Description
Filed with the SEC from July 12 to July 18:
Lincare Holdings (LNCR)
Gamco Investors (ticker: GBL) disclosed that it owns 4,509,411 shares (5.2%), all bought from July 2 through July 16 at prices that ranged from $41.15 to $41.63. On July 2, Lincare announced that it will be acquired by Linde Group of Germany for $41.50 per share in cash—22% above the prior closing price.
BUSINESS OVERVIEW
General
Lincare Holdings Inc., together with its subsidiaries (“Lincare,” the “Company,” “we” or “our”), is one of the nation’s largest providers of oxygen, respiratory and other chronic therapy services to patients in the home. Our customers typically suffer from chronic obstructive pulmonary disease (“COPD”), such as emphysema, chronic bronchitis or asthma, and require supplemental oxygen, respiratory and other chronic therapy services in order to alleviate the symptoms and discomfort of respiratory dysfunction. Lincare currently serves more than 800,000 customers in 48 U.S. states and Canada through 1,108 operating centers. Lincare Holdings Inc. was incorporated in Delaware in 1990. Our principal executive offices are located at 19387 US 19 North, Clearwater, Florida 33764, and our telephone number is (727)530-7700.
The Home Respiratory Market
We estimate that the home respiratory market (including home oxygen equipment and respiratory therapy services) represents approximately $6.0 billion in annual sales. Growth in the home respiratory market is driven by increases in the number of persons afflicted with COPD, demographic factors that contribute to an increase in the proportion of the U.S. population over the age of 65 years, and the continued trend toward treatment of patients in the home as a lower cost alternative to the acute care setting.
Business Strategy
Our strategy is to increase our market share through internal growth and strategic business acquisitions. We achieve internal growth in existing geographic markets through the addition of new customers and referral sources to our network of local operating centers. In addition, we expand into new geographic markets on a selective basis, either through acquisitions or by opening new operating centers, when we believe such expansion will enhance our business. In 2011, Lincare acquired the business of fifteen local and regional companies with operations in multiple U.S. states and Canada.
Revenue growth is dependent upon the overall growth rate of the home respiratory market and on our ability to increase market share through effective delivery of high quality equipment and services and selective business acquisitions. Continued cost containment efforts by government and private insurance reimbursement programs have created an increasingly competitive environment, accelerating consolidation trends within the home health care industry.
We will continue our focus on providing oxygen, respiratory and other chronic therapy services to patients in the home and to provide home medical equipment and other services where we believe such services will enhance our primary business. In 2011, oxygen, respiratory and other chronic therapy services accounted for approximately 90% of Lincare’s net revenues.
Products and Services
Lincare primarily provides oxygen, respiratory and other chronic therapy services to patients in the home. We also provide a variety of durable medical equipment (“DME”) and home infusion therapies in certain geographic markets. When a physician, hospital discharge planner, or other source refers a patient to one of our operating centers, our customer representative obtains the necessary medical and insurance coverage information and assignment of benefits to us, and coordinates the delivery of patient care. The prescribed therapy is delivered by one of our service representatives or clinicians at the customer’s home, where instruction and training are provided to the customer and the customer’s family regarding appropriate equipment use and maintenance and compliance with the prescribed therapy. Following the initial setup, our service representatives and/or clinicians make periodic visits to the customer’s home, the frequency of which is dictated by the type of therapy prescribed and physician orders. All services and equipment provided by Lincare are coordinated with the prescribing physician. During the period that we provide services and equipment for a customer, the customer remains under the physician’s care and medical supervision. We employ respiratory therapists, nurses and other qualified clinicians to perform certain training and other functions in connection with our services. Clinicians are licensed where required by applicable law.
Company Operations
Management. We maintain a decentralized approach to management of our local business operations. Decentralization of managerial decision-making enables our operating centers to respond promptly and effectively to local market demands and opportunities. We believe that the personalized nature of customer requirements and referral relationships characteristic of the home health care business mandate that we maintain a localized operating structure.
Each of our operating centers is managed by a center manager who is responsible and accountable for the operating and financial performance of the center. Service and marketing functions are performed at the local operating level, while strategic development, financial control and operating policies are administered at the corporate level. Reporting mechanisms are in place at the operating center level to monitor performance and ensure field accountability.
A team of area managers directly supervises individual operating center managers, serving as an additional mechanism for assessing and improving performance of our operations. Lincare’s operating centers are served by regional billing centers, which control all of our billing and reimbursement functions.
MIS Systems. We believe that our proprietary management information systems are one of our key competitive advantages. The systems provide management with critical information on a timely basis to measure and evaluate performance levels company-wide. Management reviews monthly reports, including revenues and expenses by individual center, accounts receivable and cash collection performance, equipment controls and utilization, customer activity and manpower trends. We have an in-house staff of computer programmers, which enables us to continually enhance our computer systems in order to provide timely financial and operational information and to respond promptly to changes in reimbursement regulations and policies.
Our billing system has both manual and computerized functions and processes that are designed to maintain the integrity of revenue and accounts receivable. Third-party payors, such as Medicare, that can accommodate electronic claims submission are billed electronically on a daily basis from our central computer system. Paper claims and invoices are generated and billed to various state Medicaid agencies, commercial payors and individual customers when electronic billing is unavailable. Electronic billing expedites the billing process and generally allows us to receive payment more quickly. The medical billing process requires the collection of various paper documents from customers and referral sources. Information, such as customer demographics, insurance coverage and verification, prescriptions from physicians, delivery receipts, billing authorizations and assignments of benefits to Lincare, is gathered at the local operating centers and forwarded to our regional billing offices for review and manual input into our billing system. Item codes within the system representing specific products supplied to customers are matched against the Healthcare Common Procedure Coding System (“HCPCS”) for verification and accuracy of billing codes. Price tables within the system containing expected allowable payment amounts are maintained and updated by us based on published Medicare and Medicaid fee schedules and bulletins, as well as contracts and supplier notifications from private insurance companies.
Third-party reimbursement is a complicated process that involves submission of claims to multiple payors, each having its own specific claim requirements. To operate effectively in this environment, we have designed and implemented a proprietary computer system to decrease the time required for the submission and processing of third-party claims. Our systems are capable of tailoring the submission of claims to the specifications of individual payors. Our in-house information system capabilities also enable reimbursement or regulatory changes to be adjusted quickly. These features serve to decrease the processing time of claims for payment resulting in more rapid collection of accounts receivable.
It is our policy to verify insurance benefits with the responsible third-party payor before or within 48 hours of delivery of products to customers. Medicare beneficiaries provide our service representatives with a Medicare identification card containing the beneficiary’s Health Identification Control Number (“HICN”) at the time of customer setup and delivery. The existence of an HICN indicates the beneficiary’s eligibility to receive benefits under the Medicare program for covered services. Medicare benefits are then verified with the applicable Medicare intermediaries.
Medicare and most other government and commercial payors that provide coverage to Lincare’s customers include a 20 percent co-payment provision in addition to a nominal deductible. Co-payments are generally not collected at the time of service and are invoiced to the customer or applicable secondary payor (supplemental providers of insurance coverage) on a monthly billing cycle as products are provided. A majority of our customers maintain, or are entitled to, secondary or supplemental insurance benefits providing “gap” coverage of this co-payment amount. In the event coverage is denied by the third-party payor, the customer may ultimately be responsible for all services rendered by Lincare.
Sales and Marketing
Favorable trends affecting the U.S. population and home health care have created an environment that has produced increasing demand for the services provided by Lincare. The average age of the American population is increasing and, as a person ages, more health care services are generally required. Further, well-documented changes occurring in the health care industry show a trend toward home care rather than institutional care as a matter of patient preference and cost containment.
Sales activities are generally carried out by our full-time sales representatives located at our local operating centers with assistance from our center managers. In addition to communicating the high quality of our equipment and services, our sales representatives are trained to provide information concerning the benefits of home respiratory care. Sales representatives may be licensed respiratory therapists who are highly knowledgeable in the provision of supplemental oxygen, respiratory and other chronic therapies.
Lincare primarily acquires new customers through referrals. Our principal sources of referrals are physicians, hospital discharge planners, prepaid health plans and clinical case managers. Our sales representatives maintain continual contact with these medical professionals.
Lincare’s referral sources recognize our reputation for providing high-quality equipment and service and have historically provided a steady flow of customers. While we view our referral sources as fundamental to our business, no single referral source accounts for more than one percent of our revenues. Lincare has more than 800,000 active customers, and the loss of any single referral source, customer or group of customers would not materially impact our business.
Lincare has received accreditation from the Community Health Accreditation Program. Accreditation by a national accrediting body represents a marketing benefit to our operating centers and provides for a recognized quality assurance program. Home medical equipment providers are required to be accredited by an authorized accrediting organization in order to participate in Medicare and many private insurance plans.
Acquisitions
We acquired the business of fifteen companies in 2011 with operations in multiple U.S. states and Canada and six companies in 2010. The aggregate acquisition date fair values for these acquisitions were $154.1 million and $19.0 million in 2011 and 2010, respectively.
Quality Control
We are committed to consistently providing high-quality products and services. Our quality control procedures and training programs are designed to promote greater responsiveness and sensitivity to individual customer needs and to assure the highest level of quality and convenience to the customer and the referring physician. Licensed respiratory therapists, registered nurses and other employed clinicians provide professional health care support to our customers and enhance our efforts to provide effective disease management services.
Suppliers
We purchase oxygen and other medical equipment from a variety of suppliers. We are not dependent upon any single supplier and believe that our product needs can be met by an adequate number of qualified manufacturers.
Competition
The home respiratory market is a fragmented and highly competitive industry that is served by Lincare, other national providers and, by our estimate, over 2,000 regional and local providers.
Home respiratory companies compete primarily on the basis of service, not pricing, since uniform reimbursement levels are established by fee schedules promulgated by Medicare and Medicaid or by the individual determinations of private insurance companies. Furthermore, marketing efforts by home respiratory companies are typically directed toward referral sources that generally do not share financial responsibility for the payment of services provided to customers. The relationships between a home respiratory company and its customers and referral sources are highly personal. There is no compelling incentive for either physicians or the patients to alter the relationship, so long as the home respiratory company is providing responsive, professional and high-quality service.
Medicare Reimbursement
As a provider of home oxygen, respiratory and other chronic therapy services to the home health care market, we participate in Medicare Part B, the Supplementary Medical Insurance Program, which was established by the Social Security Act of 1965. Providers of home oxygen and other respiratory therapy services have historically been heavily dependent on Medicare reimbursement due to the high proportion of elderly persons suffering from respiratory disease. Durable medical equipment (“DME”), including oxygen equipment, is traditionally reimbursed by Medicare based on fixed fee schedules.
Recent legislation, including the Patient Protection and Affordable Care Act (“PPACA”), the Medicare Improvements for Patients and Providers Act of 2008 (“MIPPA”), the Medicare, Medicaid and SCHIP Extension Act of 2007 (“SCHIP Extension Act”), the Deficit Reduction Act of 2005 (“DRA”) and the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (“MMA”), contain provisions that directly impact reimbursement for the primary respiratory and other DME products provided by Lincare. PPACA, as amended, is a comprehensive health care reform law that contains a large number of health-related provisions to take effect over the next several years, including various cost containment and program integrity changes that will apply to the home medical equipment industry. MIPPA delayed the implementation of a Medicare competitive bidding program for oxygen equipment and certain other DME items that was scheduled to begin on July 1, 2008 and instituted a 9.5% price reduction nationwide for these items as of January 1, 2009. The SCHIP Extension Act reduced Medicare reimbursement amounts for covered Part B drugs, including inhalation drugs that we provide, beginning April 1, 2008. DRA provisions negatively impacted reimbursement for oxygen equipment beginning in 2009 through the implementation of a capped rental arrangement. MMA changed the pricing formulas used to establish payment rates for inhalation drug therapies resulting in significantly reduced reimbursement beginning in 2005, established a competitive acquisition program for DME, established a Recovery Audit Contractors (“RAC”) program, which implemented a new method for recovery of Medicare overpayments by utilizing private companies operating on a contingent fee basis to identify and recoup Medicare overpayments, and implemented quality standards and accreditation requirements for DME suppliers. These legislative provisions, as currently in effect and when fully implemented, have had and will continue to have a material adverse effect on our business, financial condition, operating results and cash flows.
PPACA was signed into law on March 23, 2010. Together with the Health Care and Education Reconciliation Act of 2010 (signed into law on March 30, 2010) which amended the statute, PPACA is a comprehensive health care law that is intended to expand access to health insurance, reform the health insurance market to provide additional consumer protections, and improve the health care delivery system to reduce costs and produce better outcomes through a combination of cost controls, subsidies and mandates. Among other things, PPACA:
(1) Introduces a productivity adjustment factor that will be applied to Medicare price updates (covered item updates) for 2011 and each subsequent year. Specifically, Medicare payment amounts would be updated each year by the percentage increase in the consumer price index for all urban consumers (CPI-U) for the 12-month period ending with June of the previous year, reduced by a productivity adjustment (as projected by the Secretary of Health and Human Services). The application of the productivity adjustment may result in the covered item update being negative for a year, and may result in payment rates being less than such payment rates for the preceding year. The covered item update for Medicare items subject to the update and furnished in 2011, net of the productivity adjustment, was negative 0.1%. The net covered item update for 2012 has been established at positive 2.4%.
(2) Makes adjustments to the Medicare DME Competitive Acquisition Program (“competitive bidding”). PPACA expands the DME competitive bidding program from 79 markets under prior law to 100 markets. PPACA also adds a requirement to competitively bid all areas or use competitive bid information to set prices in all areas by 2016, effectively expanding the program to all geographic markets.
(3) Makes important changes to key fraud and abuse statutes and increases funding for fraud and abuse enforcement. PPACA increases funding for program integrity initiatives, improves screening of providers and suppliers before and after granting Medicare billing privileges and establishes new and enhanced penalties and procedures to deter fraud and abuse. PPACA also specifically adds a requirement that physician orders for covered items of DME must be written by a physician and must document that a physician, a physician assistant, a nurse practitioner, or a clinical nurse specialist has had a face-to-face encounter (including through the use of telehealth) with the individual involved during the six-month period preceding such written order, or other reasonable timeframe as determined by the Secretary of Health and Human Services.
PPACA is a complex, sweeping health care reform law that will dramatically alter the structure of health insurance markets and the practice of medicine in the United States. Due to the complex nature of the legislation and the extended time period over which various provisions of the new law will be implemented (pursuant to yet unwritten regulations), we can not predict at this time what effects PPACA and related regulations will have on our business in the future.
The MIPPA legislation imposed a 9.5% reduction in Medicare payment rates for certain specified product categories, including oxygen, effective January 1, 2009. In addition to the 9.5% reduction, the Centers for Medicare and Medicaid Services (“CMS”), as required by statute, subjected the monthly payment amount for stationary oxygen equipment to additional cuts of 2.3%, thereby reducing the monthly payment rate from $199.28 in 2008 to $175.79 in 2009. The monthly payment amount was reduced by 1.5% in 2010, to $173.17. We estimate that this reduction negatively impacted our revenues in 2010 by approximately $8.4 million when compared to the prior year period. The stationary oxygen payment rate for 2011 was increased to $173.31 per month, an increase of 0.1%, and was not material to the Company’s operating results in 2011. The stationary oxygen payment rate for 2012 has been established by CMS at $176.06 per month, an increase of 1.6%. We estimate that this increase will favorably impact our revenues in 2012 by approximately $10.0 million.
The SCHIP Extension Act, which became law on December 29, 2007, required CMS to adjust the methodology used to determine Medicare payment amounts for inhalation drugs by using volume-weighted average selling prices (“ASP”) based on actual sales volumes rather than average sales prices. CMS publishes payment rates for inhalation drugs each calendar quarter, representing the unit reimbursement rates in effect for inhalation drugs dispensed within that quarter. These payment rates may be subject to volatility as a result of the underlying ASP data used to determine the rates in effect each quarter. The quarterly ASP data published by CMS for inhalation drugs provided in 2010 and 2011 resulted in reductions in the Medicare payment rates for inhalation drugs that negatively impacted the Company’s annual net revenues by approximately $5.0 million and $14.8 million, respectively. Based upon the ASP payment rates published by CMS for the first quarter of 2012, and assuming no changes in the volume or mix of drugs that we currently dispense, we estimate that our annual net revenues will be favorably impacted by approximately $7.0 million in 2012 when compared with 2011. We can not determine whether quarterly updates in ASP pricing data will result in future reductions in payment rates for inhalation drugs, or what impact such payment reductions could have on our business in the future.
Additionally, beginning in 2011, CMS is using 103% of Average Manufacturer Price (“AMP”) rather than 106% of ASP for a drug when ASP exceeds AMP by 5% for either two straight quarters or three of the past four quarters. The policy limits substitution of the price formula in a given quarter to only those drugs where ASP and AMP can be compared using the same set of national drug codes. We can not determine at this time which, if any, inhalation drugs might meet the criteria established for substitution in a particular future quarter, nor the impact on payment rates for such drugs in the event that the AMP formula is utilized.
On February 1, 2006, Congress passed the DRA legislation which changed the reimbursement methodology for oxygen equipment from continuous monthly payment for as long as the equipment is in use by a Medicare beneficiary, which includes payment for oxygen contents, related disposable supplies and accessories and maintenance of equipment, to a capped rental arrangement whereby payment for oxygen equipment may not extend over a period of continuous use of longer than 36 months. Separate payments for oxygen contents continue to be made for the period of medical need beyond the 36 th month. Additionally, payment for routine maintenance and service of the oxygen equipment may be made following each six-month period after the 36-month rental period ends. The oxygen provisions contained in DRA became effective on January 1, 2006. In the case of beneficiaries receiving oxygen equipment prior to the effective date, the 36-month period of continuous use began on January 1, 2006. Accordingly, the first month in which the new payment methodology impacted our net revenues was January 2009. We anticipate that these oxygen payment rules will continue to negatively affect our net revenues on an ongoing basis, as each month additional customers reach the 36-month capped service period, resulting in up to two or more years without rental income from these customers. During 2011, we estimate that our sequential net revenues were reduced as a result of additional customers reaching the payment cap by approximately $20.2 million when compared to the prior year period.
CEO BACKGROUND
John P. Byrnes has served as the Chief Executive Officer of the Company since January 1997 and as a Director of the Company since May 1997. Mr. Byrnes was appointed Chairman of the Board in March 2000. Mr. Byrnes also served as the Company’s President from June 1996 until April 2003. Prior to becoming the Company’s President, Mr. Byrnes served the Company in a number of capacities over a ten-year period, including serving as the Company’s Chief Operating Officer throughout 1996. Mr. Byrnes was a director of Kinetic Concepts, Inc. until February 2011. In nominating Mr. Byrnes, the Nominating and Governance Committee considered as important factors Mr. Byrnes’ significant contribution to the success of the Company and his particular knowledge of and experience in the home health care services industry in which the Company competes.
Stuart H. Altman, Ph.D. has been a director of the Company since December 2001. Dr. Altman, Professor of National Health Policy at Brandeis University, is a member of the faculty of The Heller School for Social Policy and Management on Brandeis’ Waltham, Massachusetts campus and is an economist whose research interests are primarily in the area of federal and state health policy. He served as Co-Chair of the Governor/Legislative Health Care Task Force for the Commonwealth of Massachusetts from 2000 to 2002. In 1997, he was appointed by President Clinton to the National Bipartisan Commission on the Future of Medicare. Dr. Altman was Dean of the Heller School from 1977 to 1993 and served as interim President of Brandeis University from 1990 to 1991. Earlier in his career, Dr. Altman was Deputy Assistant Secretary for Planning and Evaluation/Health at the U.S. Department of Health Education & Welfare and has since advised national and state governments on major health care issues and legislation. Dr. Altman is a director of Aveta Inc., a health insurance organization, and several privately-held managed care and disease management companies. In nominating Dr. Altman, the Nominating and Governance Committee considered as important factors Dr. Altman’s expertise in public health care policy matters and his extensive knowledge of managed care and disease management organizations.
Chester B. Black has been a director of the Company since January 1991. From 1989 to 1995, Mr. Black served as Chairman and President of ImageAmerica (and its predecessor companies), a provider of diagnostic imaging services. Since 1998, Mr. Black has been a managing partner in Angel Healthcare Investors, a venture capital firm investing primarily in early stage health care companies. Mr. Black currently serves as managing partner of a privately-held company providing basic and life support ambulance transfers and serves as an advisor to many small health care companies in the Boston area. In nominating Mr. Black, the Nominating and Governance Committee considered as important factors Mr. Black’s extensive experience in organizing, managing and investing in numerous business entities engaged in diverse aspects of the health care services industry and his strong knowledge of, and value to, the Company’s business gained from his long record of service as a member of the Company’s board.
Angela P. Bryant has been a director of the Company since September 2010. Ms. Bryant served as General Counsel of Lincare Holdings Inc. from 1999 through 2004, and as Corporate Counsel to the Company from 1996 through 1998. From November 1991 to March 1996, Ms. Bryant served as General Counsel to Sports & Recreation, Inc. in Tampa, Florida. After receiving her Juris Doctor degree from the University of Florida in 1989, Ms. Bryant worked as an associate in the law firm of Troutman Sanders in Atlanta, Georgia until November 1991. In nominating Ms. Bryant, the Nominating and Governance Committee considered as important factors Ms. Bryant’s extensive experience with health care regulatory matters and her previous service to Lincare as General Counsel which the Committee believes will benefit the Company as it seeks to expand its scope of health care services.
Frank D. Byrne, M.D. has been a director of the Company since December 1999. Since 2004, Dr. Byrne has served as President of St. Mary’s Hospital, a 440-bed community hospital in Madison, Wisconsin. From 1991 until 2004, he served at Parkview Health, an integrated delivery network headquartered in Fort Wayne, Indiana, in a variety of executive, governance, and clinical leadership roles, including President of Parkview Hospital from 1995 to 2002. From 1982 to 1994, Dr. Byrne practiced pulmonary and critical care medicine. He is a Clinical Professor of Medicine at the University of Wisconsin School of Medicine and holds fellowships in the American College of Physicians, the American College of Chest Physicians, the American College of Healthcare Executives, and the American College of Physician Executives. Dr. Byrne has a B.S. from the University of Notre Dame, a Master of Medical Management from Carnegie Mellon University, and an M.D. from the State University of New York Downstate Medical Center. He has attended the Executive Program at the University of Michigan Business School and corporate governance education programs at Harvard Business School, the University of Wisconsin and Stanford University. Dr. Byrne also serves as a director of Steel Dynamics, Inc. In nominating Dr. Byrne, the Nominating and Governance Committee considered as important factors Dr. Byrne’s extensive executive, governance and clinical leadership roles in several leading integrated health systems and hospitals and his experience as a practicing physician in the areas of pulmonary and critical care medicine.
William F. Miller, III has been a director of the Company since December 1997. Mr. Miller is a partner with the private equity firm Highlander Partners in Dallas, Texas. From 2000 to 2005, Mr. Miller was the Chairman and Chief Executive Officer of HMS Holdings Corp., a provider of innovative revenue enhancement and services to public and private health care programs and payors. From 1983 to 1999, Mr. Miller served as President and Chief Operating Officer of Emcare Holdings, Inc., a leading national health care services firm focused on the provision of emergency physician medical services. Mr. Miller is a director of HMS Holdings Corp. and various private companies. In nominating Mr. Miller, the Nominating and Governance Committee considered as important factors Mr. Miller’s extensive experience in executive and financial management of a diverse range of health care services companies, his past experience in the preparation and examination of financial statements and his extensive knowledge and understanding of capital markets.
Ellen M. Zane has been a director of the Company since 2010. Effective September 30, 2011, Ms. Zane retired as President and Chief Executive Officer of Tufts Medical Center. From January 2004 to September 2011, she served as President and Chief Executive Officer of Tufts Medical Center, a hospital in Boston, Massachusetts. From May 1994 to January 2004, she served as Network President for Partners Healthcare System, a physician network. Prior to 2004, Ms. Zane served as Chief Executive Officer of Quincy Hospital in Quincy, Massachusetts. Ms. Zane is a director of Parexel International Corporation. In nominating Ms. Zane, the Nominating and Governance Committee considered as important factors her extensive experience in management of hospital and health care related enterprises delivered across the continuum of care which the Committee believes will benefit the Company as it explores new growth opportunities in the health care market.
Paul G. Gabos, age 47, has served as the Chief Financial Officer of the Company since June 1997. Prior to his appointment as Chief Financial Officer, Mr. Gabos served as Vice President, Administration. Before joining Lincare in 1993, Mr. Gabos worked for Coopers & Lybrand and for Dean Witter Reynolds Inc. Mr. Gabos holds a Bachelor of Science in Economics from The Wharton School of the University of Pennsylvania. Mr. Gabos is a director of MEDNAX, Inc.
Shawn S. Schabel, age 47, was appointed President of the Company in April 2003 and Chief Operating Officer of the Company in January 2001. From 1998 to 2001, Mr. Schabel served as Senior Vice President of the Company. Mr. Schabel served the Company in a number of management capacities since joining Lincare in 1989. Mr. Schabel holds a Respiratory Therapy degree from Wichita State University. Mr. Schabel served on the board of Odyssey Healthcare, Inc. until August 2010.
MANAGEMENT DISCUSSION FROM LATEST 10K
General
We continue to pursue a strategy of increasing market share in existing and surrounding geographic markets through internal growth and selective acquisition of local and regional companies. In addition, we will continue to expand into new geographic markets and product lines on a selective basis, either through acquisition or by opening new operating centers, when we believe it will enhance our business. Our focus remains primarily on oxygen, respiratory and other chronic therapy services, which represent approximately 90% of our revenues.
Critical Accounting Policies
The consolidated financial statements include the accounts of Lincare Holdings Inc. and its subsidiaries. We have made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these financial statements in conformity with generally accepted accounting principles.
Critical accounting policies are those we believe are both most important to the portrayal of our financial condition and operating results and require our most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Judgments and uncertainties affecting the application of those policies may result in materially different amounts being reported under different conditions or using different assumptions. We consider the following policies to be most critical in understanding the judgments that are involved in preparing our consolidated financial statements.
Revenue Recognition and Accounts Receivable
Our revenues are recognized on an accrual basis in the period in which services and related products are provided to customers and are recorded at net realizable amounts estimated to be paid by customers and third-party payors. The Company’s billing system contains payor-specific price tables that reflect the fee schedule amounts in effect or contractually agreed upon by various government and commercial payors for services and each item of equipment or supply provided to a customer. The Company has established an allowance to account for sales adjustments that result from differences between the payment amount received and the expected realizable amount. Actual adjustments that result from differences between the payment amount received and the expected realizable amount are recorded against the allowance for sales adjustments and are typically identified and ultimately recorded at the point of cash application or when otherwise determined pursuant to the Company’s collection procedures. We report revenues in our financial statements net of such sales adjustments.
Certain items provided by the Company are reimbursed under rental arrangements that generally provide for fixed monthly payments established by fee schedules for as long as the patient is using the equipment and medical necessity continues (subject to capped rental arrangements which limit the rental payment periods in some instances and which may result in a transfer of title to the patient at the end of the rental payment period). Once initial delivery of rental equipment is made to the patient, a monthly billing cycle is established based on the initial date of delivery. The Company recognizes rental arrangement revenues ratably over the monthly service period and defers revenue for the portion of the monthly bill that is unearned. No separate payment is earned from the initial equipment delivery and setup process. During the rental period, we are responsible for servicing the equipment and providing routine maintenance, if necessary.
Our revenue recognition policy recognizes revenue at the time the following criteria are met:
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persuasive evidence of an arrangement exists;
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delivery has occurred;
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the seller’s price to the buyer is fixed or determinable; and
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collectibility is reasonably assured.
Due to the nature of the industry and the reimbursement environment in which we operate, certain estimates are required to record net revenues and accounts receivable at their net realizable values at the time products and/or services are provided. Inherent in these estimates is the risk that they will have to be revised or updated as additional information becomes available. Specifically, the complexity of many third-party billing arrangements and the uncertainty of reimbursement amounts for certain services from certain payors may result in adjustments to amounts originally recorded. Such adjustments are typically identified and recorded by the Company at the point of cash application, claim denial or account review. Included in accounts receivable are earned but unbilled accounts receivable from earned revenues. Unbilled accounts receivable represent charges for equipment and supplies delivered to customers for which invoices have not yet been generated by the Company’s billing system. Prior to the delivery of equipment and supplies to customers, we perform certain certification and approval procedures to ensure collection is reasonably assured. Once the items are delivered, unbilled accounts receivable are recorded at net amounts expected to be paid by customers and third-party payors. Billing delays, generally ranging from several days to several weeks, can occur due to delays in obtaining certain required payor-specific documentation from internal and external sources as well as interim transactions occurring between cycle billing dates established for each customer within the billing system, and business acquisitions awaiting assignment of new provider enrollment identification numbers. In the event that a third-party payor does not accept the claim for payment, the customer is ultimately responsible for payment for the products and services. Accounts receivable are reported net of allowances for sales adjustments and uncollectible accounts. Sales adjustments are recorded against revenues and result from differences between the payment amount received and the expected realizable amount. Bad debt is recorded as an operating expense and consists of billed charges that are ultimately deemed uncollectible due to the customer’s or third-party payor’s inability to pay.
We perform analyses to evaluate the net realizable value of accounts receivable. Specifically, we consider historical realization data, accounts receivable aging trends, other operating trends and relevant business conditions. Because of continuing changes in the health care industry and third-party reimbursement, it is possible that our estimates could change, which could have a material impact on our operations and cash flows.
Bad Debt Expense, Sales Adjustments and Related Allowances for Uncollectible Accounts Receivable
Accounts receivable are reported net of allowances for sales adjustments and uncollectible accounts. The majority of our accounts receivable are due from Medicare, Medicaid and private insurance carriers, as well as from customers under co-insurance provisions. Third-party reimbursement is a complicated process that involves submission of claims to multiple payors, each having its own claims requirements. In some cases, the ultimate collection of accounts receivable subsequent to the service dates may not be known for several months. Bad debt is recorded as an operating expense and consists of billed charges that are ultimately deemed uncollectible due to the customer’s or third-party payor’s inability to pay. We record bad debt expense based on a percentage of revenue using historical Company-specific data. The percentage and amounts used to record bad debt expense and the allowance for doubtful accounts are supported by various methods, including current and historical cash collections, bad debt write-offs, and aging of accounts receivable. Our proprietary management information systems are utilized to provide this data in order to assess bad debts. In the event that collection results of existing accounts receivable are not consistent with historical experience, there may be a need to increase or decrease our allowances for doubtful accounts, which may materially impact our financial position or results of operations.
The Company has established an allowance to account for sales adjustments that result from differences between the payment amounts received from customers and third-party payors and the expected realizable amounts. Actual adjustments that result from such differences are recorded against the allowance for sales adjustments and are typically identified and ultimately recorded at the point of cash application or when otherwise determined pursuant to the Company’s collection procedures. We report revenues in our financial statements net of such adjustments.
Business Acquisition Accounting
We apply the acquisition method of accounting for business acquisitions and use available cash from operations and borrowings under our revolving credit agreement as the consideration for business acquisitions. We allocate the purchase price of our business acquisitions based on the fair value of identifiable tangible and intangible assets. The difference between the total cost of the acquisition and the sum of the fair values of acquired tangible and identifiable intangible assets less liabilities is recorded as goodwill.
Goodwill and Other Intangible Assets
We have recorded intangible assets, including goodwill, customer and contract relationships, tradenames, covenants not-to-compete and technology, in connection with business acquisitions. Estimated useful lives of amortizable intangible assets are determined by management based on an assessment of the period over which the asset is expected to contribute to future cash flows. The allocation of intangible assets impacts the amounts allocable to goodwill.
In accordance with U.S. GAAP for goodwill and other indefinite-lived intangibles, the Company tests these assets for impairment annually and whenever events or circumstances make it more likely than not that impairment may have occurred. For the purposes of that assessment, we have determined that the Company has a single reporting unit, and all goodwill and indefinite-lived intangible assets acquired in business combinations have been assigned to that single reporting unit as of the acquisition date.
The first step of the goodwill impairment analysis compares the Company’s fair value to its net book value to determine if there is an indicator of impairment. If the assessment in the first step indicates impairment then the Company performs step two. The second step compares the implied fair value of goodwill to its carrying amount in a manner similar to a purchase price allocation for a business combination. If the carrying amount of goodwill exceeds its implied fair value, an impairment loss is recognized equal to that excess. The Company evaluated its fair value using the market approach. This approach utilizes the closing market price of its common stock at the annual impairment testing date and the number of shares of common stock outstanding on that date.
The Company completed the annual goodwill impairment test on September 30, 2011 and determined that the fair value of the reporting unit substantially exceeded its carrying value indicating no impairment existed at the date of the impairment test. No recent events or circumstances have occurred to indicate that impairment may exist.
The Company tests its indefinite-lived intangible assets, comprised of tradenames, using a “relief-from-royalty” valuation method compared to the carrying value. Significant assumptions inherent in this valuation methodology include, but are not limited to, such estimates as projected business results, growth rates, the Company’s weighted-average cost of capital, royalty and discount rates. The Company completed the annual indefinite-lived intangible assets impairment test on December 31, 2011 and determined that the fair value sufficiently exceeds its carrying value indicating no impairment existed at the date of the impairment test. No recent events or circumstances have occurred to indicate that impairment may exist.
Long-Lived Assets
We review property and equipment and amortizable intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of property and equipment is measured by comparing its carrying value to the undiscounted projected future cash flows that the asset(s) are expected to generate. If the carrying amount of an asset is not recoverable, we recognize an impairment loss based on the excess of the carrying amount of the long-lived asset over its respective fair value, which is generally determined as the present value of estimated future cash flows or at the appraised value. The impairment analysis is based on significant assumptions of future results made by management, including revenue and cash flow projections. Circumstances that may lead to impairment of property and equipment include a significant decrease in the market price of a long-lived asset, a significant adverse change in the extent or manner in which a long-lived asset is being used or in its physical condition and a significant adverse change in legal factors or in the business climate that could affect the value of a long-lived asset including an adverse action or assessment by a regulator. The Company did not identify any triggering events in 2011.
In addition to consideration of impairment upon the events or changes in circumstances described above, management regularly evaluates the remaining lives of its long-lived assets. If estimates are revised, the carrying value of affected assets is depreciated or amortized over the remaining lives.
Insurance
We are subject to workers’ compensation, professional liability, auto liability and employee health benefit claims, which are primarily self-insured; however, we maintain certain stop-loss and other insurance coverage which we believe to be appropriate. Provisions for estimated settlements relating to the workers’ compensation and health benefit plans are provided in the period of the related claim on a case-by-case basis plus an amount for incurred but not reported claims. Differences between the amounts accrued and subsequent settlements are recorded in operations in the period of settlement.
Contingencies
We are involved in certain claims and legal matters arising in the ordinary course of business. We evaluate and record liabilities for contingencies based on known claims and legal actions when it is probable a liability has been incurred and the liability can be reasonably estimated.
Cost of Goods and Services
Cost of goods and services as a percentage of net revenues was 31.4% for the year ended December 31, 2011, 27.2% for the year ended December 31, 2010 and 27.8% for the year ended December 31, 2009. Cost of goods and services increased by $125.6 million, or 27.7%, in 2011 and $22.6 million, or 5.2%, in 2010. The increase in cost of goods and services in 2011 is primarily attributable to the Company’s addition of a specialty pharmacy product line with gross margins that are lower than other products and services provided by the Company and higher sale volumes of CPAP supplies and inhalation drugs. The increase in cost of goods and services in 2010 is attributable to an increase in the number of oxygen customers served and higher volumes in our inhalation drug, sleep therapy, enteral nutrition and infusion therapy product lines.
Cost of goods and services includes the cost of non-capitalized medical equipment, drugs and supplies sold to patients and certain operating costs related to the Company’s respiratory drug product line. These operating costs include an allocation of customer service, distribution and administrative costs relating to the respiratory drug product line of approximately $55.2 million, $53.7 million and $51.3 million in 2011, 2010 and 2009, respectively. Included in cost of goods and services for the year ended December 31, 2011 are salary and related expenses of pharmacists and other service professionals of $11.1 million. Such salary and related expenses were $10.7 million and $11.8 million in the years ended December 31, 2010 and 2009, respectively.
Operating and Other Expenses
Operating expenses as a percentage of net revenues for the years ended December 31, 2011, 2010 and 2009 were 23.2%, 23.9% and 25.1%, respectively. Operating expenses in 2011 increased by $28.6 million, or 7.2%, when compared with the prior year period. Operating expenses in 2010 increased $9.6 million, or 2.5%, when compared with the prior year period. The Company has been successful in achieving productivity gains that have contributed to containment of the growth in wage expenses and in managing the growth of its employee health benefit costs. During 2011, these positive developments were partially offset by increases in vehicle related expenses, most significantly fuel costs. During 2010, the positive effect on wage growth due to labor productivity was partially offset by increases in vehicle related expenses and higher facility expenses including rent and utilities.
The Company manages over 1,100 operating centers from which customers are provided equipment, supplies and services. An operating center averages approximately seven to eight employees and is typically comprised of a center manager, two customer service representatives (referred to as “CSR’s” – telephone intake, scheduling, documentation), two or three service representatives (referred to as “Service Reps” – delivery, maintenance and retrieval of equipment and delivery of disposables), a respiratory therapist (non-reimbursable and discretionary clinical follow-up with the customer and communication to the prescribing physician) and a sales representative (marketing calls to local physicians and other referral sources).
Selling, general and administrative expenses (“SG&A”) as a percentage of net revenues for the years ended December 31, 2011, 2010 and 2009, were 18.9%, 20.0% and 21.3%, respectively. SG&A expenses in 2011 increased by $16.4 million, or 4.9%, compared with the prior year period. Contributing to the change in SG&A expenses during 2011 were higher salary and related costs along with increases in advertising expenses and employee-owned vehicle reimbursement expenses. SG&A expenses in 2010 increased by $2.5 million, or 0.8%, compared with the prior year period. Contributing to the change in SG&A expenses during 2010 were higher advertising expenses partially offset by lower administrative payroll and related expenses and reductions in the fair value of contingent consideration obligations related to acquisitions.
SG&A expenses include costs related to sales and marketing activities, clinical respiratory services, corporate overhead and other business support functions. Included in SG&A during the year ended December 31, 2011 are salary and related expenses of $255.5 million. These salary and related expenses include the cost of the Company’s respiratory therapists in the amount of $69.4 million during 2011. The Company’s respiratory therapists generally provide non-reimbursable and discretionary clinical follow-up with the customer and communication, as appropriate, to the prescribing physician with respect to the customer’s plan of care. The Company includes the salaries and related expenses of its respiratory therapist personnel (licensed respiratory therapists or, in some cases, registered nurses) in SG&A because it believes that these personnel enhance the Company’s business relative to its competitors that do not employ respiratory therapists. Included in SG&A during the years ended December 31, 2010 and 2009 are salary and related expenses of $253.7 million and $257.4 million, respectively. These salary and related expenses include the cost of the Company’s respiratory therapists in the amount of $68.4 million and $66.0 million during the respective years.
Bad debt expense as a percentage of net revenues was 2.0% for the year ended December 31, 2011 and 1.9% and 1.5% for the years ended December 31, 2010 and 2009, respectively. Days sales outstanding (“DSO”) were 47 days at December 31, 2011, compared with 40 days and 35 days at December 31, 2010 and 2009, respectively. Contributing to the increase in our accounts receivable in 2011 is a significant increase in the number of claims subject to prepayment review, primarily by the DME MACs and other health care claim audit contractors, which added approximately seven days to our DSO in 2011. These claim reviews are substantially delaying the collection of our Medicare accounts receivable as well as related secondary amounts due under supplemental insurance plans. Also contributing to the increase in accounts receivable and bad debt expense are co-payments and deductibles due from customers who are finding it difficult to pay their out-of-pocket charges due to loss of insurance coverage or reductions in their investment or employment income. The increase in our bad debt expense and DSO in 2010 was largely a result of an increase in accounts receivable balances and write-offs due directly from customers and an increase in the aging of our accounts receivable due from Medicare and certain commercial payors. The general economic climate and business acquisition activities may contribute to an increase in our bad debt expense in the future. The collection of deductible balances and co-payment amounts due directly from customers may be negatively affected by weakening economic conditions in the U.S. The integration of acquired companies into our regional billing and collections offices may temporarily disrupt collections, increasing the amount of accounts receivable written-off as uncollectible.
Depreciation and amortization expense, as a percentage of net revenues was 6.8% for the year ended December 31, 2011 compared with 7.0% and 7.6% for the years ended December 31, 2010 and 2009, respectively. Included in depreciation and amortization expense in the year ended December 31, 2011 is depreciation of medical equipment of $112.2 million and depreciation of other property and equipment of $10.7 million. Included in depreciation and amortization expense in the years ended December 31, 2010 and 2009 is depreciation of medical equipment of $103.8 million and $105.8 million, respectively, and depreciation of other property and equipment of $12.7 million and $12.0 million, respectively.
Operating Income
As shown in the table below, operating income for the year ended December 31, 2011 decreased $6.1 million, when compared to the prior year period. The decrease in operating income in 2011 is attributed primarily to the negative impact on net revenues of $52.4 million of Medicare payment changes and higher expenses attributable to the development of new product lines. These payment changes include reductions in average payment rates for respiratory medications, the impact of new Medicare payment rates in the nine markets affected by the competitive bidding program and the ongoing effect of Medicare oxygen customers reaching the 36-month rental payment cap. Operating income for the year ended December 31, 2010 increased $76.7 million when compared to the prior year period. The increase in operating income in 2010 is attributed to the increase in net revenues from the Company’s core product lines and management of the growth in costs and expenses during the year partially offset by $34.9 million of Medicare payment reductions.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Medicare Reimbursement
As a provider of home oxygen, respiratory and other chronic therapy services to the home health care market, we participate in Medicare Part B, the Supplementary Medical Insurance Program, which was established by the Social Security Act of 1965. Providers of home oxygen and other respiratory therapy services have historically been heavily dependent on Medicare reimbursement due to the high proportion of elderly persons suffering from respiratory disease. Durable medical equipment (“DME”), including oxygen equipment, is traditionally reimbursed by Medicare based on fixed fee schedules.
Recent legislation, including the Patient Protection and Affordable Care Act (“PPACA”), the Medicare Improvements for Patients and Providers Act of 2008 (“MIPPA”), the Medicare, Medicaid and SCHIP Extension Act of 2007 (“SCHIP Extension Act”), the Deficit Reduction Act of 2005 (“DRA”) and the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (“MMA”), contain provisions that directly impact reimbursement for the primary respiratory and other DME products provided by Lincare. PPACA, as amended, is a comprehensive health care reform law that contains a large number of health-related provisions to take effect over the next several years, including various cost containment and program integrity changes that will apply to the home medical equipment industry. MIPPA delayed the implementation of a Medicare competitive bidding program for oxygen equipment and certain other DME items that was scheduled to begin on July 1, 2008 and instituted a 9.5% price reduction nationwide for these items as of January 1, 2009. The SCHIP Extension Act reduced Medicare reimbursement amounts for covered Part B drugs, including inhalation drugs that we provide, beginning April 1, 2008. DRA provisions negatively impacted reimbursement for oxygen equipment beginning in 2009 through the implementation of a capped rental arrangement. MMA changed the pricing formulas used to establish payment rates for inhalation drug therapies resulting in significantly reduced reimbursement beginning in 2005, established a competitive acquisition program for DME, established a Recovery Audit Contractors (“RAC”) program, which implemented a new method for recovery of Medicare overpayments by utilizing private companies operating on a contingent fee basis to identify and recoup Medicare overpayments, and implemented quality standards and accreditation requirements for DME suppliers. These legislative provisions, as currently in effect and when fully implemented, have had and will continue to have a material adverse effect on our business, financial condition, operating results and cash flows.
PPACA was signed into law on March 23, 2010. Together with the Health Care and Education Reconciliation Act of 2010 (signed into law on March 30, 2010) which amended the statute, PPACA is a comprehensive health care law that is intended to expand access to health insurance, reform the health insurance market to provide additional consumer protections, and improve the health care delivery system to reduce costs and produce better outcomes through a combination of cost controls, subsidies and mandates. Among other things, PPACA:
(1) Introduced a productivity adjustment factor that is applied to Medicare price updates (covered item updates) for 2011 and each subsequent year. Specifically, Medicare payment amounts are updated each year by the percentage increase in the consumer price index for all urban consumers (CPI-U) for the 12-month period ending with June of the previous year, reduced by a productivity adjustment (as projected by the Secretary of Health and Human Services). The application of the productivity adjustment may result in the covered item update being negative for a year, and may result in payment rates being less than such payment rates for the preceding year. The covered item update for Medicare items subject to the update and furnished in 2012, net of the productivity adjustment has been established at positive 2.4%.
(2) Made adjustments to the Medicare DME Competitive Acquisition Program (“competitive bidding”). PPACA expands the DME competitive bidding program to 100 markets from 79 markets under prior law. PPACA also added a requirement to expand competitive bidding further to additional geographic markets (certain markets may be excluded at the discretion of CMS) or use competitive bid pricing information to adjust the payment amounts otherwise in effect for areas that are not competitive acquisition areas by January 1, 2016.
(3) Made important changes to key fraud and abuse statutes and increased funding for fraud and abuse enforcement. PPACA increased funding for program integrity initiatives, improved screening of providers and suppliers before and after granting Medicare billing privileges and established new and enhanced penalties and procedures to deter fraud and abuse. PPACA also specifically added a requirement that physician orders for covered items of DME must be written by a physician and must document that a physician, a physician assistant, a nurse practitioner, or a clinical nurse specialist had a face-to-face encounter (including through the use of telehealth) with the individual involved during the six-month period preceding such written order, or other reasonable timeframe as determined by the Secretary of Health and Human Services.
PPACA is a complex, sweeping health care reform law that will dramatically alter the structure of health insurance markets and the practice of medicine in the United States. Due to the complex nature of the legislation and the extended time period over which various provisions of the new law will be implemented (pursuant to yet unwritten regulations), we can not predict at this time what effects PPACA and related regulations will have on our business in the future.
The MIPPA legislation imposed a 9.5% reduction in Medicare payment rates for certain specified product categories, including oxygen, effective January 1, 2009. In addition to the 9.5% reduction, the Centers for Medicare and Medicaid Services (“CMS”), as required by statute, subjected the monthly payment amount for stationary oxygen equipment to additional cuts of 2.3%, thereby reducing the monthly payment rate from $199.28 in 2008 to $175.79 in 2009. The monthly payment amount was reduced by 1.5% in 2010, to $173.17. We estimate that this reduction negatively impacted our annual net revenues in 2010 by approximately $8.4 million when compared to the prior year period. The stationary oxygen payment rate for 2011 was increased to $173.31 per month, an increase of 0.1%, and was not material to the Company’s operating results in 2011. The stationary oxygen payment rate for 2012 has been established by CMS at $176.06 per month, an increase of 1.6%. We estimate that this increase will favorably impact our revenues in 2012 by approximately $10.1 million.
The SCHIP Extension Act, which became law on December 29, 2007, required CMS to adjust the methodology used to determine Medicare payment amounts for inhalation drugs by using volume-weighted average selling prices (“ASP”) based on actual sales volumes rather than average sales prices. CMS publishes payment rates for inhalation drugs each calendar quarter, representing the unit reimbursement rates in effect for inhalation drugs dispensed within that quarter. These payment rates may be subject to volatility as a result of the underlying ASP data used to determine the rates in effect each quarter. The quarterly ASP data published by CMS for inhalation drugs provided in 2010 and 2011 resulted in reductions in the Medicare payment rates for inhalation drugs that negatively impacted the Company’s annual net revenues by approximately $5.0 million and $14.8 million, respectively. Based upon the ASP payment rates published by CMS for the first and second quarters of 2012, and assuming no changes in the volume or mix of drugs that we currently dispense, we estimate that our annual net revenues will be favorably impacted by approximately $12.5 million in 2012 when compared with 2011. We can not determine whether quarterly updates in ASP pricing data will result in future reductions in payment rates for inhalation drugs, or what impact such payment reductions could have on our business in the future.
Additionally, since 2011, CMS is using 103% of Average Manufacturer Price (“AMP”) rather than 106% of ASP for a drug when ASP exceeds AMP by 5% for either two straight quarters or three of the past four quarters. The policy limits substitution of the price formula in a given quarter to only those drugs where ASP and AMP can be compared using the same set of national drug codes. We can not determine at this time which, if any, inhalation drugs might meet the criteria established for substitution in a particular future quarter, nor the impact on payment rates for such drugs in the event that the AMP formula is utilized.
On February 1, 2006, Congress passed the DRA legislation which changed the reimbursement methodology for oxygen equipment from continuous monthly payment for as long as the equipment is in use by a Medicare beneficiary, which includes payment for oxygen contents, related disposable supplies and accessories and maintenance of equipment, to a capped rental arrangement whereby payment for oxygen equipment may not extend over a period of continuous use of longer than 36 months. Separate payments for oxygen contents continue to be made for the period of medical need beyond the 36 th month. Additionally, payment for routine maintenance and service of the oxygen equipment may be made following each six-month period after the 36-month rental period ends. The oxygen provisions contained in DRA became effective on January 1, 2006. In the case of beneficiaries receiving oxygen equipment prior to the effective date, the 36-month period of continuous use began on January 1, 2006. Accordingly, the first month in which the new payment methodology impacted our net revenues was January 2009. We anticipate that these oxygen payment rules will continue to negatively affect our net revenues on an ongoing basis, as each month additional customers reach the 36-month capped service period, resulting in no further rental income from these customers. During 2011, we estimate that our sequential net revenues were reduced as a result of additional customers reaching the payment cap by approximately $20.2 million when compared to the prior year period. During the first quarter of 2012, we estimate that our net revenues were reduced by $7.0 million compared to the first quarter of 2011, attributed to the oxygen rental payment cap.
In December 2003, MMA was signed into law. The MMA legislation directly impacted reimbursement for the primary respiratory and other DME products that we provide. Among other things, MMA:
(1) Established a competitive acquisition program for DME that was expected to commence in 2008, but was subsequently delayed by further legislation. MMA instructed CMS to establish and implement programs under which competitive acquisition areas would be established throughout the United States for purposes of awarding contracts for the furnishing of competitively priced items of DME, including oxygen equipment. The program was initially intended to be implemented in phases such that competition under the program would occur in nine of the largest metropolitan statistical areas (“MSAs”) in the first year and an additional 70 of the largest MSAs in a second, subsequent round of bidding.
For each competitive acquisition area, CMS is required to conduct a competition under which providers submit bids to supply certain covered items of DME. Successful bidders are expected to meet certain program quality standards in order to be awarded a contract and only successful bidders can supply the covered items to Medicare beneficiaries in the acquisition area (there are, however, regulations in place that allow non-contracted providers to continue to provide equipment and services to their existing customers at the new prices determined through the bidding process). The contracts are expected to be re-bid at least every three years. CMS is required to award contracts to multiple entities submitting bids in each area for an item or service, but has the authority to limit the number of contractors in a competitive acquisition area to the number it determines to be necessary to meet projected demand.
CMS concluded the bidding process for the first round of MSAs in September 2007, however, in July 2008, Congress enacted the MIPPA legislation which retroactively delayed the implementation of competitive bidding and reduced Medicare prices nationwide by 9.5% beginning in 2009 for the product categories, including oxygen, that were initially included in competitive bidding.
In 2009, CMS reinstituted the bidding process in the nine largest MSA markets. Reimbursement rates from the re-bidding process were publicly released by CMS on June 30, 2010. CMS announced average savings of approximately 32% off the current payment rates in effect for the product categories included in competitive bidding. As of January 1, 2011, these payment rates were in effect in the nine markets only. Lincare was offered contracts to provide oxygen equipment in just two of the nine markets, Charlotte and Miami, and we accepted and signed those contracts. The Company’s annual Medicare revenues from the product categories in the nine markets affected by competitive bidding were approximately $48.0 million at the time the program commenced. During 2011, we completed acquisitions of companies that were contracted to provide home oxygen equipment and positive airway pressure devices in all nine competitive bidding markets.
CMS is currently undertaking a second round of competitive bidding in 91 additional markets, with contracts expected to be effective in July 2013. The bid submission period closed on March 30, 2012, and CMS is expected to announce final pricing results in November 2012. The Company’s Medicare revenues from the product categories in the 91 additional markets to be included in the second round of competitive bidding were approximately $267.0 million in 2011. The PPACA legislation requires CMS to expand competitive bidding further to additional geographic markets (certain markets may be excluded at the discretion of CMS) or to use competitive bid pricing information to adjust the payment amounts otherwise in effect for areas that are not competitive acquisition areas by January 1, 2016.
We will continue to monitor developments regarding the implementation of the competitive bidding program. While we can not predict the outcome of the competitive bidding program on our business when fully implemented nor the Medicare payment rates that will be in effect in future years for the items subjected to competitive bidding, it is likely that the program will materially adversely effect our financial position and operating results.
(2)
Established a Recovery Audit Contractors (“RAC”) program to identify and recoup Medicare overpayments from providers . Started in 2005 as a demonstration project by CMS, the RAC program was designed to test a new method for recovery of Medicare overpayments by utilizing private companies operating on a contingent fee basis to identify and recoup Medicare overpayments from providers. Section 302 of the Tax Relief and Health Care Act of 2006 made the program permanent and requires the Department of Health and Human Services to expand the program to all states. The RAC contractors are empowered to audit claims submitted by health care providers and to withhold future payments, including in cases where the reimbursement rules are unclear or subject to differing interpretations. This activity, as well as the activity of intermediaries and others involved in government reimbursement, may include changes in long-standing interpretations of reimbursement rules, which could have a material adverse effect on our future financial position and operating results.
In October 2008, CMS announced the establishment of new Zone Program Integrity Contractors (“ZPICs”), who are responsible for ensuring the integrity of all Medicare-related claims. The ZPICs assumed the responsibilities previously held by Medicare’s Program Safeguard Contractors (“PSCs”). Industry-wide, ZPIC audit activity increased substantially throughout 2010 and 2011 and that activity is expected to continue to increase for the foreseeable future as additional ZPICs become operational across the country. The industry trade associations are advocating for more standardized audit procedures, contractor transparency and consistency surrounding all government audit activity directed toward the DME industry.
In order to ensure that Medicare beneficiaries only receive medically necessary and appropriate items and services, the Medicare program has adopted a number of documentation requirements. For example, the Durable Medical Equipment Medicare Administrative Contractor (“DME MAC”) Supplier Manuals provide that clinical information from the “patient’s medical record” is required to justify the initial and ongoing medical necessity for the provision of DME. Some DME MACs, CMS staff and government subcontractors have recently taken the position, among other things, that the “patient’s medical record” refers not to documentation maintained by the DME supplier but instead to documentation maintained by the patient’s physician, health care facility or other clinician, and that clinical information created by the DME supplier’s personnel and confirmed by the patient’s physician is not sufficient to establish medical necessity. It may be difficult, and sometimes impossible, for us to obtain documentation from other health care providers. Moreover, auditors’ interpretations of these policies are inconsistent and subject to individual interpretation, leading to significant increases in individual supplier and industry-wide perceived error rates. High error rates lead to further audit activity and regulatory burdens. If these or other burdensome positions are generally adopted by auditors, DME MACs, other contractors or CMS in administering the Medicare program, we would have the right to challenge these positions as being contrary to law. If these interpretations of the documentation requirements are ultimately upheld, however, it could result in our making significant refunds and other payments to Medicare and our future revenues and cash flows from Medicare may be reduced. We can not currently predict the adverse impact these interpretations of the Medicare documentation requirements might have on our operations, cash flow and capital resources, but such impact could be material.
Federal and state budgetary and other cost-containment pressures will continue to impact the home respiratory care industry. We can not predict whether new federal and state budgetary proposals will be adopted or the effect, if any, such proposals would have on our business.
Government Regulation
The federal government and all states in which we currently operate regulate various aspects of our business. In particular, our operating centers are subject to federal laws that regulate the repackaging of drugs (including oxygen) and interstate motor-carrier transportation. Our operations also are subject to state laws governing, among other things, pharmacies, nursing services, distribution of medical equipment and certain types of home health activities. Certain of our employees are subject to state laws and regulations governing the ethics and professional practice of respiratory therapy, pharmacy and nursing.
As a health care provider, we are subject to extensive government regulation, including numerous laws directed at preventing fraud and abuse and laws regulating reimbursement under various government programs. The marketing, billing, documenting and other practices of health care companies are all subject to government scrutiny. To ensure compliance with Medicare, Medicaid and other regulations, regional health insurance carriers and state agencies often conduct audits and request customer records and other documents to support our claims submitted for payment of services rendered to customers. Similarly, government agencies periodically open investigations and obtain information from health care providers pursuant to the legal process. Violations of federal and state regulations can result in severe criminal, civil and administrative penalties and sanctions, including disqualification from Medicare and other reimbursement programs, which could have a material adverse effect on our business.
Numerous federal and state laws and regulations, including the Federal Health Insurance Portability And Accountability Act of 1996 (“HIPAA”) and the Health Information Technology For Economic And Clinical Health Act (“HITECH Act”), govern the collection, dissemination, security, use and confidentiality of patient-identifiable health information. As part of our provision of, and billing for, health care equipment and services, we are required to collect and maintain patient-identifiable health information. New health information standards, whether implemented pursuant to HIPAA, the HITECH Act, congressional action or otherwise, could have a significant effect on the manner in which we handle health care related data and communicate with payors, and the cost of complying with these standards could be significant. If we do not comply with existing or new laws and regulations related to patient health information, we could be subject to criminal or civil sanctions.
Health care is an area of rapid regulatory change. Changes in the laws and regulations and new interpretations of existing laws and regulations may affect permissible activities, the relative costs associated with doing business, and reimbursement amounts paid by federal, state and other third-party payors. We can not predict the future of federal, state and local regulation or legislation, including Medicare and Medicaid statutes and regulations, or possible changes in national health care policies. Future legislative and regulatory changes could have a material adverse effect on our business.
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Fund Letters
