UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

 

 

COMMISSION FILE NUMBER: 001-34746

 

 

ACCRETIVE HEALTH, INC.

(Exact name of registrant as specified in its charter)

 

 

 

 

401 North Michigan Avenue

Suite 2700

Chicago, Illinois 60611

(Address of principal executive offices)

 

 

(312) 324-7820

(Registrant’s telephone number, including area code)

 

 

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 þ     No o

 

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ     No o

 

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

(Do not check if a smaller reporting company)

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date.

 

 

 

 

Accretive Health, Inc.

FORM 10-Q
For the period ended June 30, 2011

Table of Contents

 

 

 

Accretive Health, Inc.

 

Condensed Consolidated Balance Sheets

 

 

See accompanying notes to condensed consolidated financial statements

Accretive Health, Inc.

 

Condensed Consolidated Statements of Income (Unaudited)

 

 

See accompanying notes to condensed consolidated financial statements

Accretive Health, Inc.

 

Condensed Consolidated Statements of Cash Flows (Unaudited)

 

 

See accompanying notes to condensed consolidated financial statements

 

 

Accretive Health, Inc. (“the Company”) is a leading provider of services that help healthcare providers generate sustainable improvements in their operating margins and healthcare quality while also improving patient, physician and staff satisfaction. The Company’s core service offering helps U.S. healthcare providers to more efficiently manage their revenue cycles, which encompass patient registration, insurance and benefit verification, medical treatment documentation and coding, bill preparation and collections. Accretive’s quality and total cost of care service offering, introduced in 2010, can enable healthcare providers to effectively manage the health of a defined patient population, which the Company believes is a future direction of the manner in which healthcare services will be delivered in the United States.

 

The accompanying unaudited condensed consolidated financial statements reflect the Company’s financial position as of June 30, 2011, the results of operations for the three and six months ended June 30, 2011 and 2010, and the cash flows of the Company for the six months ended June 30, 2011 and 2010. These financial statements include the accounts of Accretive Health, Inc. and its wholly owned subsidiaries. All significant intercompany accounts have been eliminated in consolidation. These financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial reporting and as required by the rules and regulations of the U.S. Securities and Exchange Commission (the “SEC”). Accordingly, certain information and footnote disclosures required for complete financial statements are not included herein. In the opinion of management, all adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation of the interim financial information have been included. Operating results for the three and six months ended June 30, 2011 are not necessarily indicative of the results that may be expected for any other interim period or for the fiscal year ending December 31, 2011.

 

When preparing financial statements in conformity with GAAP, the Company must make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures at the date of the financial statements. Actual results could differ from those estimates. For a more complete discussion of the Company’s significant accounting policies and other information, the unaudited condensed consolidated financial statements and notes thereto should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2010, included in the Company’s Annual Report on Form 10-K filed with the SEC on March 18, 2011 (File No. 001-34746).

 

 

In October 2009, the FASB issued ASU No. 09-13, Revenue Recognition — Multiple Deliverable Revenue Arrangements, or ASU 09-13. ASU 09-13 updates the existing multiple-element revenue arrangements guidance currently included in FASB ASC 605-25. The revised guidance provides for two significant changes to the existing multiple element revenue arrangements guidance. The first change relates to the determination of when the individual deliverables included in a multiple element arrangement may be treated as separate units of accounting. The second change modifies the manner in which the transaction consideration is allocated across the separately identified deliverables. Together, these changes are likely to result in earlier recognition of revenue and related costs for multiple-element arrangements than under the previous guidance. This guidance also significantly expands the disclosures required for multiple-element revenue arrangements. The revised multiple element revenue arrangements guidance is effective for the first annual reporting period beginning on or after June 15, 2010, however, early adoption is permitted, provided that the revised guidance is retroactively applied to the beginning of the year of adoption. The Company adopted this ASU as of January 1, 2011. The adoption did not have a significant impact on the Company’s condensed consolidated financial statements.

Accretive Health, Inc.

 

Notes to Condensed Consolidated Financial Statements (Unaudited) — (Continued)

 

 

The Company records its financial assets and liabilities at fair value. The accounting standard for fair value (i) defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date, (ii) establishes a framework for measuring fair value, (iii) establishes a hierarchy of fair value measurements based upon the observability of inputs used to value assets and liabilities, (iv) requires consideration of nonperformance risk, and (v) expands disclosures about the methods used to measure fair value.

 

The accounting standard establishes a three-level hierarchy of measurements based upon the reliability of observable and unobservable inputs used to arrive at fair value. Observable inputs are independent market data, while unobservable inputs reflect the Company’s assumptions about valuation. The three levels of the hierarchy are defined as follows:

 

 

The Company’s financial assets are required to be measured at fair value on a recurring basis. These financial assets consist of cash equivalents totaling $144.0 million, which are invested in highly liquid money market funds and treasury securities and accordingly classified as Level 1 assets in the fair value hierarchy. The Company does not have any financial liabilities that are required to be measured at fair value on a recurring basis.

 

 

All of the Company’s significant operations are organized around the single business of providing end-to-end management services of revenue cycle operations for U.S.-based hospitals and other medical providers. Accordingly, for purposes of disclosure under ASC 280, Segment Reporting, the Company has only one operating segment and reporting unit. All of the Company’s net services revenue and trade accounts receivable are derived from healthcare providers domiciled in the United States.

 

While managed independently and governed by separate contracts, several of the Company’s customers are affiliated with a single healthcare system, Ascension Health. Pursuant to the Company’s master services agreement with Ascension Health, the Company provides services to Ascension Health’s affiliated hospitals that execute separate contracts with the Company. The Company’s aggregate net services revenue from these hospitals accounted for 43.9% and 53.8% of the Company’s total net services revenue during the three months ended June 30, 2011 and 2010, respectively. The Company’s aggregate net services revenue from these hospitals accounted for 46.4% and 56.3% of the Company’s total net services revenue during the six months ended June 30, 2011 and 2010, respectively.

 

Additionally, Henry Ford Health System, which is not affiliated with Ascension Health, with which the Company entered into a managed service contract in 2009, accounted for 9.4% and 10.8% of the Company’s total net services revenue in the three months ended June 30, 2011 and 2010, respectively. Henry Ford Health System’s revenue accounted for 9.2% and 10.9% of the Company’s total net services revenue in the six months ended June 30, 2011 and 2010. Fairview Health Systems, which is not affiliated with Ascension Health, with which the Company entered into a managed service contract in the first half of 2010, accounted for 13.8% and

Accretive Health, Inc.

 

Notes to Condensed Consolidated Financial Statements (Unaudited) — (Continued)

 

10.6% of the Company’s total net services revenue for the three months ended June 30, 2011 and 2010, respectively. Fairview Health Systems accounted for 14.4% and 5.8% of the Company’s total net services revenue for the six months ended June 30, 2011 and 2010, respectively.

 

 

The Company’s net services revenue consisted of the following for the three and six months ended June 30, 2011 and 2010 (in thousands):

 

 

 

Income tax provisions for interim periods are based on estimated annual income tax rates, adjusted to reflect the effects of any significant infrequent or unusual items which are required to be discretely recognized within the current interim period. The Company’s intention is to permanently reinvest its foreign earnings outside of the United States. As a result, the effective tax rates in the periods presented are largely based upon the projected annual pre-tax earnings by jurisdiction and the allocation of certain expenses in various taxing jurisdictions, where the Company conducts its business. These taxing jurisdictions apply a broad range of statutory income tax rates.

 

Income tax expense for the three and six months ended June 30, 2011 is different from the amount derived by applying the federal statutory tax rate of 35% mainly due to the impact of certain state income taxes and state taxes which are based on gross receipts.

 

The Company and its subsidiaries are subject to U.S. federal income tax as well as income taxes of multiple state and foreign jurisdictions. U.S. federal income tax returns for 2008, 2009, and 2010 are currently open for examination. State jurisdictions vary for open tax years. The statutes of limitations for most states range from three to six years.

 

 

Common Stock

 

In March 2011, the Company completed a public offering in which 7,475,000 shares of common stock were sold by certain selling stockholders at an offering price of $23.50 per share. The Company did not sell any securities nor did it receive any of the proceeds from the sale of the shares. The offering generated gross proceeds to the selling stockholders of $175.7 million, or $167.8 million net of underwriting discounts. The Company incurred approximately $1.0 million of expenses relating to this offering, which is included in selling, general and administrative expenses in the condensed consolidated statements of income.

 

Stock Options

 

The Company maintains a 2006 Amended and Restated Stock Option Plan, as amended (the “2006 Plan”). In April 2010, the Company adopted a new 2010 Stock Incentive Plan (the “2010 Plan”), which became effective immediately prior to the closing of the initial public offering. The Company will not make

Accretive Health, Inc.

 

Notes to Condensed Consolidated Financial Statements (Unaudited) — (Continued)

 

any further grants under the 2006 Plan, and the 2010 Plan provides for the grant of incentive stock options, non-statutory stock options, restricted stock awards and other stock-based awards. As of June 30, 2011, an aggregate of 14,740,806 shares were subject to outstanding options under both plans, and 6,450,188 shares were available for grant. However, to the extent that previously granted awards under the 2006 Plan or 2010 Plan expire, terminate or are otherwise surrendered, cancelled, forfeited or repurchased by the Company, the number of shares available for future awards will increase, up to a maximum of 24,374,756 shares.

 

A summary of the options activity during the six months ended June 30, 2011 is shown below:

 

 

The share-based compensation costs relating to the Company’s stock options for the three months ended June 30, 2011 and 2010 were $5.4 million and $3.6 million, with related tax benefits of approximately $2.1 million and $1.4 million, respectively. The share-based compensation costs relating to the Company’s stock options for the six months ended June 30, 2011 and 2010 were $11.3 million and $5.5 million, with related tax benefits of approximately $4.5 million and $2.2 million, respectively.

 

 

Basic net income per share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted net income per share is computed by dividing net income by the weighted average number of common shares outstanding and potentially dilutive securities outstanding during the period under the treasury stock method. Under the treasury stock method, dilutive securities are assumed to be exercised at the beginning of the periods and as if funds obtained thereby were used to purchase common stock at the average market price during the period. Securities are excluded from the computations of diluted net income per share if their effect would be anti-dilutive to earnings per share.

Accretive Health, Inc.

 

Notes to Condensed Consolidated Financial Statements (Unaudited) — (Continued)

 

The following table sets forth the computation of basic and diluted earnings per share available to common shareholders for the three and six months ended June 30, 2011 and 2010, respectively.

 

 

Because of their anti-dilutive effect, 2,006,754 and 8,868,338 common share equivalents comprised of stock options have been excluded from the diluted earnings per share calculation for the three and six months ended June 30, 2011 and 2010, respectively.

 

 

The components of total comprehensive income were as follows (in thousands):

 

 

 

From time to time, the Company has been and may become involved in legal or regulatory proceedings arising in the ordinary course of business. The Company is not presently a party to any material litigation or regulatory proceeding and the Company’s management is not aware of any pending or threatened litigation or regulatory proceeding that could have a material adverse effect on the Company’s business, operating results, financial condition or cash flows.

 

 

The Company has a $15 million line of credit with the Bank of Montreal, which may be used for working capital and general corporate purposes. Any amounts outstanding under the line of credit accrue interest at LIBOR plus 4% and are secured by substantially all of the Company’s assets. Advances under the line of credit are limited to a borrowing base and a cash deposit account which will be established at the time borrowings occur. The line of credit has an initial term of two years and is renewable annually thereafter. As of June 30, 2011, the Company had no amounts outstanding under this line of credit; however, letters of credit to various landlords in the aggregate of approximately $1.8 million reduced the Company’s available line of

Accretive Health, Inc.

 

Notes to Condensed Consolidated Financial Statements (Unaudited) — (Continued)

 

credit to $13.2 million. The line of credit contains restrictive covenants which limit the Company’s ability to, among other things, enter into other borrowing arrangements and pay dividends.

 

From time to time the Company makes commitments regarding its performance under certain portions of its managed service contracts. In the event that the Company does not meet any of these performance requirements, it may incur expenses to remedy the performance issue. The Company reviews its compliance with its contractual performance commitments on a quarterly basis. As of June 30, 2011 and December 31, 2010, the Company met all of its performance commitments and, as a result, has not recorded any liabilities for potential obligations.

 

 

On July 19, 2011 the Company notified one of its customers that it was exercising its dispute resolution rights due to, among other matters, the customer’s failure to pay outstanding trade receivables. The receivables from the customer at June 30, 2011 totaled $7.7 million. The Company believes that its billings are correct and intends to aggressively seek payment of the amounts due through the dispute resolution and arbitration provisions of the contract. The Company did not accrue any reserves relating to this receivable at June 30, 2011.

 

Unless the context indicates otherwise, references in this Quarterly Report on Form 10-Q to “Accretive Health”, “the Company,” “we,” “our,” and “us” mean Accretive Health, Inc., and its subsidiaries.

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the unaudited condensed consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and notes thereto and management’s discussion and analysis of financial condition and results of operations for the year ended December 31, 2010 included in our Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission, or SEC, on March 18, 2011 (File No. 001-34746). This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. These statements are often identified by the use of words such as “may,” “will,” “expect,” “believe,” “anticipate,” “intend,” “could,” “estimate,” or “continue,” and similar expressions or variations. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the section titled “Risk Factors,” set forth in our 2010 Annual Report on Form 10-K. The forward-looking statements in this Quarterly Report on Form 10-Q represent our views as of the date of this Quarterly Report on Form 10-Q. Subsequent events and developments may cause our views to change. While we may elect to update these forward-looking statements at some point in the future, we have no current intention of doing so except to the extent required by applicable law. You should, therefore, not rely on these forward-looking statements as representing our views as of any date subsequent to the date of this Quarterly Report on Form 10-Q.

 

About the Company

 

Accretive Health is a leading provider of services that help healthcare providers generate sustainable improvements in their operating margins and healthcare quality while also improving patient, physician and staff satisfaction. Our core service offering helps U.S. healthcare providers to more efficiently manage their revenue cycles, which encompass patient registration, insurance and benefit verification, medical treatment documentation and coding, bill preparation and collections. Our quality and total cost of care service offering, introduced in 2010, can enable healthcare providers to effectively manage the health of a defined patient population, which we believe is a future direction of the manner in which healthcare services will be delivered in the United States.

 

Our integrated revenue cycle technology and services offering spans the entire revenue cycle. We help our revenue cycle customers increase the portion of the maximum potential patient revenue they receive, while reducing total revenue cycle costs. Our quality and total cost of care solution is designed to help our customers identify the individuals who are most likely to experience an adverse health event and, as a result, incur high healthcare costs in the coming year. This data allows providers to focus greater efforts on managing these patients within and across the delivery system, as well as at home.

 

Our customers typically are multi-hospital systems, including faith-based or community healthcare systems, academic medical centers and independent ambulatory clinics, and their affiliated physician practice groups. To implement our solutions, we assume full responsibility for the management and cost of the operations we have contracted to manage and supplement the customer’s existing staff involved in such operations with seasoned Accretive Health personnel. A customer’s revenue improvements and cost savings generally increase over time as we deploy additional programs and as the programs we implement become more effective, which in turn provides visibility into our future revenue and profitability.

 

Our revenue cycle management services customers have historically achieved significant net revenue yield improvements within 18 to 24 months of implementing our solution, with such customers operating under mature managed service contracts typically realizing 400 to 600 basis points in yield improvements in the third or fourth contract year. All of a customer’s yield improvements during the period in which we provide

services are attributed to our solution because we assume full responsibility for the management of the customer’s revenue cycle. Our methodology for measuring yield improvements excludes the impact of external factors such as changes in reimbursement rates from payors, the expansion of existing services or addition of new services, volume increases and acquisitions of hospitals or physician practices, which may impact net patient revenue but are not considered changes to net revenue yield.

 

We and our customers share financial gains resulting from our solutions, which directly aligns our objectives and interests with those of our customers. Both we and our customers benefit — on a contractually agreed-upon basis — from net patient revenue increases realized by the customers as a result of our services. To date, we have experienced a contract renewal rate of 100% (excluding exploratory new service offerings, a consensual termination following a change of control and a customer reorganization). Coupled with the long-term nature of our managed service contracts and the fixed nature of the base fees under each contract, our historical renewal experience provides a core source of recurring revenue.

 

We believe that current macroeconomic conditions will continue to impose financial pressure on healthcare providers and will increase the importance of managing their operations effectively and efficiently. Additionally, the continued operating pressures facing U.S. hospitals coupled with some of the underlying themes of healthcare reform legislation enacted in March 2010 make the efficient management of the revenue cycle, including collection of the full amount of payments due for patient services, and quality and total cost of care initiatives, among the most critical challenges facing healthcare providers today.

 

Seasonality

 

Our quarterly and annual net services revenue generally increased each period due to ongoing expansion in the number of hospitals subject to managed service contracts with us and increases in the amount of incentive payments earned. The timing of customer additions is not uniform throughout the year. We also experience fluctuations in incentive payments as a result of patients’ ability to accelerate or defer elective procedures, particularly around holidays such as Thanksgiving and Christmas. Generally, incentive payments earned are lower in the first quarter of each year and higher in the fourth quarter of each year. For example, incentive payments in the quarter ended March 31, 2011 were $17.3 million, or only 75% of the $23.2 million earned in the quarter ended December 31, 2010. As a result of incentive payment fluctuations, our adjusted EBITDA is typically lower in the first quarter of each fiscal year. For example, our adjusted EBITDA of $4.4 million for the quarter ended March 31, 2010 represented less than 10% of our $45.0 million of adjusted EBITDA for the year ended December 31, 2010. We expect this seasonality to continue in our business and we believe that first quarter adjusted EBITDA will average approximately 10% of full fiscal year adjusted EBITDA for the foreseeable future; provided, however, that due to the factors described above, as well as other factors, some of which may be beyond our control, our actual results could differ materially from these estimates.

 

FINANCIAL OPERATIONS OVERVIEW

 

Net Services Revenue

 

We derive our net services revenue primarily from service contracts under which we manage our customers’ revenue cycle or quality and total cost of care operations. Revenues from managed service contracts consist of base fees and incentive payments:

 

 

 

In addition, we earn revenue from other services, which primarily include our share of revenues associated with the collection of dormant patient accounts (more than 365 days old) under some of our service contracts. We also receive revenue from other services provided to customers that are not part of our integrated service offerings, such as reviewing a customer’s charge data master, physician advisory services or consulting on the billing for individuals receiving emergency room treatment.

 

Some of our service contracts entitle customers to receive a share of the cost savings we achieve from operating their revenue cycle. This share is returned to customers as a reduction in subsequent base fees or incentive fees. Our services revenue is reported net of cost sharing, and we refer to this as our net services revenue.

 

The following table summarizes the composition of our net services revenue for the three and six months ended June 30, 2011 and 2010, on a percentage basis:

 

 

For the three and six months ended June 30, 2011 and 2010, our net base fee and incentive payments were exclusively related to our revenue cycle management services. We were unable to record revenues for the benefits that may have been achieved in our quality and total cost of care services contract as the amounts were not yet sufficiently fixed and determinable to qualify for revenue recognition under our accounting policy.

 

Costs of Services

 

Under our managed service contracts, we assume responsibility for all costs necessary to conduct our customers’ revenue cycle operations. Costs of services consist primarily of:

 

 

For the three and six months ended June 30, 2011 and 2010, our costs of services were primarily related to the revenue cycle management services.

Operating Margin

 

Operating margin is equal to net services revenue less costs of services. Our operating model is designed to improve margin under each managed service contract as the contract matures, for several reasons:

 

 

Infused Management and Technology Expenses

 

We refer to our management and staff employees that we devote on-site to customer operations as infused management. Infused management and technology expenses consist primarily of the wages, bonuses, benefits, share based compensation, travel and other costs associated with deploying our employees on customer sites to guide and manage our customers’ revenue cycle or quality and total cost of care operations. The employees we deploy on customer sites typically have significant experience in revenue cycle operations, care coordination, technology, quality control or other management disciplines. The other significant portion of these expenses is an allocation of the costs associated with maintaining, improving and deploying our integrated proprietary technology suite and an allocation of the costs previously capitalized for developing our integrated proprietary technology suite.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses consist primarily of expenses for executive, sales, corporate information technology, legal, regulatory compliance, finance and human resources personnel, including wages, bonuses, benefits and share-based compensation; fees for professional services; insurance premiums; facility charges; and other corporate expenses. Professional services consist primarily of external legal, tax and audit services. The costs of developing the processes and technology for our emerging quality and total cost of care service offering prior to November 2010, when we signed our inaugural client, are also included in selling, general and administrative expenses. Subsequent to November 2010, costs associated with operating our quality and total cost of care managed service contract are a part of infused management and technology costs. We expect selling, general and administrative expenses to increase in absolute dollars as we continue to add information technology, human resources, finance, accounting and other administrative personnel as we expand our business.

 

We also expect to incur additional professional fees and other expenses resulting from future expansion and the compliance requirements of operating as a public company, including increased audit and legal expenses, investor relations expenses, increased insurance expenses, particularly for directors’ and officers’ liability insurance, and the costs of complying with Section 404 of the Sarbanes-Oxley Act. While these costs may initially increase as a percentage of our net services revenue, we expect that in the future these expenses will increase at a slower rate than our overall business volume, and that they will eventually represent a smaller percentage of our net services revenue.

 

Although we cannot predict future changes to the laws and regulations affecting us or the healthcare industry generally, we do not expect that any associated changes to our compliance programs will have a material effect on our selling, general and administrative expenses.

 

Interest Income

 

Interest income is derived from the return achieved from our cash balances. We invest primarily in highly liquid, short-term investments, primarily those insured by the U.S. government.

Income Taxes

 

Income tax expense consists of federal and state income taxes in the United States and India. Additionally, we incur income taxes in states which impose a tax based on gross receipts in addition to a tax based on income. In August 2010, one of the states, where a large portion of our operations is conducted, enacted legislation that reduced our current and future obligations under the gross receipts tax.

 

CRITICAL ACCOUNTING POLICIES

 

For a description of our critical accounting policies and estimates, see our Annual Report on Form 10-K for the year ended December 31, 2010.

 

Legal Proceedings

 

From time to time, we have been and may become involved in legal or regulatory proceedings arising in the ordinary course of business. We are not presently a party to any material litigation or regulatory proceeding and we are not aware of any pending or threatened litigation or regulatory proceeding that could have a material adverse effect on our business, operating results, financial condition or cash flows.

 

New Accounting Standards and Disclosures

 

In October 2009, the FASB issued ASU No. 09-13, Revenue Recognition — Multiple Deliverable Revenue Arrangements, or ASU 09-13. ASU 09-13 updates the existing multiple-element revenue arrangements guidance currently included in FASB ASC 605-25. The revised guidance provides for two significant changes to the existing multiple element revenue arrangements guidance. The first change relates to the determination of when the individual deliverables included in a multiple element arrangement may be treated as separate units of accounting. The second change modifies the manner in which the transaction consideration is allocated across the separately identified deliverables. Together, these changes are likely to result in earlier recognition of revenue and related costs for multiple-element arrangements than under the previous guidance. This guidance also significantly expands the disclosures required for multiple-element revenue arrangements. The revised multiple element revenue arrangements guidance is effective for the first annual reporting period beginning on or after June 15, 2010, however, early adoption is permitted, provided that the revised guidance is retroactively applied to the beginning of the year of adoption. We adopted this ASU as of January 1, 2011. The adoption did not have a significant impact on our condensed consolidated financial statements.

CONSOLIDATED RESULTS OF OPERATIONS

 

Our key consolidated financial and operating data are as follows (in thousands):

 

 

 

 

 

RESULTS OF OPERATIONS

 

Three Months Ended June 30, 2011 Compared to Three Months Ended June 30, 2010

 

Net Services Revenues

 

The following table summarizes the composition of our net services revenue for the three months ended June 30, 2011 and 2010, respectively (in thousands):

 

 

Net services revenue increased $31.7 million, or 20.9%, to $183.6 million for the three months ended June 30, 2011, from $151.9 million for the three months ended June 30, 2010. Net base fee revenue, which accounted for the majority of the increase, increased $20.9 million, or 16.3%, to $149.1 million for the three months ended June 30, 2011, from $128.2 million for the three months ended June 30, 2010, primarily due to an increase in the number of hospitals with which we had managed service contracts from 61 as of June 30, 2010 to 74 as of June 30, 2011. We have added three new customers during the quarter ended June 30, 2011. In addition, incentive payment revenues increased by $5.8 million, or 29.1%, to $25.9 million for the three months ended June 30, 2011, from $20.1 million for the three months ended June 30, 2010, consistent with the increases that generally occur as our managed service contracts mature.

 

Our projected contracted annual revenue run rate at June 30, 2011 was $840 million to $857 million compared to $614 million to $626 million at June 30, 2010. Based on the midpoint of the two ranges, our projected contracted annual revenue run rate as of June 30, 2011 increased by $229 million, or 36.9%. We define our projected contracted annual revenue run rate as the expected total net services revenue for the subsequent twelve months for all healthcare providers for which we are providing services that are under contract as of the end of the reporting period.

 

Costs of Services

 

Our costs of services increased $18.5 million, or 15.7%, to $136.5 million for the three months ended June 30, 2011, from $118.0 million for the three months ended June 30, 2010. The increase in costs of services was primarily attributable to the increase in the number of hospitals for which we provide managed services.

 

Operating Margin

 

Operating margin increased $13.2 million, or 38.8%, to $47.1 million for the three months ended June 30, 2011 from $33.9 million for the three months ended June 30, 2010. The operating margin as a percentage of net services revenue increased from 22.3% for the three months ended June 30, 2010 to 25.6% for the three months ended June 30, 2011, primarily due to increased levels of cost efficiencies in the performance of our

managed service contracts, net of shared customer cost savings and an increased ratio of mature managed service contracts.

 

Operating Expenses

 

Infused management and technology expenses increased $5.1 million, or 31.3%, to $21.2 million for the three months ended June 30, 2011, from $16.1 million for the three months ended June 30, 2010. The increase was primarily due to the incremental costs related to our quality and total cost of care offering, an increase in the number of our management personnel deployed at customer facilities, and an increase in the number of new management personnel being hired and trained in anticipation of their deployment to customer sites.

 

Selling, general and administrative expenses increased $2.3 million, or 22.4%, to $12.6 million for the three months ended June 30, 2011, from $10.3 million for the three months ended June 30, 2010. The increase included the net incremental business development expenses of approximately $1.1 million, net of share-based compensation expense. The increase also included $1.0 million of additional depreciation, amortization and share-based compensation expense as discussed below.

 

We allocate share-based compensation expense and depreciation and amortization expense between cost of services, infused management expenses and selling, general and administrative expenses. During the three months ended June 30, 2011, the following changes affected the infused management and SG&A expense categories:

 

 

For the three months ended June 30, 2011, approximately $0.5 million and $0.6 million of share-based compensation expense and depreciation and amortization expense, respectively, was allocated to cost of services due to the expansion of our shared services centers. No such allocation was done for the three months ended June 30, 2010 as the amount was not material.

 

Income Taxes

 

Tax expense increased $1.2 million to $4.7 million for the three months ended June 30, 2011, from $3.5 million for the three months ended June 30, 2010. The increase was primarily due to the increase in taxable income during the period, offset by the reduction in gross receipts tax liability in one of the states, where a large portion of our operations is conducted, as a result of the legislative change which occurred in August 2010.

Six Months Ended June 30, 2011 Compared to Six Months Ended June 30, 2010

 

Net Services Revenues

 

The following table summarizes the composition of our net services revenue for the six months ended June 30, 2011 and 2010, respectively (in thousands):

 

 

Net services revenue increased $69.5 million, or 25.0%, to $347.3 million for the six months ended June 30, 2011, from $277.8 million for the six months ended June 30, 2010. The largest component of the increase, net base fee revenue, increased $51.3 million, or 21.4%, to $290.8 million for the six months ended June 30, 2011, from $239.6 million for the six months ended June 30, 2010, primarily due to an increase in the number of hospitals with which we had managed service contracts from 61 as of June 30, 2010 to 74 as of June 30, 2011. In addition, incentive payment revenues increased by $10.8 million, or 33.4%, to $43.2 million for the six months ended June 30, 2011, from $32.4 million for the six months ended June 30, 2010, consistent with the increases that generally occur as our managed service contracts mature.

 

Costs of Services

 

Our costs of services increased $45.8 million, or 20.8%, to $266.1 million for the six months ended June 30, 2011, from $220.3 million for the six months ended June 30, 2010. The increase in costs of services was primarily attributable to the increase in the number of hospitals for which we provide managed services.

 

Operating Margin

 

Operating margin increased $23.7 million, or 41.2%, to $81.2 million for the six months ended June 30, 2011 from $57.5 million for the six months ended June 30, 2010. The operating margin as a percentage of net services revenue increased from 20.7% for the six months ended June 30, 2010 to 23.4% for the six months ended June 30, 2011, primarily due to increased levels of cost efficiencies in the performance of our managed service contracts, net of shared customer cost savings and an increased ratio of mature managed service contracts.

 

Operating Expenses

 

Infused management and technology expenses increased $9.7 million, or 31.2%, to $40.7 million for the six months ended June 30, 2011, from $31.1 million for the six months ended June 30, 2010. The increase was primarily due to the incremental costs related to our quality and total cost of care offering, an increase in the number of our management personnel deployed at customer facilities, and an increase in the number of new management personnel being hired and trained in anticipation of their deployment to customer sites.

 

Selling, general and administrative expenses increased $9.0 million, or 50.2%, to $26.9 million for the six months ended June 30, 2011, from $17.9 million for the six months ended June 30, 2010. The increase included $1.0 million of secondary offering costs, $1.4 million of public company costs and $3.1 million for increases in sales and marketing personnel costs, net of share-based compensation expense. The increase also included $3.6 million of additional depreciation, amortization and share-based compensation expense as discussed below.

We allocate share-based compensation expense and depreciation and amortization expense between cost of services, infused management expenses and selling, general and administrative expenses. During the six months ended June 30, 2011, the following changes affected the infused management and SG&A expense categories:

 

 

For the six months ended June 30, 2011, approximately $1.1 million and $1.1 million of share-based compensation expense and depreciation and amortization expense, respectively, was allocated to cost of services due to the expansion of our shared services centers.

 

Income Taxes

 

Tax expense increased $0.5 million to $4.9 million for the six months ended June 30, 2011, from $4.4 million for the six months ended June 30, 2010. The increase was primarily due to the increase in taxable income during the period offset by reduction in gross receipts tax liability in one of the states, where a large portion of our operations is conducted, as a result of the legislative change which occurred in August, 2010.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Our primary source of liquidity is cash flows from operations. Given our current cash and cash equivalents and accounts receivable, we believe that we will have sufficient funds to meet our long-term and short-term liquidity and capital needs. We expect that the combination of our current liquidity and expected additional cash generated from operations will be sufficient for our planned capital expenditures, which are expected to consist primarily of capitalized software, fixed assets as we continue building out our infrastructure, and other investing activities, in the next 12 months.

 

Our cash and cash equivalents were $150.3 million at June 30, 2011 as compared to $155.6 million as of December 31, 2010. Our initial public offering (the “IPO”), which closed on May 25, 2010, generated gross proceeds to us of $80.8 million, net of underwriting discounts and offering expenses. Through June 30, 2011, we did not use any of our proceeds from the IPO, which are invested in highly liquid money market funds and treasury securities.

 

Cash flows from operating, investing and financing activities, as reflected in our condensed consolidated statements of cash flows, are summarized in the following table (in thousands):

 

 

Operating Activities

 

Cash used in operating activities for the six months ended June 30, 2011 totaled $28.5 million, as compared to the cash used by operating activities of $2.3 million for the six months ended June 30, 2010.

Receivables from customers increased by $38.1 million and $19.1 million during the six months ended June 30, 2011 and June 30, 2010, respectively, primarily due to the increased net services revenues and the timing of customer payments. On July 19, 2011, we notified one of our customers that we were exercising our dispute resolution rights with respect to, among other matters, the customer’s failure to pay outstanding trade receivables. The receivables from the customer totaled $7.7 million at June 30, 2011. We believe that our billings are correct and intend to aggressively seek payment of the amounts due through the dispute resolution and arbitration provisions of the contract. We did not accrue any reserves relating to this receivable at June 30, 2011. Excess tax benefits from equity-based awards of $16.9 million resulted in an equivalent increase in prepaid taxes, as these benefits could not be used in the current period as income taxes payable had already been reduced to $0. This resulted in the full $16.9 million being accounted for as cash used in operating activities. Accounts payable and accrued service costs increased by $4.3 million and $10.1 million for the six months ended June 30, 2011 and 2010, respectively, due to the timing of vendor payments. Deferred revenue decreased by $2.5 million for the six months ended June 30, 2011 and $5.9 million for the six months ended June 30, 2010 primarily due to the timing of cash receipts from our customers. For the three months ended June 30, 2011, cash provided by operating activities was $16.8 million as compared to $7.7 million for the three months ended June 30, 2010.

 

Investing Activities

 

Cash used in investing activities was $5.8 million for the six months ended June 30, 2011, which included approximately $6.8 million of capital expenditures, offset by $1.0 million of note receivable collections. Cash used in investing activities for the six months ended June 30, 2010 totaled $5.8 million. Use of cash in these periods primarily related to the purchase of furniture and fixtures, leasehold improvements, computer hardware and software to support the growth of our business.

 

Financing Activities

 

Cash provided by financing activities was $29.1 million for the six months ended June 30, 2011 primarily due to the receipt of proceeds from our employees’ stock option exercises and the related favorable effect of approximately $16.9 million on our future tax liability. Cash provided by financing activities was $84.4 million for the six months ended June 30, 2010 due to the receipt of proceeds from our IPO.

 

Revolving Credit Facility

 

On September 30, 2009, we entered into a $15 million line of credit with the Bank of Montreal, which may be used for working capital and general corporate purposes. Any amounts outstanding under the line of credit accrue interest at LIBOR plus 4% and are secured by substantially all of the Company’s assets. Advances under the line of credit are limited to a borrowing base and a cash deposit account which will be established at the time borrowings occur. The line of credit has an initial term of two years and is renewable annually thereafter. As of June 30, 2011, we had no amounts outstanding under this line of credit; however, letters of credit to various landlords in the aggregate of approximately $1.8 million reduced our available line of credit to $13.2 million. The line of credit contains restrictive covenants which limit our ability to, among other things, enter into other borrowing arrangements and pay dividends.

 

Future Capital Requirements

 

We intend to fund our future growth over the next 12 months with funds generated from operations and our net proceeds from the IPO. Over the longer term, we expect that cash flows from operations, supplemented by short-term and long-term financing, as necessary, will be adequate to fund our day-to-day operations and capital expenditure requirements. Our ability to secure short-term and long-term financing in the future will depend on several factors, including our future profitability, the quality of our accounts receivable, our relative levels of debt and equity, and the overall condition of the credit markets.

OFF-BALANCE SHEET ARRANGEMENTS

 

We do not have any off-balance sheet arrangements.

 

USE OF NON-GAAP FINANCIAL MEASURES

 

In order to provide stockholders with greater insight and to allow for better understanding of how our management and board of directors analyze our financial performance and make operational decisions, we supplement our condensed consolidated financial statements presented on a GAAP basis in this Quarterly Report on Form 10-Q with the adjusted EBITDA measure.

 

Adjusted EBITDA as a measure has limitations, as noted below, and should not be considered in isolation or in substitute for analysis of our results as reported under GAAP.

 

Our management uses adjusted EBITDA:

 

 

We believe adjusted EBITDA is useful to stockholders in evaluating our operating performance for the following reasons:

 

 

We understand that, although measures similar to adjusted EBITDA are frequently used by investors and securities analysts in their evaluation of companies, these measures have limitations as analytical tools, and you should not consider it in isolation or as a substitute for analysis of our results of operations as reported under GAAP. Some of these limitations are:

 

 

To properly and prudently evaluate our business, we encourage you to review the GAAP financial statements included elsewhere in this Form 10-Q, and not to rely on any single financial measure to evaluate our business.

 

The following table presents a reconciliation of adjusted EBITDA to net income, the most comparable GAAP measure (in thousands):

 

 

 

 

 

Interest Rate Sensitivity.  Our interest income is primarily generated from interest earned on all cash and cash equivalents. Our exposure to market risks related to interest expense is limited to borrowings under our revolving line of credit, which bears interest at LIBOR plus 4%. To date, there have been no borrowings under this facility. We do not enter into interest rate swaps, caps or collars or other hedging instruments.

 

Foreign Currency Exchange Risk.  Our results of operations and cash flows are subject to fluctuations due to changes in the Indian rupee because a portion of our operating expenses are incurred by our subsidiary in India and are denominated in Indian rupees. However, we do not generate any revenues outside of the United States. For the six months ended June 30, 2011 and 2010, less than 5% of our expenses were denominated in Indian rupees. As a result, we believe that the risk of a significant impact on our operating income from foreign currency fluctuations is not substantial.

 

 

Evaluation of Disclosure Controls and Procedures

 

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as defined in Rule 13a-15(e) under the Exchange Act as of June 30, 2011. Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives of ensuring that information we are required to disclose in the reports we file or submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures, and is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. There is no assurance that our disclosure controls and procedures will operate effectively under all circumstances. Based upon the evaluation described above our Chief Executive Officer and Chief Financial Officer concluded that, as of June 30, 2011, our disclosure controls and procedures were effective at the reasonable assurance level.

No change in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the quarter ended June 30, 2011 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

PART II — OTHER INFORMATION

 

 

The information set forth under Note 10 — Legal to the unaudited condensed consolidated financial statements of this quarterly report on Form 10-Q is incorporated herein by reference.

 

 

There have been no material changes from the Risk Factors described in our Annual Report on Form 10-K for the year ended December 31, 2010 (“2010 Form 10-K”).

 

 

Use of Proceeds from Initial Public Offering

 

From the effective date of our Initial Public Offering’s registration statement through June 30, 2011, we did not use any of our proceeds from the IPO. There has been no change in the planned use of proceeds from the initial public offering as described in our Registration Statement on Form S-1 declared effective by the SEC on May 19, 2010.

 

Unregistered Sale of Equity Securities

 

During the three months ended June 30, 2011, there were no unregistered sales of equity securities.

 

 

Not applicable.

 

 

 

Not applicable.

 

 

 

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.

 

ACCRETIVE HEALTH, INC
Registrant

 

Mary A. Tolan

Director, Founder, President and Chief Executive Officer

(Principal Executive Officer)

 

John T. Staton

Chief Financial Officer and Treasurer

(Principal Financial Officer)

 

Date: August 12, 2011