UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2006
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________________ to ________________
Commission file number: 001-32361
METROPOLITAN HEALTH NETWORKS, INC.
(Exact name of registrant as specified in its charter)
Florida 65-0635748
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
250 Australian Avenue, Suite 400
West Palm Beach, FL 33401
(Address of principal executive offices) (Zip Code)
(561) 805-8500
(Registrant's telephone number, including area code)
None
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [_]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [_] Accelerated filer [X] Non-accelerated filer [_]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes [_] No [X]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at October 31, 2006
--------------------------------------- -------------------------------
Common Stock, $.001 par value per share 50,165,426 shares
Metropolitan Health Networks, Inc.
Index
Part I. FINANCIAL INFORMATION Page
Item 1. Condensed Consolidated Financial Statements (Unaudited):
Condensed Consolidated Balance Sheets
as of September 30, 2006 and December 31, 2005 4
Condensed Consolidated Statements of
Operations for the Three and Nine Months Ended
September 30, 2006 and 2005 5
Condensed Consolidated Statements of
Cash Flows for the Nine Months Ended
September 30, 2006 and 2005 6
Notes to Condensed Consolidated
Financial Statements 7-18
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of
Operations 19-30
Item 3. Quantitative and Qualitative Disclosures About Market Risk 30-31
Item 4. Controls and Procedures 31
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 32
Item 1A. Risk Factors 32
Item 2. Changes in Securities and Use of Proceeds 32
Item 3. Default Upon Senior Securities 32
Item 4. Submission of Matters to a Vote of Security Holders 32
Item 5. Other Information 32
Item 6. Exhibits 32-33
SIGNATURES 34
2
PART 1. FINANCIAL INFORMATION
Item 1. Financial Statements
3
METROPOLITAN HEALTH NETWORKS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
================================================================================
September 30, 2006 December 31, 2005
ASSETS (Unaudited) (Audited)
------------------ ------------------
CURRENT ASSETS
Cash and equivalents $ 19,304,497 $ 15,572,862
Short-term investments 5,769,956 --
Accounts receivable, net of allowance 4,273,196 4,183,974
Inventory 245,043 201,430
Prepaid expenses 1,049,109 473,286
Deferred income taxes 3,400,000 3,500,000
Other current assets 432,187 547,976
------------------ ------------------
TOTAL CURRENT ASSETS 34,473,988 24,479,528
PROPERTY AND EQUIPMENT, net 2,070,079 899,998
INVESTMENTS 663,043 627,819
GOODWILL, net 1,992,133 1,992,133
DEFERRED INCOME TAXES 2,644,800 4,493,000
OTHER ASSETS 645,925 622,628
------------------ ------------------
TOTAL ASSETS $ 42,489,968 $ 33,115,106
================== ==================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 1,136,836 $ 969,184
Advance and unearned premiums 1,298,153 --
Estimated medical expenses payable 4,117,183 694,410
Accrued payroll and payroll taxes 1,480,696 1,459,098
Accrued expenses 821,332 293,552
------------------ ------------------
TOTAL CURRENT LIABILITIES 8,854,200 3,416,244
------------------ ------------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Preferred stock, par value $.001 per share; stated value $100 per share;
10,000,000 shares authorized; 5,000 issued and outstanding 500,000 500,000
Common stock, par value $.001 per share; 80,000,000 shares authorized;
50,132,526 and 49,851,526 issued and outstanding, respectively 50,132 49,851
Additional paid-in capital 40,926,641 40,182,889
Accumulated deficit (7,841,005) (11,033,878)
------------------ ------------------
TOTAL STOCKHOLDERS' EQUITY 33,635,768 29,698,862
------------------ ------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 42,489,968 $ 33,115,106
================== ==================
The accompanying notes are an integral part of these Condensed Consolidated
Financial Statements.
4
METROPOLITAN HEALTH NETWORKS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
================================================================================
For the nine months For the three months
ended September 30, ended September 30,
------------------------------ ------------------------------
2006 2005 2006 2005
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
------------- ------------- ------------- -------------
REVENUES, net $ 172,487,485 $ 136,688,653 $ 60,838,341 $ 44,999,881
-------------
OPERATING EXPENSES
Direct medical costs 144,945,205 114,903,124 49,647,785 37,570,720
Other medical costs 7,693,187 7,776,931 2,548,244 2,566,111
------------- ------------- ------------- -------------
Total medical expenses 152,638,392 122,680,055 52,196,029 40,136,831
Administrative payroll, payroll taxes and
benefits 7,529,738 4,211,494 2,526,552 1,529,204
Marketing and advertising 2,199,019 1,433,189 203,166 1,277,000
General and administrative 5,698,587 4,039,209 2,149,350 1,299,863
------------- ------------- ------------- -------------
TOTAL EXPENSES 168,065,736 132,363,947 57,075,097 44,242,898
------------- ------------- ------------- -------------
OPERATING INCOME 4,421,749 4,324,706 3,763,244 756,983
------------- ------------- ------------- -------------
OTHER INCOME
Interest income, net 717,930 263,246 305,792 126,196
Other 1,394 129,624 193 10
------------- ------------- ------------- -------------
TOTAL OTHER INCOME 719,324 392,870 305,985 126,206
------------- ------------- ------------- -------------
INCOME BEFORE INCOME TAXES 5,141,073 4,717,576 4,069,229 883,189
INCOME TAXES (1,948,200) (1,790,696) (1,537,200) (343,696)
------------- ------------- ------------- -------------
NET INCOME $ 3,192,873 $ 2,926,880 $ 2,532,029 $ 539,493
============= ============= ============= =============
NET EARNINGS PER SHARE:
Basic $ 0.06 $ 0.06 $ 0.05 $ 0.01
============= ============= ============= =============
Diluted $ 0.06 $ 0.06 $ 0.05 $ 0.01
============= ============= ============= =============
The accompanying notes are an integral part of these Condensed Consolidated
Financial Statements.
5
METROPOLITAN HEALTH NETWORKS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
================================================================================
For the nine months ended September 30,
2006 2005
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 3,192,873 $ 2,926,880
------------ ------------
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 378,801 253,555
Deferred income taxes 1,948,200 711,000
Stock-based compensation expense 545,983 --
Tax benefit on exercise of stock options -- 1,079,000
Loss on sale of assets 191 --
Amortization of securities issued for professional services 57,300 96,334
Changes in operating assets and liabilities:
Accounts receivable, net (89,222) (1,680,695)
Inventory (43,613) 52,386
Prepaid expenses (575,823) (307,896)
Other current assets 115,790 195,959
Other assets (25,381) (334,981)
Accounts payable 167,653 213,199
Advance and unearned premiums 1,298,153 424,476
Estimated medical expenses payable 3,422,773 --
Accrued payroll 21,598 (395,589)
Accrued expenses 527,779 868,786
------------ ------------
Total adjustments 7,750,182 1,175,534
------------ ------------
Net cash provided by operating activities 10,943,055 4,102,414
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Short-term investments (5,769,955) 1,500,000
Investments (35,224) (601,783)
Redemption of restricted certificates of deposit -- 1,000,000
Capital expenditures (1,546,991) (255,684)
------------ ------------
Net cash (used in)/provided by investing activities (7,352,170) 1,642,533
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments on notes payable -- (1,061,500)
Repurchase of warrants -- (85,000)
Proceeds from exercise of stock options and warrants 140,750 1,285,257
Net proceeds from issuance of common stock -- --
------------ ------------
Net cash provided by financing activities 140,750 138,757
------------ ------------
NET INCREASE IN CASH AND EQUIVALENTS 3,731,635 5,883,704
CASH AND EQUIVALENTS - BEGINNING 15,572,862 11,344,113
------------ ------------
CASH AND EQUIVALENTS - ENDING $ 19,304,497 $ 17,227,817
============ ============
The accompanying notes are an integral part of these Condensed Consolidated
Financial Statements.
6
METROPOLITAM HEALTH NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
================================================================================
NOTE 1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
--------------------------------------------------------------------------------
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information and with the
instructions to Form 10-Q. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally accepted
in the United States of America for complete financial statements. In the
opinion of management, all adjustments considered necessary for a fair
presentation have been included and such adjustments are of a normal recurring
nature. Operating results for the three and nine months ended September 30, 2006
are not necessarily indicative of the results that may be expected for the year
ending December 31, 2006.
The audited financial statements at December 31, 2005, which were included in
the Company's Form 10-K filed on March 16, 2006, should be read in conjunction
with these condensed consolidated financial statements.
Unless otherwise indicated or the context requires, all references in this Form
10-Q to the "Company" refers to Metropolitan Health Networks, Inc. and its
consolidated subsidiaries.
SEGMENT REPORTING
The Company applies Financial Accounting Standards Boards ("FASB") Statement No.
131, "Disclosure about Segments of an Enterprise and Related Information." The
Company has considered its operations and has determined that, in 2005, it
operated, and continues to operate in 2006, in two segments for purposes of
presenting financial information and evaluating performance, a Provider Service
Network (managed care and direct medical services), operated through its wholly
owned subsidiary, Metcare of Florida, Inc. (the "PSN"), and a Medicare Advantage
HMO, operated through its wholly owned subsidiary Metcare Health Plans, Inc.
(the "HMO").
As such, the accompanying financial statements present information in a format
that is consistent with the financial information used by management for
internal use. See "Note 6. Business Segment Information" for additional
information regarding the Company's business segments.
CASH AND EQUIVALENTS
The Company considers all highly liquid investments with original maturities of
three months or less to be cash equivalents. From time to time, the Company
maintains cash balances with financial institutions in excess of federally
insured limits.
SHORT-TERM INVESTMENTS
All investments with original maturities of greater than 90 days are accounted
for in accordance with Statement of Financial Accounting Standards ("SFAS") No.
115, "Accounting for Certain Investments in Debt and Equity Securities." As of
September 30, 2006, the Company's short-term investments consisted of commercial
paper and certificates of deposit classified as available-for-sale. All income
generated from these short-term investments during the three and nine months
ended September 30, 2006 was recorded as interest income.
LONG-TERM INVESTMENTS
Long-term investments, which consist primarily of a non-controlling equity
interest in a non-assessable reciprocal insurance organization through which the
Company has renewed its malpractice insurance, are carried at cost. If an
impairment occurs that is not considered temporary, the investment will be
written down to net realizable value.
INCOME TAXES
The Company accounts for income taxes pursuant to Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS 109"), which
requires income taxes to be accounted for under the asset and liability method.
Under this method, deferred income tax assets and liabilities are determined
based upon differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases using enacted tax
rates in effect for the year in which the differences are expected to reverse.
The effect on deferred tax assets and liabilities of a change in tax rates is
recognized in earnings in the period that includes the enactment date.
7
METROPOLITAM HEALTH NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SFAS No. 109 requires a valuation allowance to reduce the deferred tax assets
reported if, based on the weight of the evidence, it is more likely than not
that some portion or all of the deferred tax assets will not be realized. After
consideration of all the evidence, both positive and negative (including, among
others, projections of future taxable income, current year net operating loss
carryforward utilization and the Company's profitability in recent years), the
Company determined that future realization of its deferred tax assets was more
likely than not. In the event it is determined that it is more likely than not
that the Company would not be able to realize all or part of its net deferred
tax assets in the future, an adjustment to record a deferred tax asset valuation
allowance would be charged to income in the period such determination would be
made. Changes in deferred tax assets are reflected in the "Income Taxes" expense
line of the Company's Condensed Consolidated Statements of Operations.
Due to the availability of deferred tax assets during the three and nine months
ended September 30, 2006, the Company has not recorded any amounts payable for
U.S. federal income taxes and does not expect any cash outlay to be required in
connection with the income tax provisions.
REVENUE RECOGNITION
The Company's PSN is a party to two managed care contracts with Humana, Inc.
(the "Humana Agreements") and provides medical care to Humana's members through
wholly-owned and contracted independent medical practices and providers
(collectively, the "Affiliated Providers"). The PSN receives a monthly fee for
each patient that chooses one of the Affiliated Providers as his or her primary
care physician in exchange for the PSN's assumption of responsibility for the
provision of all necessary medical services to such patient, even those medical
services not directly provided by one of the Affiliated Providers. Fees received
by the PSN under these Humana Agreements are reported as revenues. The cost of
both Affiliated Provider and non-Affiliated Provider services under these Humana
Agreements are not included as a deduction to net revenues of the Company, but
are reported as an operating expense. Changes in revenues resulting from
periodic changes in risk adjustment scores are recognized when the amounts
become determinable and the collectibility is reasonably assured. In connection
with the Humana Agreements, the Company is exposed to losses to the extent of
the PSN's share of deficits, if any, on its Affiliated Providers. The PSN's
share of deficits is 100% for Medicare Part A in the Central Florida market, 50%
for Medicare Part A in the South Florida market and 100% for Medicare Part B in
both the Central Florida and South Florida market. Revenues generated under the
Humana Agreements accounted for approximately 85% and 98% of the Company's total
revenues for the quarters ended September 30, 2006 and 2005, respectively, and
approximately 88% and 99% of the Company's total revenues for the nine months
ended September 30, 2006 and 2005, respectively.
Humana may immediately terminate either of the Humana Agreements and/or any
individual physician credentialed under the Humana Agreements, upon written
notice, (i) if the PSN and/or any of its Affiliated Provider's continued
participation may adversely affect the health, safety or welfare of any Humana
member or bring Humana into disrepute; (ii) in the event of one of the PSN's
physician's death or incompetence; (iii) if any of the PSN's physicians fail to
meet Humana's credentialing criteria; (iv) in accordance with Humana's policies
and procedures as specified in Humana's manual, (v) if the PSN engages in or
acquiesces to any act of bankruptcy, receivership or reorganization; or (vi) if
Humana loses its authority to do business in total or as to any limited segment
or business (but only to that segment). The PSN and Humana may also terminate
each of the Humana Agreements upon 90 days' prior written notice (with a 60 day
opportunity to cure, if possible) in the event of the other's material breach of
the applicable Humana Agreement.
Failure to maintain the Humana Agreements on favorable terms, for any reason,
would adversely affect the Company's results of operations and financial
condition.
The Company also recognizes non-Humana fee-for-service revenues, net of
contractual allowances, as medical services are provided to patients by the
Company's wholly-owned medical practices. These services are typically billed to
patients, Medicare, Medicaid, health maintenance organizations and insurance
companies. The Company provides an allowance for uncollectible amounts and for
contractual adjustments relating to the difference between standard charges and
agreed upon rates paid by certain third party payers.
8
METROPOLITAM HEALTH NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Effective July 1, 2005 the Company obtained the requisite Florida and federal
licenses, approvals and contract to begin marketing, enrolling and providing
services to Medicare beneficiaries through its own Medicare Advantage HMO. The
contract with the Centers for Medicare and Medicaid Services ("CMS") renews on
an annual basis. The HMO receives a monthly premium for each enrollee in its
plan and is responsible for the provision of all covered medical services for
that enrollee. Premium revenues are recognized as income in the period members
are entitled to receive services, and are recorded net of retroactive membership
adjustments. Retroactive membership adjustments result from enrollment changes
not yet processed or not yet reported by CMS. Changes in revenues from CMS
resulting from the periodic changes in risk adjustment scores for the HMO's
membership are recognized when the amounts become determinable and the
collectibility is reasonably assured.
MARKETING AND ADVERTISING COSTS
Marketing and advertising costs are expensed as incurred. Marketing and
advertising expense was approximately $203,000 and $1.3 million for the quarters
ended September 30, 2006 and 2005, respectively, and $2.2 million and $1.4
million for the nine months ended September 30, 2006 and 2005, respectively.
USE OF ESTIMATES
Revenue, Expense and Receivables
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the amounts reported in the accompanying
financial statements. The most significant area requiring estimates relates to
the PSN's arrangements with Humana. Such estimates are based on knowledge of
current events and anticipated future events, and accordingly, actual results
may ultimately differ materially from those estimates.
With regard to virtually all of the revenues, expenses and receivables arising
from the Humana Agreements, the Company estimates the amounts it believes will
ultimately be realizable based in part upon estimates of claims incurred but not
reported ("IBNR") and estimates of retroactive adjustments or unsettled costs to
be applied by Humana. The IBNR estimates are made by Humana utilizing actuarial
methods and are continually evaluated by management of the Company based upon
its specific claims experience. It is reasonably possible that some or all of
these estimates could change in the near term by an amount that could be
material to the financial statements.
From time to time, Humana charges the PSN for certain medical expenses, which
the Company believes are erroneous or are not supported by the Humana
Agreements. Management's estimate of recovery on these contestations is based
upon its judgment and its consideration of several factors including the nature
of the contestations, historical recovery rates and other qualitative factors.
During 2005, the Company incurred approximately $4.0 million of medical costs
related to the implantation of certain Implantable Automatic Defibrillators
("AICD's"). CMS directed that the costs of certain of these procedures that met
2005 eligibility requirements be paid by CMS, rather than billed to Medicare
Advantage plans. The Company is working with Humana and the related providers to
secure reimbursement for these amounts, and estimated a recovery of
approximately $2.2 million at December 31, 2005. Approximately $379,000 of this
amount was collected during the nine months ended September 30, 2006, while an
additional $500,000 was written off during the second quarter of 2006 due to
revised guidance issued by CMS in July 2006 regarding the costs payable by CMS
in connection with these procedures. During the quarter ended September 30,
2006, the Company recorded an additional $500,000 reserve against this
receivable to reflect management's concerns about the ultimate collection of
these receivables. Accordingly, related accounts receivable in the accompanying
consolidated balance sheets were $772,000 and $2.2 million at September 30, 2006
and December 31, 2005, respectively. It is reasonably possible that this
estimate could change in the near term by an amount that could be material to
the financial statements.
9
METROPOLITAM HEALTH NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Included in revenues for the quarter and nine months ended September 30, 2006
were estimated amounts payable to the Company as a result of funding increases
under the Medicare risk adjustment ("MRA") program. The purpose of the MRA
program is to use health status indicators to improve the accuracy of payments
and establish incentives for plans to enroll and treat less healthy Medicare
beneficiaries. From 2000 to 2003, risk adjustment payments accounted for only
10% of the payment made by CMS to the Medicare health plans, with the remaining
90% based on demographic factors. In 2004 and 2005, the percentage of payment
attributable to risk adjustment was increased to 30% and 50%, respectively. The
percentage of payment attributable to risk has increased to 75% in 2006, with
the 100% phase-in of risk-adjusted payment expected in 2007. We accrued
approximately $5.4 million during the nine months ended September 30, 2006
related to incremental revenues anticipated to be received as a result of the
MRA funding increases. $4.2 million has been received during the first nine
months of 2006. Accounts receivable in the accompanying consolidated balance
sheets at September 30, 2006 include $1.2 million of accrued MRA receivables
that we expect to be received during the fourth quarter of 2006 and in the first
quarter of 2007. It is reasonably possible that this estimate could change in
the near term by an amount that could be material to the financial statements.
Non-Humana fee-for-service accounts receivable, aggregating to approximately
$1,155,000 and $797,000 at September 30, 2006 and December 31, 2005,
respectively, relate principally to medical services provided on a non-capitated
basis, and are reduced by amounts estimated to be uncollectible (approximately
$798,000 and $555,000 at September 30, 2006 and December 31, 2005,
respectively). Management's estimate of uncollectible amounts is based upon its
analysis of historical collections and other qualitative factors, however it is
possible the Company's estimate of uncollectible amounts could change in the
near term. In addition, accounts receivable at September 30, 2006 and December
31, 2005 includes approximately $519,000 and $159,000, respectively, due to the
HMO from CMS and HMO enrollees, which is reduced by amounts estimated to be
uncollectible at September 30, 2006 in the amount of $17,000.
With regards to the HMO, the cost of medical benefits is recognized in the
period in which services are provided and includes an IBNR estimate based on
management's best estimate of medical benefits payable. Included in this
estimate are loss adjustment expenses of approximately 3% of the IBNR balance.
It is reasonably possible that some or all of these estimates could change in
the near term by an amount that could be material to the financial statements.
The HMO memberships' average risk adjustment factor declined from December 2005
to June 2006 as a result of a large influx of new members in 2006. This decline
resulted in decreased average member monthly premiums. The Company believes that
the actual average risk adjustment factor for its population during this period
was higher and that an increase will be reflected as claims and health data for
these new members are entered into the CMS system, which is expected to result
in retroactive premium adjustments. The Company has estimated the retroactive
premium adjustment to be approximately $534,000 at September 30, 2006.
Accounting for Prescription Drug Benefits under Medicare Part D
On January 1, 2006, the HMO and the PSN, through the Humana Agreements, began
covering prescription drug benefits in accordance with the requirements of
Medicare Part D, to the HMO's and PSN's Medicare Advantage members. The benefits
covered under Medicare Part D are in addition to the benefits covered by the HMO
and the PSN under Medicare Parts A and B.
In general, pursuant to Medicare Part D, pharmacy benefits may vary in terms of
coverage levels and out-of-pocket costs for beneficiary premiums, deductibles
and co-insurance. However, all Part D plans must offer either "standard
coverage" or its actuarial equivalent (with out-of-pocket threshold and
deductible amounts that do not exceed those of standard coverage). These
"defined standard" benefits represent the minimum level of benefits mandated by
Congress. In addition to defined standard plans offered by the HMO, the PSN,
through the Humana Agreements, offers certain prescription drug plans containing
benefits in excess of the standard coverage limits.
The payment the Company's HMO receives monthly from CMS for coverage under
Medicare Part D (the "CMS Payment") generally represents the HMO's bid amount
for providing Part D insurance coverage. The Company recognizes premium revenue
for the HMO's provision of this Part D insurance coverage ratably over the term
of the CMS Agreement. However, the ultimate amount of the CMS Payment is subject
to 1) risk corridor adjustments and 2) subsidies provided by CMS in order for
the HMO and CMS to share the risk associated with financing the ultimate costs
of the Medicare Part D benefit.
10
METROPOLITAM HEALTH NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The CMS payment is subject to adjustment, positive or negative, based upon the
application of risk corridors that compare the prescription drug benefit costs
estimated by the HMO in making its bid to CMS (the "Estimated Costs") to actual
incurred prescription drug benefit costs (the "Actual Costs"). For 2006 and
2007, in accordance with federal regulations, the HMO will bear all gains and
losses that fall within 2.5% of its Estimated Costs. To the extent the Actual
Costs exceed the Estimated Costs by more than 2.5%, CMS may make additional
payments to the HMO. Conversely, to the extend the Estimated Costs exceed the
Actual Costs by more than 2.5%, the HMO may be required to refund to CMS a
portion of the CMS Payment. Actual Costs subject to risk sharing with CMS are
limited to the costs that are, or would have been, incurred under the CMS
"defined standard" benefit plan . The Company estimates and recognizes an
adjustment to premium revenues from CMS related to the risk corridor payment
adjustment based upon pharmacy claims experience to date as if the CMS Agreement
were to end at the end of each reporting period. Accordingly, this estimate does
not take into consideration projected future pharmacy claims experience. It is
reasonably possible that this estimate could change in the near term by an
amount that could be material.
Certain subsidies represent reimbursements from CMS for claims the HMO paid for
even though it is not ultimately required to bear the risk in connection with
such claims. These include federally reinsured claims where an HMO member's
actual drug spending reaches Part D's annual catastrophic threshold and certain
deductible, coinsurance and co-payment amounts for low-income beneficiaries. The
Company accounts for these subsidies as current liabilities in its balance sheet
and as an operating activity in its statement of cash flows. The Company does
not recognize premium revenue or claims expense for these subsidies.
The HMO recognizes pharmacy benefit costs as incurred. It has subcontracted the
pharmacy claims administration to a third party pharmacy benefit manager.
With regards to the PSN, the Company receives Medicare Part D revenue pursuant
to the applicable percent of premium provided for in the Humana Agreements.
Humana does not provide the Company with a separate accounting for the
incremental amount of the Part D premium and expense. As with the HMO, the
Company recognizes pharmacy benefit costs as such costs are incurred by the PSN.
With regards to the estimated amount of any risk corridor adjustments, the
Company has relied upon estimates provided by Humana to the Company and has
recorded a downward adjustment to premium revenue based on these estimates. It
is reasonably possible that this estimate could change in the near term by an
amount that could be material.
Deferred Tax Asset
The Company has recorded a deferred tax asset of approximately $6.0 million at
September 30, 2006. Realization of the deferred tax asset is dependent on
generating sufficient taxable income in the future. Management believes that it
is more likely than not that it will have the ability to realize the recorded
deferred tax asset. The amount of the deferred tax asset considered realizable
could change in the near term if estimates of future taxable income are modified
and those changes could be material.
In the future, if the Company determines that it cannot, on a more likely than
not basis, realize all or part of its deferred tax assets in the future, an
adjustment to establish (or record an increase in) the deferred tax asset
valuation allowance would be charged to income in the period in which such
determination is made.
ACCOUNTS RECEIVABLE
Accounts receivable at September 30, 2006 and December 31, 2005 were as follows:
September 30, 2006 December 31, 2005
------------------ ------------------
Humana accounts receivable, net $ 3,414,000 $ 3,782,000
Non-Humana accounts receivable, net 859,000 402,000
------------------ ------------------
Accounts receivable, net $ 4,273,000 $ 4,184,000
================== ==================
11
METROPOLITAM HEALTH NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
EARNINGS PER SHARE
The Company applies Statement of Financial Accounting Standards No. 128,
"Earnings Per Share" ("SFAS 128") which requires presentation of both basic net
income per share and diluted net income per share. Basic earnings per share is
computed using the weighted average number of common shares outstanding during
the period. Diluted earnings per share is computed using the weighted average
number of common shares outstanding during the period adjusted for incremental
shares attributed to outstanding options and warrants, convertible debt and
preferred stock convertible into shares of common stock.
For the nine months ended For the three months ended
September 30, September 30,
2006 2005 2006 2005
------------ ------------ ------------ ------------
Net Income $ 3,193,000 $ 2,927,000 $ 2,532,000 $ 539,000
Less:Preferred stock dividend (38,000) (38,000) (13,000) (13,000)
------------ ------------ ------------ ------------
Income available to common shareholders $ 3,155,000 $ 2,889,000 $ 2,519,000 $ 526,000
============ ============ ============ ============
Denominator:
Weighted average common shares outstanding 49,981,000 48,716,000 50,108,000 49,269,000
============ ============ ============ ============
Basic earnings per common share $ 0.06 $ 0.06 $ 0.05 $ 0.01
============ ============ ============ ============
Income available to common shareholders $ 3,155,000 $ 2,889,000 $ 2,532,000 $ 526,000
============ ============ ============ ============
Denominator:
Weighted average common shares outstanding 49,981,000 48,716,000 50,108,000 49,269,000
Common share equivalents of outstanding stock:
Convertible perferred stock -- -- 437,000 --
Options and warrants 1,402,000 2,789,000 1,494,000 1,879,000
------------ ------------ ------------ ------------
Weighted average common shares outstanding 51,383,000 51,505,000 52,039,000 51,148,000
============ ============ ============ ============
Diluted earnings per common share $ 0.06 $ 0.06 $ 0.05 $ 0.01
============ ============ ============ ============
NEW ACCOUNTING PRONOUNCEMENTS
SFAS No. 154, Accounting Changes and Error Corrections, was issued in May 2005
and replaces APB Opinion No. 20 (Accounting Changes) and SFAS No. 3 (Reporting
Accounting Changes in Interim Financial Statements). SFAS No. 154 requires
retrospective application for voluntary changes in accounting principle in most
instances and is required to be applied to all accounting changes made in fiscal
years beginning after December 15, 2005. The Company adopted SFAS No. 154 on
January 1, 2006 and it did not have a material impact on the Company's
consolidated financial condition or results of operations.
In July 2006, the FASB issued FASB Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes-an Interpretation of FASB Statement 109", or FIN 48.
FIN 48 prescribes a comprehensive model for how a company should recognize,
measure, present, and disclose in its financial statements regarding uncertain
tax positions that the company has taken or expects to take on a tax return. FIN
48 also revises disclosure requirements and introduces a prescriptive, annual,
tabular roll-forward of the unrecognized tax benefits. FIN 48, which will become
effective for the Company beginning January 1, 2007, requires the change in net
assets that results from the application of the new accounting model to be
reflected as an adjustment to retained earnings. The Company currently is
evaluating the impact of adopting FIN 48.
12
METROPOLITAM HEALTH NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which
defines fair value, establishes a framework for measuring fair value pursuant to
generally accepted accounting principles, and expands disclosures about fair
value measurements. SFAS No. 157 does not require any new fair value
measurements, but provides guidance on how to measure fair value by providing a
fair value hierarchy used to classify the source of the information. This
statement is effective for fiscal years beginning after November 15, 2007. We
are currently assessing the potential impact that the adoption of SFAS No. 157
will have on our financial statements.
In September 2006, the Securities and Exchange Commission issued Staff
Accounting Bulletin ("SAB") 108, "Considering the Effects of Prior Year
Misstatements when Qualifying Misstatements in Current Year Financial
Statements." SAB 108 requires companies to quantify misstatements using both the
balance sheet (iron curtain) and income statement (rollover) approaches and to
evaluate whether either approach results in quantifying an error that is
material in light of relevant and qualitative factors. The requirements are
effective for annual financial statements covering the first fiscal year ending
after November 15, 2006. The Company has initially determined that the potential
financial impact could range between $500,000 and $525,000 upon the adoption of
SAB 108.
================================================================================
NOTE 2. DEBT
--------------------------------------------------------------------------------
On May 6, 2005 the Company executed an unsecured commercial line of credit
agreement with a bank, which provided for borrowings and issuance of letters of
credit of up to $1.0 million. The credit line expired on March 31, 2006 and was
automatically renewed for an additional one-year period until March 31, 2007.
The outstanding balance, if any, bears interest at the bank's prime rate. The
credit facility requires the Company to comply with certain financial covenants,
including a minimum liquidity requirement of $2.0 million. As of September 30,
2006, the availability under the line of credit secures a $1.0 million letter of
credit that the Company has caused to be issued in favor of Humana. As of
September 30, 2006, the Company has not borrowed funds under the commercial line
of credit.
================================================================================
NOTE 3. STOCK BASED COMPENSATION
--------------------------------------------------------------------------------
The Company has three stock option plans that are administered by the
Compensation Committee of the Board of Directors. The 2001 Stock Option Plan and
the Supplemental Stock Option Plan have 1,049,110 and 1,345,400 outstanding
options granted under the plans, respectively, as of September 30, 2006. The
Company does not intend to issue additional options from either plan in the
future. The Omnibus Equity Compensation Plan (the "Omnibus Plan") provides for
the grant of non-qualified or incentive stock options and other stock based
awards to directors, executives and key employees of the Company, as well as to
any other persons approved by the Compensation Committee. A total of 6,000,000
shares of Metropolitan's common stock are authorized for issuance pursuant the
Omnibus Plan. As of September 30, 2006, options granted pursuant to the Omnibus
Plan to purchase 2,776,700 shares of the Company's common stock are currently
outstanding. Under the Omnibus Plan, options are granted at the fair market
value of the stock at the date of grant and expire no later than 10 years after
the date of grant. Options granted under this Omnibus Plan generally vest over
periods up to four years.
Prior to January 1, 2006, the Company followed Accounting Principles Board
Opinion No. 25, ("APB No. 25"), "Accounting for Stock Issued to Employees," and
related Interpretations in accounting for its employee stock options. Under APB
No. 25, when the exercise price of the Company's employee stock options equaled
or exceeded the market price of the underlying stock on the date of grant, no
compensation expense was recognized. For the quarter and nine months ended
September 30, 2005, no stock-based employee compensation expense was recognized
in the accompanying condensed consolidated statement of income.
Effective January 1, 2006, the Company adopted SFAS No. 123(R) ("SFAS No.
123(R)"), "Share-Based Payment," which is a revision of SFAS No. 123, using the
modified prospective transition method and therefore has not restated prior
periods' results. Under the transition method, stock-based compensation expense
for the first quarter of fiscal 2006 included compensation expense for all
stock-based compensation awards granted prior to, but not yet vested as of,
January 1, 2006, based on the grant date fair value estimated in accordance with
the original provision of SFAS No. 123. Stock-based compensation expense for all
share-based payment awards granted after January 1, 2006 is based on the
grant-date fair value estimated in accordance with the provisions of SFAS No.
123(R). The Company recognizes these compensation costs net of an estimated
forfeiture rate and recognizes the compensation costs for only those shares
expected to vest. The Company calculates the fair value of employee stock
options using a Black-Scholes option pricing model at the time the stock options
are granted and that amount is amortized on a straight-line basis over the
vesting period of the stock options, which is generally up to four years. The
Company estimated the forfeiture rate based on its historical experience.
13
METROPOLITAM HEALTH NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The fair value for employee stock options granted during the nine months ended
September 30, 2006 was calculated based on the following assumptions: risk-free
interest rate from 4.80% to 4.99%; dividend yield of 0%; volatility factor of
the expected market price of the Company's common stock of 50%; and expected
option lives of two years. The expected life of the options is based on the
historical exercise behavior of the Company's employees. The expected volatility
factor is based on the historical volatility of the market price of the
Company's common stock. The risk-free rate for periods within the contractual
life of the option is based on the U.S. Treasury yield curve in effect at the
time of grant.
As a result of adopting SFAS No. 123(R) on January 1, 2006, for the quarter and
nine month periods ended September 30, 2006, the Company's income before income
taxes was approximately $182,000 and $546,000 lower, respectively, and net
income was lower by approximately $113,000 and $341,000, respectively, than if
it had continued to account for share-based compensation under APB No. 25. The
total income tax benefit recognized in the income statement for share-based
compensation was approximately $69,000 and $205,000 for the quarter and nine
month periods ended September 30, 2006.
SFAS No. 123(R) requires the tax benefits resulting from tax deductions in
excess of the compensation cost recognized for options (excess tax benefits) to
be classified as financing cash flows. For the quarter and nine months ended
September 30, 2006, the Company had net operating loss carryforwards and did not
recognize any tax benefits resulting from the exercise of stock options because
the related tax deductions would not have resulted in a reduction of income
taxes payable. During the quarter and nine months ended September 30, 2006, the
Company issued 26,000 and 221,000 shares of common stock resulting from the
exercise of stock options, respectively. Cash received from the option exercises
was approximately $1,000 and $140,750 for the quarter and nine months ended
September 30, 2006.
The following table illustrates the effect on net income and earnings per share
if the Company had applied the fair value recognition provisions of SFAS No. 123
for the quarter and nine months ended September 30, 2005. For purposes of this
pro forma disclosure, the fair value of these options were estimated at the date
of grant using a Black-Scholes option pricing model based on the following
assumptions for the quarter and nine months ended September 30, 2005: risk-free
interest rate from 2.82% to 4.24%; dividend yield of 0%; volatility factor of
the expected market price of the Company's common stock of 50%; and expected
option lives ranging from one to four and one-half years, depending on the
vesting provisions of each option. The expected life of the options is based on
the historical exercise behavior of the Company's employees. The expected
volatility factor is based on the historical volatility of the market price of
the Company's common stock. The risk-free rate for periods within the
contractual life of the option is based on the U.S. Treasury yield curve in
effect at the time of grant. The Company's pro forma information follows:
Nine months ended Three months ended
September 30, 2005 September 30, 2005
------------------- -------------------
Net income, as reported $ 2,927,000 $ 539,000
Less:Total stock-based employee compensation
expense determined under SFAS No. 123
for all awards, net of related tax (714,000) (227,000)
------------------- -------------------
Pro forma net income $ 2,213,000 $ 312,000
=================== ===================
Earnings per share:
Basic, as reported $ 0.06 $ 0.01
=================== ===================
Basic, pro forma $ 0.05 $ 0.01
=================== ===================
Diluted, as reported $ 0.06 $ 0.01
=================== ===================
Diluted, pro forma $ 0.04 $ 0.01
=================== ===================
14
METROPOLITAM HEALTH NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Stock option activity as of September 30, 2006 and changes during the nine
months ended September 30, 2006 were as follows:
Aggregate
Number of Weighted Average Intrinsic
Options Exercise Price Value
---------- ---------------- ----------
Balance, December 31, 2005 6,385,810 $ 1.63
Granted 50,000 $ 2.08
Exercised and returned (221,000) $ 0.75
Forfeited and expired (1,043,600) $ 2.68
----------
Balance, September 30, 2006 5,171,210 $ 1.47 $4,727,303
==========
Exercisable, September 30, 2006 3,041,537 $ 1.17 $3,918,525
==========
The weighted-average grant-date fair value of options granted during the nine
months ended September 30, 2006 and 2005 was $0.65 and $0.93, respectively. The
aggregate intrinsic value in the table above represents the total pretax
intrinsic value (the difference between the Company's closing stock price on the
last trading day of the first quarter of fiscal 2006 and the exercise price,
multiplied by the number of in-the-money options) that would have been received
by the option holders had all option holders exercised their options on
September 30, 2006. This amount will change based on the fair market value of
the Company's stock. Total intrinsic value of options exercised for the nine
months ended September 30, 2006 and 2005 was approximately $414,000 and
$2,866,000, respectively. Total fair value of options vested for the nine months
ended September 30, 2006 and 2005 was approximately $87,000 and $101,000,
respectively.
As of September 30, 2006, there was $650,965 of total unrecognized compensation
cost related to non-vested stock options, which is expected to be recognized
over a weighted-average period of 1.09 years.
The following table summarizes information about stock options outstanding and
exercisable at September 30, 2006:
Options Outstanding Options Exercisable
------------------- -------------------
Weighted Weighted Average Weighted Weighted Average
Number of Average Remaining Number of Average Remaining
Exercise Price Options Exercise Price Contractual Life Options Exercise Price Contractual Life
-------------- --------- -------------- ---------------- --------- -------------- ----------------
$0.35 - $1.00 2,114,510 $ 0.53 2.26 2,064,510 $ 0.52 2.18
$1.14 - $1.98 2,319,900 $ 1.81 7.86 727,452 $ 1.77 7.28
$2.05 - $2.69 586,800 $ 2.27 8.51 99,575 $ 2.61 5.94
$4.00 - $6.50 150,000 $ 6.17 0.60 150,000 $ 6.17 0.60
--------- ---------
5,171,210 $ 1.47 5.43 3,041,537 $ 1.17 3.45
========= =========
Non-vested stock option awards as of September 30, 2006 and changes during the
nine months ended September 30, 2006 were as follows:
Weighted Average
Number of Grant-Date
Shares Fair Value
---------- ----------------
Non-vested, December 31, 2005 2,337,782 $ 0.94
Granted 50,000 $ 0.65
Vested (137,075) $ 0.63
Forfeited and expired (121,034) $ 1.13
----------
Non-vested, September 30, 2006 2,129,673 $ 0.94
==========
15
METROPOLITAM HEALTH NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Non-vested restricted stock awards as of September 30, 2006 and changes during
the nine months ended September 30, 2006 were as follows:
Weighted Average
Restricted Grant-Date
Shares Fair Value
---------- -----------------
Balance, December 31, 2005 -- $ --
Granted 60,000 $ 2.08
Vested -- $ --
Forfeited and expired -- $ --
----------
Balance, September 30, 2006 60,000 $ 2.08
==========
In the quarter and nine months ended September 30, 2006, the Company recognized
approximately $31,000 and $57,000, respectively, of compensation costs related
to non-vested restricted stock awards. As of September 30, 2006, there was
approximately $67,000 of total unrecognized compensation cost related to
non-vested restricted stock awards, which is expected to be recognized over a
weighted-average period of 0.56 years.
================================================================================
NOTE 4. STOCKHOLDERS' EQUITY
--------------------------------------------------------------------------------
The Company issued 221,000 shares of common stock in connection with the
exercise of stock options during the first nine months of 2006. In addition, an
aggregate of 60,000 shares of restricted common stock were issued to two new
members of the Company's Board of Directors upon their appointment to the Board
of Directors in the second quarter of 2006.
================================================================================
NOTE 5. COMMITMENTS AND CONTINGENCIES
--------------------------------------------------------------------------------
LITIGATION
The Company is party to certain claims arising in the ordinary course of
business. Management believes that the outcome of these matters will not have a
material adverse effect on the financial position or the results of operations
of the Company.
================================================================================
NOTE 6. BUSINESS SEGMENT INFORMATION
--------------------------------------------------------------------------------
In 2006, the Company is operating in two segments for purposes of presenting
financial information and evaluating performance, the PSN and the HMO. The HMO
commenced operations effective July 1, 2005.
NINE MONTHS ENDED SEPTEMBER 30, 2006 PSN HMO Total
-------------------------------------------------------------------- ------------ ------------ ------------
Revenues from external customers $152,628,000 $ 19,859,000 $172,487,000
Segment gain (loss) before allocated overhead 16,150,000 (6,218,000) 9,932,000
Allocated corporate overhead 2,732,000 2,059,000 4,791,000
Segment gain (loss) after allocated overhead and before income taxes 13,418,000 (8,277,000) 5,141,000
Segment assets 22,973,000 16,685,000 39,658,000
Goodwill 1,992,000 0 1,992,000
16
METROPOLITAM HEALTH NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, 2005 PSN HMO Total
-------------------------------------------------------------------- ------------ ------------ ------------
Revenues from external customers $136,218,000 $ 471,000 $136,689,000
Segment gain (loss) before allocated overhead 12,244,000 (4,086,000) 8,158,000
Allocated corporate overhead 2,377,000 1,063,000 3,440,000
Segment gain (loss) after allocated overhead and before income taxes 9,867,000 (5,149,000) 4,718,000
Segment assets 24,888,000 4,567,000 29,455,000
Goodwill 1,992,000 0 1,992,000
THREE MONTHS ENDED SEPTEMBER 30, 2006 PSN HMO Total
-------------------------------------------------------------------- ------------ ------------ ------------
Revenues from external customers $ 52,316,000 $ 8,522,000 $ 60,838,000
Segment gain (loss) before allocated overhead 7,659,000 (2,049,000) 5,610,000
Allocated corporate overhead 914,000 627,000 1,541,000
Segment gain (loss) after allocated overhead and before income taxes 6,745,000 (2,676,000) 4,069,000
THREE MONTHS ENDED SEPTEMBER 30, 2005 PSN HMO Total
-------------------------------------------------------------------- ------------ ------------ ------------
Revenues from external customers $ 44,529,000 $ 471,000 $ 45,000,000
Segment gain (loss) before allocated overhead 4,241,000 (2,354,000) 1,887,000
Allocated corporate overhead 558,000 446,000 1,004,000
Segment gain (loss) after allocated overhead and before income taxes 3,683,000 (2,800,000) 883,000
================================================================================
NOTE 7. SUBSEQUENT EVENTS
--------------------------------------------------------------------------------
On November 11, 2006, management and the Audit & Finance Committee of the Board
of Directors of the Company concluded that the unaudited consolidated financial
statements included in the Company's Quarterly Reports on Form 10-Q as of and
for the quarters ended March 31, 2006 and June 30, 2006 should be restated to
reflect a correction of such financial statements related to the Company's
over-recording of revenues generated by the PSN during such quarters.
More specifically, the Company determined that it over-recorded revenues
generated by the PSN by approximately $666,000 during each of the first quarter
and second quarter of 2006. During 2005, the majority of Humana, Inc. members
serviced by the PSN in the PSN's Daytona market were required to pay a monthly
premium of $15 to Humana, Inc. (the "Monthly Premium"). As part of its monthly
capitation payments from Humana, Inc., the Company was paid approximately $12 of
the Monthly Premium per member. Commencing in January 2006, as a result of a
change in health plan benefits, the Monthly Premium was eliminated in the
Daytona market. However, the data the Company received from Humana, Inc. from
January 2006 until July 2006 regarding the revenues the Company were entitled to
receive from Humana, Inc., inadvertently continued to reflect the Monthly
Premium and, accordingly, the Company was over-paid by Humana, Inc. and
over-recorded its net revenues and accounts receivable by approximately $666,000
in the first quarter of 2006 and the second quarter of 2006.
Accordingly, the Company's financial statements contained within its Quarterly
Report on Form 10-Q for each of the quarters ended March 31, 2006 and June 30,
2006 should not be relied upon.
On November 14, 2006, the Company:
o restated its previously issued financial statements for the first quarter
of 2006 by amending its Quarterly Report on Form 10-Q for the fiscal
quarter ended March 31, 2006; and
o restated its previously issued financial statements for the second quarter
of 2006 by amending its Quarterly Report on Form 10-Q for the fiscal
quarter ended June 30, 2006.
17
METROPOLITAM HEALTH NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Management and the Audit & Finance Committee discussed these issues with the
Company's independent registered public accounting firm, Grant Thornton, LLP.
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE OUR ANNUAL
REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2005, AS WELL AS THE
FINANCIAL STATEMENTS AND NOTES THERETO.
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
Sections of this Quarterly Report contain statements that are forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933 (the
"Securities Act") and Section 21E of the Securities Exchange Act of 1934 (the
"Exchange Act"), and we intend that such forward-looking statements be subject
to the safe harbors created thereby. Statements in this Report containing the
words "estimate," "project," "anticipate," "expect," "intend," "believe,"
"will," "could," "should," "may," and similar expressions may be deemed to
create forward-looking statements. Accordingly, such statements, including
without limitation, those relating to our future business, prospects, revenues,
working capital, liquidity, capital needs, interest costs and income, wherever
they may appear in this document or in other statements attributable to us,
involve estimates, assumptions and uncertainties which could cause actual
results to differ materially from those expressed in the forward-looking
statements. Specifically, this Quarterly Report contains forward-looking
statements, including the following:
o the PSN's ability to renew the Humana Agreements and maintain the
Humana Agreements on favorable terms;
o our ability to adequately predict and control medical expenses and
to make reasonable estimates and maintain adequate accruals for
incurred but not reported, or IBNR, claims; and
o the HMO's ability to renew, maintain or to successfully rebid for
its agreement with CMS.
The forward-looking statements reflect our current view about future events and
are subject to risks, uncertainties and assumptions. We wish to caution readers
that certain important factors may have affected and could in the future affect
our actual results and could cause actual results to differ significantly from
those expressed in any forward-looking statement. The following important
factors could prevent us from achieving our goals and cause the assumptions
underlying the forward-looking statements and the actual results to differ
materially from those expressed in or implied by those forward-looking
statements:
o reductions in government funding of Medicare programs;
o disruptions in the PSN's, the HMO's or Humana's healthcare provider
networks;
o failure to receive claims processing, billing services, data
collection and other information on a timely basis from Humana;
o future legislation and changes in governmental regulations;
o increased operating costs;
o the impact of Medicare Risk Adjustments on payments we receive for
our managed care operations;
o loss of significant contracts;
o general economic and business conditions;
o increased competition;
o the relative health of our patients;
o changes in estimates and judgments associated with our critical
accounting policies;
19
o federal and state investigations;
o our ability to successfully recruit and retain key management
personnel and qualified medical professionals; and
o impairment charges that could be required in future periods.
Additional information concerning these and other risks and uncertainties is
contained in our filings with the Securities and Exchange Commission (the
"Commission"), including the sections entitled "Risk Factors" in our Annual
Report on Form 10-K for the year ended December 31, 2005 and our Quarterly
Reports on Form 10-Q for the quarters ended March 31, 2006 and June 30, 2006.
Forward-looking statements should not be relied upon as a prediction of actual
results. Subject to any continuing obligations under applicable law or any
relevant listing rules, we expressly disclaim any obligation to disseminate,
after the date of this Quarterly Report on Form 10-Q, any updates or revisions
to any such forward-looking statements to reflect any change in expectations or
events, conditions or circumstances on which any such statements are based.
On November 14, 2006, the Company filed amendments to its Quarterly Reports on
Form 10-Q as of and for the quarters ended March 31, 2006 and June 30, 2006 to
restate the financial statements included therein. See "Note 7 to the Condensed
Consolidated Financial Statements" of each of the quarterly reports referenced
herein for further information.
BACKGROUND
Through our provider service network ("the PSN") and our health maintenance
organization ("the HMO"), we currently provide healthcare benefits to Medicare
beneficiaries in Florida. As of September 30, 2006, the PSN and the HMO provided
healthcare benefits to approximately 25,900 and 3,500 Medicare Advantage
beneficiaries, respectively (collectively, the "Participating Members").
Substantially all of our revenues are directly or indirectly derived from
reimbursements generated by Medicare Advantage health plans. As a result, our
revenue and profitability are dependent on government funding levels for
Medicare Advantage programs.
Provider Service Network
Pursuant to two contracts with Humana, Inc. (the "Humana Agreements"), the
nation's second largest participant in the Medicare Advantage program
("Humana"), the PSN provides, on a non-exclusive basis, healthcare services to
Medicare beneficiaries in Flagler and Volusia Counties ("Central Florida") and
Palm Beach, Broward and Miami-Dade Counties ("South Florida") who have elected
to receive benefits from Humana's Medicare Advantage Plans. As of September 30,
2006, the Humana Agreements covered approximately 19,400 Humana Plan Members (as
defined below) in Central Florida and 6,500 Humana Plan Members in South
Florida.
The PSN is comprised both of medical practices owned by us as well as
independently owned medical practices and providers with whom it has contracted
("IPs"). We currently own and operate eight primary care physician practices and
a medical oncology physician practice. We also contract with twenty-nine primary
care IPs. Through the Humana Agreements, the PSN has established referral
relationships with a large number of specialist physicians, ancillary service
providers and hospitals throughout South Florida and Central Florida.
Humana directly contracts with the Centers for Medicare and Medicaid Services
("CMS") and is paid a monthly premium payment for each member ("Humana Plan
Member") enrolled in Humana's Medicare Advantage Plan. The monthly amount varies
by patient, county, age and severity of health status. Pursuant to the Humana
Agreements, the PSN provides or arranges for the provision of covered medical
services to each Humana Plan Member who selects one of our affiliated providers
as his or her primary care physician (a "Humana Participating Member"). In
return for the provision of these medical services, the PSN receives from Humana
a monthly fee, also known as a "capitated fee", for each Humana Participating
Member. The fee rates are established by the contracts between the PSN and
Humana and comprise a vast majority of the monthly premiums received by Humana
from CMS with respect to Humana Participating Members.
20
The PSN assumes the full financial responsibility for the provision of all
Medicare-covered medical care to Humana Participating Members, including those
medical services that the PSN does not itself provide. To the extent the costs
of providing such medical care are less than the related premiums received from
Humana, the PSN generates an operating profit. Conversely, if the medical costs
exceed the fees received from Humana, the PSN experiences an operating loss.
The vast majority of the PSN's revenues come from the Humana Agreements. We do
receive additional revenue for providing primary care services to non-Humana
Plan Members on a fee-for-service basis in the medical practices we own and
operate.
For the three and nine months ended September 30, 2006, approximately 85% and
88%, respectively, of our revenue was generated pursuant to the Humana
Agreements. The Humana Agreements have one-year terms and renew automatically
each December 31 for additional one-year terms unless terminated for cause or
upon 180 days prior notice. Failure to maintain the Humana Agreements on
favorable terms would adversely affect our results of operations and financial
condition.
Health Maintenance Organization
Effective July 1, 2005, the HMO became licensed as a Medicare Advantage HMO and
entered into a contract with CMS (the "CMS Agreement") to begin offering
Medicare Advantage plans to Medicare beneficiaries in six Florida counties which
include the cities of Fort Pierce, Port St. Lucie, Fort Myers, Port Charlotte
and Sarasota. The HMO has been marketing its "AdvantageCare" branded plan since
July 2005. The HMO is seeking to expand its HMO and as of September 30, 2006,
the total number of enrollees in its plan was approximately 3,500.
In addition to growth within existing service areas, the HMO is expanding its
business into new geographic areas. However, we do not intend to provide HMO
services in the geographic markets with respect to which the PSN has a contract
with Humana. We view our HMO business as an extension of our existing core
competencies.
The HMO's revenues are generated by premiums consisting of monthly payments per
member that are established by the CMS Agreement. The HMO recorded its first
revenues in the third quarter of fiscal 2005.
The Humana Agreements and the CMS Agreement are risk agreements under which the
PSN and the HMO, respectively, receive monthly payments per Participating Member
at a rate established by the agreements, also called a capitated fee. In
accordance with the agreements, the total monthly payment is a function of the
number of Participating Members, regardless of the actual utilization rate of
covered services.
To the extent that the Participating Members require more care than is
anticipated, aggregate capitation rates may be insufficient to cover the costs
associated with the treatment of such members. If medical expenses exceed our
estimates, except in very limited circumstances, we will be unable to increase
the premiums we receive under these contracts during the then-current terms.
Relatively small changes in our ratio of medical expense to revenue can create
significant changes in our financial results. Accordingly, the failure to
adequately predict and control medical expenses and to make reasonable estimates
and maintain adequate accruals for incurred but not reported, or IBNR, claims,
may have a material adverse effect on our financial condition, results of
operations and/or cash flows.
Although we have operated as a risk provider since 1997, we have only operated
the HMO since July 1, 2005. While the HMO's business has continued to grow, such
growth has continued to require capital. In the nine months ended September 30,
2006, the HMO's business generated a $6.2 million segment loss before allocated
overhead and income taxes. We project that in fiscal 2006, the HMO's business
will generate a loss of $8 million to $10 million before allocated overhead and
income taxes. The amount of the loss will be determined by a number of factors
including membership, medical utilization and related costs, and our decisions
related to expansion and growth efforts. We are still not in a position to
meaningfully estimate when, if ever, the HMO's business will become profitable
and/or generate cash from operations and we may be required to fund the
development and expansion of the HMO business, including any associated losses,
for an extended period of time. Nonetheless, we anticipate that the on-going
development efforts, reserve requirements and operating costs for our still
developing HMO business can be funded by our current resources and projected
cash flows from operations until at least September 30, 2007.
21
To successfully operate the HMO, we believe we will have to continue our
development of the following capabilities, among others: sales and marketing,
customer service and regulatory compliance. No assurances can be given that we
will be successful in operating this segment of our business despite our
allocation of a substantial amount of resources for this purpose. If the HMO
does not develop as anticipated or planned, we may have to devote additional
managerial and/or capital resources to the HMO, which could limit our ability to
manage and/or grow the PSN. There can be no assurances that, if for any reason,
we elect to discontinue the HMO business and/or seek to sell such business, we
will be able to fully recoup our expenditures to date with respect to the HMO
business.
CRITICAL ACCOUNTING POLICIES
Our significant accounting policies are described in Note 1 of the "Notes to
Condensed Consolidated Financial Statements" included in this Form 10-Q. We
believe our most critical accounting policies include the policies set forth
below.
USE OF ESTIMATES
Revenue, Expense and Receivables
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the amounts reported in the accompanying
financial statements. The most significant area requiring estimates relates to
the PSN's arrangements with Humana. Such estimates are based on knowledge of
current events and anticipated future events, and accordingly, actual results
may ultimately differ materially from those estimates.
With regard to virtually all of the revenues, expenses and receivables arising
from the Humana Agreements, the Company estimates the amounts it believes will
ultimately be realizable based in part upon estimates of claims incurred but not
reported ("IBNR") and estimates of retroactive adjustments or unsettled costs to
be applied by Humana. The IBNR estimates are made by Humana utilizing actuarial
methods and are continually evaluated by management of the Company based upon
its specific claims experience. It is reasonably possible that some or all of
these estimates could change in the near term by an amount that could be
material to the financial statements.
From time to time, Humana charges the PSN for certain medical expenses, which
the Company believes are erroneous or are not supported by the Humana
Agreements. Management's estimate of recovery on these contestations is based
upon its judgment and its consideration of several factors including the nature
of the contestations, historical recovery rates and other qualitative factors.
During 2005, the Company incurred approximately $4.0 million of medical costs
related to the implantation of certain Implantable Automatic Defibrillators
("AICD's"). CMS directed that the costs of certain of these procedures that met
2005 eligibility requirements be paid by CMS, rather than billed to Medicare
Advantage plans. The Company is working with Humana and the related providers to
secure reimbursement for these amounts, and estimated a recovery of
approximately $2.2 million at December 31, 2005. Approximately $379,000 of this
amount was collected during the nine months ended September 30, 2006, while an
additional $500,000 was written off in the second quarter of 2006 due to revised
guidance issued by CMS in July 2006 regarding the costs payable by CMS in
connection with these procedures. During the quarter ended September 30, 2006,
the Company recorded an additional $500,000 reserve against this receivable to
reflect management's concerns about the ultimate collection of these
receivables. Accordingly, related accounts receivable in the accompanying
consolidated balance sheets were $772,000 and $2.2 million at September 30, 2006
and December 31, 2005, respectively. It is reasonably possible that this
estimate could change in the near term by an amount that could be material to
the financial statements.
22
Included in revenues for the quarter and nine months ended September 30, 2006
were estimated amounts payable to the Company as a result of funding increases
under the Medicare risk adjustment ("MRA") program. The purpose of the MRA
program is to use health status indicators to improve the accuracy of payments
and establish incentives for plans to enroll and treat less healthy Medicare
beneficiaries. From 2000 to 2003, risk adjustment payments accounted for only
10% of the payment made by CMS to the Medicare health plans, with the remaining
90% based on demographic factors. In 2004 and 2005, the percentage of payment
attributable to risk adjustment was increased to 30% and 50%, respectively. The
percentage of payment attributable to risk has increased to 75% in 2006, with
the 100% phase-in of risk-adjusted payment expected in 2007. We accrued
approximately $5.4 million during the nine months ended September 30, 2006
related to incremental revenues anticipated to be received as a result of the
MRA funding increases. $4.2 million has been received during the first nine
months of 2006. Accounts receivable in the accompanying consolidated balance
sheets at September 30, 2006 include $1.2 million of accrued MRA receivables
that we expect to be received during the fourth quarter of 2006 and in the first
quarter of 2007. It is reasonably possible that this estimate could change in
the near term by an amount that could be material to the financial statements.
Non-Humana fee-for-service accounts receivable, aggregating to approximately
$1,155,000 and $797,000 at September 30, 2006 and December 31, 2005,
respectively, relate principally to medical services provided on a non-capitated
basis, and are reduced by amounts estimated to be uncollectible (approximately
$798,000 and $555,000 at September 30, 2006 and December 31, 2005,
respectively). Management's estimate of uncollectible amounts is based upon its
analysis of historical collections and other qualitative factors, however it is
possible the Company's estimate of uncollectible amounts could change in the
near term. In addition, accounts receivable at September 30, 2006 and December
31, 2005 includes approximately $519,000 and $159,000, respectively, due to the
HMO from CMS and HMO enrollees, which is reduced by amounts estimated to be
uncollectible at September 30, 2006 in the amount of $17,000.
With regards to the HMO, the cost of medical benefits is recognized in the
period in which services are provided and includes an IBNR estimate based on
management's best estimate of medical benefits payable. It is reasonably
possible that some or all of these estimates could change in the near term by an
amount that could be material to the financial statements.
The HMO memberships' average risk adjustment factor declined from December 2005
to June 2006 as a result of a large influx of new members in 2006. This decline
resulted in decreased average member monthly premiums. The Company believes that
the actual average risk adjustment factor for its population during this period
was higher and that an increase will be reflected as claims and health data for
these new members are entered into the CMS system, which is expected to result
in retroactive premium adjustments. The Company has estimated the retroactive
premium adjustment to be approximately $534,000 at September 30, 2006.
Accounting for Prescription Drug Benefits under Medicare Part D
On January 1, 2006, the HMO and the PSN, through the Humana Agreements, began
covering prescription drug benefits in accordance with the requirements of
Medicare Part D, to the HMO's and PSN's Medicare Advantage members. The benefits
covered under Medicare Part D are in addition to the benefits covered by the HMO
and the PSN under Medicare Parts A and B.
In general, pursuant to Medicare Part D, pharmacy benefits may vary in terms of
coverage levels and out-of-pocket costs for beneficiary premiums, deductibles
and co-insurance. However, all Part D plans must offer either "standard
coverage" or its actuarial equivalent (with out-of-pocket threshold and
deductible amounts that do not exceed those of standard coverage). These
"defined standard" benefits represent the minimum level of benefits mandated by
Congress. In addition to defined standard plans offered by the HMO, the PSN,
through the Humana Agreements, offers certain prescription drug plans containing
benefits in excess of the standard coverage limits.
The payment the Company's HMO receives monthly from CMS for coverage under
Medicare Part D (the "CMS Payment") generally represents the HMO's bid amount
for providing Part D insurance coverage. The Company recognizes premium revenue
for the HMO's provision of this Part D insurance coverage ratably over the term
of the CMS Agreement. However, the ultimate amount of the CMS Payment is subject
to 1) risk corridor adjustments and 2) subsidies provided by CMS in order for
the HMO and CMS to share the risk associated with financing the ultimate costs
of the Medicare Part D benefit.
The CMS payment is subject to adjustment, positive or negative, based upon the
application of risk corridors that compare the prescription drug benefit costs
estimated by the HMO in making its bid to CMS (the "Estimated Costs") to actual
incurred prescription drug benefit costs (the "Actual Costs"). For 2006 and
2007, in accordance with federal regulations, the HMO will bear all gains and
losses that fall within 2.5% of its Estimated Costs. To the extent the Actual
Costs exceed the Estimated Costs by more than 2.5%, CMS may make additional
payments to the HMO. Conversely, to the extend the Estimated Costs exceed the
Actual Costs by more than 2.5%, the HMO may be required to refund to CMS a
portion of the CMS Payment. Actual Costs subject to risk sharing with CMS are
limited to the costs that are, or would have been, incurred under the CMS
"defined standard" benefit plan. The Company estimates and recognizes an
adjustment to premium revenues from CMS related to the risk corridor payment
adjustment based upon pharmacy claims experience to date as if the CMS Agreement
were to end at the end of each reporting period. Accordingly, this estimate does
not take into consideration projected future pharmacy claims experience. It is
reasonably possible that this estimate could change in the near term by an
amount that could be material.
23
Certain subsidies represent reimbursements from CMS for claims the HMO paid for
even though it is not ultimately required to bear the risk in connection with
such claims. These include federally reinsured claims where a MetHMO member's
actual drug spending reaches Part D's annual catastrophic threshold and certain
deductible, coinsurance and co-payment amounts for low-income beneficiaries. The
Company accounts for these subsidies as current liabilities in its balance sheet
and as an operating activity in its statement of cash flows. The Company does
not recognize premium revenue or claims expense for these subsidies.
The HMO recognizes pharmacy benefit costs as incurred. It has subcontracted the
pharmacy claims administration to a third party pharmacy benefit manager.
With regards to the PSN, the Company receives Medicare Part D revenue pursuant
to the applicable percent of premium provided for in the Humana Agreements.
Humana does not provide the Company with a separate accounting for the
incremental amount of the Part D premium and expense. As with the HMO, the
Company recognizes pharmacy benefit costs as such costs are incurred by the PSN.
With regards to the estimated amount of any risk corridor adjustments, the
Company has relied upon estimates provided by Humana to the Company and has
recorded a downward adjustment to premium revenue based on these estimates. It
is reasonably possible that this estimate could change in the near term by an
amount that could be material.
Deferred Tax Asset
The Company has recorded a deferred tax asset of approximately $6.0 million at
September 30, 2006. Realization of the deferred tax asset is dependent on
generating sufficient taxable income in the future. The amount of the deferred
tax asset considered realizable could change in the near term if estimates of
future taxable income are modified and those changes could be material.
In the future, if the Company determines that it cannot, on a more likely than
not basis, realize all or part of its deferred tax assets in the future, an
adjustment to establish (or record an increase in) the deferred tax asset
valuation allowance would be charged to income in the period in which such
determination is made.
Stock-Based Compensation Expense
Effective January 1, 2006, the Company adopted SFAS 123(R) using the modified
prospective transition method. SFAS 123(R) requires the Company to recognize
compensation costs related to share-based payment transactions with employees in
its financial statements. SFAS 123(R) requires the Company to calculate this
cost based on the grant date fair value of the equity instrument. Consistent
with its prior disclosures under SFAS 123, the Company elected to calculate the
fair value of its employee stock options using the Black-Scholes option pricing
model. Based on the Black-Scholes model and its assumptions, the Company
recognized stock-based employee compensation expense of approximately $182,000
and $546,000 for the quarter and nine months ended September 30, 2006,
respectively (See "Notes to Condensed Consolidated Financial Statements," Note
3.").
SFAS 123(R) does not require the use of any particular option valuation model.
Because the Company's stock options have characteristics significantly different
from traded options and because changes in the subjective input assumptions can
materially affect the fair value estimate, it is possible that existing models
may not necessarily provide a reliable measure of the fair value of the
Company's employee stock options. It selected the Black-Scholes model based on
prior experience with it, its wide use by issuers comparable to the Company, and
the Company's review of alternate option valuation models. Based on these
factors, the Company believes that the Black-Scholes model and the assumptions
it made in applying it provide a reasonable estimate of the fair value of its
employee stock options.
The effect of applying the fair value method of accounting for stock options on
reported net income for any period might not be representative of the effects
for future periods because outstanding options typically vest over a period of
several years and additional awards may be made in future periods.
RESULTS OF OPERATIONS
24
We recognized Revenues, net of $60.8 million for the quarter ended September 30,
2006 compared to $45 million in quarter ended September 30, 2005, an increase of
$15.8 million, or 35.2%. Net income for the quarter ended September 30, 2006 was
$2.5 million compared to $539,000 for the quarter ended September 30, 2005.
For the nine months ended September 30, 2006, we recognized Revenues, net of
$172.5 million compared to $136.7 million for the nine months ended September
30, 2005, an increase of $35.8million, or 26.2%. Net income for the nine months
ended September 30, 2006 was $3.2 million compared to $2.9 million for the nine
months ended September 30, 2005.
Net Earnings Per Share, Basic was $.05 and $.01 for the quarters ended September
30, 2006 and 2005, respectively. The weighted average shares outstanding for the
quarter increased from 49,269,000 at September 30, 2005 to 50,108,000 at
September 30, 2006.
For the nine months ended September 30, 2006 and 2005, Net Earnings Per Share,
Basic was $.06 and $.06, respectively. The weighted average shares outstanding
for the nine-month period increased from 48,716,000 at September 30, 2005 to
49,981,000 at September 30, 2006.
In both 2005 and 2006, we operated in two financial reporting segments, the PSN
business and the Medicare Advantage HMO business, which began enrolling members
effective July 1, 2005. The PSN reported a Segment gain (loss) before allocated
overhead of $7.7 million and $16.1 million for the quarter and nine months ended
September 30, 2006, respectively, compared to $4.2 million and $12.2 million for
the quarter and nine months ended September 30, 2005, respectively. The HMO
incurred a Segment loss before allocated overhead of $2.0 million and $6.2
million for the quarter and nine months ended September 30, 2006, compared to
$2.4 million and $4.1 million for the quarter and nine months ended September
30, 2005, respectively.
MEMBERSHIP
The PSN
As of September 2006, the PSN was providing healthcare services to approximately
25,900 Humana Participating Members as compared to approximately 26,700 Humana
Participating Members in September 2005, a decrease of 800 members or 3%.
Effective October 1, 2005, we discontinued our contractual obligation with a
number of our South Florida physician practices due to non-compliance with our
policies and procedures. These centers accounted for approximately 700 members.
Humana Participating Member months, which is defined as the aggregate of the
PSN's Humana Plan membership for each month during the fiscal quarter, decreased
to approximately 77,500 for third quarter 2006 from approximately 79,900 for
third quarter 2005. Humana Participating Member months for the nine months ended
September 30, 2006 were approximately 232,500 as compared to 239,200 for the
nine months ended September 30, 2005, a decrease of 6,700 member months. As
discussed above, we discontinued our contractual obligation with a number of our
South Florida physician practices due to non-compliance with our policies and
procedures in 2005. These centers accounted for approximately 6,500 member
months for the nine months ended September 30, 2005.
The HMO
The HMO commenced operations in July 2005. As of September 2006, there were
approximately 3,500 Participating Members enrolled in the HMO, compared to 500
in September 2005. The HMO's Participating Member months was approximately
10,300 and 24,700 for the quarter and nine months ended September 30, 2006. The
HMO's marketing efforts during the first nine months of 2006 have generated
approximately 2,100 net additional members.
COMPARISON OF THE QUARTERS ENDED SEPTEMBER 30, 2006 AND SEPTEMBER 30, 2005
REVENUES
Revenues, net for the quarter ended September 30, 2006 increased $15.8 million,
or 35.2%, over the quarter ended September 30, 2005, from $45.0 million to $60.8
million.
25
The PSN
Our most significant revenue component during both the third quarter of 2005 and
the third quarter of 2006 was the premium revenue generated pursuant to the
Humana Agreements (the "Humana Related Revenue"). The Humana Related Revenue
increased from $44.3 million in the third quarter of 2005 to $52.0 million in
the third quarter of 2006, an increase of approximately $7.7 million or 17.3%.
Included in revenue during this period was $763,000 of MRA retroactive
adjustments related to prior years. Average per member per month revenue
increased approximately $671 in the third quarter of 2006 compared to $554 in
the third quarter of 2005. The increased per member per month premium accounted
for a total revenue increase of approximately $9.3 million which was partially
offset by the 2,400 decrease in Humana Participating Member months or $1.6
million.
The HMO
Revenues for the HMO, which began enrolling members in July 2005, amounted to
$8.5 million for the third quarter of 2006 as compared to $471,000 for the third
quarter of 2005. Average per member per month premiums amounted to approximately
$825 in the third quarter of 2006.
OPERATING EXPENSES
Total Medical Expenses
Total medical expenses represent the total costs of providing patient care and
are comprised of two components, direct medical costs and other medical costs.
Direct medical costs include the costs of medical services provided to
Participating Members by providers other than our affiliated providers
("Non-Affiliated Providers"). Approximately 95% of our Total medical expenses
are attributable to the costs of medical services provided by Non-Affiliated
Providers. Other medical costs include costs associated with the operations of
our wholly owned physician practices and oncology center including salaries and
benefits, supplies, malpractice insurance and office related expenses.
Total medical expenses totaled $52.2 million and $40.1 million for the quarters
ended September 30, 2006 and 2005, respectively. The ratio of the Company's
Total medical expense as a percentage of Revenue, ("MER"), improved to 85.8% in
the third quarter of 2006 from 89.2% in the third quarter of 2005.
The PSN's MER improved to 83.8% in the quarter ended September 30, 2006 compared
to 89.3% in the year earlier period. A number of factors contributed to this
improvement, including, but not limited to, improved utilization trends, prior
year MRA adjustments included in revenues during the period and the termination
of certain South Florida medical practices in October 2005, which practices
generated an average MER of greater than 100%.
The HMO's MER was 98.3% for the third quarter of 2006. Due to its relatively
small membership, our HMO's operations are volatile from a medical utilization
standpoint. We expect that the volatility will decline as membership grows and
anticipate that the HMO's MER will decrease in future periods.
Administrative Payroll, Payroll Taxes and Benefits
Administrative payroll, payroll taxes and benefits include salaries and related
costs for our executive and administrative staff. For the quarter ended
September 30, 2006, administrative payroll, payroll taxes and benefits were $2.5
million, compared to $1.5 million for the quarter ended September 30, 2005.
Costs associated with the HMO accounted for the $300,000 of the incremental
increases in expenses. In addition, we incurred $200,000 of stock option related
non-cash expenses and $130,000 in incremental bonus and 401(k) contribution
accruals. The HMO had 55 employees at September 30, 2006 compared in 26 a
September 30, 2005. The PSN's and corporate administrative headcount totaled 131
employees at September 30, 2006, an increase of 9 as compared to September 30,
2005.
Marketing and Advertising
Marketing and advertising expense for the third quarter of 2006 was $203,000,
compared to expenses of $1.3 million in the third quarter of 2005. During the
third quarter of 2005, we were conducting an open enrollment and launching our
HMO . The Medicare industry entered its first lock-in period effective May 15,
2006. During this lock-in period, which continues until November 15, 2006, most
people are not eligible to join or switch Medicare Advantage plans. The next
open enrollment period begins November 15, 2006 and will extend until March 30,
2006. Based on the limited ability to enroll members, our marketing and sales
efforts and expenditures decreased in the quarter ended September 30, 2006.
26
General and Administrative
General and administrative expenses for the third quarter of 2006 amounted to
$2.1 million, an increase of $849,000 over the third quarter of 2005.
Approximately $500,000 of the increase is attributable to expenses incurred in
connection with the HMO, including $250,000 for claims processing, $100,000 of
incremental stoploss insurance premiums, and $100,000 in legal and accounting
fees.
OTHER INCOME AND EXPENSE
Total other income for the third quarter of 2006 totaled $305,000 as compared to
$126,000 in the third quarter of 2005, primarily the result of increased cash
balances and higher interest rates.
COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 2006 AND SEPTEMBER 30, 2005
REVENUES
Revenues, net for the nine months ended September 30, 2006 increased $35.8
million, or 26.2%, over the nine months ended September 30, 2005, from $136.7
million to $172.5 million.
The PSN
Our most significant revenue component during both the nine months ending
September 30, 2005 and the nine months ending September 30, 2006 was the Humana
Related Revenue. The Humana Related Revenue increased from $135.1 million in the
nine months ended September 30, 2005 to $151.6 million in the nine months ended
September 30, 2006, an increase of approximately $16.5 million or 12.2%.
Included in revenue during this period was $4.2 million of MRA retroactive
adjustments related to prior years. Average per member per month revenue was
approximately $652 in the nine months ended September 30, 2006 compared to $565
in the nine months ended September 30, 2005. The increased per member per month
premium accounted for a total revenue increase of approximately $20.8 million
which was partially offset by the 6,700 decrease in Humana Participating Member
months or $4.3 million.
The HMO
Revenues for the HMO, which began enrolling members in July 2005, amounted to
$19.9 million for the nine months ending September 30, 2006 as compared to
$471,000 for the nine months ended September 30, 2005. Average per member per
month premiums amounted to approximately $806 in the nine months ended September
30, 2006.
OPERATING EXPENSES
Total Medical Expenses
Total medical expenses represent the total costs of providing patient care and
are comprised of two components, direct medical costs and other medical costs.
Direct medical costs include the costs of medical services provided to
Participating Members by providers other than our affiliated providers
("Non-Affiliated Providers"). Approximately 95% of total medical expenses are
attributable to the costs of medical services provided by Non-Affiliated
Providers. Other medical costs include costs associated with the operations of
our wholly owned physician practices and oncology center including salaries and
benefits, supplies, malpractice insurance and office related expenses.
27
Total medical expenses totaled $152.6 million and $122.7 million for the nine
months ended September 30, 2006 and 2005, respectively. Our MER improved to
88.5% in the nine months ended September 30, 2006 compared to 89.8% in the nine
months ending September 30, 2005.
The PSN's MER improved to 87.8% in the nine months ended September 30, 2006
compared to 89.8% in the nine months ended September 30, 2005. A number of
factors contributed to the decrease including, among other things, improved
utilization trends, prior year MRA adjustments included in revenues during the
period and the termination of certain South Florida medical practices in October
2005, which practices generated an average MER of greater than 100%.
The HMO's MER was 94.1% for the nine months ended September 30, 2006. Due to its
relatively small membership, our HMO's operations are volatile from a medical
utilization standpoint. We expect that the volatility will decline as membership
grows and anticipate that the HMO's MER will decrease in future periods.
Administrative Payroll, Payroll Taxes and Benefits
Administrative payroll, payroll taxes and benefits include salaries and related
costs for our executive and administrative staff. For the nine months ended
September 30, 2006, administrative payroll, payroll taxes and benefits were $7.5
million, compared to $4.2 million for the nine months ended September 30, 2005.
Costs associated with the HMO accounted for the $1.4 million of the incremental
increases in expenses. In addition, we incurred $546,000 of stock option related
non-cash expenses and $390,000 in incremental bonus and 401(k) contribution
accruals. The HMO had 55 employees at September 30, 2006 compared to 26
September 30, 2005. The PSN's and corporate administrative headcount totaled 131
employees at September 30, 2006, an increase of 9 since September 30, 2005.
Marketing and Advertising
Marketing and advertising expense for the nine months ended September 30, 2006
was $2.2 million, compared to expenses of $1.4 million in the nine months ended
September 30, 2005. We operated our HMO for the full first nine months of 2006
during which time we incurred marketing and advertising expenses. The HMO
commenced operations in July 2005 and we incurred significant marketing and
advertising expenses only in the third quarter of the year.
The Medicare industry entered its first lock-in period effective May 15, 2006
that extends to November 15, 2006 during which period most people with Medicare
cannot join or switch Medicare Advantage plans. The next open enrollment period
begins November 15, 2006 and will extend to March 30, 2007. Based on the limited
ability to enroll members, our marketing and sales efforts and expenditures
decreased in the quarter ended September 30, 2006.
General and Administrative
General and administrative expenses for the nine months ended September 30, 2006
amounted to $5.7 million, an increase of $1.7 million over the third quarter of
2005. Approximately $1.1 million of the increase is attributable to the expenses
incurred in connection with the HMO, including $560,000 for claims processing,
$175,000 of incremental stoploss insurance premiums, and $100,000 in legal and
accounting fees.
OTHER INCOME AND EXPENSE
Total other income in the nine months ended September 30, 2006 totaled $719,000
as compared to $393,000 in the nine months ended September 30, 2005, primarily
the result of increased cash balances and higher interest rates.
LIQUIDITY AND CAPITAL RESOURCES
Total Cash and equivalents and Short-term investments at September 30, 2006
totaled approximately $25.1 million compared to approximately $15.6 million at
December 31, 2005. As of September 30, 2006, $9.6 million of our Cash and
equivalents and Short-term investments were in accounts established for the HMO.
While available to fund ongoing operations for the HMO, these balances are not
otherwise available for non-HMO operations or other general corporate uses. As
of September 30, 2006, we had a working capital surplus of approximately $25.6
million, compared to a surplus of approximately $21.1 million as of December 31,
2005, an increase of $4.5 million.
28
Our Total stockholder equity increased approximately $3.9 million, from
approximately $29.7 million at December 31, 2005 to approximately $33.6 million
at September 30, 2006.
At September 30, 2006, we had no outstanding debt.
Net cash provided by operating activities for the nine months ended September
30, 2006 was approximately $10.9 million. The largest sources of cash from
operating activities were:
o $3.4 million in cash generated from an increase in estimated medical
expenses payable;
o $3.2 million of cash generated from net income;
o $1.9 million in cash generated from a decrease in deferred income
taxed;
o $1.3 million of cash generated by an increase in advance and
unearned premiums;
o $546,000 of cash generated from an increase in stock based
compensation expense;
o $527,000 of cash generated from an increase in accrued expenses;
o $379,000 of cash generated from depreciation and amortization;
o $168,000 of cash generated by an increase in accounts payable; and
o $116,000 of cash generated by a decrease in other current assets.
These sources of cash were partially offset by the following uses of cash:
o $576,000 increase in prepaid expenses; and
o $89,000 increase in accounts receivable.
Net cash used in investing activities for the nine months ended September 30,
2006 was approximately $7.3 million. The Company purchased $5.8 million of
short-term investments and incurred $1.6 million in capital expenditures during
the first nine months of 2006.
The Company's financing activities for the nine months ended September 30, 2006
provided approximately $141,000 of cash in connection with the issuance of
common stock upon the exercise of outstanding options.
During 2005, we incurred approximately $4.0 million of medical costs related to
the implantation of certain Implantable Automatic Defibrillators ("AICD's"). CMS
directed that the costs of certain of these procedures that met 2005 eligibility
requirements be paid by CMS, rather than billed to Medicare Advantage plans. We
are working with Humana and the related providers to secure reimbursement for
these amounts, and estimated a recovery of approximately $2.2 million at
December 31, 2005. Approximately $379,000 of this amount was collected during
the nine months ended September 30, 2006, while an additional $500,000 was
written off in the second quarter of 2006 due to revised guidance issued by CMS
regarding the costs payable by CMS in connection with these procedures. An
additional reserve of $500,000 was recorded during the quarter ending September
30, 2006 reflecting our concerns regarding the ultimate collection of these
recoveries and the timing of the collections.
On May 6, 2005 the Company executed an unsecured commercial line of credit
agreement with a bank, which provided for borrowings and issuance of letters of
credit of up to $1.0 million. The credit line expired on March 31, 2006 and was
automatically renewed for a one-year period until March 31, 2007. The
outstanding balance, if any, bears interest at the bank's prime rate. The credit
facility requires the Company to comply with certain financial covenants,
including a minimum liquidity requirement of $2.0 million. As of September 30,
2006, the availability under the line of credit secures a $1.0 million letter of
credit that the Company has caused to be issued in favor of Humana. As of
September 30, 2006, the Company has not borrowed funds under this commercial
line of credit.
Although we have operated as a risk provider since 1997, we have only operated
the HMO since July 1, 2005. While the HMO's business has continued to grow, such
growth has continued to require capital. In the nine months ended September 30,
2006, The HMO's business generated a $6.2 million segment loss before allocated
overhead and income taxes. We project that in fiscal 2006, the HMO's business
will generate a loss of $8 million to $10 million before allocated overhead and
income taxes. The amount of the loss will be determined by a number of factors
including membership, medical utilization and related costs, and our decisions
related to expansion and growth efforts. We are still not in a position to
meaningfully estimate when, if ever, the HMO's business will become profitable
and/or generate cash from operations and may be required to fund the development
and expansion of the HMO business, including any associated losses, for an
extended period of time. Nonetheless, we anticipate that the on-going
development efforts, reserve requirements and operating costs for our still
developing HMO business can be funded by our current resources and projected
cash flows from operations until at least September 30, 2007.
29
To successfully operate the HMO, we believe we will have to continue our
development of the following capabilities, among others: sales and marketing,
customer service and regulatory compliance. No assurances can be given that we
will be successful in operating this segment of our business despite our
allocation of a substantial amount of resources for this purpose. If The HMO
does not develop as anticipated or planned, we may have to devote additional
managerial and/or capital resources to the HMO, which could limit our ability to
manage and/or grow The PSN. There can be no assurances that, if for any reason,
we elect to discontinue the HMO business and/or seek to sell such business, we
will be able to fully recoup our expenditures to date with respect to the HMO
business.
In 2004, we adopted an investment policy with respect to the investment of our
Cash and equivalents. The investment policy goal is to obtain the highest yield
possible while investing only in highly rated instruments or investments with
nominal risk of loss of principal. The investment policy sets forth a list of
"Permitted Investments" and provides that the Chief Financial Officer or the
Chief Executive Officer must approve any exceptions to the policy. We had
approximately $5.8 million of short-term investments as of September 30, 2006
compared to none at December 31, 2005.
OFF-BALANCE SHEET ARRANGEMENTS
The Company does not have any Off-Balance Sheet Arrangements that have or are
reasonably likely to have a current or future effect on the Company's financial
condition, changes in financial condition, revenues or expenses, results of
operations, liquidity, capital expenditures or capital resources that are
material to investors.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk
Market risk generally represents the risk of loss that may result from the
potential change in value of a financial instrument as a result of fluctuations
in interest rates and market prices. At September 30, 2006, the Company had only
commercial paper, certificates of deposit and cash equivalents invested in high
grade, short-term and long-term securities, which are not typically subject to
material market risk. The Company has established policies and internal
processes related to the management of market risks, which it uses in the normal
course of its business operations.
Interest Rate Risk
The Company believes a change in interest rates would not have a material impact
on its financial condition, future results of operations or cash flows.
Intangible Asset Risk
The Company has a substantial amount of intangible assets. It is required to
perform goodwill impairment tests whenever events or circumstances indicate that
the carrying value may not be recoverable from estimated future cash flows. As a
result of its periodic evaluations, the Company may determine that the
intangible asset values need to be written down to their fair values, which
could result in material charges that could be adverse to its operating results
and financial position. Although at September 30, 2006 the Company believes its
intangible assets were recoverable, changes in the economy, the business in
which it operates and its own relative performance could change the assumptions
used to evaluate intangible asset recoverability. The Company continues to
monitor those assumptions and their effect on the estimated recoverability of
its intangible assets.
Equity Price Risk
The Company does not own any equity investments, other than in its subsidiaries.
As a result, it does not currently have any direct equity price risk.
30
Commodity Price Risk
The Company does not enter into contracts for the purchase or sale of
commodities. As a result, it does not currently have any direct commodity price
risk.
ITEM 4. CONTROLS AND PROCEDURES
Our Chief Executive Officer, who is also serving as Interim Chief Financial
Officer, participated in an evaluation by our management of the effectiveness of
our disclosure controls and procedures as of the end of our fiscal quarter that
ended on September 30, 2006. Based on his participation in that evaluation, our
CEO concluded that our disclosure controls and procedures were effective as of
September 30, 2006 to ensure that the information included in the reports that
we file or submit under the Securities Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
forms and that such information is accumulated and communicated to our
management, including our Chief Executive Officer, as appropriate, to allow
timely decisions regarding required disclosure. As described in detail in Note 7
to our condensed consolidated financial statements, we have amended our Form
10-Qs as of and for the quarterly periods ended March 30, 2006 and June 30,
2006. Our management, including our CEO, has re-evaluated our disclosure
controls and procedures as of the end of the period covered by this Report to
determine whether such restatement changes their prior conclusion, and has
determined that it does not change their conclusion that as of September 30,
2006, our disclosure controls and procedures were effective to ensure that the
information included in the reports that we file or submit under the Securities
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the SEC's rules and forms. Our CEO has concluded that he
does not believe that the internal control deficiency constitutes a material
weakness due to, among other things:
o The remote likelihood that the significant deficiency will result in
a material misstatement not being prevented or detected in the
future. (Humana, Inc.'s member premium revenue program in the
Daytona market was discontinued in 2006); and
o Various qualitative factors, including Humana, Inc.'s vested
interest in not paying us premiums that Humana, Inc. has not
received from its members.
During the third quarter of 2006, we announced the departure of our Chief
Financial Officer. The Chief Financial Officer is an integral part of our
internal control structure over financial reporting. During the third quarter
financial reporting process, our CEO was appointed Interim CFO and assumed the
responsibilities of the CFO related to the internal controls over financial
reporting. We have appointed a new CFO and anticipate that he will commence his
employment in November 2006. Other than the departure of the former CFO, there
have been no significant changes made in our internal controls over financial
reporting that occurred during the last fiscal quarter that have materially
affected or are reasonably likely to materially affect our internal control over
financial reporting.
31
PART II OTHER INFORMATION
ITEM 1. SUMMARY OF LEGAL PROCEEDINGS
The Company is a party to various legal proceedings which are either
immaterial in amount to the Company and its subsidiaries or involve
ordinary routine litigation incidental to the business of the Company and
its subsidiaries. There are no material pending legal proceedings, other
than routine litigation incidental to the business of the Company and its
subsidiaries, to which the Company or any of its subsidiaries is a party
of or which any property of the Company or its subsidiaries is the
subject.
ITEM 1A. RISK FACTORS
There have been no material changes in our risk factors from those
disclosed in our Annual Report on Form 10-K for the fiscal year ended
December 31, 2005 other than as set forth below:
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
NONE
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
NONE
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
NONE
ITEM 5. OTHER INFORMATION
NONE
ITEM 6. EXHIBITS
3.1 Articles of Incorporation, as amended (1)
3.2 Amended and Restated Bylaws (2)
10.1 Physician Practice Management Participation Agreement, dated August 2,
2001, between Metropolitan of Florida, Inc. and Humana, Inc. (3)
10.2 Letter of Agreement, dated February 2003, between Metropolitan of Florida,
Inc. and Humana, Inc. (4)
10.3 Physician Practice Management Participation Agreement, dated December
1,1998, between Metcare of Florida, Inc. and Humana, Inc. (9)
10.4 Supplemental Stock Option Plan (5)
10.5 Omnibus Equity Compensation Plan (6)
10.6 Amended and Restated Employment Agreement between Metropolitan and Michael
M. Earley dated January 3, 2005 (8)
10.7 Amended and Restated Employment Agreement between Metropolitan and David
S. Gartner dated January 3, 2005 (8)
10.8 Amended and Restated Employment Agreement between Metropolitan and Roberto
L. Palenzuela dated January 3, 2005 (8)
10.9 Amended and Restated Employment Agreement between Metropolitan and Debra
A. Finnel dated January 3, 2005 (8)
10.10 Employment Agreement between Metcare of Florida, Inc. and Jose A. Guethon,
M.D. (9)
10.11 Form of Option Award Agreement for Option Grants to Directors pursuant to
the Omnibus Compensation Plan (9)
10.12 Form of Option Award Agreement for Option Grants to Key Employees pursuant
to the Omnibus Compensation Plan (9)
10.13 Form of Option Award Agreement for Option Grants to Employees pursuant to
the Omnibus Compensation Plan (9)
32
10.14 Agreement between Metcare of Florida, Inc. and the Centers for Medicare
and Medicaid Services (10)
10.15 Code of Business Conduct and Ethics (9)
10.16 Employment Agreement between Metropolitan and Robert J. Sabo (11)
31.1 Certification of the Chief Executive Officer and Interim Chief Financial
Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
32.1 Certification of the Chief Executive Officer and Interim Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002**
----------------------------
* filed herewith
**furnished herewith
(1) Incorporated by reference to Metropolitan's Registration Statement on Form
8-A12B filed with the Commission on November 19, 2004 (No. 001-32361).
(2) Incorporated by reference to Metropolitan's Current Report on Form 8-K
filed with the Commission on September 30, 2004.
(3) Incorporated by reference to Metropolitan's Amendment to Registration
Statement on Form SB-2/A filed with the Commission on August 2, 2001 (No.
333-61566). Portions of this document were omitted and were filed
separately with the SEC on or about August 2, 2001 pursuant to a request
for confidential treatment.
(4) Incorporated by reference to Metropolitan's Amendment to Annual Report for
the fiscal year ended December 31, 2003 on Form 10-K/A filed with the
Commission on July 28, 2004. Portions of this document have been omitted
and were filed separately with the SEC on July 28, 2004 pursuant to a
request for confidential treatment.
(5) Incorporated by reference to Metropolitan's Amendment to Annual Report for
the fiscal year ended December 31, 2003 on Form 10-K/A filed with the
Commission on July 28, 2004.
(6) Incorporated by reference to Metropolitan's Registration Statement on Form
S-8 filed with the Commission on February 24, 2005 (No. 333-122976).
(7) Incorporated by reference to the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 2003, as filed with the Commission on
March 22, 2004.
(8) Incorporated by reference to the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 2004, as filed with the Commission on
March 22, 2005.
(9) Incorporated by reference to the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 2005, as filed with the Commission on
March 16, 2006.
(10) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the fiscal quarter ended March 31, 2006, as filed with the Commission
on May 15, 2006.
(11) Incorporated by reference to the Company's Current Report on Form 8-K
filed with the Commission on October 20, 2006.
33
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
Undersigned thereunto duly authorized.
METROPOLITAN HEALTH NETWORKS, INC.
Registrant
Date: November 14, 2006 /s/ Michael M. Earley
---------------------
Michael M. Earley
Chairman, Chief Executive Officer and
Interim Chief Financial Officer
34