evolving health
systems market; and
· an expanded and extended contract during the three and nine months ended
September 30, 2012 which moved from a cost-plus model to a volume-based model
in which revenues are expected to ramp over time, while the underlying cost
structure remained consistent with the three and nine months ended September
30, 2011.
These increases were partially offset by decreases in cost of services
(excluding depreciation and amortization) as a percentage of revenues due to the
following:
· an increase in performance-based revenues wherein a significant portion of the
related costs were incurred and recognized in a prior period;
· costs associated with implementing a new and innovative contract in 2011 for
which we weren't able to recognize revenue until 2012;
· decreased costs associated with an initiative during the three months ended
September 30, 2011 to promote member participation in certain of our programs;
and
· efficiencies gained in our fitness solutions through certain cost management
initiatives.
Selling, General and Administrative Expenses
Selling, general and administrative expenses as a percentage of revenues
increased to 8.8% for the three months ended September 30, 2012 compared to 8.1%
for the three months ended September 30, 2011 primarily due to increased legal
fees related to new and ongoing legal proceedings.
Selling, general and administrative expenses as a percentage of revenues
decreased to 8.7% for the nine months ended September 30, 2012 compared to 9.8%
for the nine months ended September 30, 2011 primarily due to a restructuring of
the Company that was largely completed during the fourth quarter of 2011.
Depreciation and Amortization
Depreciation and amortization expense increased $0.8 million and $0.9 million
for the three and nine months ended September 30, 2012 compared to the same
periods in 2011, primarily due to increased depreciation expense related to our
Embrace platform.
Interest Expense
Interest expense remained relatively consistent for the three months ended
September 30, 2012 compared to the three months ended September 30, 2011. For
the nine months ended September 30, 2012, interest expense increased $1.0
million compared to the same period in 2011, primarily due to the write-off of
previously deferred loan costs as a result of entering into the Fifth
Amended Credit Agreement on June 8, 2012.
Income Tax Expense
Our effective tax rate decreased to 41.1% for the three months ended September
30, 2012 compared to 43.5% for the three months ended September 30, 2011,
primarily due to a favorable impact on the effective tax rate related to routine
reconciliations of tax return filings as well as a favorable impact from the
higher relative level of foreign earnings, which are taxed at statutory rates
lower than our domestic earnings.
29
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Our effective tax rate remained relatively consistent for the nine months ended
September 30, 2012 compared to the nine months ended September 30, 2011.
Outlook
We anticipate that revenues for 2012 will decrease slightly compared to 2011
primarily due to the wind-down of our current contract with CIGNA in advance of
the contract's expiration in February 2013 and the expansion and extension of a
certain contract during the three months ended September 30, 2012 which moved
from a cost-plus model to a volume-based model in which revenues are expected to
ramp over time. We expect these decreases will be mostly offset by increased
revenues from new and expanded contracts and an increase in participation in our
fitness solutions, as well as in the number of members eligible to participate
in such solutions.
We expect cost of services (excluding depreciation and amortization) as a
percentage of revenues for 2012 to increase compared to 2011 primarily due to
the wind-down of our current contract with CIGNA and certain contract or program
terminations with three smaller health plan customers to whom we provided
traditional disease management services, all of which carried a lower than
average cost of services as a percentage of revenues. We expect selling, general
and administrative expenses as a percentage of revenues for 2012 to decrease
slightly compared to 2011 primarily due to cost savings from a restructuring of
the Company that was largely completed during the fourth quarter of 2011. We
anticipate depreciation and amortization expense for 2012 will increase compared
to 2011 primarily due to continued investment in our Embrace platform.
As discussed in "Liquidity and Capital Resources" below, a significant portion
of our long-term debt is subject to fixed interest rate swap agreements;
however, we cannot predict the potential for changes in interest rates, which
would impact our variable rate debt.
Liquidity and Capital Resources
Operating activities for the nine months ended September 30, 2012 provided cash
of $23.4 million compared to $58.3 million for the nine months ended September
30, 2011, primarily due to the following:
· a decrease in net income;
· an increase in days sales outstanding from 50 days at September 30, 2011 to 57
days at September 30, 2012;
· an increase in certain long-term incentive and other benefit payments; and
· an increase in severance payments in 2012 made as a result of a restructuring
of the Company that was largely completed during the fourth quarter of 2011.
Investing activities during the nine months ended September 30, 2012 used $51.5
million in cash, which primarily consisted of capital expenditures associated
with our Embrace platform.
Financing activities during the nine months ended September 30, 2012 provided
$29.8 million in cash, primarily due to net borrowings under our credit
agreement.
On June 8, 2012, we entered into the Fifth Amended Credit Agreement. The Fifth
Amended Credit Agreement provides us with a $200.0 million revolving credit
facility that expires June 8, 2017 and includes a swingline sub facility of
$20.0 million and a $75.0 million sub facility for letters of credit. The Fifth
Amended Credit Agreement also provides a $200.0 million term loan facility that
matures on June 8, 2017, all of which remained outstanding on September 30,
2012, and an uncommitted incremental accordion facility of $200.0
30
--------------------------------------------------------------------------------
million. As of September 30, 2012, availability under the revolving credit
facility totaled $71.9 million as calculated under the most restrictive
covenant.
Borrowings under the Fifth Amended Credit Agreement generally bear interest at
variable rates based on a margin or spread in excess of either (1) the
one-month, two-month, three-month or six-month rate (or with the approval of
affected lenders, nine-month or twelve-month rate) for Eurodollar deposits (
"LIBOR") or (2) the greatest of (a) the prime lending rate, (b) the federal
funds rate plus 0.50%, and (c) one-month LIBOR plus 1.00% (the "Base Rate"), as
selected by the Company. The LIBOR margin varies between 1.75% and 3.00%, and
the Base Rate margin varies between 0.75% and 2.00%. The Fifth Amended Credit
Agreement also provides for an annual fee ranging between 0.30% and 0.50% of the
unused commitments under the revolving credit facility. The Fifth Amended
Credit Agreement is secured by guarantees from all of the Company's active
domestic subsidiaries and by security interests in substantially all of the
Company's and such subsidiaries' assets.
We are required to repay outstanding revolving loans under the revolving credit
facility on June 8, 2017. We are required to repay term loans in quarterly
principal installments aggregating (1) 1.250% of the original aggregate
principal amount of the term loans during each of the first eight quarters
following the closing, (2) 1.875% of the original aggregate principal amount of
the term loans during each of the next four quarters following the closing,
(3) 2.500% of the original aggregate principal amount of the term loans during
each of the remaining quarters prior to maturity on June 8, 2017, at which time
the entire unpaid principal balance of the term loans is due and payable.
The Fifth Amended Credit Agreement contains various financial covenants, which
require us to maintain, as defined therein, ratios or levels of 1) total funded
debt to EBITDA and 2) fixed charge coverage. The Fifth Amended Credit Agreement
also limits the amount of dividends and repurchases of the Company's common
stock. As of September 30, 2012, we were in compliance with all of the covenant
requirements of the Fifth Amended Credit Agreement.
In order to reduce our exposure to interest rate fluctuations on our floating
rate debt commitments, we maintain interest rate swap agreements that
effectively modify our exposure to interest rate risk by converting a portion of
our floating rate debt to fixed obligations, thus reducing the impact of
interest rate changes on future interest expense. Under these agreements, we
receive a variable rate of interest based on LIBOR, and we pay a fixed rate of
interest with interest rates ranging from 0.370% to 3.385% plus a spread. We
maintain interest rate swap agreements with current notional amounts of $475.0
million and termination dates ranging from December 31, 2012 to December 31,
2016. Of this amount, $200.0 million will become effective in 2013, and $50.0
million in 2015, as older interest rate swap agreements expire. We have
designated these interest rate swap agreements as qualifying cash flow
hedges. We currently meet the hedge accounting criteria under U.S. GAAP in
accounting for these interest rate swap agreements.
In October 2010, our Board of Directors authorized a share repurchase program,
which allowed for the repurchase of up to $60 million of our common stock from
time to time in the open market or in privately negotiated transactions through
October 19, 2012. As of September 30, 2012, $31.8 million of our common stock
was still subject to repurchase under this program. No shares were repurchased
between October 1 and October 19, 2012 pursuant to the program.
We believe that cash flows from operating activities, our available cash, and
our anticipated available credit under the Fifth Amended Credit Agreement will
continue to enable us to meet our contractual obligations and to fund our
current operations for the foreseeable future. However, if our operations
require significant additional financing resources, such as capital expenditures
for technology improvements, additional well-being improvement centers and/or
letters of credit or other forms of financial assurance to guarantee our
performance under the terms of new contracts, or if we are required to refund
performance-based fees pursuant to contract terms, we may need to raise
additional capital by expanding our existing credit facility and/or issuing debt
or
31
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equity. If we face a limited ability to arrange such financing, it may restrict
our ability to effectively operate our business. We cannot assure you that we
would always be able to secure additional financing if needed and, if such funds
were available, whether the terms or conditions would be acceptable to us.
If contract development accelerates or acquisition opportunities arise, we may
need to issue additional debt or equity to provide the funding for these
increased growth opportunities. We may also issue equity in connection with
future acquisitions or strategic alliances. We cannot assure you that we would
be able to issue additional debt or equity on terms that would be acceptable to
us.
Recently Issued Accounting Standard
In July 2012, the FASB issued ASU No. 2012-02, "Intangibles-Goodwill and Other
(Topic 350)-Testing Indefinite-Lived Intangible Assets for Impairment". ASU No.
2012-02 permits an entity to perform a qualitative assessment to determine
whether it is more likely than not that the fair value of an indefinite-lived
intangible asset is less than its carrying value. If the entity concludes that
this is the case, it must perform the currently prescribed quantitative
impairment test by comparing the fair value of the indefinite-lived intangible
asset with its carrying value. Otherwise, the quantitative impairment test is
not required. ASU No. 2012-02 is effective for fiscal years beginning after
September 15, 2012, with earlier adoption permitted. We do not expect the
adoption of this standard to have a material impact on our consolidated results
of operations, financial position, cash flows, or notes to the consolidated
financial statements.
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