Envision Healthcare
EVHC
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ENVISION HEALTHCARE : Management's Discussion and Analysis of Financial Condition and Results of Operations (form 10-Q)

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11/03/2017 | 09:28 pm

Forward-Looking Statements



This report contains certain forward-looking statements (all statements other
than with respect to historical fact) within the meaning of the federal
securities laws, which are intended to be covered by the safe harbors created
thereby. Investors are cautioned that all forward-looking statements involve
known and unknown risks and uncertainties including, without limitation, those
described in this report and in our Annual Report on Form 10-K for the year
ended December 31, 2016 (Form 10-K). Although we believe that the assumptions
underlying the forward-looking statements contained herein are reasonable, any
of the assumptions could be inaccurate. Therefore there can be no assurance that
the forward-looking statements included in this report will prove to be
accurate. Actual results could differ materially and adversely from those
contemplated by any forward-looking statement. In light of the significant risks
and uncertainties inherent in the forward-looking statements included herein,
the inclusion of such information should not be regarded as a representation by
us or any other person that our objectives and plans will be achieved. We
undertake no obligation to publicly release any revisions to any forward-looking
statements in this discussion to reflect events and circumstances occurring
after the date hereof or to reflect unanticipated events.



Among the factors that could cause future results to differ materially from
those provided in this report, including our liquidity, financial condition and
results of operations, are: risks related to the Merger, including that we may
fail to realize the anticipated benefits of the Merger; changes to payment rates
or methods of third-party payors; potential decreases in our revenue and profit
margin under our fee for service contracts and arrangements due to changes in
volume, payor mix and reimbursement rates; volumes at our existing surgery
centers; our loss of existing contracts; our significant client relationships
that result in a concentration of revenue; our failure to assess the costs under
new contracts; our ability to successfully recruit and retain physicians and
other healthcare professionals; enforceability of our non-compete agreements;
our failure to implement our business strategy; our ability to cross-sell or
sell bundled services to customers; the success of our partnerships with payors
and other healthcare providers; litigation for which we are not fully reserved
and our ability to accurately set reserves; failure to comply with laws and
regulations or adjust operations as appropriate in response to changing laws and
regulations; acquisitions that could divert the attention of management; our
ability to manage growth effectively; the high level of competition in our lines
of business; our ability to maintain our information systems; disruptions in our
disaster recovery systems, management continuity planning or information
systems; challenges by tax authorities on our treatment of certain physicians as
independent contractors; our ability to successfully maintain effective internal
controls over financial reporting; shortages of products, equipment and medical
supplies; potential write-offs of intangible assets, such as goodwill; the
negative impact of weather and other factors on our business; our
responsibilities to the minority owners of entities through which we own our
surgery centers; failure to timely or accurately bill for services; unfavorable
changes in regulatory, economic and other conditions; our ability to adequately
protect our intellectual property; risks related to our substantial
indebtedness; the impact of the Health Reform Law, as currently structured, and
the potential repeal or modification or changes to the implementation of the
Health Reform Law; the impact of federal and state investigations and compliance
reviews; initiatives to reduce spending on healthcare procedures; our ability to
timely enroll our providers in the Medicare program; risks associated with the
ability to consummate the pending sale of our medical transportation business
and timing of the closing of the transaction; risks related to the Company's
previously announced review of strategic alternatives; and the other risks and
uncertainties discussed in this report and in our Form 10-K, including under
"Item 1A. - Risk Factors" of Form 10-K.



Executive Overview



We are a nationwide provider of healthcare services, offering a highly
differentiated array of clinical solutions, including physician-led services,
ambulatory services and post-acute services. The Company was formed on June 10,
2016
for the purpose of effecting the Merger. Prior to the Merger, the Company
did not conduct any activities other than those incidental to its formation and
matters in connection with the consummation of the Merger. On December 1, 2016,
AmSurg and EHH completed the Merger and the strategic combination of their
respective businesses. In connection with the Merger, (i) AmSurg merged with and
into the Company, a wholly owned subsidiary of AmSurg, with the Company as the
surviving entity and (ii) EHH merged with and into the Company, with the Company
as the surviving entity. While the Merger was a merger of equals of AmSurg and
EHH, AmSurg was the accounting acquirer in the Merger; therefore, the historical
consolidated financial statements of AmSurg for periods prior to the Merger are
considered to be the historical financial statements of the Company. The
Company's unaudited consolidated financial statements reflect AmSurg's results
for the three and nine months ended September 30, 2016, and the Company's
results as of December 31, 2016 and for the three and nine months ended
September 30, 2017. The Company accounted for the Merger using the acquisition
method of accounting in accordance with accounting principles generally accepted
in the United States of America (GAAP) and Financial Accounting Standards Board
(FASB) Accounting Standards Codification Topic 805, "Business Combinations" (ASC
805).





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The Company's consolidated balance sheet as of December 31, 2016 reflects the
full consolidation of EHH's assets and liabilities as of December 1, 2016. The
Company's purchase accounting for the Merger remains preliminary as permitted
under GAAP and, as a result, there will likely be changes to certain balance
sheet items relating to the value, as well as allocation, of the acquired assets
and liabilities, associated amortization expense and goodwill, upon further
review. Any such changes could be material.



Following the completion of the Merger, we had three reportable segments:
physician services, medical transportation and ambulatory services. The
physician services segment reflects the combination of AmSurg's physician
services segment and EHH's physician services segment while the ambulatory
services segment reflects AmSurg's ambulatory services segment. During the nine
months ended September 30, 2017, the Board approved a plan to actively market
and divest the American Medical Response (AMR) business. Accordingly, the
results of the medical transportation business have been recorded in
discontinued operations for the three and nine months ended September 30, 2017
and assets and liabilities have been recorded as held for sale as of
September 30, 2017 and December 31, 2016. The medical transportation business is
no longer a separate reportable segment. On August 7, 2017, we executed a
definitive agreement to sell our medical transportation business to an entity
controlled by funds affiliated with KKR & Co. L.P. for approximately $2.40
billion
in cash. The transaction is subject to regulatory approval and customary
closing conditions, including clearance under the Hart-Scott-Rodino Antitrust
Improvements Act. We received a second request from the FTC asking for further
information related to the transaction, and the buyer is exploring potential
divestiture remedies to address certain concerns raised by the FTC. We expect
that the transaction will be completed during the fourth quarter of 2017 or the
first quarter of 2018.



Review of Strategic Alternatives



On October 31, 2017, the Company announced that the Board, in consultation with
management and financial and legal advisors, had unanimously decided to initiate
a full review of a broad range of strategic alternatives to enhance shareholder
value. The Board has not set a timetable for completion of its review. There can
be no assurance that this review will result in a transaction or other
alternatives of any kind, or if such strategic alternative does occur, that it
will successfully enhance shareholder value.



Physician Services Overview



At September 30, 2017, we delivered physician services, primarily in the areas
of emergency department and hospitalist services, anesthesiology services,
radiology/tele-radiology services, and children's services to more than 1,800
clinical departments in healthcare facilities in 46 states and the District of
Columbia
, with a significant presence in Arizona, California, Florida, New
Jersey
and Texas. At September 30, 2017, we employed more than 26,900 physicians
and other healthcare professionals in our physician services business. We
receive reimbursement from third-party payors primarily for fee for service
medical services rendered by our affiliated healthcare professionals and other
employees to the patients who receive medical treatment at these facilities. In
certain cases, in addition to this primary form of reimbursement, we also
receive contract revenue directly from the facilities where we perform our
services through a variety of payment arrangements that supplement payments from
third-party payors. We also provide physician services and manage office-based
practices in the areas of pain management, gynecology, obstetrics and
perinatology.



Ambulatory Services Overview



We acquire, develop and operate surgery centers in partnership primarily with
physicians. Our surgery centers are typically located adjacent to or in close
proximity to the medical practices of our partner physicians. At September 30,
2017
, we operated 263 ASCs in 35 states and the District of Columbia with
approximately 2,000 physician partners and 1,000 other affiliated physicians who
utilize our centers. We generally own a majority interest, primarily 51%, in the
surgery centers we operate. We also own a minority interest in certain surgery
centers in partnership with leading health systems and physicians, and intend to
continue to pursue such partnerships.



Health Care Reform and Government Sponsored Programs



Our physician services and ASC businesses depend upon third-party reimbursement
programs, including governmental and private insurance programs, to pay for
substantially all of the services rendered to patients. For the nine months
ended September 30, 2017, we derived approximately 28% of both our physician
services and ambulatory services net revenue from governmental healthcare
programs, primarily Medicare and managed Medicare programs, and the remainder
from a wide mix of commercial payors and patient co-pays and deductibles. The
Medicare program currently reimburses physician practices and ASCs in accordance
with predetermined fee schedules. We are not required to file cost reports and,
accordingly, we have no unsettled amounts from governmental third-party payors.



The payments we receive under government healthcare programs are often less than
our standard charges for the healthcare services provided. Furthermore,
reimbursement payments under federally-funded healthcare programs are subject to
across-the-board spending cuts to the federal budget imposed by the Budget
Control Act of 2011. These spending cuts, commonly referred to as
"sequestration,"




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may not be more than 2% for a FFY (federal fiscal year). The sequestration cuts
have been extended through FFY 2025. In addition, the Health Reform Law contains
a number of provisions designed to reduce Medicare program spending. We cannot
predict what other deficit reduction initiatives may be proposed by Congress,
whether Congress will attempt to restructure or suspend sequestration or the
impact sequestration may have on our business.



Physician services payment. Medicare pays for physician services based upon the
Medicare Physician Fee Schedule (MPFS), which contains a list of uniform payment
rates. These payment rates are determined based on national relative value units
(RVU), which CMS assigns to most medical procedures and services in an effort to
capture the various resources required by a physician to provide the service
relative to all other services. Each RVU is calculated based on a combination of
work required in terms of time and intensity of effort for the service, practice
expense attributable to the service and malpractice insurance expense
attributable to the service. The work, practice expense, and malpractice
insurance elements are each modified by a geographic adjustment factor to
account for local practice costs and then aggregated. MACRA provides for an
increase of 0.5% to the MPFS reimbursement rate each calendar year through 2019,
partially offset by various adjustments and policy updates, and outlines a new
method for determining updates thereafter. In 2017, after accounting for various
adjustments, payment rates under the MPFS will be 0.24% more than 2016 payment
rates.



In addition, MACRA required the establishment of the Quality Payment Program
(QPP), a payment methodology intended to reward high-quality patient care.
Beginning in 2017, physicians and certain other health care clinicians are
required to participate in one of two QPP tracks. Under both tracks, as
currently structured, performance data collected in 2017 will affect Medicare
payments in 2019. CMS expects to transition increasing financial risk to
providers as the QPP evolves. The Advanced Alternative Payment Model (Advanced
APM) track makes incentive payments available for participation in specific
innovative payment models approved by CMS. Providers may earn a 5% Medicare
incentive payment and will be exempt from the reporting requirements and payment
adjustments imposed under the Merit-Based Incentive Payment System (MIPS) if the
provider has sufficient participation (based on percentage of payments or
patients) in an Advanced APM. Alternatively, providers may participate in the
MIPS track. Providers electing this option may receive payment incentives or be
subject to payment reductions of up to 4% of the provider's Medicare payments
based on their performance with respect to clinical quality, resource use,
clinical improvement activities, and meaningful use of EHRs. The adjustment
percentage will increase incrementally, up to 9%, by 2022. MIPS will consolidate
components of several existing physician incentive programs: the Physician
Quality Reporting System, the Physician Value-Based Payment Modifier, and the
Medicare EHR Incentive Program.



ASC payments. Medicare reimburses facility services provided by ASCs under a
system that is primarily linked to HOPD payments, which are set under the
hospital outpatient prospective payment system (OPPS). Reimbursement rates for
ASCs are updated annually based on a conversion rate that accounts for changes
in the consumer price index and a productivity adjustment. In 2016, CMS
increased ASC reimbursement rates by 0.3%, which did not have a significant
impact on our 2016 ambulatory services revenues. For 2017, CMS has increased ASC
reimbursement rates by 1.9%. However, based on our current procedure mix, the
impact of these rate adjustments would result in a reduction in our ambulatory
services revenue of approximately $2.5 million in 2017. We estimate that ASC
reimbursement rates for 2018, which were finalized on November 1, 2017 but are
still being evaluated, would positively impact our 2018 ambulatory services
revenue by approximately $6.9 million.



Health reform. In recent years, the U.S. Congress and certain state legislatures
have passed a large number of laws and regulations intended to result in
significant change across the healthcare industry. The most prominent of these
reform efforts, the Health Reform Law, expands health insurance coverage through
a combination of public program expansion and private sector health reforms. For
example, the Health Reform Law expanded eligibility under existing Medicaid
programs in states that have not opted out of Medicaid expansion provisions.
Private health insurance market reforms include a ban on lifetime limits and
pre-existing condition exclusions, new benefit mandates, and increased dependent
coverage. As currently structured, the Health Reform Law requires many health
plans to cover certain preventive services designated by the U.S. Preventive
Services Task Force
, including screening colonoscopies.



We believe that health insurance market reforms that expand health insurance
coverage have resulted in increased volumes of certain procedures. However, the
future of the Health Reform Law is uncertain as a result of efforts by the
president and certain members of Congress to repeal, revise or replace, or alter
the implementation of the Health Reform Law through legislative or executive
actions. We cannot predict whether the Health Reform Law will be repealed or
whether or how the Health Reform Law or its implementation will ultimately be
changed. The impact of repeal or any such changes to the Healthcare Reform Law
on the healthcare industry and our business is unknown.



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Critical Accounting Policies



A summary of significant accounting policies is disclosed in our 2016 Annual
Report on Form 10-K under the caption "Critical Accounting Policies" in
Management's Discussion and Analysis of Financial Condition and Results of
Operations. There have been no material changes in the nature of our critical
accounting policies or the application of those policies other than those below
since December 31, 2016.



Intangible Assets



Due to the Merger, and as a result of purchase accounting, the book value of the
indefinite-lived intangibles acquired from the legacy EHH physician services
reporting unit was recorded at fair value as of the acquisition date and
subsequently was combined within our existing physician services reporting unit.
As a result, the excess of fair value over carrying value of the
indefinite-lived intangibles as of December 31, 2016 was not significant. During
the three months ended September 30, 2017, we experienced lower than expected
operating results in our physician services reporting unit combined with an
observed decline in market capitalization, which prompted us to evaluate whether
circumstances had changed that would more likely than not reduce the fair value
of the physician services reporting unit below its carrying amount. While
conducting this evaluation, we considered macroeconomic and industry conditions,
overall financial performance of the reporting unit and the decline in the share
price, among other factors, all of which require considerable judgment. After
considering the totality of the events and circumstances, we concluded that an
interim impairment test was not required. We will perform our annual goodwill
impairment test during the fourth quarter of 2017 and there can be no assurance
that the estimates and assumptions made for purposes of this qualitative
evaluation will prove to be an accurate prediction of future results. Factors
that could impact the final determination of fair value in connection with the
completion of the annual goodwill impairment process include a sustained decline
in market capitalization, changes in the estimated fair values of the physician
services assets and liabilities, changes in projected future earnings and net
cash flows, changes in market related multiples, and changes in valuation
related assumptions such as discount rates and perpetual growth rates.



Recent Accounting Pronouncements



See Note 1 in the Notes to the Unaudited Consolidated Financial Statements.



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Results of Operations



Our consolidated statements of operations include the results of our physician
services and ambulatory services segments. Our revenue primarily consists of fee
for service revenue and is derived principally from the provision of physician
services to patients of the healthcare facilities and from facility fees for the
procedures performed at our surgery centers. Contract revenue represents income
earned from our hospital customers to supplement payments from third-party
payors.



Factors Impacting Revenues



Our revenues are influenced by national healthcare trends, hospital specific
factors, changes in third-party reimbursement rates, changes in payor mix and
other factors affecting patient needs for medical services. National trends can
change based on changes in patient utilization, population growth and
demographics, weather related disruptions as well as general economic factors.
Hospital-specific elements include changes in local availability of alternative
sites of care to the patient, changes in surgeon utilization of the facility,
construction and regulations that affect patient flow through the hospital. We
believe patient utilization can be affected by changes in the portion of medical
costs for which the patients themselves bear financial responsibility, by
general economic conditions and by other factors.



Factors Impacting Operating Expenses



Salaries and benefits expense is the most significant expense associated with
our physician services segment and includes compensation and benefits for our
employed and affiliated physicians and other professional providers as well as
the salaries and benefits of our administrative support staff. Other operating
expenses of our physician services segment includes costs of business
development and marketing, information technology, dues and licenses, occupancy
costs and other administrative functions that are indirectly related to the
operations of our physician practices. Our insurance expense includes provisions
for paid and estimated losses for actual claims and estimates of claims likely
to be incurred in the period, based on our past loss experience and actuarial
analysis provided by a third-party, as well as actual direct costs, including
investigation and defense costs, and other costs related to insured liabilities.
We plan to continue to expand our investment in administrative support
initiatives to support our planned future growth.



Expenses associated with our ambulatory services segment relate directly and
indirectly to procedures performed and include: clinical and administrative
salaries and benefits, supply cost and other operating expenses such as linen
cost, repair and maintenance of equipment, billing fees and bad debt expense.
The majority of our salary and benefits cost is associated directly with the
number of surgery centers we own and manage and tends to grow in proportion to
the growth in our number of surgery centers in operation. We also incur
operating expenses resulting from our ambulatory segment oversight function,
which includes salaries and benefits of our operators and administrative support
infrastructure. Our surgery centers also incur costs that are more fixed in
nature, such as lease expense, property taxes, utilities and depreciation and
amortization.



Our depreciation expense primarily relates to charges for medical equipment and
leasehold improvements. Amortization expense primarily relates to intangible
assets recorded for customer relationships arising from acquisitions and
computer software.



Our interest expense results primarily from our borrowings used to fund
acquisition and development activity, as well as interest incurred on capital
leases and the amortization of deferred financing costs.



Income Tax Expense



The effective tax rate on pre-tax earnings (loss) as presented in the statements
of operations is typically lower due to the inclusion of noncontrolling
interests. However, after removing the earnings attributable to noncontrolling
interests, our adjusted effective tax rate, excluding discrete items, generally
increases to approximately 40%. We file a consolidated federal income tax return
and numerous state income tax returns with varying tax rates which reflects the
blending of these rates.



Noncontrolling Interests



Profits and losses are allocated to our noncontrolling partners in proportion to
their individual ownership percentages and reflected in the aggregate as total
net earnings attributable to noncontrolling interests. The noncontrolling
partners are typically organized as general partnerships, LPs or LLCs that are
not subject to federal income tax. Each noncontrolling partner shares in the
pre-tax earnings or loss of the entity of which it is a partner. Accordingly,
net earnings attributable to the noncontrolling interests in each of our LPs and
LLCs are generally determined on a pre-tax basis, and pre-tax earnings are
presented before net earnings attributable to noncontrolling interests have been
subtracted.





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