Rural/Metro Corp. CEO JACK E BRUCKER bought 70000 shares on 5-15-2008 at $2.35
Rural/Metro Corporation was founded in 1948 as an Arizona private fire protection services business providing services to residential and commercial property owners on a subscription fee basis. In 1983 the Company began its expansion into the ambulance services industry, which involved the acquisition of various ambulance service providers throughout the United States for a period of time ending in 1998. For the twelve months ended June 30, 2007, we provided ambulance services and other services to more than one million individuals in approximately 400 communities nationwide generating net revenue of $467.6 million, of which ambulance services and other services represented 84% and 16%, respectively.
All references to the â€śCompany,â€ť â€śwe,â€ť â€śour,â€ť â€śus,â€ť â€śR/M,â€ť or â€śRural/Metroâ€ť refer to Rural/Metro Corporation, and its predecessors, operating divisions, direct and indirect subsidiaries and affiliates. Rural/Metro Corporation, a Delaware corporation, is strictly a holding company. All services, operations and management functions are provided through its subsidiaries and affiliated entities. The website for Rural/Metro Corporation is located at www.ruralmetro.com. The information in our website is not incorporated in, and is not a part of, this Report.
Ambulance Industry Overview
We estimate that expenditures for emergency and non-emergency medical ambulance services in the United States were approximately $8.0 billion for 2007. Ambulance services are provided by municipalities, private providers, hospitals and volunteer organizations. According to the Journal of Emergency Medical Services â€™ 2005 Annual 200-City Survey, 47% of the nationâ€™s largest 200 cities outsourced emergency ambulance services to private service providers. Non-emergency ambulance services are primarily provided by private providers. There are a limited number of regional ambulance providers and we are one of only two national providers.
We believe the following are key factors affecting the ambulance service industry:
Aging U.S. population . According to the U.S. Census Bureau, about 72 million Americans, or 20% of the U.S. population, will be age 65 or older in 2030 compared to 37 million, or 12%, today. As of June 30, 2007, 42% of our ambulance transports are for patients age 65 or older. The continued growth in the aging population will fuel demand for ambulance services.
Stable Medicare reimbursement environment . The reimbursement for ambulance services through Medicare has stabilized over the past several years, reflecting the implementation of a revised Medicare pricing schedule. Historically, Medicare reimbursement rates were based on various complex methodologies under which rates varied widely among communities. The Medicare fee schedule implemented in 2002 simplified and stabilized Medicare reimbursement. The Medicare Prescription Drug, Improvement and Modernization Act of 2003 modified the Medicare fee schedule by providing for a 1% increase in reimbursement for urban transports and a 2% increase for rural transports through calendar 2006. Other fee adjustments will be fully phased by January 1, 2010.
Increase in outsourcing. Municipalities, governmental agencies and healthcare facilities are under significant budgetary pressure to reduce cost of care, ambulance transports being one component. The outsourcing of ambulance transports has become a preferred avenue to achieve these goals.
Increased use of ambulance services. The increased availability of specialized treatment healthcare facilities, nursing homes and home care have contributed to greater demand for non-emergency ambulance services.
Increase in public/private partnerships. We believe the complexities associated with the emergency ambulance business, including the exacting and time-consuming claim submission requirements of third-party payers such as Medicare and Medicaid, are leading many public providers of emergency ambulance services to consider partnerships with private ambulance companies. An example from our experience is that some local fire departments have entered into collaborations with private ambulance companies in which the fire department provides first responder services and the private company transports the patient and handles billing. These partnerships benefit both parties â€“ they allow public entities to be reimbursed for certain costs while relieving them of the billing and collection obligations associated with delivering emergency services.
We have four regional reporting segments that correspond with the manner in which the associated operations are managed and evaluated by our chief executive officer. Although some of our operations do not align with our segmentsâ€™ geographic designation, all operations have been structured to capitalize on managementâ€™s strengths.
We generally provide two primary levels of ambulance services â€” Advanced Life Support (â€śALSâ€ť) and Basic Life Support (â€śBLSâ€ť). We staff our ALS ambulances with either two paramedics or one paramedic and an Emergency Medical Technician (â€śEMTâ€ť) and equip them with ALS equipment (such as cardiac monitors/defibrillators, advanced airway equipment and oxygen delivery systems) as well as pharmaceuticals and medical supplies. We staff our BLS ambulances with two EMTs and equip them with medical supplies and equipment necessary to administer first aid and basic medical treatment. Ambulance services encompass both emergency response and non-emergency response services, including critical care, inter-facility and to a lesser extent wheelchair transports.
Emergency Response Services
We provide 911 emergency response services under long-term, exclusive contracts with counties, municipalities, fire districts and other governmental agencies. Our agreements require we respond to all 911 emergency calls in a designated area within a specified response time.
None of these contracts accounted for more than 10% of our annual net revenue during fiscal 2007, 2006 or 2005. These contracts, which are similar to licenses, grant us the right to provide 911 emergency ambulance services. The contracts typically specify rates that we may charge and set forth performance criteria, such as response times, staffing levels, types of vehicles and equipment, quality assurance, indemnity and insurance coverage. The rates we may charge under a contract for 911 emergency ambulance services depend largely on:
the nature of services rendered; and
any federal, state or county authority to regulate rates.
Counties, fire districts and municipalities award 911 emergency ambulance service contracts through a competitive bidding process. Generally, our 911 contracts extend for three to five years for the initial term with options for earned extensions of two to three years. In some instances in which we are the incumbent provider, the county or municipality may elect to renegotiate our existing contract rather than re-bid the contract at the end of any earned extensions.
Under the majority of our contracts, the local fire department is the first responder to an emergency scene. In these situations, the fire department begins stabilization of the patient. Upon arrival, our crew members deploy portable life support equipment, ascertain the patientâ€™s medical condition and, if required, administer ALS interventions, including tracheal intubation, cardiac monitoring, defibrillation of certain cardiac dysrhythmias and the administration of medications and intravenous solutions under the direction of a physician. The crew also may perform BLS services, including cardiopulmonary resuscitation (â€śCPRâ€ť), basic airway management and basic first aid. As soon as medically appropriate, the patient is placed on a portable gurney and transferred into the ambulance. While one crew member monitors and treats the patient, the other crew member drives the ambulance to a hospital designated either by the patient or applicable medical protocol. While on scene or en route, the ambulance crew alerts the hospital regarding the patientâ€™s medical condition and, if necessary, the attending ambulance crew member consults an emergency physician as to treatment. Upon arrival at the hospital, the patient generally is taken to the emergency department where care is transferred to the emergency department staff.
We provide emergency ambulance services on a fee-for-service basis and record revenue based on the level of medical service we provide. Additionally, our fee-for service revenue may be supplemented by the communities we serve in the form of a subsidy, which further supports the level of medical services we provide.
Non-Emergency Response Services
We provide non-emergency response services and critical care transfers, preferably as a preferred provider, with healthcare facilities, hospitals, nursing homes and other specialty care providers or at the request of a patient.
These services are typically controlled by the facility discharge planners, nurses or physicians who are responsible for requesting ambulance services. Non-emergency medical transportation services may be scheduled in advance or provided on an as-needed basis. Quality of services, reliability and name recognition are critical factors in obtaining non-emergency business.
We utilize either ALS or BLS ambulance units to provide non-emergency ambulance services, depending on the patientâ€™s medical condition, to and from residences, hospitals, nursing homes, long-term care centers and other healthcare facilities. These services may be provided when a home-bound patient requires examination or treatment at a healthcare facility or when a hospital patient requires tests or treatments, dialysis and chemotherapy at another facility. These services are administered by an EMT or paramedic.
We also provide critical care transfer services to medically unstable patients (such as cardiac patients and neonatal patients) who require critical care while being transported between healthcare facilities. Critical care services differ from ALS or BLS services in that the ambulance may be equipped with additional medical equipment and may be staffed by a medical specialist provided by us or by a healthcare facility. Staffing may also include registered nurses, respiratory therapists, neo-natal nurse specialists and/or specially trained paramedics.
We provide subscription fire protection services to residential and commercial property owners in emerging communities or unincorporated areas where neither a public sector nor volunteer fire department operates. We also provide such services to industrial sites, airports and other self-contained facilities on a national basis. In addition, we provide other services such as home health care services, and protection services.
Billing and Collections
We maintain five billing processing centers across the United States and a centralized self-pay collection center. We receive payment for our services from third-party payers, including federal and state government funded programs primarily under Medicare and Medicaid, commercial insurance companies, individual patients and to a lesser extent, community subsidies.
We have substantial experience in processing claims to third-party payers and employ a billing staff trained in third-party coverage and reimbursement procedures. Our integrated billing and collection system uses proprietary software to tailor the submission of claims to Medicare, Medicaid and other third-party payers and has the capability to electronically submit claims to the extent third-party payersâ€™ systems permit. The system also provides for tracking of accounts receivable and status pending payment. In addition, the self-pay collection center utilizes an automated predictive dialer that pre-selects and dials accounts based on their status within the billing and collection cycle. We believe the automated predictive dialer enhances the efficiency of the collection staff. For further discussion, see â€śManagementâ€™s Discussion and Analysis of Financial Condition and Results of Operations.â€ť
Companies in the ambulance service industry may experience significant levels of uncompensated care compared to companies in other segments of the healthcare industry. Collection of complete and accurate patient billing information during an emergency service call is sometimes difficult, and incomplete information hinders post-service collection efforts. As a result, we often receive partial or no compensation for services provided to patients who are not covered by Medicare, Medicaid or commercial insurance. Uncompensated care generally is higher with respect to revenue derived directly from patients than for revenue derived from third-party payers, and generally is higher for services resulting from 911 calls than for non-emergency response requests. See â€śRisk Factorsâ€ť in Item 1A of this Report.
In an effort to offset the cost of uncompensated care, we will negotiate subsidies with communities whose payer mix reflects a higher level of self-pay individuals. These subsidies, which are included in net revenue, totaled $10.7 million, $9.1 million and $8.9 million for fiscal years ended June 30, 2007, 2006 and 2005, respectively.
Cor J. Clement, Sr. has served as Chairman of our Board of Directors since August 1998 and as a member of our Board of Directors since May 1992. Mr. Clement served as Vice Chairman of the Board of Directors from August 1994 to August 1998. Mr. Clement served as the President and Chief Executive Officer of NVD, an international provider of security and industrial fire protection services headquartered in the Netherlands, from February 1980 until his retirement in January 1997.
Jack E. Brucker has served as our President and Chief Executive Officer and has been a member of our Board of Directors since February 2000. Mr. Brucker served as our Senior Vice President and Chief Operating Officer from December 1997 until February 2000.
Henry G. Walker has been a member of our Board of Directors since September 1997 and Vice Chairman since July 2004. Mr. Walker is currently a partner in the management consulting firm of Andrade/Walker Consulting, LLC. From March 1997 to March 2004, he served as President and Chief Executive Officer of Providence Health System, comprised of hospitals, long-term care facilities, physician practices, managed care plans, and other health and social services. From 1996 to March 1997, Mr. Walker served as President and Chief Executive Officer of Health Partners of Arizona, a state-wide managed care company. From 1992 to 1996, he served as President and Chief Executive Officer of Health Partners of Southern Arizona, a healthcare delivery system.
Louis G. Jekel has served as a member of our Board of Directors since 1968 and as Vice Chairman of our Board of Directors from August 1998 to December 2006. Mr. Jekel served as our Secretary from 1968 through 2003. Mr. Jekel is a partner in the law firm of Jekel & Howard, Scottsdale, Arizona.
Robert E. Wilson became a member of our Board of Directors in November 2003. He has served as Chief Financial Officer of Billings Clinic, an integrated health provider system, since January 2007. Mr. Wilson was employed by Arthur Andersen LLP from 1972 to 2001, becoming a partner in 1986. Among other responsibilities as a partner, he served as a member of the firmâ€™s national healthcare industry business turnaround practice. From 2001 through 2003, Mr. Wilson provided commercial litigation and financial due diligence consultation services through a national consulting firm. Mr. Wilson is a member of the Board of Directors and Chairman of the Audit and Compliance Committees of Providence Health & Services, a not-for-profit community healthcare system.
Conrad A. Conrad became a member of our Board of Directors in October 2005. Mr. Conrad was employed with The Dial Corporation from August 2000 to October 2005, and served as its Executive Vice President and Chief Financial Officer. From 1999 to 2000, Mr. Conrad was engaged in a number of personal business ventures, including providing consulting services to Pennzoil-Quaker State Company, which acquired Quaker State Corporation in December 1998. From 1974 to 1998, Mr. Conrad held various positions, most recently Vice Chairman and Chief Financial Officer, with Quaker State Corporation, a leading manufacturer of branded automotive consumer products and services. Mr. Conrad is a member of the Board of Directors of Universal Technical Institute, Inc. and Fender Musical Instruments Corporation.
Christopher S. Shackelton will be appointed to the Board of Directors effective as of the date of the Annual Meeting. Mr. Shackelton is a managing partner and co-founder of Coliseum Capital Management, LLC. Coliseum is a private investment partnership that makes long-term investments in both public and private companies. Prior to founding Coliseum, Mr. Shackelton was an analyst at Watershed Asset Management from 2003 through 2005. Earlier in his career, Mr. Shackelton worked in the investment banking division of Morgan Stanley & Co. Mr. Shackelton presently serves as a Trustee for the Walter Johnson Foundation. He earned a BA in Economics from Yale University.
Eugene I. Davis will be appointed to the Board of Directors effective as of the date of the Annual Meeting. Mr. Davis has served as the Chairman and Chief Executive Officer of PIRINATE Consulting Group, L.L.C., a consulting firm specializing in turn-around management, mergers and acquisitions and strategic planning advisory services, since 1999. He served as Chief Operating Officer of Total-Tel USA Communications, Inc., an integrated telecommunications provider, from 1998 to 1999. Mr. Davis served in various capacities including as director, Executive Vice President, President and Vice Chairman of Emerson Radio Corp., a distributor of consumer electronics products, from 1990 to 1997. He served in various capacities including as a director, Chief Executive Officer and Vice Chairman of Sports Supply Chain, Inc., a distributor of sporting goods and athletic equipment, from 1996 to 1997. Prior to such time, Mr. Davis was an attorney in private practice. Mr. Davis presently serves as Chairman of the Board of Atlas Air Worldwide Holdings, Inc., Atari, Inc. and Foamex International, Inc. Mr. Davis also serves as a Director of American Commercial Lines, Inc., Delta Air Lines, Inc., Knology, Inc., Medicor Ltd., Oglebay Norton Company, Silicon Graphics, Inc., Footstar Inc. and Pliant Corporation.
Earl P. Holland is nominated for election as a Class I director. Mr. Holland served from 1981 to January 2001 in a number of capacities, and most recently as the Chief Operating Officer and Vice Chairman, of Health Management Associates, Inc., a hospital company operator that trades on the New York Stock Exchange. He retired in January 2001 and is now a private investor. Mr. Holland currently serves as a director and member of the compensation committee of Team Health, a private company in the business of supplying physician staffing for hospitals and military bases. He is also a director of Orion Bancorp, a large private bank in Florida, where he serves as the chairman of each of the audit committee and compensation committee. Mr. Holland is also the Vice Chairman of the board of directors of Cornerstone National Insurance Co., a private automobile insurance company, and serves on its compensation committee. Mr. Holland is also a director of Medical Diagnostic Technology, a private company specializing in early cancer detection.
Kristine B. Ponczak is currently serving as the Senior Vice President, Chief Financial Officer, Treasurer and Secretary. Ms. Ponczak served as Vice President and Treasurer from December 2004 to October 2006. In addition, Ms. Ponczak served as Director of Financial Planning from April 1998 until December 2004. Prior to joining us in 1998, Ms. Ponczak served as Corporate Controller for Sun Street Foods from 1995 to 1998 where she was responsible for managing the financial reporting and banking relationships of that privately held company, which represented a management buyout of certain subsidiaries of Main Street & Main Inc. From 1993 to 1995, she worked at Main Street & Main Inc. as Controller over two subsidiaries. Prior to that, Mrs. Ponczak was a member of the managing consulting/business valuation group at the public accounting firm Coopers & Lybrand, where she focused on corporate valuations, litigation support, and acquisition structures.
Kurt M. Krumperman currently serves as Senior Vice President for Federal Affairs and Strategic Initiatives. From 2002 to 2004, Mr. Krumperman held the office of President â€“ Rural/Metro Fire/EMS Group and National Disaster Response Coordinator/Corporate Vice President for Federal Affairs. In 1996, Mr. Krumperman served as Northeast Emergency Service Group President and National Coordinator of Rural/Metro Corporation Disaster Response Team, a position he maintained until 2002. Mr. Krumperman joined the Company in 1994 as General Manager of Rural/Metro Medical Services of Central New York.
Gregory A. Barber joined the Company in June 2006 as Vice President and Corporate Controller. Prior to joining the Company, Mr. Barber served in various positions with Giant Industries, Inc., including Vice President, Chief Accounting Officer and Assistant Secretary from August 2005 to June 2006; Vice President and Corporate Controller from April 2004 to August 2005; Vice President, Special Project Management from March 2001 to June 2004; and Vice President, Branded Wholesale Marketing from February 1999 to March 2001.
Brian O. Allery currently serves as Corporate Vice President of Risk, Insurance, Safety, National Purchasing and Real Estate. Mr. Allery was named Managing Director of Corporate Risk Management, Purchasing, Distribution, Benefits Administration, and Real Estate in 2004. From 2001 to 2004, Mr. Allery held the position of Director of National Risk Management, Insurance, Purchasing and Distribution. Mr. Allery served as Corporate Purchasing Manager in 1998 and as Corporate Technology Buyer in 1996.
Elements of Compensation Program . This section describes the various elements of the NEO compensation programs for fiscal 2007. The Compensation Committee believes that an allocation of each NEOâ€™s compensation among the following elements promotes the objectives discussed above.
Base salaries are the foundation for compensation of all the NEOs. The Compensation Committee believes that it is appropriate for a meaningful portion of the NEOâ€™s compensation to be provided in a fixed amount of cash in order to provide some level of stable income to the NEOs. Base salary also provides the ability to establish pay guidelines that are expressed as a percentage of salary. As the base salary changes, there is a proportional change in the applicable NEOâ€™s MIP. The base salary for each of the NEOs is established at a level that the Compensation Committee believes is sufficient to attract and retain such NEOs for the long-term financial success of the Company. The Compensation Committee believes that such levels are sufficient through a review of the competitiveness of the total compensation package for each NEO, identifiable alternative employment for each NEO and internal pay equity.
Salaries of the NEOs are reviewed by the Compensation Committee on an annual basis in December. In addition, base salary level is reviewed at the time of a promotion or other change in responsibilities. Pursuant to the employment agreements for each NEO, reduction of the NEOâ€™s base salary is not permitted in an amount exceeding 10% unless such reduction is part of a company-wide reduction affecting similarly situated executives. The employment agreement for the CEO expresses the partiesâ€™ intent that there will be no increase in the stated base salary of the CEO during its term other than cost of living increases.
As discussed above under the heading â€śRetention of Compensation Consultant,â€ť the Compensation Committee engaged Watson Wyatt to provide updated peer group information to assist the committee in setting base salaries. The Compensation Committee did not obtain formal salary survey or similar information in setting base salaries for 2007, instead basing its decisions on factors such as negotiated contractual provisions, internal pay equity considerations, and certain publicly-available information regarding companies in the Phoenix, Arizona metropolitan area.
Short-Term Incentives â€” Management Incentive Plan
The performance-based MIP is an annual cash incentive plan for key executives and employees of the Company. NEOs are eligible to earn annual cash awards under the MIP, expressed as a percentage of base salary. The MIP is designed to reward NEOs for Company and individual performance with an annual award which, when added to base salary, produces total cash compensation for the NEOs in an amount consistent with Company objectives. At the beginning of each fiscal year, performance goals are created between the Company and the participant that document the participantâ€™s accountabilities and define levels of performance on those accountabilities.
For fiscal 2007, award opportunities varied from:
50% to 125% of the participantâ€™s base salary at the CEO level;
31% to 75% of the participantâ€™s base salary at the senior or executive vice president level; and
25% to 75% of the participantâ€™s base salary at the group president and corporate vice president level.
None of the NEOs received a payout under the 2007 MIP. See â€śCompensation of Named Executive Officers - Grants of Plan-Based Awards (Fiscal 2007)â€ť below.
For the CEO, as set forth in his employment agreement, 100% of the potential award is based upon achievement of budgeted consolidated net income from continuing operations. For other NEOs, 70% of the participantâ€™s award is based upon achievement of budgeted consolidated net income from continuing operations, with the remaining 30% based upon achievement of personal goals tailored to the responsibilities of the participantâ€™s position. The Compensation Committee believes that it is appropriate for 100% of the CEOâ€™s potential award to be based upon the quantitative financial goal because of the nature of the CEOâ€™s company-wide responsibilities in comparison to the more specific responsibilities of the other NEOs.
On June 7, 2007, the Board of Directors adopted an amended and restated MIP effective commencing fiscal 2008. The primary substantive change to the MIP was to delete language that provided for payment of a reduced MIP award upon achievement of 90% of quantitative financial goals. The amended and restated MIP provides that no MIP award will be payable unless 100% of the quantitative goal has been met. Potential MIP awards are adjusted ratably for achievement between 100% (formerly 90%) and 150% of the applicable budgeted target. No award is payable for performance below 100% (formerly 90%) of the applicable budgeted target, and awards are capped at achievement of 150% of the applicable budgeted target. Commencing with fiscal 2008, award opportunities vary from 80% to 125% of the participantâ€™s base salary at the CEO level; 50% to 75% of the participantâ€™s base salary at the senior or executive vice president level; and 45% to 67.5% of the participantâ€™s base salary at the group president and corporate vice president level.
The amended and restated MIP for fiscal 2008 also clarifies that no MIP award shall be paid to corporate executives or regional group presidents for achievement of personal goals unless the corporate or regional financial goal is achieved. The amended and restated MIP also provides that participantsâ€™ personal goals will be measured on a fiscal year basis (rather than a calendar year basis as previously provided). This revision brings the measurement period for personal goals into alignment with the measurement period for quantitative financial goals. Awards, if any, will be paid after audited results are available but no later than October 31.
The Compensation Committee structured incentive payments under the MIP so that our Company would provide meaningful rewards to executive officers for superior performance, make smaller payments if our Company achieved financial performance levels that exceed the threshold level of required performance but did not satisfy the target levels, and not make incentive payments if our Company did not achieve the threshold minimum corporate financial performance levels established at the beginning of the fiscal year. The Compensation Committee has discretionary authority under the MIP to recommend an incentive award greater or less than the potential bonus as calculated under the MIP, but did not exercise its discretion in fiscal 2007.
The Compensation Committee believes that budgeted consolidated net income from continuing operations is the preferred target for our Company because it reflects the ongoing performance expectations developed by the Board of Directors and management for the Company. The annual budget is initially developed by management, and is finalized based upon interaction between the Board and management, with the Board holding final authority. Historically, the budgeted consolidated net income from continuing operations targets established by the Compensation Committee have been met by management, and the NEOs have earned awards under the MIP. The NEOs did not receive any award under the MIP for performance in fiscal 2007 as the Company did not achieve the threshold minimum corporate financial performance levels established for the fiscal year. The NEOs did receive payment during fiscal 2007 on awards that were earned under the MIP for fiscal 2006. Currently, based on historical achievements, the Company believes that it is more likely than not that the NEOs will earn an award under the 2008 MIP; however, as the NEOs did not receive any award relating to fiscal 2007, any expectation regarding a payout at this time is not certain.
Long-Term Incentives â€” Equity Plans
In the past, the Compensation Committee has granted stock options pursuant to equity plans in furtherance of the stated objective to align the interests of the Companyâ€™s executive officers with the stockholders of the Company. Due to the expiration of the 1992 Stock Option Plan, the only option plan in which NEOs were eligible to participate, in November 2002, there were no grants of stock options to the NEOs during fiscal 2007. For a summary of the option holdings of the NEOs as of June 30, 2007, please see â€śExecutive Compensation â€” Option Holdingsâ€ť below.
As discussed above, the Compensation Committee engaged Watson Wyatt to provide certain consulting services to the Compensation Committee, including the analysis and proposal of a long-term incentive plan that would provide the Company the ability to grant equity awards to the NEOs. As a result of Watson Wyattâ€™s recommendations, the Compensation Committee and the Board adopted, in February 2008, the 2008 Incentive Stock Plan (â€ś2008 Stock Planâ€ť), subject to stockholder approval at the Annual Meeting. See below, under the heading â€śRecent Developments in our Executive Compensation Programâ€ť, and also â€śProposal to Approve the 2008 Stock Planâ€ť, above. If approved by our stockholders, the 2008 Stock Plan would authorize awards of stock options, restricted stock, restricted stock units (RSUs), stock appreciation rights (SARs), and other equity-based awards. Also as a result of Watson Wyattâ€™s recommendations, the Compensation Committee would initially utilize performance-contingent RSUs and stock-settled SARs (in the case of executives), with the award opportunities to be granted in accordance with the Compensation Committeeâ€™s assessment, for the relevant year, of the appropriate balance between cash and equity compensation. See â€śProposal to Approve the 2008 Incentive Stock Planâ€ť, above. In making such assessment, the Compensation Committee will consider various factors, including the relative merits of cash and equity as a device for retaining and incentivizing NEOs and the recommendations of the Compensation Committeeâ€™s independent compensation consultant. In addition, the Compensation Committee will consider Company and individual performance, comparative compensation for the NEOs and the value of already outstanding awards. The Compensation Committee believes that a mix of equity and cash compensation aligns the interests of management and stockholders by focusing employees and management on increasing stockholder value. The use of any equity compensation as discussed herein is subject to stockholder approval of a long-term incentive plan.
Personal Benefits and Perquisites
With limited exceptions, the Compensation Committee disfavors awarding personal benefits and perquisites to the NEOs that are not available to all employees. The NEOs have the opportunity to participate in a number of health and welfare benefits programs that are generally available to all eligible employees, including group medical and dental insurance plans. The Company does not have a pension plan or deferred compensation plan applicable to the NEOs. The Company does have a tax-qualified 401(k) plan that allows employees, including the NEOs, to contribute a portion of their cash compensation on a pre-tax basis.
The Company provides the NEOs with life insurance, and short- and long-term disability benefits at an enhanced level compared to what is provided for other employees, as well as physical evaluations. Additionally, the NEOs are provided director/officer liability insurance coverage and are parties to indemnity agreements with the Company. See the Summary Compensation Table for details regarding the perquisites provided in fiscal 2007.
Change in Control Agreements
The Compensation Committee believes that the Companyâ€™s use of change in control agreements should be limited to the positions of CEO and CFO. The Compensation Committee has selected those positions because of the importance of such positions to the Company and the vulnerability typically associated with such positions in a change in control environment. Accordingly the Company is a party to only three change in control agreements (with the CEO, the CFO and one legacy agreement with an NEO). The agreements provide certain benefits to the NEOs if each of two triggering events occur: (i) a change in control, and (ii) the termination of the NEOâ€™s employment by the Company without cause (or by the executive for good reason) within 24 months after the change in control. See â€śPotential Payment Upon Termination or Change in Controlâ€ť described below.
The Compensation Committee believes that these change in control arrangements are an important part of overall compensation for the NEOs because they assist the Company in maximizing stockholder value by allowing such persons to participate in an objective review of any proposed transaction and whether such proposal is in the best interest of the stockholders, notwithstanding any concern they might have regarding their own continued employment prior to or following a change in control.
In addition, the Company has entered into employment agreements with certain members of its senior management, including each of the NEOs. Each of these agreements provides for certain payments and other benefits if the NEOâ€™s employment terminates under certain circumstances. During the term of the severance payments, these agreements prohibit the NEO from disclosing the Companyâ€™s confidential information and from engaging in certain competitive activities or soliciting the Companyâ€™s employees, customers, potential customers, or acquisition prospects. See â€śExecutive Compensation â€” Employment Agreementsâ€ť for further discussion.
A NEO will forfeit the NEOâ€™s right to receive post-termination compensation if the NEO breaches these or other restrictive covenants in their employment agreement. The Compensation Committee believes that these severance arrangements are important as a recruitment and retention device, and that the arrangements support important post-employment restrictions.
The Effects of Regulatory Requirements on NEO Compensation
Deductibility of Executive Compensation . Section 162(m) of the Internal Revenue Code of 1986, as amended, provides that compensation in excess of $1,000,000 paid to the CEO or to any of the most highly compensated executive officers of a public company that are deemed to be a covered person pursuant to IRS Notice 2007-49 will not be deductible for federal income tax purposes unless such compensation is paid pursuant to one of the exceptions set forth in Section 162(m). Based upon compensation levels in fiscal 2007 and fiscal 2008, Section 162(m) is only applicable to the Companyâ€™s CEO. The Compensation Committee attempts to structure the NEO compensation programs such that compensation paid will be tax deductible by the Company whenever that is consistent with the Companyâ€™s compensation philosophy. The deductibility of some types of compensation payments, however, can depend upon the timing of an executiveâ€™s vesting or exercise of previously granted rights. Interpretations of, and changes in, applicable tax laws and regulations, as well as other factors beyond the Companyâ€™s control, also can affect deductibility of compensation.
The Compensation Committeeâ€™s primary objective in designing and administering the NEO compensation programs is to support and encourage the achievement of the objectives stated above, including the enhancement of long-term stockholder value. For these and other reasons, the Compensation Committee has determined that it will not seek to limit executive compensation to the amount that will be fully deductible under Section 162(m) in all cases. The Compensation Committee will continue to monitor developments and assess alternatives for preserving the deductibility of compensation payments and benefits to the extent reasonably practicable, as determined by the Compensation Committee to be consistent with the Companyâ€™s compensation programs and philosophy, and in the best interests of the Company and its stockholders.
Of the compensation paid to each of the NEOs in 2007, $236,004 was not deductible by the Company under Section 162(m). The Company currently has net operating losses available to offset any such excess for tax purposes, though there can be no certainty that these net operating losses can be fully utilized to offset all future nondeductible payments.
Nonqualified Deferred Compensation . On October 22, 2004, the American Jobs Creation Act of 2004 was signed into law, which added Section 409A of the Internal Revenue Code. Section 409A changed the tax rules applicable to nonqualified deferred compensation arrangements. If an executive is entitled to nonqualified deferred compensation that is subject to Section 409A, and such arrangement does not comply with Section 409A, the executive will be taxed on the benefits when they vest (even if not distributed), and will be subject to an additional 20% federal income tax and interest. While the final Treasury Regulations on Section 409A have not yet become effective, the Company believes it operates and administers its NEO compensation arrangements in accordance with a reasonable good faith interpretation of the statutory provisions, which were effective January 1, 2005.
MANAGEMENT DISCUSSION FROM LATEST 10K
During the fourth quarter of fiscal 2007, the Company reviewed its tax positions in accordance with Financial Accounting Interpretation No. 48, Accounting for Uncertainty in Income Taxes â€” an interpretation of FASB Statement No. 109 â€ť (â€śFIN 48â€ť), which is effective for the Company at the beginning of the first quarter of fiscal 2008. In connection with its review, the Company concluded that certain positions related to federal and state income taxes met the probable threshold for the recognition of loss contingencies as promulgated by Financial Accounting Standard No 5, Accounting for Contingencies , (FAS 5), and therefore the Company should have recognized an additional income tax provision in the years affected. These errors included state income tax adjustments for jurisdictions in which the Company has not previously filed tax returns and adjustments to the calculation of taxable income related to certain intercompany charges. Other tax-related errors included erroneously recording benefits for net operating losses of certain wholly-owned subsidiaries that the Company determined may not be sustainable within its consolidated tax return, and other errors related to deductions taken on prior tax returns. In addition, the Company discovered additional tax-related errors related to the calculation of temporary differences related to partnership investments, which were identified by management when the temporary differences did not fully reverse upon dissolution of certain partnerships. As a result of these errors, all previously issued financial statements contained in the Form 10K/A for the year ended June 30, 2006 have been restated to reflect the additional income tax expense or benefit, as applicable, to correct these errors. The combined impact of these errors resulted in a decrease in net income of $146,000 and an increase in net income of $473,000 for the years ended June 30, 2006 and 2005, respectively. The cumulative effect of these errors on net income for all periods preceding fiscal 2005 was $1,237,000, which is reflected as an increase in the accumulated deficit at July 1, 2004. There was no material effect on cash flows from operating, investing or financing activities for the years ended June 30, 2006 and 2005 as a result of this adjustment.
During the fourth quarter of fiscal 2007, management determined that the Company had prematurely recognized revenue for certain fire subscription services and ambulance subscription services provided by the Company. Generally, the Company is obligated to provide coverage to its customers for subscription services after the Company has received both a signed executed agreement and payment for the coverage period. In accordance with generally accepted accounting principles, the Company is required to recognize revenue for these services on a straight-line basis over the contractual life of the subscription agreement, which begins on the date in which both the signed agreement and the payment are received. Based on a review conducted by management, it was determined that the Company improperly recognized a full month of revenue for the month in which the subscription payment was received instead of recognizing revenue for only the remaining number of calendar days left in the month. In addition, management also determined that the Company prematurely recognized revenue in situations where customers renewed subscription agreements prior to the expiration of the existing contractual period. In these situations the Company failed to defer its revenue recognition for the renewal period
until its obligations under the existing contractual period were satisfied. As a result of these errors, all previously issued financial statements contained in the Form 10K/A for the year ended June 30, 2006 have been restated to adjust subscription revenue to its proper amount. The combined impact of these errors resulted in a decrease in net income of $229,000 and an increase in net income of $701,000 for the years ended June 30, 2006 and 2005, respectively. The cumulative effect of these errors on net income for all periods preceding fiscal 2005 was $2,378,000, which is reflected as an increase in the accumulated deficit at July 1, 2004. There was no material effect on cash flows from operating, investing or financing activities for the years ended June 30, 2006 and 2005 as a result of this adjustment.
During the fourth quarter of fiscal 2007, management discovered a misapplication of generally accepted accounting principles with respect to the Companyâ€™s accounting for certain of its operating leases that had been executed prior to fiscal 2007. In accordance with Statement of Financial Accounting Standards No. 13, Accounting for Leases, (SFAS 13), lessees are required to account for operating leases, which contain fixed escalating payment terms, by recognizing rent expense on a straight-line basis over the lease term. In connection with a review of the Companyâ€™s real estate leases, management identified multiple operating leases containing payment escalation provisions under which rental expense was not being recognized on a straight-line basis. As a result of this error, all previously issued financial statements contained in the Form 10K/A for the year ended June 30, 2006 have been restated to reflect the additional expense attributable to the misapplication of SFAS 13. The impact of this error resulted in a decrease in net income of $43,000 and an increase in net income of $127,000 for the years ended June 30, 2006 and 2005, respectively. The cumulative effect of this error on net income for all periods preceding fiscal 2005 was $725,000, which is reflected as an increase in the accumulated deficit at July 1, 2004. There was no material effect on cash flows from operating, investing or financing activities for the years ended June 30, 2006 and 2005 as a result of this adjustment.
Retirement Plan Matching Contributions
During the fourth quarter of fiscal 2007, management determined that the Company had not recognized an expense for its obligation to provide matching contributions on elective deferrals under a 401(k) plan (the â€śPlanâ€ť) made by certain employees covered by a collective bargaining agreement. Based on a review conducted by management, it was determined that the Company had properly funded its obligation with respect to the matching obligation since the Planâ€™s inception; however, instead of recognizing an offsetting expense for the amount of the contribution, the Company improperly relieved an accrued liability associated with an unrelated 401k plan. As a result of this error, all previously issued financial statements contained in the Form 10K/A for the year ended June 30, 2006 have been restated to reflect the additional expense attributable to the Companyâ€™s obligation to provide matching contributions on certain 401k deferrals. The impact of this error resulted in a decrease in net income of $219,000 and $84,000 for the years ended June 30, 2006 and 2005, respectively. Since this error originated during fiscal 2005, there was no impact on net income for any periods preceding July 1, 2004. There was no material effect on cash flows from operating, investing or financing activities for the years ended June 30, 2007 and 2006 as a result of this adjustment.
Results of Operations
Fiscal 2007 Compared To Fiscal 2006 â€” Consolidated
Our results for the year ended June 30, 2007 reflect an increase in net revenue of $17.1 million, or 3.8% compared to the fiscal year ended June 30, 2006. The $3.9 million decrease in net income is attributable to a decrease of $10.1 million in income from continuing operations offset by a decrease in losses from discontinued operations of $6.2 million.
The $10.3 million increase in ambulance services revenue was driven by $6.5 million in new contract revenue and $3.8 million in same service area revenue. The increase in same service area revenue included $1.6 million of new subsidy revenue and was offset by a $0.7 million reserve for a change in estimate related to a review of levels of service provided to certain patients. The increase in same service area revenue also includes the impact of a $6.3 million decrease in net medical transport APC due to higher levels of uncompensated care.
Below we provide two tables providing fiscal year comparative transport data. The first table summarizes medical transport volume into same service area and new contracts, while the second table summarizes total transport volume into emergency, non-emergency and wheelchair.
Medical transportation volume increased 4.4% in fiscal 2007. This increase was a result of same service area growth of 27,400 transports and new contract transport growth of 18,218, which is due to our new contracts in Missouri, Utah and Washington.
Contractual Allowances and Uncompensated Care
Contractual allowances applicable to Medicare, Medicaid and other third-party payers related to continuing operations, which are reflected as a reduction of gross medical ambulance revenue, totaled $286.2 million and $249.7 million for fiscal 2007 and 2006, respectively. The increase of $36.5 million is primarily a result of rate increases and a change in payer mix in certain markets. Uncompensated care as a percentage of gross medical ambulance revenue was 14.7% and 13.3% for fiscal 2007 and 2006, respectively. An increase in transport volume associated with emergency response services coupled with higher write-offs due to denial for medical necessity, non-covered services, co-pays and deductibles have resulted in a rise in uncompensated care over the same period in the prior year.
Both contractual allowances and uncompensated care are reflected as a reduction of gross medical ambulance revenue.
Net Medical Transport APC
Our net medical transport APC for fiscal 2007 was $335 compared to $342 for fiscal 2006. The 2.0% decrease reflects four drivers: increased transport rates offset by a concentration of transport growth within the emergency response sector, increase in the number of basic life support versus advanced life support transports provided and an increase in uncompensated care in addition to a $0.7 million reserve for a change in estimate related to a review of levels of service provided to patients in the West Segment.
The $6.8 million increase in other services revenue is primarily due to a $2.9 million increase in master contract fire fees associated with our industrial and airport contracts including our new Sarasota, Florida airport contract which we entered into in October 2006. Additionally, fire subscription revenue increased $4.1 million, or 9.6%.
Payroll and Employee Benefits
Payroll and employee benefits expense was $291.3 million, or 62.3% of net revenue for fiscal 2007, an increase of $22.4 million from $268.9 million, or 59.7% of net revenue for fiscal 2006. The increase included a $3.7 million increase in employee health insurance expense due to higher claims paid under our self-insured program, a $2.2 million increase in headcount as a result of hiring paramedics in our San Diego operation that were historically independent contractors and thus reflected in other operating expenses, a $1.6 million increase in executive severance expense, a $1.6 million increase in workers compensation expense, and the balance due to competitive wage increases within specific markets to counter paramedic shortages and increased transport volume. These increases were partially offset by a $4.3 million decrease in management incentive plan accrual.
The increase in workers compensation expense is primarily due to $5.8 million positive actuarial claims adjustment recognized in 2007 compared to a $7.6 million positive actuarial claims adjustment recognized in 2006.
Depreciation and Amortization
The increase in depreciation and amortization of $1.0 million or 9.1% in the 2007 fiscal year versus 2006 fiscal year is primarily due to additional capital expenditures during the year.
Other Operating Expenses
Other operating expenses were $112.6 million, or 24% of net revenue for fiscal 2007, an increase of $4.7 million from $107.9 million, or 24% of net revenue for fiscal 2006. The dollar increase in other operating expenses included a $1.5 million increase in medical supplies due to transport volume, a $0.8 million increase in fuel costs, a $1.4 million increase in leased property expense, a $1.3 million reserve related to negotiations surrounding alleged billing inaccuracies in Ohio during 1997-2001, offset by a decrease in independent contractors expense as a result of hiring paramedics in our San Diego operation that are now recorded in payroll expense.
The auto/general liability expense was $18.1 million, or 3.9% of net revenue for fiscal 2007, an increase of $5.0 million from $13.1 million, or 2.9% for fiscal 2006. The increase is due primarily to $1.1 million negative actuarial claims adjustment recognized in 2007 compared to a $2.8 million positive actuarial claims adjustment recognized in 2006. In addition, we expensed a settlement of $0.9 million related to third party administrative fees.
Gain on Sale of Assets
The decrease in gain on sale of assets was due to a $1.3 million gain on the sale of real estate located in Arizona recognized during fiscal 2006. Cash proceeds from this transaction totaled $1.6 million.
The increase in interest expense of $0.5 million was primarily due to the continued non-cash accretion of our Senior Discount Notes, which totaled $7.8 million in fiscal 2007 as compared to $6.9 million in fiscal 2006 offset by a decrease in interest expense on our term loan B as a result of $19.0 million of unscheduled prepayments made during fiscal 2007.
Minority interest relates to the City of San Diegoâ€™s portion (50%) of the San Diego Medical Services Enterprise, LLC fiscal year-to-date net income. The increase in minority interest expense during fiscal 2007 is due to increased net income, which is attributable to a $0.8 million increase in subsidy revenue as well as a 5% increase in transport volume.
Income Tax Provision
Our income tax provision consists primarily of deferred income tax expense, as we utilize net operating loss carryforwards to reduce federal and state taxes currently payable and the associated deferred tax benefits are realized. As a result, minimal current cash payments are required.
During fiscal 2007, we recorded a $1.6 million income tax provision related to continuing operations. This provision includes $0.8 million of deferred income tax provision, which does not require a current cash payment. The deferred income tax expense results primarily from utilization of tax benefits, primarily resulting from net operating loss carryforwards, generated in prior years.