UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2006
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________
Commission file number: 0-28456
METROPOLITAN HEALTH NETWORKS, INC.
(Exact name of registrant as specified in its charter)
Florida 65-0635748
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
250 Australian Avenue South, Suite 400
West Palm Beach, Fl. 33401
(Address of principal executive offices) (Zip Code)
(561) 805-8500
(Registrant's telephone number, including area code)
None
(Former name, former address and former fiscal year, if changed since last
report)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
Common Stock, $.001 par value American Stock Exchange
per share
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act. Yes |_| No |X|
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes |_| No |X|
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |_|
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange
Act.
Large accelerated filer |_| Accelerated filer |X| Non-accelerated filer |_|
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X|
As of June 30, 2006, the aggregate market value of the registrant's common
stock held by non-affiliates of the registrant was $114,760,624 based on the
closing sale price as reported on the American Stock Exchange. This calculation
has been performed under the assumption that all directors, officers and
stockholders who own more than 10% of our outstanding voting securities are
affiliates of the Company.
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Class Outstanding at March 1, 2007
Common Stock, $.001 par value per share 50,270,964 shares
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III of this report, to the extent not set
forth herein, is incorporated by reference from the registrant's definitive
proxy statement relating to the 2007 annual meeting of shareholders, which
definitive proxy statement will be filed with the Securities and Exchange
Commission within 120 days after the end of the fiscal year to which this report
relates.
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METROPOLITAN HEALTH NETWORKS, INC.
FORM 10-K
For the Year Ended
December 31, 2006
TABLE OF CONTENTS
Page
ITEM No.
---- ----
PART I
1 Business ............................................................ 6
1A Risk Factors 21
1B Unresolved Staff Comments 30
2 Properties .......................................................... 30
3 Legal Proceedings ................................................... 31
4 Submission of Matters to a Vote of Security Holders ................. 31
PART II
5 Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities.................. 31
6 Selected Financial Data.............................................. 33
7 Management's Discussion and Analysis of Financial Conditions and
Results of Operations ............................................. 34
7A Quantitative and Qualitative Disclosures about Market Risk .......... 45
8 Financial Statements and Supplementary Data ......................... 46
9 Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure .............................................. 47
9A Controls and Procedures ............................................. 47
PART III
10 Directors, Executive Officers, and Corporate Governance ............. 49
11 Executive Compensation .............................................. 49
12 Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters.................................... 49
13 Certain Relationships and Related Transactions and Director
Independence ...................................................... 49
14 Principal Accounting Fees and Services .............................. 49
PART IV
15 Exhibits, Financial Statement Schedules ............................. 50
EXHIBIT INDEX 51
SIGNATURES 53
16 Schedule 1 - Condensed Financial Statements - Parent Company Only 58
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GENERAL
Unless otherwise indicated or the context otherwise requires, all references in
this Form 10-K to "we," "us," "our," "Metropolitan" or the "Company" refers to
Metropolitan Health Networks, Inc. and its consolidated subsidiaries unless the
context suggests otherwise. We disclaim any intent or obligation to update
"forward looking statements".
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the discussion under the captions "Risk Factors," "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
"Business" and elsewhere in this Form 10-K may include certain "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934, including, without
limitation, statements with respect to anticipated future operations and
financial performance, growth and acquisition opportunity and other similar
forecasts and statements of expectation. We intend such statements to be covered
by the safe harbor provisions for forward looking statements created thereby.
These statements involve known and unknown risks and uncertainties, such as our
plans, objectives, expectations and intentions, and other factors that may cause
us, or our industry's actual results, levels of activity, performance or
achievements to be materially different from any future results, levels of
activity, performance or achievements expressed or implied by the
forward-looking statements. Many of these factors are listed in Item 1A"Risk
Factors" and elsewhere in this Form 10-K.
In some cases, you can identify forward-looking statements by statements
that include the words "estimate," "project," "anticipate," "expect," "intend,"
"may," "should," "believe," "seek" or other similar expressions.
Specifically, this report contains forward-looking statements, including
the following:
o the PSN's ability to maintain its automatic renewal status
related to the Humana Agreements and do so on favorable terms;
o our ability to adequately predict and control medical expenses
and to make reasonable estimates and maintain adequate
accruals for incurred but not reported, or IBNR, claims; and
o the HMO's ability to renew, maintain or to successfully rebid
the agreement with the Center for Medicare and Medicaid
Services ("CMS").
The forward-looking statements reflect our current view about future
events and are subject to risks, uncertainties and assumptions. We wish to
caution readers that certain important factors may have affected and could in
the future affect our actual results and could cause actual results to differ
significantly from those expressed in any forward-looking statement. The
following important factors could prevent us from achieving our goals and cause
the assumptions underlying the forward-looking statements and the actual results
to differ materially from those expressed in or implied by those forward-looking
statements:
o reductions in government funding of Medicare programs;
o disruptions in the PSN's, the HMO's or Humana's healthcare
provider networks;
o failure to receive claims processing, billing services, data
collection and other information on a timely basis from Humana
or HF Administrative Services;
o failure to receive, on a timely or accurate basis customer
information from CMS;
o future legislation and changes in governmental regulations;
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o increased operating costs;
o the impact of Medicare Risk Adjustments on payments we receive
from CMS or Humana;
o the impact of the Medicare prescription drug plan on our
operations;
o loss of significant contracts;
o general economic and business conditions;
o increased competition;
o the relative health of our patients;
o changes in estimates and judgments associated with our
critical accounting policies;
o federal and state investigations;
o our ability to grow our HMO customers in our current
geographic markets and our ability to expand our HMO into new
geographic markets;
o our ability to successfully recruit and retain key management
personnel and qualified medical professionals; and
o impairment charges that could be required in future periods.
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PART I
ITEM 1 DESCRIPTION OF BUSINESS
Overview
We operate two primary businesses in Florida, a provider service network ("PSN")
that provides and arranges for medical care primarily to Humana, Inc. customers
and our health maintenance organization ("HMO") which provides healthcare
benefits to Medicare beneficiaries in Florida that have selected our plan. As of
December 31, 2006, the PSN and the HMO provided healthcare benefits to
approximately 25,600 and approximately 3,800 Medicare Advantage beneficiaries,
respectively.
Both our PSN and HMO operations primarily focus on individuals covered by
Medicare, the national, federally-administered health insurance program that
covers the cost of hospitalization, medical care, and some related health
services for U.S. citizens aged 65 and older, qualifying disabled persons and
persons suffering from end-staged renal disease. Substantially all of our
revenue in 2006 was generated by providing services to Medicare beneficiaries
through arrangements that require us to assume responsibility to provide and/or
manage the care for all of our customers' medical needs in exchange for a
monthly fee, also known as a capitated fee or capitation arrangement.
Our concentration on Medicare customers provides us the opportunity to focus our
efforts on understanding the specific needs of Medicare beneficiaries,
especially Medicare beneficiaries in our local service areas, and designing
plans and programs intended to meet such needs. Our management team has
extensive experience developing and managing providers and provider networks.
We were incorporated in the State of Florida in January 1996, and began
operations as a Physician Practice Management Group. Although we thereafter
acquired a number of physician practices and ancillary service providers, we
abandoned the group practice strategy in late 1999. We acquired a diagnostic
laboratory and a pharmacy business in 2000 and 2001, respectively. The
laboratory was shut down in 2002 and the pharmacy was sold in November 2003.
The PSN's first contract with Humana Inc. ("Humana") was secured through an
acquisition in 1997, and expanded through an additional acquisition in early
1999. Pursuant to this agreement, the PSN contracted with Humana to manage
certain designated Humana Medicare Advantage customers in South Florida. In
2000, an additional contract was secured to manage certain designated Humana
Medicare Advantage lives in Central Florida. The PSN renegotiated its most
significant contract with Humana, covering the Central Florida area, effective
January 1, 2003. This renegotiation increased the percentage of Medicare premium
the PSN received from Humana and resolved a number of contractual disputes
between the PSN and Humana.
Effective July 1, 2005, the HMO commenced operations as a Medicare Advantage
HMO. The HMO operates in twelve Florida counties where it markets its
"AdvantageCare" branded health plans.
Our corporate headquarters are located at 250 South Australian Avenue, Suite
400, West Palm Beach, Florida 33401 and our telephone number is (561) 805-8500.
Our corporate website is www.metcare.com. Information contained on our website
is not incorporated by reference into this report and we do not intend the
information on or linked to our website to constitute part of this report. We
make available our annual reports on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K, and any amendments to those reports on our website,
free of charge, to individuals interested in acquiring such reports. The reports
can be accessed at our website as soon as reasonably practical after they are
electronically filed with, or furnished to, the Securities and Exchange
Commission, or SEC. The public may read and copy these materials at the SEC's
public reference room at 100F Street, N.E., Washington D.C. 20549 or on their
website at http://www.sec.gov. Questions regarding the operation of the public
reference room may be directed to the SEC at 1-800-732-0330.
Provider Service Network
We have two network contracts (the "Humana Agreements") with Humana. Humana is
one of the largest participants in the Medicare Advantage program in the United
States. Our PSN provides, on a non-exclusive basis, healthcare services to
Medicare beneficiaries in Flagler and Volusia counties ("Central Florida") and
Palm Beach, Broward and Miami-Dade counties ("South Florida") who have elected
to receive benefits from Humana's Medicare Advantage Plan. As of December 31,
2006, the Humana Agreements covered approximately 19,200 Humana Plan Customers
(as defined below) in Central Florida and 6,400 Humana Plan Customers in South
Florida. Approximately 86.9% of our total 2006 revenue was generated through the
Humana Agreements.
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We have built our PSN physician network by contracting with primary care
physicians for their services and acquiring and operating our own physician
practices. We currently have contracts in place with twenty-eight independent
primary care physician practices (individually an "IPA") and we own and operate
eight primary care physician practices and one medical oncology physician
practice (collectively with the IPAs, the "PSN Physicians"). In addition,
through our Humana Agreements we have established referral relationships with a
large number of specialist physicians, ancillary service providers and hospitals
throughout South Florida and Central Florida. See "Business Model - Provider
Agreements" for more information regarding the PSN's relationships with PSN
Physicians, specialist physicians, ancillary service providers and hospitals.
Humana directly contracts with the Centers for Medicare and Medicaid Services
("CMS") and is paid a fixed monthly premium payment for each customer (each a
"Humana Plan Customer") enrolled in Humana's Medicare Advantage Plan. The
monthly premium varies by patient, county, age and severity of health status.
Pursuant to the Humana Agreements, the PSN provides or arranges for the
provision of covered medical services to each Humana Plan Customer who selects
one of the PSN Physicians as his or her primary care physician (a "Humana
Participating Customer"). In return for the provision of these medical services,
the PSN receives from Humana a capitated fee for each Humana Participating
Customer. The fee rates are established by the Humana Agreements and comprise a
substantial portion of the monthly premiums received by Humana from CMS with
respect to Humana Participating Customers.
In Central Florida, our PSN assumes full responsibility for the provision of all
necessary medical care for each Humana Participating Customer, even for services
we do not provide directly. In South Florida, the PSN and Humana share in the
cost of inpatient hospital services and the PSN assumes full responsibility for
the provision of all other medical care provided to the Humana Participating
Customer. To the extent the costs of providing such medical care are less than
the related premiums received from Humana, our PSN generates a gross profit.
Conversely, if medical expenses exceed the premiums received from Humana, our
PSN experiences a gross loss.
Substantially all of our PSN's revenue comes from the Humana Agreements. We do
receive additional revenue in the medical practices we own and operate by
providing primary care services to non-Humana Participating Customers on a
fee-for-service basis.
Health Maintenance Organization
We operate the HMO through Metcare Health Plans, Inc., our wholly owned
subsidiary that was issued a Health Care Provider Certificate ("HCPC") by
Florida's Agency for Health Care Administration ("AHCA") on March 16, 2005. The
Department of Financial Services, Office of Insurance Regulation ("OIR")
approved the HMO's application and a Certificate of Authority to operate a HMO
in the State of Florida ("COA") on April 22, 2005.
Effective July 1, 2005, the HMO entered into a contract with CMS (the "CMS
Contract") to begin offering Medicare Advantage plans to Medicare beneficiaries
in six Florida counties - Lee, Charlotte, Sarasota, Martin, St. Lucie and
Okeechobee. Beginning January 1, 2007, the HMO began to provide services in
Polk, Glades, Manatee, Marion, Lake and Sumter. The HMO has been marketing its
"AdvantageCare" branded plan since July 2005.
The HMO is required to maintain satisfactory minimum net worth requirements
established by the Florida State Department of Insurance. The HMO is restricted
from making dividend payments without appropriate regulatory notifications and
approvals or to the extent such dividends would put us out of compliance with
statutory capital requirements. Additional information regarding our statutory
requirements is set forth in Note 15 to the "Notes to Consolidated Financial
Statements" contained in this Form 10-K.
We are continuing to evaluate expanding our HMO business into other counties
within Florida. However, we do not intend to provide HMO services in the
geographic markets covered by the Humana Agreements. We view our HMO business as
an extension of our existing core competencies.
The HMO's revenue is generated by premiums consisting of monthly payments per
customer that are established by the CMS Contract. The HMO recorded its first
revenue in the third quarter of 2005.
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Our HMO continues to require a considerable amount of capital. In 2006, we
contributed approximately $6.8 million to the HMO to finance the operations and
growth of the HMO. During 2006 and 2005, we incurred losses before allocated
overhead and income taxes of approximately $11.7 million and $6.6 million,
respectively, in connection with the development and operation of the HMO. We
are continuing to commit resources in an effort to increase our HMO customer
base. Our future operating results will be impacted by the effectiveness of our
sales and marketing efforts in enrolling customers and the HMO's ability to
manage medical expenses. We are not in a position to meaningfully estimate when,
if ever, the HMO's business will become profitable and/or generate cash from
operations and we may be required to fund the development and expansion of the
HMO business, including any associated losses, for an extended period of time.
We anticipate that the on-going development efforts, reserve requirements and
operating costs for our still developing HMO business can be funded by our
current resources and projected cash flows from operations until at least
December 31, 2007.
Additional information regarding our PSN and HMO segments for 2006, 2005 and
2004 is set forth in Note 18 to the "Notes to Consolidated Financial Statements"
contained in this Form 10-K.
The Medicare Program and Medicare Managed Care
Medicare
In a report issued in February 2007, CMS estimated that healthcare spending in
the United States was $2 trillion or approximately 17% of the gross domestic
product in 2006 and would grow to $4 trillion, or 20% of the gross domestic
product, by 2016. In the United States, health care outlays have grown faster
than the consumer price index. According to CMS, health care outlays are
projected to grow at a rate of 6.4% annually between 2007 and 2016. The
projected principal drivers for this growth include continued cost-increasing
medical innovation, inflation, continued strong demand for prescription drugs
and the aging baby-boomer demographic.
The Medicare program has four primary components:
(i) Part A - Medicare Part A covers inpatient hospital, skilled nursing
facility, and hospice care. All citizens of the United States are
automatically enrolled in Medicare Part A upon reaching the age of 65.
(ii) Part B - Medicare's Part B is optional and is financed largely by monthly
premiums paid by individuals enrolled in the program. Medicare Part B
covers almost all reasonable and necessary medical services, including
doctors' services, laboratory and x-ray services, durable medical
equipment (i.e, wheelchairs, hospital beds), ambulance services,
outpatient hospital care, home health care, blood and medical supplies.
Participants often have the Medicare Part B monthly premium automatically
deducted from their Social Security check. The monthly premium of $88.50
per month in 2006 increased to $93.50 in 2007. Medicare Part B had an
annual deductible requirement of $124 in 2006; which increased to $131 in
2007. Once the deductible has been met, Medicare Part B generally pays 80%
of the Medicare allowable fee schedule and beneficiaries pay the remaining
20%.
(iii) Part C - Medicare Part C is an alternative to the traditional
fee-for-service Medicare program. In geographic areas where a managed care
plan has contracted with CMS pursuant to the Medicare Advantage program,
Medicare beneficiaries may choose to receive benefits from a managed care
plan. The current Medicare managed care program was established in 1997
when Congress created Medicare Part C, formerly known as Medicare+Choice
and now known as Medicare Advantage.
(iv) Part D - First available in 2006, Medicare Part D permits every Medicare
recipient to select a prescription drug plan. Medicare Part D replaces the
transitional prescription drug discount program and replaces Medicaid
prescription drug coverage for dual-eligible beneficiaries.
Initially, Medicare was offered only on a fee-for-service basis. Under the
Medicare fee-for-service payment system, an individual can choose any licensed
physician and use the services of any hospital, healthcare provider, or facility
certified by Medicare. CMS reimburses providers if Medicare covers the service
and CMS considers it "medically necessary."
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Individuals who elect to participate in the Medicare Advantage program receive
greater benefits than traditional fee-for-service Medicare beneficiaries, which
benefits may include eye exams, hearing aids and routine physical exams.
Out-of-pocket costs for the Medicare beneficiary may also be lower. However, in
exchange for these enhanced benefits, customers are generally required to use
only the services and provider networks offered by the Medicare Advantage plan.
This participation of private health plans in the Medicare Advantage Program
under full risk contracts began in the 1980's and grew to 6.9 million customers
in 1999. According to information provided by the Henry J. Kaiser Family
Foundation, after a drop to 5.3 million customers in 2003, the number of
enrollees in Medicare Advantage plans in the United States has increased to 8.3
million as of February 2007. Also, since 2003, the number of Medicare Advantage
plans in the United States has increased from 285 to 604 as of February 2007.
Medicare Advantage plans contract with CMS to provide benefits that exceed those
offered under the traditional fee-for-service Medicare program by at least
thirty percent in exchange for a fixed premium payment per customer per month
from CMS (the "PCPM"). The monthly premium varies based on the county in which
the customer resides, as adjusted to reflect the customer's demographics and the
individual customer's health status.
Prior to 1997, CMS reimbursed health plans participating in the Medicare program
primarily on the basis of the demographic data of the plans' customers. CMS has
phased in its risk adjustment payment system, originally implemented as part of
the Balance Budget Act of 1997 and modified pursuant to the Medicare, Medicaid,
and SCHIP Benefits Improvement and Protection Act of 2000. During 2003, risk
adjusted payments accounted for only 10% of Medicare health plan payments, with
the remaining 90% being reimbursed in accordance with the traditional
demographic rate book. The portion of risk adjusted payments was increased to
30% in 2004, 50%, in 2005, and 75% in 2006, and increased to 100% in 2007. The
risk adjusted payment model bases the CMS reimbursement payments on various
clinical and demographic factors including hospital inpatient diagnoses,
additional diagnosis data from ambulatory treatment settings, hospital
outpatient department and physician visits, gender, age, and Medicaid
eligibility. CMS requires that all managed care companies capture, collect, and
submit the necessary diagnosis code information to CMS twice a year for
reconciliation with CMS's internal database. Under this system, the risk
adjusted portion of the total CMS payment to the Medicare Advantage plans will
equal the local rate set forth in the traditional demographic rate book,
adjusted to reflect the plan's customers average gender, age, and disability
demographics.
The Medicare Modernization Act
The Medicare Prescription Drug, Improvement and Modernization Act of 2003, known
as the Medicare Modernization Act ("MMA"), signed into law in December 2003,
provided sweeping changes to the Medicare program. The MMA increased the amount
paid to Medicare Advantage plans such as ours and expanded Medicare beneficiary
healthcare options. We believe that the changes enacted by the MMA have enabled
Medicare Advantage plans to offer more attractive and comprehensive benefits and
increase preventive care to its customers, while also reducing out-of-pocket
expenses for beneficiaries. We further believe that these changes will encourage
increased enrollment in Medicare managed care plans in the upcoming years.
In addition to generally increasing the rates payable to Medicare Advantage
plans from CMS, the MMA, among other things, (i) added the Medicare Part D
prescription drug benefit beginning in January 2006, (ii) implemented a
competitive bidding process for the Medicare Advantage Program and (iii)
provided a limited annual enrollment period.
The MMA made favorable changes to the premium rate calculation methodology and
generally provides for program rates that will better reflect the increased cost
of medical services provided by managed care organizations to Medicare
beneficiaries. CMS has announced that the MMA program rates for 2007 are
expected to reflect an average increase of 1.1% over 2006.
Medicare Part D
As part of the MMA, effective January 1, 2006, all Medicare beneficiaries are
eligible to receive assistance paying for prescription drugs through Medicare
Part D. The drug benefit is not part of the traditional fee-for-service Medicare
program, but rather is offered through private insurance plans. Medicare
beneficiaries are able to choose and enroll in a prescription drug plan through
Medicare Part D. Prescription drug coverage under Part D is voluntary.
Fee-for-service beneficiaries may purchase Part D coverage from a stand-alone
prescription drug plan (a "stand-alone PDP") that is included on a list approved
by CMS.
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Individuals who are enrolled in a Medicare Advantage that offers drug coverage
must receive their drug coverage through their Medicare Advantage prescription
drug plan ("MA-PD") and may not enroll in a stand-alone PDP. For example, Humana
Plan Customers and the HMO's customers were automatically enrolled in their
MA-PDs as of January 1, 2006 unless they affirmatively chose to use another
provider's prescription drug coverage. Any customer of a Medicare Advantage Plan
that enrolls in a stand-alone PDP is automatically disenrolled from the Medicare
Advantage plan altogether, thereby resuming traditional fee-for-service Medicare
coverage. Beneficiaries who are eligible for both Medicare and Medicaid, known
as dual eligible beneficiaries (discussed in greater detail below), who have not
enrolled in a MA-PD or a stand-alone PDP have been automatically enrolled by CMS
with approved stand-alone PDPs in their region. Medicare Advantage customers
have the right to change drug plans, either MA-PD or stand-alone PDP, one time
during the open enrollment period. Dual eligible beneficiaries and other
customers qualified for the low-income subsidy (LIS) may change plans throughout
the year.
The Medicare Part D prescription drug benefit is largely subsidized by the
federal government and is additionally supported by risk-sharing with the
federal government through risk corridors designed to limit the profits or
losses of the drug plans and reinsurance for catastrophic drug costs. The
government subsidy is based on the national weighted average monthly bid for
this coverage, adjusted for customer demographics and risk factor payments. If
the plan bid exceeds the government subsidy the beneficiary is responsible for
the difference, together with the amount of the beneficiary's co-pays,
deductibles and late enrollment penalties, if applicable.
A "dual-eligible" beneficiary is a person who is eligible for both Medicare,
because of age or other qualifying status, and Medicaid, because of economic
status. Health plans that serve dual-eligible beneficiaries receive a higher
premium from CMS for dual-eligible customers. The additional premium for a
dually-eligible beneficiary is based upon the estimated incremental cost CMS
incurs, on average, to care for dual-eligible beneficiaries. By managing
utilization and implementing disease management programs, many Medicare
Advantage plans can profitably care for dually-eligible customers. The MMA
provides subsidies and reduced or eliminated deductibles for certain low-income
beneficiaries, including dual-eligible individuals. Pursuant to the MMA, since
January 1, 2006 dual-eligible individuals receive their drug coverage from the
Medicare program rather than the Medicaid program. Companies offering
stand-alone PDP with bids at or below the regional weighted average bid
resulting from the annual bidding process received a pro-rata allocation and
automatic enrollment of the dual-eligible beneficiaries within their applicable
region.
Competitive Bidding Process
Beginning in 2006, CMS began to use a new rate calculation system for Medicare
Advantage plans. The new system is based on a competitive bidding process that
allows the federal government to share in any cost savings achieved by Medicare
Advantage plans. In general, the statutory payment rate for each county, which
is primarily based on CMS's estimated per beneficiary fee-for-service expenses,
has been relabeled as the "benchmark" amount, and local Medicare Advantage plans
annually submit bids that reflect the costs they expect to incur in providing
the base Medicare Part A and Part B benefits in their applicable service areas.
If the bid is less than the benchmark for that year, Medicare pays the plan its
bid amount, as adjusted, based on its customers risk scores plus a rebate equal
to 75% of the amount by which the benchmark exceeds the bid, resulting in an
annual adjustment in reimbursement rates. Plans must use the rebate to provide
beneficiaries with extra benefits, reduced cost sharing, or reduced premiums,
including premiums for MA-PDs and other supplemental benefits. CMS has the right
to audit the use of these proceeds. The remaining 25% of the excess amount will
be retained in the statutory Medicare trust fund. If a Medicare Advantage plan's
bid is greater than the benchmark, the plan will be entitled to charge a premium
to enrollees equal to the difference between the bid amount and the benchmark.
For 2006, the county benchmarks were 4.8% greater than the 2005 rates, which is
the national growth rate in fee-for-service expenditures. County benchmarks for
2007 are anticipated to be 7.1% greater than 2006 rates.
Enrollment Period
Prior to the MMA, Medicare beneficiaries were permitted to enroll in a Medicare
managed care plan or change plans at any point during the year. Beginning in
2006, Medicare beneficiaries have defined enrollment periods, similar to
commercial plans, in which they can select a Medicare Advantage plan, a
stand-alone PDP, or traditional fee-for-service Medicare coverage. The initial
enrollment period for 2006 was November 15, 2005 through May 15, 2006 for a
MA-PD or stand-alone PDP. In addition, beneficiaries had an open election period
from January 1, 2006 through June 30, 2006 in which they could make or change an
equivalent election. Starting in November 2006 and on a going-forward basis, the
annual enrollment period for a stand alone PDP will be from November 15 through
December 31 of each year, and enrollment in Medicare Advantage plans will occur
from November 15 through March 31 of the subsequent year. Enrollment prior to
December 31 will generally be effective as of January 1 of the following year
and enrollment on or after January 1 and within the enrollment period is
effective the first day of the month following enrollment. After the defined
enrollment period ends, generally only seniors turning 65 during the year,
Medicare beneficiaries who permanently relocate to another service area,
dual-eligible beneficiaries, others who qualify for special needs plans, and
employer group retirees will be permitted to enroll in or change health plans
during the year. In addition, in certain circumstances, such as the bankruptcy
of a health plan, CMS may offer a special election period during which the
customers effected are allowed to change plans.
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The Florida Medicare Advantage Market
Behind only California, which has approximately 4.4 million Medicare eligible
beneficiaries, Florida has the second largest Medicare population in the U.S.
with an estimated 3.1 million Medicare eligible beneficiaries. At December 31,
2006, California's Medicare Advantage penetration was approximately 32% while
Florida's was 22%. We believe that of the approximate 981,000 and 690,000
Medicare eligible individuals in the counties served by our PSN and HMO,
approximately 38.1% and 9.6%, respectively, are customers of Medicare Advantage
plans. According to the Florida Office of Economic and Demographic Research
Florida's Medicare eligible population is expected to grow from 2.8 million per
the 2000 census to almost 5.0 million by 2020.
According to CMS, the number of enrollees in PDPs as of January 16, 2007 was
10.98 million, compared to 10.37 million last June, an increase of 5.9%. MA-PD
enrollment increased to 6.65 million from 6.04 million, a 10% increase over the
same period, while Medicare-Medicaid dual eligible enrollment increased to 6.27
million from 6.07 million during this same period.
Medicare Advantage Penetration in Counties Served By PSN
(CMS data modified January 2006)
Medicare
Medicare Advantage Penetration
Service Area Eligibles Penetration %
--------------- --------- ----------- -----------
Central Florida 130,000 38,000 29.2%
South Florida 851,000 336,000 39.5%
------- -------
Total 981,000 374,000 38.1%
======= =======
Medicare Advantage Penetration in Counties Served By HMO
(Source: CMS Data Modified January 2007)
Medicare
Medicare Advantage Penetration
Service Area Eligibles Penetration %
--------------- --------- ----------- -----------
Treasure Coast 102,000 10,700 10.5%
Gulf Coast 367,000 29,000 7.9%
Central Florida 268,000 30,700 11.5%
------- ------
Total 737,000 70,400 9.6%
======= ======
The Central Florida region for the PSN includes the counties of Flagler and
Volusia; the South Florida service area includes the counties of Broward,
Miami-Dade and Palm Beach.
The Treasure Coast service area for the HMO includes Martin, St. Lucie, Glades
and Okeechobee counties; the Gulf Coast service area includes Charlotte, Lee,
Manatee and Sarasota counties. We began marketing in the Central Florida service
area in late 2006 with customers joining the plan effective January 1, 2007. The
Central Florida service area includes Polk, Sumter, Lake and Marion counties.
Business Model
Provider Services Network
- 11 -
Our PSN provides and arranges healthcare services to Medicare Advantage
beneficiaries who participate in the Medicare Advantage program through Humana.
We conduct all of our PSN business operations through Metcare of Florida, Inc.,
our wholly owned subsidiary.
Humana Agreements
Pursuant to the Humana Agreements, the PSN provides and arranges for the
provision of covered medical services to each Humana Participating Customer. Our
Humana Agreement covering the Central Florida area (the "Central Florida Humana
Agreement") is a global risk agreement and our Humana Agreement covering the
South Florida area (the "South Florida Humana Agreement") is a full risk
agreement. Pursuant to both Humana Agreements, the PSN receives a capitated fee
with respect to each Humana Participating Customer, which fee represents a
significant portion that Humana receives with respect to that Humana Plan
Customer. Under the Central Florida Humana Agreement, the PSN assumes full
responsibility for the provision of all necessary medical care for each Humana
Participating Customer, even for services we do not provide directly. Under the
South Florida Humana Agreement the PSN and Humana share in the cost of inpatient
hospital services and the PSN assumes full responsibility for the provision of
all other medical care provided to the Humana Participating Customer. In
accordance with the Humana Agreements, we are required to comply with Humana's
general policies and procedures, including Humana's policies regarding
referrals, approvals, utilization management and quality assurance.
The Humana Agreements have one-year terms and renew automatically each December
31 for additional one-year terms unless terminated for cause or upon 180 days'
prior notice. In addition, Humana may immediately terminate either of the Humana
Agreements and/or any individual physician credentialed under the Humana
Agreements, upon written notice, (i) if the PSN and/or any of the PSN
Physician's continued participation may adversely affect the health, safety or
welfare of any Humana customer or bring Humana into disrepute; (ii) in the event
of one of the PSN physician's death or incompetence; (iii) if any of the PSN
physicians fail to meet Humana's credentialing criteria; (iv) in accordance with
Humana's policies and procedures as specified in Humana's manual, (v) if the PSN
engages in or acquiesces to any act of bankruptcy, receivership or
reorganization; or (vi) if Humana loses its authority to do business in total or
as to any limited segment or business (but only to that segment). The PSN and
Humana may also each terminate each of the Humana Agreements upon 90 days' prior
written notice (with a 60 day opportunity to cure, if possible) in the event of
the other's material breach of the applicable Humana Agreement.
Humana may provide 30 days notice as to certain amendments or modifications of
the Humana Agreements, including but not limited to, compensation rates, covered
benefits and other terms and conditions. If Humana exercises its right to amend
either of the Humana Agreements, the PSN may object to such amendment within the
30 day notice period. If the PSN objects to such amendment within the requisite
time frame, Humana may terminate the applicable Humana Agreement upon 90 days'
written notice.
The Humana Agreements are also subject to changes to the covered benefits that
Humana elects to provide to Humana Participating Customers and other terms and
conditions.
For the term of the Central Florida Humana Agreement:
o Humana has agreed that it will not, with the exception of one
existing service provider, enter into any new global risk agreements
for Humana's Medicare Advantage HMO products in the Central Florida
area.
o The PSN has agreed that it will not enter into any global, full or
limited risk contracts with respect to Medicare Advantage customers
with any non-Humana Medicare Advantage HMO or provider sponsored
organization in the Florida counties in which Humana has a Medicare
Advantage contract.
In addition, for the term plus one year for each of the Humana Agreements, we
have agreed that the PSN and its affiliated providers will not, directly or
indirectly, engage in any activities which are in competition with Humana's
health insurance, HMO or benefit plans business, including obtaining a license
to become a managed health care plan offering HMO or point of service ("POS")
products, or (ii) acquire, manage, establish or have any direct or indirect
interest in any provider sponsored organization or network for the purpose of
administering, developing, implementing or selling government sponsored health
insurance or benefit plans, including Medicare and Medicaid, or (iii) contract
or affiliate with another licensed managed care organization, where the purpose
of such affiliation is to offer and sponsor a HMO or POS products and where the
PSN and/or its affiliated providers obtain an ownership interest in the HMO or
POS products to be marketed, and (iv) enter into agreements with other managed
care entities, insurance companies or provider sponsored networks for the
provision of healthcare services to Medicare HMO, Medicare POS and/or other
Medicare replacement patients at the same office sites or within five miles of
the office sites where services are provided to the Humana Plan Customers.
- 12 -
Provider Agreements
Pursuant to our contracts with twenty-two of the twenty-eight IPAs, we pay such
IPA providers on a set amount per customer per month and require them to provide
all the necessary primary care medical services to Humana Participating
Customers. The monthly amount is negotiated and is subject to change based on
certain quality metrics under the PSN's Partners In Quality ("PIQ") program, a
proprietary care management model that we implemented in 2002. The contracts
with the other six IPAs provide for payments on a fee for service basis,
pursuant to which the provider is paid only for the services provided.
PIQ is a "pay for performance" program that measures performance based on
quality metrics including patient satisfaction, disease state management of
high-risk, chronically ill patients, increased frequency of physician-patient
encounters, and enhanced medical record documentation. Management believes that
the PIQ program differentiates our PSN from other PSNs or Management Service
Organizations ("MSO").
The contracts with our IPAs generally have one-year terms and renew
automatically for one-year periods unless either party provides written notice
at least 120 days prior to the termination date. The IPA providers, during the
term of their contract with the PSN, and for a period of six months after the
expiration or termination of such contract, are generally prohibited from
participating in any other PSN, HMO or other agreement which contracts directly
or indirectly with the Medicare or Medicaid Program on a capitated or risk
basis. The IPA providers are further prohibited during the term and for a period
of six months after the expiration of the terms from encouraging or soliciting
the Humana Participating Customers to change their primary care provider,
disenroll from their health plan, or leave the PSN's network.
The PSN has established referral relationships with a large number of specialist
physicians, ancillary service providers and hospitals throughout South Florida
and Central Florida areas that are under contract with Humana. These providers
have contracted with Humana to deliver services to our PSN patients based on
certain fee schedules and care requirements. Specialist physicians, ancillary
service providers and hospitals are generally paid on a contractual
fee-for-service basis. Certain specialist physicians dealing with a high volume
of cases are paid on a capitated basis.
Claims Processing
The PSN does not pay or process any of the payments to its providers. Pursuant
to the Humana Agreements, Humana, among other things, processes claims received
by PSN Physicians, makes a determination whether and to what extent to allow
such claims and makes payments for covered services rendered to Humana
Participating Customers using Humana's claims processing policies, procedures
and guidelines. Humana provides notice to the PSN upon qualification of a claim
and we have the opportunity within seven days of receipt of a claim to review
such claim and approve, deny or modify the claim, as appropriate. Humana
provides the PSN with electronic data and reports on a monthly basis which are
maintained on a server system at our executive offices. We statistically
evaluate the data provided by Humana for a variety of factors including the
number of customers assigned to the PSN, the reasonableness of revenue paid to
us and the claims paid on our behalf. We also regularly monitor and measure
Humana's estimates of claims incurred but not yet reported.
The PSN's claims suspense staff seeks to identify and correct non-qualifying
claims prior to payment. After payments are made by Humana, the PSN's
contestation staff is responsible for reviewing paid claims, identifying errors
and seeking recoveries.
The PSN is certified as a Utilization Review Agent by AHCA. Utilization review
is a process whereby multiple data is analyzed and considered to ensure that
appropriate health services are provided in a cost-effective manner. Factors
include the risks and benefits of a medical procedure, the cost of providing
those services, specific payer coverage guidelines, and historical outcomes of
healthcare providers such as physicians and hospitals.
PSN Growth Strategy
Our growth strategy for the PSN includes, among other things:
- 13 -
o Increasing the volume of patients treated by the PSN
Physicians through enhanced marketing efforts; and
o selectively expanding the PSN's network of providers to
include additional physician practices within its existing
geographic markets.
Increasing Patient Volume
We believe the PSN's existing network of providers has the capacity to care for
additional Humana Plan Customers and could realize certain additional economies
of scale if the number of Humana Plan Customers utilizing the network increased.
We seek to increase the number of patients using the PSN network through the
general marketing efforts of Humana and through our own targeted marketing
efforts towards Medicare eligible patients.
Selectively Expanding Its Network of Physician Practices
Within our existing geographic markets, we are seeking to add additional
physician practices to the PSN's existing network either through acquisition,
start up or affiliation with a current PSN Physician. We identify and select
candidates based in large part on the following broad criteria:
o a history of profitable operations or a perceived synergy such
as opportunities for economies of scale through a
consolidation of management or service provision functions;
o a geographic proximity to underserved areas within our service
regions; and
o a geographic proximity to our current operations.
PSN Competition
We believe that there are at least five and fifteen Medicare Advantage plans in
the Central Florida and South Florida markets, respectively. It is our
understanding that as of December 2006 Humana has enrolled in its Medicare
Advantage Plans approximately 55% and 37% of the persons enrolled in Medicare
Advantage Plans in Central Florida and South Florida, respectively. We also
believe that through our PSN Physicians we provide medical services to
approximately 91% and 5% of the Humana Plan Customers in the Central Florida and
South Florida markets, respectively.
Some of our direct competitors in the PSN industry are Continucare Corporation,
MCCI, Primary Care Associates, Inc., and Island Doctors, are all based and
operating in Florida. We believe that Continucare Corporation, MCCI, and Primary
Care Associates, Inc. provide PSN services to Humana in South Florida and Island
Doctors provides PSN services to Humana in Central Florida. See "RISK FACTORS -
Our Industry is Already Very Competitive..."
Health Maintenance Organization
Effective July 1, 2005, the HMO began offering its Medicare Advantage health
plan in the Florida counties of Martin, St. Lucie, Okeechobee, Lee, Charlotte
and Sarasota. Our Medicare Advantage plan covers Medicare eligible customers who
reside at least six months or more in the service area and offers benefits that
are better than those offered under traditional Medicare fee-for-service plans.
Through our Medicare Advantage Plan, we have the flexibility to offer benefits
not covered under traditional fee-for-service Medicare. These benefits are
designed to be attractive to seniors and include prescription drug benefits, eye
glasses, hearing aids, dental care, over-the-counter drug plans and health club
memberships. In addition we offer a "special needs" zero premium, zero
co-payment plan to dual-eligible individuals in our markets.
During 2006, the HMO's Medicare Advantage customers, depending on the market,
paid either a $0 or $10 monthly premium. Effective January 1, 2007 this amount
was reduced to $0 for all customers. In some cases, the HMO customers are
subject to co-payments and deductibles, depending upon the market and benefit.
Except in limited cases, including emergencies, our HMO customers are required
to use primary care physicians within the HMO's network of providers and
generally must receive referrals from their primary care physician in order to
see a specialist or ancillary providers.
- 14 -
Pursuant to the CMS Agreement, the HMO has agreed to provide services to
Medicare beneficiaries pursuant to the Medicare Advantage program. Under the CMS
Agreement, CMS pays the HMO a fixed capitation payment based on the number of
customers enrolled, which payment is adjusted for demographic and health risk
factors. Inflation, changes in utilization patterns and average per capita
fee-for-service Medicare costs are also considered in the calculation of the
fixed capitation payment by CMS. The initial term of the CMS Agreement has been
renewed to December 31, 2007 and is subject to annual renewal at the election of
CMS. Amounts payable under the CMS Agreement are subject to annual revision by
CMS. Pursuant to the CMS Agreement, the HMO is required to comply with federal
Medicare laws and regulations and the CMS Agreement is subject to termination by
CMS in the event of the HMO's noncompliance.
The amount of premiums we receive for each Medicare customer is established by
CMS, although it varies according to various demographic factors, including the
customer's geographic location, age, and gender, and is further adjusted based
on our plans' average risk scores. During the month of December 2006, the
premiums we received from CMS across our service areas ranged from approximately
$738 to $979 per customer per month. In addition to the premiums payable to us,
the CMS Agreement regulates, among other matters, benefits provided, quality
assurance procedures, and marketing and advertising for our Medicare products.
To successfully operate the HMO, we believe we will have to continue our
development of the following capabilities, among others: medical management,
sales and marketing, customer service and regulatory compliance. No assurances
can be given that we will be successful in operating this segment of our
business despite our allocation of a substantial amount of resources for this
purpose. If the HMO does not develop as anticipated or planned, we may have to
devote additional managerial and/or capital resources to the HMO, which could
limit our ability to manage and/or grow the PSN. There can be no assurances
that, if for any reason, we elect to discontinue the HMO business and/or seek to
sell such business, we will be able to fully recoup our expenditures to date
with respect to the HMO business.
Medical Health Services Management and Provider Networks
One of our primary goals is to arrange for high quality healthcare services for
our HMO customers. To achieve our goal of ensuring high quality, cost-effective
healthcare, we have established various quality management programs, including
disease management and utilization management programs.
The disease management programs are focused on prevention and care and are
designed to support the coordination of healthcare intervention,
physician/patient relationships and plans of care, preventive care, and patient
empowerment with the goal of improving the quality of patient care and
controlling related costs. These disease management programs are focused
primarily on high-risk care management and the treatment of our chronically ill
customers and are designed to efficiently treat patients with specific high risk
or chronic conditions such as coronary artery disease, congestive heart failure,
diabetes, asthma related conditions, and certain other conditions. In addition
to internal disease management efforts, the HMO has engaged disease management
companies to educate customers on chronic medical conditions, help them comply
with medication regimens, and counsel customers on healthy lifestyles.
We also have implemented utilization and case management programs to provide
more efficient and effective use of healthcare services by our HMO customers.
The case management programs are designed to improve outcomes for customers with
chronic conditions through standardization, proactive management, coordinating
fragmented healthcare systems to reduce duplication, and improve collaboration
with physicians. These programs monitor hospitalization, coordinate care, and
ensure timely discharge from the hospital. In addition, the HMO uses internal
case management programs and contracts with other third parties to manage
severely and chronically ill patients. The HMO utilizes on-site critical care
intensivists, hospitalists and concurrent review nurses, who manage the
appropriate times for outpatient care, hospitalization, rehabilitation or home
care.
Additionally, we internally monitor and evaluate, and seek to enhance, the
performance of the HMO providers. Our related programs include:
o review of utilization of preventive measures and disease/case
management resources and related outcomes;
o customer satisfaction surveys;
o review of grievances and appeals by customers and providers;
- 15 -
o orientation visits to, and site audits of, select providers;
o ongoing provider and customer education programs; and
o medical record audits.
As more fully described below under "Provider Arrangements and Payment Methods,"
the HMO's reimbursement methods are also designed to encourage providers to
utilize preventive care, and the disease and case management services in an
effort to improve clinical outcomes.
We believe strong provider relationships are essential to increasing our HMO
customer base, improving the quality of care to our HMO customers and making our
health plan profitable. We have established comprehensive networks of providers
in each of the areas the HMO serves. The HMO seeks providers who have experience
in managing the Medicare population, including experience in providing care
through a risk-sharing or other relationship with a Medicare Advantage plan. Our
goal is to create mutually beneficial and collaborative arrangements with our
HMO providers. We believe provider incentive arrangements should not only help
us attract providers, but also help align their interests with our objective of
providing high-quality, cost-effective healthcare and ultimately encourage
providers to deliver a level of care that promotes customer wellness, reduces
avoidable catastrophic outcomes, and improves clinical outcomes.
In our efforts to improve the quality and cost-effectiveness of heath care for
our HMO customers, we continue to refine and develop new methods of medical
management and physician engagement. Two such initiatives are currently
underway, the acute care system and post-discharge recovery plan. These
initiatives focus on timely outreach and close monitoring of customers
identified as high-risk or clinically unstable and the development of a
comprehensive recovery plan to stabilize those types of customers.
Generally, the HMO contracts for pharmacy services through an unrelated pharmacy
benefits manager, or PBM, who is reimbursed at a discount to the "average
wholesale price" for the provision of covered outpatient drugs. In addition, the
HMO is entitled to share in the PBM's rebates based on pharmacy utilization
relating to certain qualifying medications.
We strive to be the preferred Medicare Advantage partner for providers in each
market the HMO serves. In addition to risk-sharing and other incentive-based
financial arrangements, we seek to promote a provider-friendly relationship by
paying claims promptly, providing periodic performance and efficiency
evaluations, providing convenient, web-based access to eligibility data and
other information, and encouraging provider input on plan benefits. We also
emphasize quality assurance and compliance by periodically reviewing our HMO's
networks and providers. By fostering a collaborative, interactive relationship
with our providers, we are better able to gather data relevant to improving the
health of our customers.
Provider Arrangements and Payment Methods
Our HMO has primarily structured its non-exclusive provider contracts on a fee
for service basis. We may also supplement provider payments with incentive
arrangements based, in general, on the quality of healthcare delivery. For
example, as an incentive to encourage our providers to deliver high quality care
for their patients and assist us with our quality assurance and medical
management programs, we often seek to implement incentive arrangements whereby
we compensate our providers for "quality performance," including increased
fee-for-service rates for specified preventive health services and additional
payments for providing specified encounter data on a timely basis. We also seek
to implement financial incentives relating to other operational matters where
appropriate.
In some cases, particularly with respect to contracts between hospitals or
health care systems and our HMO, we may be at risk for medical expenses above
and beyond a negotiated amount (a so-called "stop loss" provision), which amount
is typically calculated by reference to a percentage of billed charges, in some
cases back to the first dollar of medical expense. In the case of a Medicare
patient who is admitted to a non-contracting hospital, we are only obligated to
pay the amount that the hospital would have received from CMS under traditional
fee-for-service Medicare.
We believe our HMO's incentive and arrangements with physicians help to align
their interests with us and our customers and improve both clinical and
financial outcomes. We will continue to seek to implement these arrangements
where possible in our HMO's existing and new service areas.
- 16 -
Management Services
The HMO has engaged a third party service provider, HF Administrative Services,
Inc. ("HFAS"), to provide various administrative and management services,
including, but not limited to, claims processing and adjudication, certain
management information services, regulatory reporting and customer services
pursuant to the terms of an Administrative Services Agreement (the "Services
Agreement").
The HMO compensates HFAS for its management services based upon the number of
customers enrolled in the HMO, subject to various monthly minimum payments. The
minimum monthly fee was $25,000 per month through July 2006 this fee increased
to $60,000 per month for the remaining term of the Services Agreement. In
addition, HFAS is compensated for providing additional programming services on
an hourly basis. The initial term of the Services Agreement is for five years
ending on June 30, 2010. Thereafter, the Services Agreement is automatically
renewable for additional one-year terms unless terminated by either party for
any reason upon 180 days notice. During 2006 and 2005, we paid an aggregate of
$751,000 and $487,000 to HFAS for services in accordance with the Services
Agreement.
Pursuant to the Services Agreements, HFAS verifies claims by the HMO's
affiliated providers against the HMO's policies regarding customer eligibility,
benefits, referrals and pre-authorizations and makes a determination whether and
to what extent to allow such claims using the HMO's guidelines. HFAS provides
notice to the HMO of claim denials. The HMO has the right and responsibility
within three business days of receipt of a claim denial to independently review
such claim and approve, deny or modify the claim, as appropriate. The HMO has
access to the management information systems provided and maintained by HFAS for
its benefit. In addition, HFAS is required under the Services Agreement to
provide the HMO with reports and information regarding claim adjudication.
Either party may terminate the Services Agreement upon prior written notice
(with a 30 day opportunity to cure) in the event of the other's material breach
of the Services Agreement in any manner, including but not limited to, the HMO's
failure to maintain sufficient funds in order for HFAS to pay claims, or in the
event the HMO engages in or acquiesce to any act of bankruptcy, receivership or
reorganization or in the event either party fails to secure any license,
government approval or exemption required by law. See "RISK FACTORS - We Depend
on Third Parties to Provide It Crucial Information and Data."
Sales and Marketing Programs
As of December 31, 2006, the HMO's sales force consists of third party agents
and internally licensed sales employees. The third party agents are compensated
on a commission basis. Medicare Advantage enrollment is generally an individual
decision made by the customer. We regularly participate in local community
health fairs and events, and seek to become involved with local senior citizen
organizations to promote our products and the benefits of preventive care. Our
sales and marketing programs are tailored to each of our local service areas and
are designed with the goal of educating, attracting, and retaining customers and
providers. In addition, the HMO's sales agents and representatives focus their
efforts on in-person contacts with potential enrollees. The HMO's marketing
efforts also utilize direct mail and print advertising.
Our sales and marketing activities are heavily regulated by CMS and other
governmental agencies. For example, CMS has oversight over all marketing
materials used by our Medicare Advantage plans and, in some cases, has imposed
advance approval requirements with respect to marketing materials. Our sales
activities are limited to activities such as conveying information regarding the
benefits of preventive care, describing the operations of managed care plans,
and providing information about eligibility requirements. The activities of our
third-party brokers and agents are also heavily regulated.
Prior to 2006, Medicare beneficiaries could enroll in or change health plans at
any time during the year. Commencing in 2006, Medicare beneficiaries have a
limited annual enrollment period during which they can choose between a Medicare
Advantage plan and traditional fee-for-service Medicare. After this annual
enrollment period ends, generally only seniors turning 65 during the year,
dual-eligible beneficiaries, Low-Income Subsidy (LIS) beneficiaries, others who
qualify for special needs plans, Medicare beneficiaries permanently relocating
to another service area, and employer group retirees will be permitted to enroll
in or change health plans. See "Industry - The Medicare Modernization Act -
Enrollment Period."
- 17 -
Quality Assurance
The HMO has implemented processes designed to ensure compliance with regulatory
and accreditation standards. Internal programs that credential providers are
designed to help ensure we meet the audit standards of federal and state
agencies, including CMS and AHCA, as well as applicable external accreditation
standards.
Our providers must satisfy specific criteria, such as licensing, credentialing,
patient access, office standards, after-hours coverage, and other factors. Our
participating hospitals must also meet specific criteria, including
accreditation criteria established by CMS.
HMO Competition
We believe that the Medicare Advantage market is highly competitive. The recent
changes in Medicare reimbursement may result in new plans entering the market or
existing plans expanding in to new markets or increasing sales and marketing
efforts. The new reimbursement may also result in the development of different
models, such as Preferred Provider Organizations that could impact the growth of
the HMO. There are a number of Medicare Advantage plans being offered to
Medicare beneficiaries in the twelve Florida counties where the HMO operates
including plans being offered by Vista HealthPlan, Wellcare, Universal
Healthcare and Quality Health Plan. As of December 31, 2006, we estimate that we
have enrolled approximately 2.8% and .3% of the Medicare eligible customers in
the Treasure Coast and Gulf Coast, respectively. See "RISK FACTORS - Our
Industry is Already Very Competitive..."
We believe that our HMO has certain strengths which makes it competitive within
the markets we serve. Some of the HMO's strengths include:
o Our strong network of physicians and hospitals that provide
medical care to our customers.
o Our management experience in non urban Florida counties.
o Our Partners-In-Quality program which rewards physicians for
providing quality care to our customers
Insurance
We rely upon insurance to protect us from many business risks, including medical
malpractice, errors and omissions and certain significantly higher than average
customer medical expenses. Although we maintain insurance of the types and in
the amounts that we believe are reasonable, there can be no assurances that the
insurance policies maintained by us will insulate us from material expenses
and/or losses in the future. See "RISK FACTORS - Claims Relating to Medical
Malpractice and Other Litigation...."
Employees
As of December 31, 2006, Metropolitan had 204 full-time employees, 68 of which
were employed at our executive offices. Of this total, 115 and 71 were employed
by the PSN and the HMO, respectively, with the balance representing corporate
administrative employees. None of our employees are covered by a collective
bargaining agreement or are represented by a labor union. We consider our
employee relations to be good.
Government Regulation
Our businesses are regulated by the federal government and the State of Florida.
The laws and regulations governing our operations are generally intended for the
benefit of health plan customers and providers. These laws and regulations,
along with the terms of our contracts, regulate how we do business, what
services we offer, and how we interact with Humana Participating Customers, HMO
customers, affiliated providers and the public. The government agencies
administering these laws and regulations have broad latitude to enforce them. We
are subject to various governmental reviews, audits and investigations to verify
our compliance with our contracts and applicable laws and regulations.
- 18 -
We believe that we are in material compliance with all government regulations
applicable to our business. We further believe that we have implemented
reasonable systems and procedures to assist us in maintaining compliance with
such regulations. Nonetheless, we face a variety of regulatory related risks.
See "Risk Factors - Reductions in Government Funding...", "-The MMA Will
Materially Impact Our Operations...", "CMS Risk Adjustment Payment System...",
"Our Business Activities Are Highly Regulated...", "The Healthcare Industry is
Highly Regulated...", "If the HMO Is Required to Maintain Higher Statutory
Capital Levels..." and "We Are Required to Comply with Laws..."
A summary of the material aspects of the government regulations to which we are
subject is set forth below.
Federal and State Reimbursement Regulation
Our operations are affected on a day-to-day basis by numerous legislative,
regulatory and industry-imposed operational and financial requirements, which
are administered by a variety of federal and state governmental agencies as well
as by self-regulating associations and commercial medical insurance
reimbursement programs.
Federal "Fraud and Abuse" Laws and Regulations
The federal Anti-Kickback Law makes it a criminal felony offense to knowingly
and willfully offer, pay, solicit or receive remuneration in order to induce
business for which reimbursement is provided under federal health care programs,
including without limitation, the Medicare and Medicaid programs. Violations of
these laws are punishable by monetary fines, civil and criminal penalties,
exclusion from care programs and forfeiture of amounts collected in violation of
such laws. The scope of prohibited payments covered by the Anti-Kickback Law is
broad and includes economic arrangements involving hospitals, physicians and
other health care providers, including joint ventures, space and equipment
rentals, purchases of physician practices and management and personal services
contracts.
CMS has promulgated regulations that prohibit health plans with Medicare
contracts from including any direct or indirect payment to physicians or other
providers as an inducement to reduce or limit medically necessary services to a
Medicare beneficiary. These regulations impose disclosure and other requirements
relating to physician incentive plans including bonuses or withholdings that
could result in a physician being at "substantial financial risk" as defined in
Medicare regulations.
Federal False Claims Act
We are subject to a number of laws that regulate the presentation of false
claims or the submission of false information to the federal government. For
example, the federal False Claims Act provides, in part, that the federal
government may bring a lawsuit against any person or entity whom it believes has
knowingly presented, or caused to be presented, a false or fraudulent request
for payment from the federal government, or who has made a false statement or
used a false record to get a claim approved. The federal government has taken
the position that claims presented in violation of the federal Anti-Kickback Law
may be considered a violation of the federal False Claims Act. Violations of the
False Claims Act are punishable by treble damages and penalties of up to $11,000
per false claim. In addition to suits filed by the government, a special
provision under the False Claims Act allows a private individual (e.g., a
"whistleblower" such as a disgruntled former employee, competitor or patient) to
bring an action under the False Claims Act on behalf of the government alleging
that an entity has defrauded the federal government and permits the
whistleblower to share in any settlement or judgment that may result from that
lawsuit.
Florida Fraud and Abuse Regulations
Florida enacted "The Patient Brokering Act" which imposes criminal penalties,
including jail terms and fines, for receiving or paying any commission, bonus,
rebate, kickback, or bribe, directly or indirectly in cash or in kind, or engage
in any split-fee arrangement, in any form whatsoever, to induce the referral of
patients or patronage from a healthcare provider or healthcare facility. The
Florida statutory provisions regulating the practice of medicine include similar
language as grounds for disciplinary action against a physician.
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Restrictions on Physician Referrals
Federal regulations under the Social Security Act that restrict physician
referrals to health care entities with which they have financial relationships
(commonly referred to as the "Stark Law") prohibit certain patient referrals by
physicians. Specifically, the Stark Law prohibits a physician, or an immediate
family customer, who has a financial relationship with a health care entity,
from referring Medicare patients with limited exceptions, to that entity for
certain "designated health services". A financial relationship is defined to
include an ownership or investment in, or a compensation relationship with, a
health care entity. The Stark Law also prohibits a health care entity receiving
a prohibited referral from billing the Medicare or Medicaid programs for any
services rendered to a patient as a result of the prohibited referral. The Stark
Law contains certain exceptions that protect parties from liability if the
parties comply with all of the requirements of the applicable exception. The
sanctions under the Stark Law include denial and refund of payments, civil
monetary penalties and exclusions from participation in the Medicare programs.
Privacy Laws
The privacy, security and transmission of health information is subject to
federal and state laws and regulations, including the Healthcare Insurance
Portability and Accountability Act of 1996 ("HIPAA"). Final regulations with
respect to the privacy of certain individually identifiable health information
(the "Protected Health Information") became effective in April 2003 (the
"Privacy Rule"). The Privacy Rule specifies authorized or required uses and
disclosures of the Protected Health Information, as well as the rights patients
have with respect to their health information. HIPAA also provides that to the
extent that state laws impose stricter privacy standards than the HIPAA privacy
rule, such standards are not preempted, requiring compliance with any stricter
state privacy law. In addition, in October 2002, the electronic data standards
regulations under HIPAA became effective. The final HIPAA security rule became
effective in February 2003, and established security standards with respect to
Protected Health Information transmitted or maintained electronically. These
regulations establish uniform standards relating to data reporting, formatting,
and coding that certain health care providers must use when conducting certain
transactions involving health information.
Clinic Licensure
AHCA requires us to license each of our physician practices individually as
health care clinics. Each physician practice must renew its health care clinic
licensure biennially.
Occupational Safety and Health Administration ("OSHA")
In addition to OSHA regulations applicable to businesses generally, we must
comply with, among other things, the OSHA directives on occupational exposure to
blood borne pathogens, the federal Needlestick Safety and Prevention Act, OSHA
injury and illness recording and reporting requirements, federal regulations
relating to proper handling of laboratory specimens, spill procedures and
hazardous waste disposal, and patient transport safety requirements.
Medicare Marketing Restrictions
We are subject to federal marketing rules and regulations that limit, among
other things, offering any gift or other inducement to Medicare beneficiaries to
encourage them to come to the Company for their health care.
State Regulation
The HMO is subject to the rules, regulations and oversight by the OIR and AHCA
in the areas of licensing and solvency. The HMO files reports with these state
agencies describing its capital structure, ownership, financial condition,
certain inter-company transactions and business operations. It also is generally
required to demonstrate, among other things, that it has an adequate provider
network, that its systems are capable of processing provider's claims in a
timely fashion and of collecting and analyzing the information needed to manage
their business. State regulations also require the prior approval or notice of
acquisitions or similar transactions involving a HMO, and of certain
transactions between a HMO and its parent or affiliated entities or persons.
Generally, HMOs are limited in their ability to pay dividends to their
stockholders.
The HMO is required to maintain a minimum level of statutory capital. These
requirements assess the capital adequacy of a HMO based upon investment asset
risks, insurance risks, interest rate risks and other risks associated with its
business to determine the amount of statutory capital believed to be required to
support the HMO's business. If the HMO's statutory capital level falls below
certain required capital levels, it may be required to submit a capital
corrective plan to the state department of insurance, and at certain levels may
be subjected to regulatory orders, including regulatory control through
rehabilitation or liquidation proceedings.
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ITEM 1A. RISK FACTORS
The PSN's Operations are Dependent on Humana, Inc.
The PSN currently derives, and expects to continue to derive, the substantially
all of its revenue from its Humana Agreements which provide for the receipt of
capitated fees. For the twelve months ended December 31, 2006, approximately
99.2% of the PSN total revenue was obtained from these Humana Agreements. Humana
may immediately terminate either of the Humana Agreements and/or any individual
physician credentialed under the Humana Agreements upon the occurrence of
certain events. Humana may also amend the material terms of the Humana
Agreements under certain circumstances. See "ITEM 1. BUSINESS - Humana
Agreements" for a detailed discussion of the Humana Agreements.
Failure to maintain the Humana Agreements on favorable terms, for any reason,
would adversely affect our results of operations and financial condition. A
material decline in enrollees in Humana's Medicare Advantage program could also
have a material adverse effect on our results of operation.
There Can be No Assurance that We Will be Successful in Our Operation of the
HMO.
Although we have operated as a risk provider since 1997, we have only operated
the HMO since July 1, 2005. While the HMO's business has continued to grow, such
growth has required and is expected to continue to require a considerable amount
of require capital. We contributed approximately $6.8 million to the HMO during
2006 and another $6.5 million subsequent to year end to finance the operations
and growth of the HMO. In the year ended December 31, 2006, the HMO's business
generated an $11.7 million segment loss before allocated overhead and income
taxes. We project that in 2007, the HMO's business will continue to generate a
loss before allocated overhead and income taxes. The HMO's actual cash needs and
losses for 2007 are expected to be strongly influenced by, among other things,
the HMO's membership levels and medical expense utilization rates as wells as
the scale, cost and effectiveness of various marketing programs we may
undertake. We are still not in a position to meaningfully estimate when, if
ever, the HMO's business will become profitable and/or generate cash from
operations, and we may be required to fund the development and expansion of the
HMO business, including any associated losses, for an extended period of time.
Nonetheless, we anticipate that the on-going development efforts, reserve
requirements and operating costs for our still developing HMO business can be
funded by our current resources and projected cash flows from operations until
at least December 31, 2007.
To successfully operate the HMO, we believe we will have to continue our
development of the following capabilities, among others: sales and marketing,
customer service and regulatory compliance. No assurances can be given that we
will be successful in operating this segment of our business despite our
allocation of a substantial amount of resources for this purpose. If the HMO
does not develop as anticipated or planned, we would likely explore strategic
alternatives for the business and/or devote additional managerial and/or capital
resources to the HMO, which could limit our ability to manage and/or grow the
PSN. There can be no assurances that, if for any reason, we elect to discontinue
the HMO business and/or seek to sell such business, we will be able to fully
recoup our expenditures to date with respect to the HMO business.
The failure of the HMO to perform as projected could also limit our ability to
manage and/or grow the PSN. Most of our senior management team provides
management, support and assistance to both the HMO and the PSN. To the extent
one business consumes a higher than anticipated amount of our executive
resources, the other business could suffer.
In our contract with CMS we commit to provide various healthcare services for a
year long period and we must notify CMS by June if we intend not to renew a
contract term that commences in January. Accordingly, even if we deemed it
economically necessary or desirable to scale back or discontinue operations in
one or more HMO service areas, our financial and service commitments to CMS and
our customers might preclude us from doing so at the desired rate, which would
likely increase our losses associated with such service area. Moreover, we
believe there are certain inherent economies of scale associated with our
business. Accordingly, any individual decision to scale back or discontinue
operations in even part of one service area could have a disproportionately
large negative effect on our results of operations.
- 21 -
Because we must elect whether or not to renew our contracts with CMS
approximately six months before a service period commences, our ability to
accurately project the results of future operations for at least 18 months is
very important. Because of the short history of the HMO, it is difficult to
accurately make long term projections regarding the HMO business. We have found
it especially difficult to precisely budget our customer growth and medical
expenses. Although we have implemented a strategy to improve our ability to
reduce these planning impediments, we recognize that they may remain significant
obstacles to our ability to project the results of the HMO business.
Because Most of Our Revenue Is Established by Contract and Cannot Be Modified
During the Contract Terms, Our Operating Margins Could be Negatively Impacted if
We Are Unable to Manage Our Medical Expenses Effectively.
The Humana Agreements and the CMS Agreement are risk agreements under which we
receive monthly payments for each Humana Participating Customer and each
customer enrolled in our HMO (collectively, the "Participating Customers") at a
rate established by the agreements, also called a capitated fee. In accordance
with the agreements, the total monthly payment is a function of the number of
Participating Customers, regardless of the actual utilization rate of covered
services. In return, the PSN or the HMO, as applicable, through its affiliated
providers, assumes full financial responsibility for the provision of all
necessary medical care to the Participating Customers, regardless of whether or
not its affiliated providers directly provide the covered medical services.
To the extent that the Participating Customers require more care than is
anticipated, aggregate capitation rates may be insufficient to cover the costs
associated with the treatment of such Participating Customers. If medical
expenses exceed our estimates, except in very limited circumstances, we will be
unable to increase the premiums received under these contracts during the
then-current terms.
Relatively small changes in our ratio of medical expense to revenue can create
significant changes in our financial results. Accordingly, the failure to
adequately predict and control medical expenses and to make reasonable estimates
and maintain adequate accruals for incurred but not reported, or IBNR, claims,
may have a material adverse effect on our financial condition, results of
operations, or cash flows.
Historically, our medical expenses as a percentage of revenue have fluctuated.
Factors that may cause medical expenses to exceed estimates include:
o higher than expected utilization of new or existing healthcare
services or technologies;
o an increase in the cost of healthcare services and supplies,
including pharmaceuticals, whether as a result of inflation or
otherwise;
o changes to mandated benefits or other changes in healthcare
laws, regulations, and practices;
o Humana's periodic renegotiation of provider contracts with
specialist physicians, hospitals and ancillary providers;
o periodic renegotiation of contracts with our affiliated
primary care physicians;
o changes in the demographics of our customers and medical
trends affecting Medicare risk scores;
o contractual or claims disputes with providers, hospitals, or
other service providers within the Humana network; and
o the occurrence of catastrophes, major epidemics, or acts of
terrorism.
We attempt to control these costs through a variety of techniques, including
capitation and other risk-sharing payment methods, collaborative relationships
with primary care physicians and other providers, advance approval for hospital
services and referral requirements, case and disease management and quality
assurance programs, information systems, and reinsurance. Despite our efforts
and programs to manage our medical expenses, we may not be able to continue to
manage these expenses effectively in the future.
If Our HMO Contracts Are Not Renewed or Are Terminated, the HMO's Business Would
Be Negatively Impacted.
A new CMS Agreements was entered into effective January 1, 2007 and expires on
December 31, 2007. Pursuant to the CMS Agreement, the HMO is required to comply
with federal Medicare laws and regulations, and the CMS Agreement is subject to
termination by CMS in the event of the HMO's noncompliance. If the HMO is unable
to renew or to successfully rebid for the CMS Agreement, or if the CMS Agreement
is terminated, its business would be negatively impacted.
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Reductions in Government Funding for Medicare Programs Could Adversely Affect
Our Results of Operations
Substantially all of our revenue is directly or indirectly derived from
reimbursements generated by Medicare Advantage health plans. As a result, our
revenue and profitability are dependent on government funding levels for
Medicare Advantage programs. The Medicare programs are subject to statutory and
regulatory changes, retroactive and prospective rate adjustments, administrative
rulings, and funding restrictions, any of which could have the effect of
limiting or reducing reimbursement levels. These government programs, as well as
private insurers such as Humana, have taken and may continue to take steps to
control the cost, use and delivery of health care services. Any changes that
limit or reduce Medicare reimbursement levels could have a material adverse
effect on our business. For example, the following events could result in an
adverse effect on our results of operations:
o reductions in or limitations of reimbursement amounts or rates
under programs;
o reductions in funding of programs;
o expansion of benefits without adequate funding;
o elimination of coverage for certain benefits; or
o elimination of coverage for certain individuals or treatments
under programs.
The MMA Will Materially Impact Our Operations and Could Reduce Our Profitability
and Increase Competition for Customers.
The MMA substantially changed the Medicare program and is complex and
wide-ranging. While many of these changes will generally benefit the Medicare
Advantage sector, certain provisions of the MMA may increase competition, create
challenges with respect to educating the PSN's and the HMO's existing and
potential customers about the changes, and create other risks and substantial
and potentially adverse uncertainties, including the following:
o Increased reimbursement rates for Medicare Advantage plans could
result in a further increase in the number of plans that participate
in the Medicare program. This could create new competition that
could adversely affect the number of customers the PSN or the HMO
serve and their respective results of operations.
o Managed care companies began offering various new products in 2006
pursuant to the MMA, including regional preferred provider
organizations, or PPOs, and private fee-for-service plans. Medicare
PPOs and private fee-for-service plans allow their customers more
flexibility in selecting physicians than Medicare Advantage HMOs,
which typically require customers to coordinate with a primary care
physician. The MMA has encouraged the creation of regional PPOs
through various incentives, including certain risk corridors, or
cost-reimbursement provisions, a stabilization fund for incentive
payments, and special payments to hospitals not otherwise contracted
with a Medicare Advantage plan that treat regional plan enrollees.
It is too early to determine whether the formation of regional
Medicare PPOs and private fee-for-service plans will affect our
PSN's or HMO's relative attractiveness to existing and potential
Medicare customers in their service areas.
o The payments for the local and regional Medicare Advantage plans are
based on a competitive bidding process that may directly or
indirectly cause the PSN and/or the HMO to decrease the amount of
premiums paid to it or cause it to increase the benefits it offers.
o Medicare beneficiaries generally have a more limited annual
enrollment period during which they can choose to participate in a
Medicare Advantage plan or receive benefits under the traditional
fee-for-service Medicare program. After the annual enrollment
period, most Medicare beneficiaries will not be permitted to change
their Medicare benefits. This "lock-in" may make it difficult for
the HMO to retain an adequate sales force. The new annual enrollment
process and subsequent "lock-in" provisions of the MMA may adversely
affect our level of revenue growth as it will limit the HMO's
ability to market to and enroll new customers in its established
service areas outside of the annual enrollment period. Such
limitations could adversely and materially affect our profitability
and results of operations.
o Managed care companies that offer Medicare Advantage plans are
required to offer prescription drug benefits as part of their
Medicare Advantage plans. Managed care plans offering drug benefits
are, under the new law, called MA-PDs. There is insufficient
information to determine whether the governmental payments will be
adequate to cover the actual costs for these new MA-PD benefits or
whether we will be able to profitably or competitively manage our
MA-PDs. Individuals who are enrolled in a Medicare Advantage plan
must receive their drug coverage through their Medicare Advantage
prescription drug plan. Enrollees may prefer a stand-alone drug plan
and may cease to be a Medicare Advantage customer in order to
participate in a stand-alone PDP. Accordingly, the new Medicare Part
D prescription drug benefit could reduce Participating Customer
enrollment and revenue.
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CMS's Risk Adjustment Payment System and Budget Neutrality Payment Adjustments
Make Our Revenue and Profitability Difficult to Predict and Could Result In
Material Retroactive Adjustments to Our Results of Operations.
CMS has implemented a risk adjustment payment system for Medicare health plans
to improve the accuracy of payments and establish incentives for Medicare plans
to enroll and treat less healthy Medicare beneficiaries. CMS is phasing-in this
payment methodology with a risk adjustment model that bases a portion of the
total CMS reimbursement payments on various clinical and demographic factors
including hospital inpatient diagnoses, diagnostic data from ambulatory
treatment settings, including hospital outpatient facilities and physician
visits, gender, age, and Medicaid eligibility. CMS requires that all managed
care companies capture, collect, and submit the necessary diagnosis code
information to CMS twice a year for reconciliation with CMS's internal database.
As part of the phase-in, during 2003, risk adjusted payments accounted for 10%
of Medicare health plan payments, with the remaining 90% being reimbursed in
accordance with the traditional CMS demographic rate books. The portion of risk
adjusted payments was increased to 30% in 2004, 50% in 2005, and 75% in 2006 and
to 100% in 2007. As a result of this process, it is difficult to predict with
certainty our future revenue or profitability. In addition, the HMO's and/or
Humana's risk scores for any period may result in favorable or unfavorable
adjustments to the payments directly or indirectly received from CMS and our
Medicare premium revenue. There can be no assurance that our contracting
physicians and hospitals will be successful in improving the accuracy of related
recording diagnostic code information and thereby enhancing its risk scores.
Since 2003, payments to Medicare Advantage plans have also been adjusted by a
"budget neutrality" factor that was implemented by Congress and CMS to prevent
health plan payments from being reduced overall while, at the same time,
directing higher, risk adjusted payments to plans with more chronically ill
enrollees. In general, this adjustment has favorably impacted payments to all
Medicare Advantage plans. The Deficit Reduction Act of 2005 which, among other
changes, provides for an accelerated phase-out of budget neutrality for risk
adjustment of payments made to Medicare Advantage plans. This legislation will
have the effect of reducing payments to Medicare Advantage plans in general.
Consequently, we expect the premiums we receive could be reduced, dependent upon
the HMO's and Humana's risk scores.
A Disruption in Our Healthcare Provider Networks Could Have an Adverse Effect on
Our Operations and Profitability.
Our operations and profitability are dependent, in part, upon our ability to
contract with healthcare providers and provider networks on favorable terms. In
any particular service area, healthcare providers or provider networks could
refuse to contract with us, demand higher payments, or take other actions that
could result in higher healthcare costs, disruption of benefits to our
customers, or difficulty in meeting our regulatory or accreditation
requirements. In some service areas, healthcare providers may have significant
market positions. If healthcare providers refuse to contract with us, use their
market position to negotiate favorable contracts, or place us at a competitive
disadvantage, then our ability to market products or to be profitable in those
service areas could be adversely affected. Our provider networks could also be
disrupted by the financial insolvency of a large provider group. Any disruption
in our provider network could result in a loss of customers or higher healthcare
costs.
A Disruption in Humana's Healthcare Provider Networks Could Have an Adverse
Effect on Our Operations and Profitability.
A significant portion of the PSN's Total Medical Expenses are payable to
entities that are not customers and/or directly contracted with the PSN.
Although virtually all of such entities are Humana approved service providers,
and although the PSN can provide Humana input with respect to Humana's service
providers, the PSN does not control the process by which Humana negotiates
and/or contracts with service providers in the Humana Medicare Advantage
network.
We Depend on Third Parties to Provide Us with Crucial Information and Data.
- 24 -
Humana provides a significant amount of information and services to the PSN,
including claims processing, billing services, data collection and other
information, including reports and calculations of costs of services provided
and payments to be received by the PSN. The PSN does not own or control such
systems and, accordingly, has limited ability to ensure that these systems are
properly maintained, serviced and updated. In addition, information systems such
as these may be vulnerable to failure, acts of sabotage and obsolescence. The
PSN's business and results of operations could be materially and adversely
affected by its inability, for any reason, to receive timely and accurate
information from Humana.
The HMO relies on HFAS, a third party service provider, to provide various
administrative and management services, including, but not limited to, claims
processing and adjudication, certain management information services, regulatory
reporting and customer services pursuant to the terms of the Services Agreement.
Because these services are outsourced as opposed to performed internally, we
have less control over the manner in which these matters are handled and the
accuracy and timeliness of the data provided to us than if we handled these
functions internally. Additionally, any loss of information by Humana or HFAS
could have a material adverse effect on our business and the results of its
operations.
Claims Relating to Medical Malpractice and Other Litigation Could Cause Us to
Incur Significant Expenses.
From time to time, we are a party to various litigation matters, some of which
seek monetary damages. Managed care organizations may be sued directly for
alleged negligence, including in connection with the credentialing of network
providers or for alleged improper denials or delay of care. In addition,
providers affiliated with the PSN or the HMO involved in medical care decisions
may be exposed to the risk of medical malpractice claims. A small percentage of
these providers do not have malpractice insurance. As a result of increased
costs or inability to secure malpractice insurance, the percentage of physicians
who do not have malpractice insurance may increase. Although most of its network
providers are independent contractors, claimants sometimes allege that a PSN
and/or HMO should be held responsible for alleged provider malpractice,
particularly where the provider does not have malpractice insurance, and some
courts have permitted that theory of liability. Similar to other managed care
companies, the HMO may also be subject to other claims of its customers in the
ordinary course of business, including claims arising out of decisions to deny
or restrict reimbursement for services.
We cannot predict with certainty the eventual outcome of any pending litigation
or potential future litigation, and there can be no assurances that we will not
incur substantial expense in defending these or future lawsuits or indemnifying
third parties with respect to the results of such litigation. The loss of even
one of these claims, if it results in a significant damage award, could have a
material adverse effect on our business. In addition, exposure to potential
liability under punitive damage or other theories may significantly decrease our
ability to settle these claims on reasonable terms.
We maintain errors and omissions insurance and other insurance coverage that we
believe are adequate based on industry standards. Nonetheless, potential
liabilities may not be covered by insurance, insurers may dispute coverage or
may be unable to meet their obligations or the amount of insurance coverage
and/or related reserves may be inadequate. There can be no assurances that we
will be able to obtain insurance coverage in the future, or that insurance will
continue to be available on a cost-effective basis, if at all. Moreover, even if
claims brought against us are unsuccessful or without merit, we would have to
defend our self against such claims. The defense of any such actions may be
time-consuming and costly and may distract management's attention. As a result,
we may incur significant expenses and may be unable to effectively operate our
business.
Our Industry is Already Very Competitive; Increased Competition Could Adversely
Affect Our Revenue; the PSN Competes with Other Service Providers for Humana's
Business.
We compete in the highly competitive and regulated health care industry, which
is subject to continuing changes with respect to the provisioning of services
and the selection and compensation of providers. In 2006, approximately 86.9% of
our revenue was generated pursuant to the Humana Agreements. Humana competes
with other HMOs and PPOs in securing and serving patients in the Medicare
Advantage Program. Companies in other health care industry segments, some of
which have financial and other resources comparable to or greater than Humana,
may become competitors to Humana. The market in Florida may become increasingly
attractive to HMOs and PPOs that may compete with Humana or the HMO. Humana and
the HMO may not be able to continue to compete effectively in the health care
industry if additional competitors enter the same market.
The PSN competes with other service providers for Humana's business and Humana
competes with other HMOs and PPOs in securing and serving patients in the
Medicare Advantage Program. Failure to maintain favorable terms in its
agreements with Humana would adversely affect our results of operations and
financial condition.
- 25 -
Competitors of our PSN vary in size and scope, in terms of products and services
offered. Our PSN competes directly with various national, regional and local
companies that provide similar services. Some of the PSN's direct competitors
are Continucare Corporation, Primary Care Associates, Inc., MCCI and Island
Doctors, all based and operating in Florida. We believe that Continucare
Corporation, Primary Care Associates, Inc. and MCCI provide PSN services to
Humana in South Florida and Island Doctors provides PSN services to Humana in
Central Florida. Additionally, companies in other health care industry segments,
some of which have financial and other resources greater than ours, may become
competitors in providing similar services at any given time. The market in
Florida may become increasingly attractive to competitor PSNs due to the large
population of Medicare participants. We and Humana may not be able to continue
to compete effectively in the health care industry if additional competitors
enter the same markets.
We believe that many of our competitors and potential competitors are
substantially larger than our PSN and/or the HMO and have significantly greater
financial, sales and marketing, and other resources. We believe that most of our
competitors also have more experience operating as an HMO and that these
competitors may be able to respond more rapidly to changes in the regulatory
environment in which they operate and changes in managed care organization
business or to devote greater resources to the development and promotion of
their services than we can. Furthermore, it is our belief that some of our
competitors may make strategic acquisitions or establish cooperative
relationships among themselves.
We are Dependent upon Certain Executive Officers and Key Management Personnel
for Our Future Success.
Our success depends, to a significant extent, on the continued contributions of
certain of our executive officers and key management personnel. The loss of
these individuals could have a material adverse effect on our business, results
of operations, financial condition and plans for future development. While we
have employment contracts with certain executive officers and key customers of
management, these agreements may not provide sufficient incentive for these
persons to continue their employment with us. We compete with other companies in
the industry for executive talent and there can be no assurance that highly
qualified executives would be readily and easily available without delay, given
the limited number of individuals in the industry with expertise particular to
our business operations.
Our Business Activities Are Highly Regulated and New and Proposed Government
Regulation or Legislative Reforms Could Increase Our Cost of Doing Business, and
Reduce Our Customer Base, Profitability, and Liquidity.
Our business is subject to substantial federal and state regulation. These laws
and regulations, along with the terms of our contracts and licenses, directly or
indirectly regulate how we do business, what services we offer, and how we
interact with our customers, providers, and the public. Healthcare laws and
regulations are subject to frequent change and varying interpretations. Changes
in existing laws or regulations, or their interpretations, or the enactment of
new laws or the issuance of new regulations could adversely affect our business
by, among other things:
o imposing additional license, registration, or capital reserve
requirements;
o increasing our administrative and other costs;
o forcing us to undergo a corporate restructuring;
o increasing mandated benefits without corresponding premium
increases;
o limiting our ability to engage in inter-company transactions
with our affiliates and subsidiaries;
o forcing us to restructure our relationships with providers; or
o requiring us to implement additional or different programs and
systems.
It is possible that future legislation and regulation and the interpretation of
existing and future laws and regulations could have a material adverse effect on
our ability to operate under the Medicare program and to continue to serve and
attract new customers.
The Health Care Industry is Highly Regulated. Our Failure to Comply with Laws or
Regulations, or a Determination that in the Past We Had Failed to Comply with
Laws or Regulations, Could Have an Adverse Effect on Our Business, Financial
Condition and Results of Operations.
- 26 -
The health care services that we and our affiliated professionals provide are
subject to extensive federal, state and local laws and regulations governing
various matters such as the licensing and certification of our facilities and
personnel, the conduct of our operations, billing and coding policies and
practices, policies and practices with regard to patient privacy and
confidentiality, and prohibitions on payments for the referral of business and
self-referrals. These laws are generally aimed at protecting patients and not
our shareholders, and the agencies charged with the administration of these laws
have broad authority to enforce them. See "ITEM 1. BUSINESS - Government
Regulation" for a discussion of the various federal government and the State
laws and regulations to which we are subject.
The federal and state agencies administering the laws and regulations applicable
to us have broad discretion to enforce them. We are subject, on an ongoing
basis, to various governmental reviews, audits, and investigations to verify our
compliance with our contracts, licenses, and applicable laws and regulations.
These reviews, audits and investigations can be time consuming and costly. An
adverse review, audit, or investigation could result in any of the following:
o loss of the PSN's or the HMO's right to directly or indirectly
participate in the Medicare program;
o loss of one or more of the PSN's and/or the HMO's licenses to
act as a service provider, HMO or third party administrator or
to otherwise provide a service;
o forfeiture or recoupment of amounts the PSN and/or the HMO has
been paid pursuant to its contracts;
o imposition of significant civil or criminal penalties, fines,
or other sanctions on the Company and/or its key employees;
o damage to our reputation in existing and potential markets;
o increased restrictions on marketing of the PSN's or the HMO's
products and services; and
o inability to obtain approval for future products and services,
geographic expansions, or acquisitions.
The U.S. Department of Health and Human Services Office of the Inspector
General, Office of Audit Services, or OIG, conducts reviews of Medicare
Advantage plans to determine whether they used payment increases consistent with
the requirements of the MMA. Under the MMA, when a Medicare Advantage plan
receives a payment increase, it must reduce beneficiary premiums or cost
sharing, enhance benefits, put additional payment amounts in a benefit
stabilization fund, or use the additional payment amounts to stabilize or
enhance access. There can be no assurances that the findings of an audit or
investigation of our business would not have an adverse effect on us or require
substantial modifications to our operations. In addition, private citizens,
acting as whistleblowers, are entitled to bring enforcement actions under a
special provision of the federal False Claims Act.
A Failure to Estimate Incurred But Not Reported Medical Benefits Expense
Accurately Could Affect Our Profitability.
Direct medical expenses include estimates of future medical claims that have
been incurred by the customer but for which the provider has not yet billed us
("IBNR"). IBNR estimates are made utilizing actuarial methods and are
continually evaluated and adjusted by management, based upon our historical
claims experience. Adjustments, if necessary, are made to direct medical
expenses when the criteria used to determine IBNR change and when actual claim
costs are ultimately determined. Due to the inherent uncertainties associated
with the factors used in these estimations, materially different amounts could
be reported in our financial statements for a particular period under different
conditions or using different, but still reasonable, assumptions. Although our
past estimates of IBNR have typically been adequate, they may be inadequate in
the future, which would adversely affect our results of operations. Further, the
inability to estimate IBNR accurately may also affect our ability to take timely
corrective actions, further exacerbating the extent of any adverse effect on our
results.
If the HMO Is Required to Maintain Higher Statutory Capital Levels for Our
Existing Operations or if We Are Subject to Additional Capital Reserve
Requirements as We Pursue New Business Opportunities, Our Liquidity May Be
Adversely Affected.
The HMO is subject to state regulations that, among other things, require the
maintenance of minimum levels of statutory capital, or net worth, and restrict
the payment of dividends without appropriate regulatory notification and
approvals.
At December 31, 2006, all of the HMO's cash and cash equivalents are subject to
the restriction on the payment of dividends. The State of Florida may raise the
statutory capital level from time to time. Other states have adopted risk-based
capital requirements based on guidelines adopted by the National Association of
Insurance Commissioners, which tend to be, although are not necessarily, higher
than existing statutory capital requirements. Regardless of whether Florida
adopts risk-based capital requirements, the Florida Department of Insurance can
require the HMO to maintain minimum levels of statutory capital in excess of
amounts required under the applicable state laws if it determines that
maintaining additional statutory capital is in the best interests of the HMO's
customers. Any increases in these requirements could materially increase our
reserve requirements. In addition, as we continue to expand plan offerings in
Florida or pursue new business opportunities, the HMO may be required to
maintain additional statutory capital reserves. In either case, available funds
could be materially reduced, and we could have less capital available to our PSN
business operations, both of which could harm our ability to implement our
business strategy.
- 27 -
We Are Required to Comply With Laws Governing the Transmission, Security and
Privacy of Health Information That Require Significant Compliance Costs, and Any
Failure to Comply With These Laws Could Result in Material Criminal and Civil
Penalties.
Regulations under the Health Insurance Portability and Accountability Act of
1996, or HIPAA, require us to comply with standards regarding the exchange of
health information within our company and with third parties, including
healthcare providers, business associates and customers. These regulations
include standards for common healthcare transactions, including claims
information, plan eligibility, and payment information; unique identifiers for
providers and employers; security; privacy; and enforcement. HIPAA also provides
that to the extent that state laws impose stricter privacy standards than HIPAA
privacy regulations, a state seeks and receives an exception from the Department
of Health and Human Services regarding certain state laws, or state laws
concerning certain specified areas, such state standards and laws are not
preempted.
We conduct our operations in an attempt to comply with all applicable HIPAA
requirements. Given the complexity of the HIPAA regulations, the possibility
that the regulations may change, and the fact that the regulations are subject
to changing and, at times, conflicting interpretation, our ongoing ability to
comply with the HIPAA requirements is uncertain. Furthermore, a state's ability
to promulgate stricter laws, and uncertainty regarding many aspects of such
state requirements, make compliance more difficult. To the extent that we submit
electronic healthcare claims and payment transactions that do not comply with
the electronic data transmission standards established under HIPAA, payments may
be delayed or denied. Additionally, the costs of complying with any changes to
the HIPAA regulations may have a negative impact on operations. Sanctions for
failing to comply with the HIPAA health information provisions include criminal
penalties and civil sanctions, including significant monetary penalties. In
addition, failure to comply with state health information laws that may be more
restrictive than the regulations issued under HIPAA could result in additional
penalties.
Recent Challenges Faced by CMS Related to Implementation of Part D May
Temporarily Disrupt or Adversely Affect the PSN's and the HMO's Relationships
with their Respective Customers.
Partially in anticipation of the implementation of Part D, CMS transitioned to
new information and reporting systems, which has generated confusing and, we
believe in some cases, erroneous customer and payment reports concerning
Medicare eligibility and enrollment, most of which we believe reflects
inadvertently disenrolled dual-eligible and other beneficiaries who were already
customers of our PSN or HMO. In addition, recent media reports are prevalent
concerning the confusion caused by failures in systems and reporting for Part D,
particularly as these failures adversely affect the access of dual-eligibles and
low-income beneficiaries to their prescription drugs. These developments could
cause us to experience short-term disruptions in our operations and challenge
our information and communications systems which could temporarily disrupt or
adversely affect the PSN's or the HMO's relationships with their respective
customers, resulting in a reduction of our customer base and adversely affecting
our operating results.
We May Be Unsuccessful in Implementing Our Growth Strategy If We Are Unable to
Expand into New Service Areas in a Timely Manner in Accordance with Our
Strategic Plans.
Our strategy is to continue to focus on growth within certain geographic regions
of Florida. Continued growth may impair our ability to manage existing
operations and provide services efficiently and to manage our employees
adequately. Future results of operations could be materially adversely affected
if we are unable to manage growth efforts effectively.
We are seeking to continue to increase the PSN and the HMO customer base and to
expand to new service areas within our existing markets and in other markets.
We are likely to incur additional costs if the PSN or the HMO enters service
areas where it does not currently operate. Our rate of expansion into new
geographic areas may also be limited by:
o the time and costs associated with obtaining an HMO license to
operate in a new area or expanding the HMO's licensed service area,
as the case may be;
- 28 -
o the PSN and/or the HMO's inability to develop a network of
physicians, hospitals, and other healthcare providers that meets
their respective requirements and those of the applicable
regulators;
o competition, which could increase the costs of recruiting customers,
reduce the pool of available customers, or increase the cost of
attracting and maintaining providers;
o the cost of providing healthcare services in those areas;
o demographics and population density; and
o the new annual enrollment period and lock-in provisions of the MMA.
We have Anti-Takeover Provisions Which May Make it Difficult to Acquire Us or
Replace or Remove Current Management.
Provisions in our Articles of Incorporation and Bylaws may delay or prevent our
acquisition, a change in our management or similar change in control
transaction, including transactions in which our shareholders might otherwise
receive a premium for their shares over then current prices or that shareholders
may deem to be in their best interests. In addition, these provisions may
frustrate or prevent any attempts by our shareholders to replace or remove
current management by making it more difficult for shareholders to replace
members of the Board of Directors. Because the Board of Directors is responsible
for appointing the members of the management team, these provisions could in
turn affect any attempt by our shareholders to replace the current members of
the management team. These provisions provide, among other things, that:
o any shareholder wishing to properly bring a matter before a meeting
of shareholders must comply with specified procedural and advance
notice requirements;
o special meetings of shareholders may be called only by the Chairman
of the Board of Directors, the President or by the Board of
Directors pursuant to a resolution adopted by a majority of the
directors;
o the authorized number of directors may be changed only by resolution
of the Board of Directors; and
o the Board of Directors has the ability to issue up to 10,000,000
shares of preferred stock, with such rights and preferences as may
be determined from time to time by the Board of Directors, without
shareholder approval.
Our Quarterly Results Will Likely Fluctuate, Which Could Cause the Value of Our
Common Stock to Decline.
We are subject to quarterly variations in medical expenses due to sometimes
pronounced fluctuations in patient utilization. We have significant fixed
operating costs and, as a result, are highly dependent on patient utilization to
sustain profitability. Our results of operations for any quarter are not
necessarily indicative of results of operations for any future period or full
year. For example, we usually experience a greater use of medical services in
the winter months. As a result, our results of operations may fluctuate
significantly from period to period, which could cause the value of our Common
Stock to decline.
The Market Price of Our Common Stock Could Fall as a Result of Sales of Shares
of Common Stock in the Market or the Price Could Remain Lower because of the
Perception that Such Sales May Occur.
We cannot predict the effect, if any, that future sales or the possibility of
future sales may have on the market price of our Common Stock. As of December
31, 2006, there were approximately 50.3 million shares of our Common Stock
outstanding, all of which are freely tradable without restriction or tradable in
accordance with Rule 144 of the Securities Act with the exception of
approximately 15.9 million shares, owned by certain of our officers, directors
and affiliates which may be sold publicly at any time subject to the volume and
other restrictions promulgated pursuant to Rule 144 of the Securities Act. In
addition, as of December 31, 2006, approximately 5.2 million shares of our
Common Stock were reserved for issuance upon the exercise of options which were
previously granted and 355,000 shares of our Common Stock were reserved for
future issuance upon conversion of the Series A Preferred Stock.
- 29 -
Sales of substantial amounts of our Common Stock or the perception that such
sales could occur could adversely affect prevailing market prices which could
impair our ability to raise funds through future sales of Common Stock.
The market price and trading volume of our Common Stock could fluctuate
significantly and unexpectedly as a result of a number of factors, including
factors beyond our control and unrelated to our business. Some of the factors
related to our business include: termination of the Humana Agreements,
announcements relating to our business or that of our competitors, adverse
publicity concerning organizations in our industry, changes in state or federal
legislation and programs, general conditions affecting the industry, performance
of companies comparable to us, and changes in the expectations of analysts with
the respect to our future financial performance. Additionally, our Common Stock
may be affected by general economic conditions or specific occurrences such as
epidemics (such as influenza), natural disasters (including hurricanes), and
acts of war or terrorism. Because of the limited trading market for our Common
Stock, and because of the possible price volatility, our shareholders may not be
able to sell their shares of Common Stock when they desire to do so. The
inability to sell shares in a rapidly declining market may substantially
increase our shareholders' risk of loss because of such illiquidity and because
the price for our Common Stock may suffer greater declines because of our price
volatility.
Delisting of Our Common Stock from AMEX Would Adversely Affect Us and Our
Shareholders.
Our Common Stock is listed on the AMEX. To maintain listing of securities, the
AMEX requires satisfaction of certain maintenance criteria that we may not be
able to continue to be able to satisfy. If we are unable to satisfy such
maintenance criteria in the future and we fail to comply, our Common Stock may
be delisted from trading on AMEX. If our Common Stock is delisted from trading
on AMEX, then trading, if any, might thereafter be conducted in the
over-the-counter market in the so-called "pink sheets" or on the "Electronic
Bulletin Board" of the National Association of Securities Dealers, Inc. and
consequently an investor could find it more difficult to dispose of, or to
obtain accurate quotations as to the price of, our Common Stock.
Our Common Stock May Not be Excepted from "Penny Stock" Rules, Which May
Adversely Affect the Market Liquidity of Our Common Stock.
The Securities Enforcement and Penny Stock Reform Act of 1990 requires
additional disclosure relating to the market for penny stocks in connection with
trades in any stock defined as a "penny stock". The Securities and Exchange
Commission's (the "Commission" or the "SEC") regulations generally define a
penny stock to be an equity security that has a market price of less than $5.00
per share, subject to certain exceptions. For example, such exceptions include
any equity security listed on a national securities exchange such as the AMEX.
Currently, our Common Stock meets this exception. Unless an exception is
available, the regulations require the delivery, prior to any transaction
involving a penny stock, of a disclosure schedule explaining the penny stock
market and the risks associated therewith. In addition, if our Common Stock
becomes delisted from the AMEX and we do not meet another exception to the penny
stock regulations, trading in our Common Stock would be covered by the
Commission's Rule 15g-9 under the Exchange Act for non-national securities
exchange listed securities. Under this rule, broker/dealers who recommend such
securities to persons other than established customers and accredited investors
must make a special written suitability determination for the purchaser and
receive the purchaser's written agreement to a transaction prior to sale.
Securities also are exempt from this rule if the market price is at least $5.00
per share. If our Common Stock becomes subject to the regulations applicable to
penny stocks, the market liquidity for our Common Stock could be adversely
affected. In such event, the regulations on penny stocks could limit the ability
of broker/dealers to sell our Common Stock and thus the ability of purchasers of
our Common Stock to sell their shares in the secondary market.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2 PROPERTIES
Our principal executive office is located at 250 Australian Avenue South, Suite
400, West Palm Beach, Florida where we occupy 18,100 square feet at a current
monthly rent of approximately $23,900 pursuant to a lease expiring March 31,
2011.
We have a satellite office in Daytona Beach, Florida where we occupy 5,700
square feet at a monthly rent of $8,800 pursuant to a lease expiring in January
2012.
- 30 -
The PSN leases eight offices serving patients in Central Florida and South
Florida with an aggregate monthly rental payments of $45,000 pursuant to lease
agreements with expiration dates ranging from one to six years from December 31,
2006.
The HMO leases four offices with an aggregate monthly rental payments of $18,900
pursuant to lease agreements with expiration dates ranging from two to four
years from December 31, 2006. The HMO has recently entered in to a lease
agreement, with a term commencing in May 2007 and expiring in May 2011, for a
new facility in Central Florida with a monthly rental of $4,000.
ITEM 3 LEGAL PROCEEDINGS
We are a party to various legal proceedings which are either immaterial in
amount to us or involve ordinary routine litigation incidental to our business
and the business of our subsidiaries. There is no material pending legal
proceedings, other than routine litigation incidental to our business to which
we are a party or of which any of our property is the subject.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of the security holders, through the
solicitation of proxies or otherwise, during the quarter ended December 31,
2006.
PART II
ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
Our Common Stock is currently traded on the American Stock Exchange under the
symbol "MDF". The following table sets forth the high and low sales prices for
our Common Stock, as reported by American Stock Exchange, for each full
quarterly period within the two most recent years:
High Low
($) ($)
----- -----
COMMON STOCK
Quarter ended March 31, 2005 $3.25 $2.14
Quarter ended June 30, 2005 $3.14 $2.16
Quarter ended September 30, 2005 $2.85 $2.41
Quarter ended December 31, 2005 $2.68 $2.00
Quarter ended March 31, 2006 $2.46 $1.82
Quarter ended June 30, 2006 $2.79 $1.94
Quarter ended September 30, 2006 $2.86 $2.21
Quarter ended December 31, 2006 $3.39 $2.12
At March 1, 2007, the price per share of our common stock was $2.16 and we
believe we had approximately fifteen beneficial shareholders.
We have never declared or paid any cash dividends on our Common Stock and do not
intend to pay cash dividends in the foreseeable future. Pursuant to Florida law,
we are prohibited from paying dividends or otherwise distributing funds to our
shareholders, except out of legally available funds. The declaration and payment
of dividends on our Common Stock and the amount thereof will be dependent upon
our results of operations, financial condition, cash requirements, future
prospects and other factors deemed relevant by the Board of Directors. No
assurance can be given that we will pay any dividends on our Common Stock in the
future. We presently intend to invest our earnings, if any, in the development
and growth of our operations.
- 31 -
In December 2006, we issued 25,000 shares of our common stock in settlement of
certain litigation regarding services alleged to be performed by the plaintiff
for our benefit. In exchange for our issuance of these shares, the plaintiff
agreed to release us from any and all claims he has now or in the future against
us. These shares of common stock were issued in reliance on the exemption from
registration provided by Section 4(2) of the Securities Act of 1933, as amended.
Equity Compensation Plans
The following table provides certain information regarding our existing equity
compensation plans as of December 31, 2006:
Number of securities to be
issued upon exercise of Weighted-average Number of securities
outstanding options, exercise price of remaining available for
warrants outstanding options, issuance under equity
and rights warrants and rights compensation plans
-------------------------- -------------------- -----------------------
Equity compensation plans approved by
security holders .................. 5,235,511 $1.52 2,238,400
--------- ----- ---------
- 32 -
ITEM 6 SELECTED FINANCIAL DATA
Set forth below is our selected historical consolidated financial data for the
five years ended December 31, 2006. The selected historical consolidated
financial data should be read in conjunction with the consolidated financial
statements and accompanying notes and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" included in Item 7 of this Annual
Report. The consolidated statement of operations data and balance sheet data for
the years ended December 31, 2002, 2003, 2004 and 2005 are derived from our
audited consolidated financial statements which have been audited by Kaufman,
Rossin & Co., P.A. The consolidated statement of operations data and balance
sheet data for the year ended December 31, 2006 are derived from our audited
consolidated financial statements which have been audited by Grant Thornton LLP
our independent registered public accounting firm.
For the years ended December 31,
------------------------------------------------------------------------
2006 2005 2004 2003 2002
------------ ------------ ------------ ------------ ------------
Net revenues $228,216,073 $183,765,191 $158,069,791 $143,874,488 $140,063,566
Operating (loss)/ income $ (232,952) $ 3,232,678 $ 11,855,915 $ 7,106,428 $(10,898,177)
Income/(loss) from continuing
operations before income taxes $ 825,561 $ 3,849,549 $ 11,473,732 $ 5,861,303 $(13,865,800)
Income/(loss) from continuing
operations $ 472,561 $ 2,381,743 $ 18,853,978 $ 5,861,303 $(13,865,800)
Discontinued operations, net of tax -- -- $ (31,266) $ (1,459,550) $ (3,215,087)
Net income/(loss) $ 472,561 $ 2,381,743 $ 18,822,712 $ 4,401,753 $(17,080,887)
Basic income/(loss) from continuing
operations per share $ 0.01 $ 0.05 $ 0.42 $ 0.17 $ (0.46)
Basic earnings/(loss) per share $ 0.01 $ 0.05 $ 0.42 $ 0.13 $ (0.56)
Diluted earnings/(loss) per share $ 0.01 $ 0.05 $ 0.38 $ 0.10 $ (0.56)
Weighted average common shares
outstanding-basic 50,032,555 48,975,803 45,123,843 34,750,173 30,374,669
Weighted average common shares
outstanding-diluted 51,472,616 51,007,396 50,028,303 46,914,839 30,374,669
Cash dividend declared -- -- -- -- --
Financial Position
Cash and equivalents $ 23,110,042 $ 15,572,862 $ 11,344,113 $ 2,176,204 $ 399,614
Total current assets $ 30,464,838 $ 24,479,528 $ 18,923,011 $ 5,452,254 $ 5,957,163
Total assets $ 41,841,033 $ 33,115,106 $ 28,037,263 $ 9,223,729 $ 10,158,911
Total current liabilities $ 10,911,770 $ 3,416,244 $ 3,224,633 $ 7,822,298 $ 13,784,575
Total liabilities $ 10,911,770 $ 3,416,244 $ 3,474,633 $ 9,726,390 $ 17,027,204
Total working capital $ 19,553,068 $ 21,063,284 $ 15,698,378 $ (2,370,044) $ (7,827,412)
Long - term obligations,
including current portion -- -- $ 1,132,000 $ 2,983,576 $ 5,603,370
Total stockholder's equity/
(accumulated deficit) $ 30,929,263 $ 29,698,862 $ 24,562,630 $ (502,661) $ (6,868,293)
(1) The financial data for 2004 includes a deferred tax asset of $8,281,110
and a benefit from income taxes of $7,380,246.
(2) The financial data for 2005 includes a deferred tax asset of $7,993,000
and an income tax expense of $1,467,806.
(3) The financial data for 2006 includes a deferred tax asset of $7,367,000
and an income tax expense of $353,000.
- 33 -
ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
As of December 31, 2006, substantially all of our revenue was directly or
indirectly derived from reimbursements generated by Medicare Advantage health
plans. As a result, our revenue and profitability are dependent on government
funding levels for Medicare Advantage programs. See "ITEM 1 - DESCRIPTION OF
BUSINESS - Medicare", "-Medicare Modernization Act".
For the twelve months ended December 31, 2006, approximately 86.9% of our
revenue came from the Humana Agreements. The Humana Agreements have one-year
terms and renew automatically each December 31 for additional one-year terms
unless terminated for cause or upon 180 days' prior notice. Failure to maintain
the Humana Agreements on favorable terms would adversely affect our results of
operations and financial condition.
The Humana Agreements and the CMS Agreement are risk agreements under which the
PSN and the HMO, respectively, receive net monthly payments per Participating
Customer at a rate established by the agreements, also called a capitated fee.
In accordance with the agreements, the capitated fee is a function of the number
of Participating Customers, regardless of the actual utilization rate of covered
services.
To the extent that the Participating Customers require more care than is
anticipated, aggregate capitation fees may be insufficient to cover the costs
associated with the treatment of such customers. If medical expenses exceed our
estimates, except in very limited circumstances, we will be unable to increase
the premiums we receive under these contracts during the then-current terms.
Relatively small changes in our ratio of medical expense to revenue can create
significant changes in our financial results. Accordingly, the failure to
adequately predict and control medical expenses and to make reasonable estimates
and maintain adequate accruals for incurred but not reported ( "IBNR") claims,
may have a material adverse effect on our financial condition, results of
operations and/or cash flows.
See "ITEM 1A. RISK FACTORS" for further discussion of the most significant risks
that affect our business, financial condition, results of operations and/or cash
flows.
Critical Accounting Policies
Our significant accounting policies are more fully described in Note 2 of the
"Notes to Consolidated Financial Statements" included in this Form 10-K. As
disclosed in Note 2, the preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the amounts
reported in the accompanying financial statements. Actual results may ultimately
differ materially from those estimates. We believe that the following discussion
addresses our most critical accounting policies, including those that are
perceived to be the most important to the portrayal of our financial condition
and results of operations and that require complex and/or subjective judgments
by management.
We believe that our most critical accounting policies include "Use of Estimates,
Revenue, Expense and Receivables" and "Use of Estimates, Deferred Tax Asset."
Use of Estimates, Revenue, Expense and Receivables.
Revenue is primarily derived from risk-based health insurance arrangements in
which the premium is fixed and paid to us on a monthly basis. We assume the
economic risk of funding our customers' health care services and related
administrative costs. Premium revenue is recognized in the period in which
eligible individuals are entitled to receive health care services. Because we
have the obligation to fund medical expenses we recognize gross revenue and
medical expenses for these contracts in our consolidated financial statements.
We record health care premium payments we receive in advance of the service
period as unearned premiums.
CMS periodically retroactively adjusts the premiums paid to us based on the
updated health status of participants. The factors considered in this update
include changes in demographic factors, risk adjustment scores, customer
information and adjustments required by the risk sharing requirements for
prescription drug benefits under Part D of the Medicare program. In addition,
CMS also retroactively adjusts the number of customers enrolled in our HMO or
PSN as a result of enrollment changes not yet processed, or not yet reported by
Humana or CMS. These retroactive adjustments could, in the near term, materially
impact the revenue that has been recorded by us for both our HMO and PSN. We
record any adjustments to this revenue at the time the information necessary to
make the determination of the adjustment is received from Humana or CMS and the
collectibility of the amount is reasonably assured.
- 34 -
Medical expenses for both the PSN and HMO are recognized in the period in which
services are provided and include an estimate of our obligations for medical
services that have been provided to our customers but for which we have either
not yet received or processed claims, and for liabilities for physician,
hospital and other medical expense disputes. We develop estimates for medical
expense incurred but not reported using an actuarial process that is
consistently applied. The actuarial models consider factors such as time from
date of service to claim receipt, claim backlogs, care provider contract rate
changes, medical care consumption and other medical expense trends. The
actuarial process and models develop a range of projected medical claims payable
and we accrue to the low end of the range. We accrue to the low end of the
range, in accordance with FASB Interpretation No. 14, Reasonable Estimation of
the Amount of a Loss, which states that when no amount within the range is a
better estimate than any other amount, the minimum amount should be accrued. We
estimate liabilities for physician, hospital and other medical expense disputes
based upon an analysis of potential outcomes, assuming a combination of
litigation and settlement strategies.
Each period, we re-examine previously established medical claims payable
estimates based on actual claim submissions and other changes in facts and
circumstances. As the liability estimate recorded in prior year periods become
more exact, we adjust the amount of our liability estimates, and include the
changes in estimates in medical expense in the period in which the change is
identified. In each reporting period, our operating results include the effects
of more completely developed medical expense payable estimates associated with
previously reported periods. While we believe our medical expenses payable are
adequate to cover future claims payments required, such estimates are based on
claims experience to date and various assumptions. Therefore, the actual
liability could differ materially from the amounts recorded. See "Notes 2 and 6
to the Consolidated Financial Statements and "RISK FACTORS - "A Failure To
Estimate Incurred But Not Reported..."
Use of Estimates, Deferred Tax Asset.
We have recorded a deferred tax asset of approximately $7.4 million at December
31, 2006. Realization of the deferred tax asset is dependent on generating
sufficient taxable income in the future. In order to utilize the deferred tax
assets, we would have to generate taxable income of approximately $19.7 million.
We believe that our current operations will generate sufficient income to fully
utilize this asset. The amount of the deferred tax asset considered realizable
could change in the near term if estimates of future taxable income are modified
and those changes could be material (see "Notes to Consolidated Financial
Statements").
In the event we determine that we cannot, on a more likely than not basis,
realize all or part of our deferred tax assets in the future, an adjustment to
establish a deferred tax asset valuation allowance would be charged to income in
the period such determination is made.
Net operating loss carryforwards by year of expiration are as follows:
Year of
Expiration Amount
---------- -----------
2022 $15,098,000
2025 1,193,000
-----------
$16,291,000
===========
Pending Adoption of an Accounting Pronouncement
In June 2006, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 48, Accounting for Uncertainty in Income Taxes -- an
interpretation of FASB Statement No. 109, Accounting for Income Taxes ("FIN
48"). FIN 48 clarifies the accounting for uncertainty in income taxes recognized
in the financial statements. FIN 48 prescribes a recognition threshold and
measurement attribute for the financial statement recognition and measurement of
a tax position taken or expected to be taken in the tax return and is effective
for fiscal years beginning after December 15, 2006. We will adopt FIN 48 as of
January 1, 2007, as required. The cumulative effect of adopting FIN 48 will be
recorded in retained earnings and other accounts as applicable. We are currently
evaluating the effect this Interpretation will have on our financial position,
liquidity and statement of income.
- 35 -
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which
defines fair value, establishes a framework for measuring fair value pursuant to
generally accepted accounting principles, and expands disclosures about fair
value measurements. SFAS No. 157 does not require any new fair value
measurements, but provides guidance on how to measure fair value by providing a
fair value hierarchy used to classify the source of the information. This
statement is effective for fiscal years beginning after November 15, 2007. We
are currently assessing the potential impact that the adoption of SFAS No. 157
will have on our financial statements.
Adoption of Recent Accounting Pronouncement
During the fourth quarter of 2006, we adopted the Securities and Exchange
Commission's Staff Accounting Bulletin ("SAB") 108, Considering the Effects of
Prior Year Misstatements when Qualifying Misstatements in Current Year Financial
Statements. We determined that in 2004 we had included in our operating loss
carryforward a tax benefit of approximately $513,000 that related to a
subsidiary that had previously been liquidated. As a result of the prior
liquidation of this subsidiary, the losses related to that subsidiary were not
available to us and should not have been included in our deferred tax benefit
when that benefit was realized in 2004 as a result of a reduction of the
valuation allowance. We evaluated this matter using both the balance sheet (iron
curtain) and income statement (rollover) approaches and concluded that the
impact of this error was not material in 2004. We have determined that the
impact of correcting this misstatement is material in 2006 and, therefore, as
allowed by SAB 108, have recorded this as a cumulative effect change in the
Consolidated Statement of Changes in Stockholders' Equity.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have or are reasonably
likely to have a current or future effect on our financial condition, changes in
financial condition, revenue or expenses, results of operations, liquidity,
capital expenditures or capital resources that are material to investors.
Contractual Obligations
Payment Due by Period
--------------------------------------------------------------
Less Than 1 - 3 3 - 5 More Than
Contractual Obligations Total 1 Year Years Years 5 years
--------------------------- ----------- ---------- ---------- ---------- ---------
Operating lease obligations $ 6,317,000 $1,475,000 $2,671,000 $1,696,000 $475,000
Service Agreement 2,520,000 720,000 1,440,000 360,000 --
Employment obligations 1,410,000 1,410,000 -- -- --
----------- ---------- ---------- ---------- --------
$10,247,000 $3,605,000 $4,111,000 $2,056,000 $475,000
=========== ========== ========== ========== ========
As of December 31, 2006, we had no long-term debt and no payment obligations
that would constitute capital lease obligations.
Impact of Inflation
Inflation has a significant impact on the cost of medical care. According to a
report issued in February 2007 by the Office of the Actuary at CMS, health care
outlays are projected to grow at a rate of 6.4% annually between 2007 and 2016.
The projected principal drivers for this growth include continued
cost-increasing medical innovation, inflation, continued strong demand for
prescription drugs and the aging baby-boomer demographic. We seek to minimize
the impact of these increases by developing fixed fee or capitated arrangements
that run for multiple years and which include built price increases that are
more in line with the projected increases in Medicare reimbursement, which we
are estimating to be approximately 3% annually.
Share Based Payments
Prior to January 1, 2006, we applied the intrinsic-value-based method of
accounting prescribed by Accounting Principles Board ("APB") Opinion No. 25,
Accounting for Stock Issued to Employees and related interpretations including
FASB Interpretation No. 44, Accounting for Certain Transactions involving Stock
Compensation, an interpretation of APB Opinion No. 25, to account for our
fixed-plan stock options. Under this method, compensation expense was recorded
for fixed-plan stock options only if the current market price of the underlying
stock exceeded the exercise price on the date of grant. SFAS No. 123 Accounting
for Stock-Based Compensation and SFAS No. 148 Accounting for Stock-Based
Compensation-Transition and Disclosure, an amendment to FASB Statement No. 123
established accounting and disclosure requirements using a fair-value-based
method of accounting for stock-based employee compensation plans.
- 36 -
Effective January 1, 2006, we adopted the fair value recognition provisions of
SFAS No. 123(R) Share-Based Payment using the modified prospective transition
method therefore we have not restated prior period results. Under the transition
method, stock-based compensation expense for 2006 includes compensation expense
for all stock-based compensation awards granted prior to, but not yet vested as
of January 1, 2006, based on the grant date fair value estimated in accordance
with the original provision of SFAS No. 123.
As of December 31, 2006, there was $716,637 of total unrecognized compensation
cost related to non-vested share-based compensation arrangements granted under
the Plans. That cost is expected to be recognized over a weighted average period
of 1.8 years.
Comparison of 2006 and 2005
Summary
For the year ended December 31, 2006, we realized revenue of $228.2 million
compared to $183.8 million in the prior year, an increase of approximately $44.4
million or 24.2%. Medical expenses for 2006 were $205.6 million, an increase of
$40.5 million over 2005. Our ratio of medical expense to revenue (the "Medical
Expense Ratio") increased to 90.1% in 2006 compared to 89.9% in 2005. As
described below, effective July 1, 2005, the HMO began to provide services and
realize revenue as compared to a full year of operations in 2006.
Income from continuing operations before income taxes for 2006 was $826,000
compared to $3.8 million in 2005. As described below, our results of operations
for 2006, like those of 2005, continue to be negatively impacted by the losses
related to the operations of our Medicare Advantage HMO. Net income for 2006 was
$473,000 compared to $2.4 million for the year ended December 31, 2005.
Net earnings per share, basic was $0.01 for 2006 compared to $0.05 for 2005. The
decrease in the basic net earnings per share in 2006, while primarily due to the
decrease in net income, is also partially affected by the increase in the number
of weighted average shares outstanding, from 48,975,803 in 2005 to 50,032,555 in
the current year. The majority of the shares issued during 2006 relate to shares
issued upon the exercise of stock options.
In both 2005 and 2006, we operated in two financial reporting segments, the PSN
business and the Medicare Advantage HMO business.
The PSN reported a segment gain before income taxes and allocated overhead of
$19.9 million for the year ended December 31, 2006, an increase of $4.4 million
or 28.4% increase as compared to the prior year. The HMO segment, which
commenced operations in July 2005, incurred a net loss before income taxes and
allocated overhead of $11.7 million for the year ended December 31, 2006,
compared to a loss of $6.6 million in 2005. Allocated overhead amounted to $7.4
million and $5.0 million in the years ended December 31, 2006 and 2005,
respectively.
Customer Information
The table set forth below provides (i) the total number of customers to whom we
were providing healthcare services through the PSN and HMO as of December 31,
2006 and December 31, 2005 and (ii) the aggregate customers months the PSN and
the HMO during 2006 and 2005.
Customers at Customer
December 31 Months In
--------------- -----------------
2006 2005 2006 2005
------ ------ ------- -------
PSN 25,600 26,200 309,000 315,000
HMO 3,800 1,400 35,600 4,200
------ ------ ------- -------
Total 29,400 27,600 344,600 319,200
====== ====== ======= =======
- 37 -
At February 1, 2007 the HMO had approximately 4,600 customers and the PSN had
approximately 25,700 customers.
In August 2005, the PSN discontinued its contractual relationship with one of
its South Florida-based physician practices providing care to approximately 110
of the Humana Participating Customers and discontinued our contractual
relationship with two additional South Florida-based physician practices
providing care to approximately 680 of the Humana Participating Customers due to
non-compliance with our policies and procedures. For the nine months ended
September 30, 2005, the revenue and medical expenses related to these practices
were $3.9 million and $4.1 million, respectively, resulting in a medical expense
ratio of 104.2% and a net loss of approximately $163,000.
Revenue
Year Ended December 31
--------------------------- $ %
2006 2005 Increase Change
------------ ------------ ----------- ------
PSN revenue from Humana $198,429,000 $179,646,000 $18,783,000 10.5%
Percentage of total revenue 86.9% 97.8%
HMO revenue 28,235,000 2,825,000 25,410,000 899.5%
Percentage of total revenue 12.4% 1.5%
Other 1,552,000 1,294,000 258,000 19.9%
Percentage of total revenue 0.7% 0.7%
------------ ------------ -----------
Total revenue $228,216,000 $183,765,000 $44,451,000 24.2%
============ ============ ===========
Revenue for 2006 increased $44.5 million, or 24.2%, over the prior year, from
$183.8 million to $228.2 million.
PSN revenue is comprised of the following:
Year Ended December 31 $
--------------------------- Increase %
2006 2005 (Decrease) Change
------------ ------------ ----------- ------
Humana premiums $198,429,000 $179,646,000 $18,783,000 10.5%
Fee-for-service 1,551,000 1,294,000 $ 257,000 19.9%
------------ ------------ -----------
Total $199,980,000 $180,940,000 $19,040,000 10.5%
============ ============ ===========
PSN revenue increased 10.5%, from $180.9 million in 2005 to $200.0 million in
2006.
The PSN's significant source of revenue during both 2006 and 2005 was the
premium revenue generated pursuant to the Humana Agreements (the "Humana Related
Revenue"). The Humana Related Revenue increased from $179.6 million in 2005 to
$198.4 million in 2006, an increase of approximately 10.5%.
The increase in Humana Related Revenue in 2006 (the "Humana Increase") is
primarily attributable to:
o approximately $21.4 million in rate increase of which $19.1 million
of the increase related to Medicare Part D; and
o Medicare risk adjustments ("MRA") that were retroactively approved
by CMS in 2006 for 2004 and 2005 (approximately $809,000 of the
Humana Increase). CMS adjusts the payments made to health plans
based on changes on the MRA score. The purpose of risk adjustment is
to use health status indicators to improve the accuracy of payments
and establish incentives for plans to enroll and treat less healthy
Medicare beneficiaries. From 2000 to 2003, risk adjusted payment
accounted for only 10% of Medicare health plans payment, with the
remaining 90% based on demographic factors. In 2004 and 2005, the
portion of risk-adjusted payment was increased to 30% and 50%,
respectively. The portion of risk-adjusted payment increased to 75%
in 2006, with a 100% phase-in of risk-adjusted payment in 2007. The
retroactive payments increased revenue in 2006.
- 38 -
This Humana Increase was primarily offset by a 2.0% decrease in Humana
Participating Customer months from 315,000 in 2005 to 309,000 in 2006, which
decreased Humana Related Revenue by approximately $3.3 million. As previously
discussed, the decline in customer months in 2006 from 2005 was primarily a
result of the termination of the contractual relationship with certain
physicians during the last half of 2005.
The PSN's average per customer per month premium increased during 2006
approximately 15% in the Central Florida market and 7% in the South Florida
market as compared to 2005. This increase is substantially due to the Part D
premium, which began in 2006.
Based on the payments we have received from Humana in early 2007, we believe
that the per customer per month premium from Humana will increase approximately
3% to 4% from 2006.
The fee-for-service revenue represents amounts earned from medical services
provided to non-Humana customers in our owned physician practices.
Revenue for the HMO was $28.2 million in 2006 as compared to $2.8 million in
2005. The HMO began generating revenue during the last two quarters of 2005. The
increase in revenue in 2006 is primarily attributable to the increase in our
customer base during 2006 and the operation of the HMO for the full year.
Included in the HMO's 2006 revenue is approximately $53,000 attributable to MRA
scores that were retroactively approved by CMS in 2006 for 2005.
We have estimated that the retroactive MRA score adjustment in 2007 for 2006
will not have a material impact on our revenue. However, there can be no
assurance that our estimate of the retroactive risk score adjustment will not be
materially different than that is ultimately approved by CMS. See "RISK FACTORS
- CMS's Risk Adjustment Payment System and Budget Neutrality..."
Expenses
2006 2005 (Decrease) Change
------------ ------------ ----------- ------
Total medical expenses $205,619,000 $165,131,000 $40,488,000 24.5%
Percentage of total revenue 90.1% 89.9%
Administrative payroll, payroll
taxes and benefits 10,844,000 6,867,000 $ 3,977,000 57.9%
Percentage of total revenue 4.8% 3.7%
Marketing and advertising 3,710,000 2,754,000 $ 956,000 34.7%
Percentage of total revenue 1.6% 1.5%
General and administrative 8,277,000 5,781,000 $ 2,496,000 43.2%
Percentage of total revenue 3.5% 3.1%
------------ ------------ -----------
Total expenses $228,450,000 $180,533,000 $47,917,000 26.5%
============ ============ ===========
Total operating expenses for the year ended December 31, 2006 were $228.5
million, an increase of $47.9 over 2005. In 2006 we incurred approximately $40.4
million in expenses related to our HMO division, compared to $9.5 million in
2005.
Total Medical Expenses
Total medical expenses represent the total costs of providing patient care and
are comprised of two components, direct medical expenses and other medical
expenses. Total medical expenses were $205.6 million and $165.1 million for the
years ended December 31, 2006 and 2005, respectively. Our Medical Expense Ratio
increased from 89.9% in 2005 to 90.1% in the current year. Approximately $195.0
or 94.8% of our total medical expenses in 2006 are attributable to direct
medical services such as inpatient and outpatient services, pharmacy benefits
and physician services by non-affiliated providers. In 2005, approximately
$154.8 or 93.8% of our total medical expenses were attributable to direct
medical services. The increase is due, in part, to the fact that the HMO was in
operation for all of 2006 and the HMO's direct medical expenses increased by
approximately $26.5 million. The PSN's direct medical expenses increased by
approximately $13.7 million, primarily as a result of the drug costs associated
with the Part D benefit implemented in 2006. Other medical expenses include the
salaries, taxes and benefits of the PSN's affiliated health professionals
providing primary care services, as well as other costs associated with the
operations of those practices. Approximately $10.6 million of our total medical
expenses in 2006 related to physician practices we own as compared to $10.3
million in 2005.
- 39 -
Because the Humana Agreements provide that the PSN is financially responsible
for all medical services provided to the Humana Participating Customers, direct
medical expenses include the cost of medical services provided to Humana
Participating Customers by providers other than the PSN's affiliated providers
("Non-Affiliated Providers"). The Medical Expense Ratio for the PSN segment
improved to 88.4% in 2006 as compared to 89.9% in 2005. During 2006, the PSN
implemented various medical management techniques to improve the medical
management of our customers. Some of these techniques included chart audits for
all PSN Physicians, increasing our focus on certain elements of our Partners in
Quality Program, implementing an outreach program for our more acutely ill
customers in an effort to better manage the care for these individuals and
developing a comprehensive recovery plan for customers that had serious events,
such as hospitalizations or significant procedures.
During 2005, the PSN incurred approximately $4.0 million of medical expenses
related to the implantation of certain Implantable Automatic Defibrillators
("AICD"). CMS has directed that the costs of certain of these procedures that
meet 2005 eligibility requirements be paid by CMS rather than billed to Medicare
Advantage plans. At December 31, 2005, we had estimated a recovery for AICD
claims we had paid at December 31, 2005 of approximately $2.2 million, which was
recorded as a reduction of medical expenses in 2005. During 2006, we continued
to work with Humana to make certain that these cases met the eligibility
criteria for payment by CMS. As a result of this effort, during 2006 we
collected approximately $260,000 of this amount and recorded a charge of $1.6
million to medical expenses to reflect management's concern about the ultimate
collectibility of this amount in light of, among other things, revised guidance
by CMS regarding its reimbursement policies. At December 31, 2006 we estimated
future recoveries of approximately $270,000 related to AICDs implanted in 2005.
These amounts decreased our Medical Expense Ratio by 1.2 % in 2005 and increased
our Medical Expense Ratio by .8% in 2006.
On February 26, 2007, CMS sent a notice to all Medicare Advantage organizations
that certain formulas that had previously been provided by CMS for 2006
involving in the Part D risk corridor calculations were in error and needed to
be corrected. These formulas related to fixed and flexible capitated Part D
payment demonstration target amounts. The HMO was not impacted by these formula
errors however; the PSN, through Humana, provides drug coverage that includes
these types of arrangements. Since this formula error impacted 2006, we computed
the impact and decreased our 2006 revenue by approximately $1.2 million for the
estimated amount that we will be required to refund back to CMS through Humana.
The HMO's Medical Expense Ratio in 2006 was 102.4% as compared to 85.4% in 2005.
Substantially all of this increase was attributed to the rapid growth of HMO in
2006, which, among other things, negatively impacted the medical management
process and also resulted in higher than expected costs paid for medical
services. During 2006, as a part of the medical management process, primary care
physicians were required to pre-approve all medical services provided to the
customer. We have determined that this pre-approval requirement was not
effective and resulted in excess utilization and higher than expected costs paid
for medical services. In early 2007, we have changed this process and now
require the HMO's medical director pre-approve for certain services. As a result
of the increased number of customers, the HMO is renegotiating the rates paid to
certain hospitals and providers of outpatient services. We anticipate that as
our customer base continues to grow, we will be able to positively impact our
HMO's Medical Expense Ratio by entering into more capitated, rather than fee for
service, contracts.
At December 31, 2006, we estimated our IBNR accrual for the HMO was between $4.6
million and $5.3 million and we recorded a liability of $4.6 million. At
December 31, 2005, our IBNR accrual was estimated to be $694,000. Claims paid
for 2005 in 2006 totaled $960,000 which exceeded the estimated accrual by
$266,000. This difference was recorded as additional claims expense in 2006. The
IBNR for the PSN at December 31, 2006 was determined to be between $11.5 million
and $13.6 million and, as is our policy, we recorded an accrual of $11.5
million. At December 31, 2005, the IBNR accrual was estimated to be $12.5
million compared to actual claims paid in 2006 for 2005 of $13.2 million, a
difference of $743,000. This difference increased medical expense in 2006.
Administrative Payroll, Payroll Taxes and Benefits
- 40 -
Administrative payroll, taxes and benefits include salaries and related costs
for our executive, administrative and sales staff. For 2006, administrative
payroll, taxes and benefits were $10.8 million, compared to the prior year's
total of $6.9 million, an increase of $3.9 million. Administrative payroll,
taxes and benefit costs associated with the HMO segment were $4.2 million in
2006 as compared to $2.5 million in 2005, an increase of approximately 68%. The
HMO commenced operations in 2005 and these costs were incurred for only a
portion of the year. In addition, during 2006 we increased the number of full
time equivalents employed by the HMO from 47 to 71 as the number of customers
enrolled in the HMO increased.
As the HMO increased in size and activity we also increased our corporate staff
from 49 at December 31, 2005 to 68 at December 31, 2006, resulting in an
increase in administrative payroll, taxes and benefits to $4.3 million in 2006
as compared to $2.5 million in 2005, a 72% increase. Substantially all of this
increase is a result of the addition of new employees or a full year of
compensation for employees added in 2005 with approximately $736,000 of the
increase related to stock-based compensation expense.
Marketing and Advertising
Marketing and advertising expense, which are primarily advertising expense and
commissions, for 2006 was $3.7 million in 2006 as compared to $2.8 million in
2005, an increase of 32.1%. When we launched the HMO in the second half of 2005,
we incurred large initial marketing and advertising costs while introducing,
branding and selling our HMO product. In 2006, we continued to brand our plan
and also increased our marketing and advertising for new customers. Commencing
in 2006, CMS instituted a limited enrollment period for Medicare Advantage plans
between November and March which increased our marketing and advertising costs
during the last quarter of 2006. We expect that these costs will decline
slightly in 2007.
General and Administrative
General and administrative expenses for 2006 amounted to $8.3 million, an
increase of $2.5 million, or 43.2% over the prior year. Approximately $1.8
million of this increase is attributable to the HMO being operational for all of
2006. The HMO incurred increased costs of $593,000 for claims processing and
customer services costs, $400,000 in professional services fees primarily
attributable to the expansion in 2007, $269,000 in lease costs relating to rents
for the entire year and $149,000 in recruitment costs. Corporate general and
administrative costs increased approximately $668,000 as a result of an increase
in fees paid to our Board of Directors of $140,000; professional service costs
of approximately $250,000, recruitment costs of $141,000 and lease costs of
$70,000.
Other Income (Expense)
We realized other income of $617,000 in 2005 compared to $1.1 million in 2006.
The increase was primarily as a result of an increase in investment income of
$607,000 as we had more cash to invest and rates increased over 2005. Cash is
invested in highly liquid securities, primarily certificates of deposits with
short term maturities and money market fund. We expect to continue to invest our
excess cash in this manner in 2007.
Income taxes
The 2006 results included income taxes of approximately $353,000, as compared to
$1.5 million. This difference is a result of the decrease in pre-tax income
between 2005 and 2006.
Comparison of 2005 and 2004
Summary
For the year ended December 31, 2005, we recognized revenue of $183.8 million
compared to $158.1 million in the prior year, an increase of $25.7 million or
16.3%. Medical expenses for 2005 were $165.1 million, an increase of $27.3
million over 2004, resulting in an increase in our medical expense ratio from
87.1% to 89.9%.
Income before income taxes for 2005 was $3.8 million compared to $11.5 million
in 2004. As described below, the 2005 results reflect losses related to the
start-up operations of our Medicare Advantage HMO. Net income for 2005,
inclusive of an income tax provision of $1.5 million, was $2.4 million compared
to $18.9 million for the year ended December 31, 2004. The prior year included a
$7.4 million tax benefit recorded at December 31, 2004. Basic net earnings per
share, inclusive of a $0.03 charge to income tax, was $0.05 for the year ended
December 31, 2005 compared to $0.42 in 2004. The prior year included $0.16 per
share attributable to the $7.4 million tax benefit recorded at December 31,
2004. The decrease in the basic net earnings per share for the year ended
December 31, 2005, while primarily due to the decrease in net income, partially
reflects the increase in the number of weighted average shares outstanding, from
45,123,843 at December 31, 2004 to 48,975,803 in the current year. The majority
of the shares issued during 2005 relate to shares issued upon the exercise of
stock options.
- 41 -
In both 2004 and 2005, we operated in two financial reporting segments, the PSN
business and the Medicare Advantage HMO business.
The PSN reported a segment gain before income taxes and allocated overhead of
$15.5 million for the year ended December 31, 2005, a decrease of $1.7 million
compared to the prior year. We began developing the Medicare Advantage HMO in
the second half of 2004, and officially launched operations in July 2005. The
HMO segment incurred a net loss before income taxes and allocated overhead of
$6.6 million for the year ended December 31, 2005, compared to a net loss of
only $433,000 in 2004. Allocated overhead amounted to $5.0 million and $5.4
million in the years ended December 31, 2005 and 2004, respectively. See Note 17
to the consolidated financial statements for additional segment information.
Customer Information
Total Medicare Advantage lives, the number of Medicare beneficiaries cared for
by either our PSN or HMO, increased by approximately 900 customers from December
2004 to approximately 27,600 customers at December 2005. Customer months, the
combined total customers of the HMO and PSN for each month of the measurement
period, were 319,200 and 304,000 for the 2005 and 2004 years, respectively.
Included in these numbers was approximately 4,200 customer months in our HMO in
2005, its first year of operation. Total customers enrolled in the HMO were
approximately 1,400 at December 2005. The HMO's marketing efforts in December
generated approximately 400 additional customers effective January 1, 2006.
During the year we discontinued our contractual relationship with three of our
South Florida physician practices due to non-compliance with our policies and
procedures. These centers accounted for approximately 790 customers, with
corresponding revenue and medical expenses for the nine months of $3.9 million
and $4.1 million, respectively, resulting in a medical expense ratio of 104.2%
and a net loss of approximately $163,000 on this business. Two of the centers,
accounting for approximately 680 of the customers, were cancelled effective
October 1, 2005. The other center was cancelled effective August 1, 2005.
Revenue
Year Ended
--------------------------- %
12/31/2005 12/31/2004 Change
------------ ------------ ------
PSN revenue from Humana $179,646,000 $156,648,000 14.7%
Percentage of total revenue 97.8% 99.1%
HMO revenue 2,825,000 -- n/a
Percentage of total revenue 1.5% 0.0%
Other 1,294,000 1,421,000 -8.9%
Percentage of total revenue 0.7% 0.9%
------------ ------------
Total revenue $183,765,000 $158,069,000 16.3%
============ ============
Revenue for the year ended December 31, 2005 increased $25.7 million, or 16.3%,
over the prior year, from $158.1 million to $183.8 million. PSN revenue from
Humana increased 14.7%, from $156.6 million to $179.6 million. Approximately
$15.4 million in incremental revenue was generated by 2005 premium and MRA
increases that averaged approximately 9.6% in the Daytona market and 10.5% in
South Florida, with the net increase in the customer base accounting for the
balance.
Included in the 2005 funding increases were MRA increases totaling approximately
$2.9 million. The purpose of risk adjustment is to use health status indicators
to improve the accuracy of payments and establish incentives for plans to enroll
and treat less healthy Medicare beneficiaries. From 2000 to 2003, risk adjusted
payment accounted for only 10% of Medicare health plans payment, with the
remaining 90% based on demographic factors. In 2004 and 2005, the portion of
risk-adjusted payment was increased to 30% and 50%, respectively. The portion of
risk-adjusted payment has increased to 75% in 2006, with the 100% phase-in of
risk-adjusted payment to be completed in 2007.
- 42 -
For the last two years, we believe our has been positively impacted by
Medicare's risk adjustment program. See "RISK FACTORS - CMS's Risk Adjustment
Payment System and Budget Neutrality..."
Revenue for our newly operational HMO amounted to $2.8 million for 2005, all of
which was generated in the last two quarters of the year.
Expenses
Year Ended
--------------------------- %
12/31/2005 12/31/2004 Change
------------ ------------ ------
Total medical expenses 165,131,000 137,756,000 19.9%
Percentage of total revenue 89.9% 87.1%
Administrative payroll, payroll
taxes and benefits 6,867,000 $ 4,394,000 56.3%
Percentage of total revenue 3.7% 2.8%
Marketing and advertising 2,754,000 139,000 1884.0%
Percentage of total revenue 1.5% 0.1%
General and administrative 5,781,000 3,924,000 47.3%
Percentage of total revenue 3.1% 2.5%
------------ ------------
Total expenses $180,533,000 $146,213,000 23.5%
============ ============
Total operating expenses for the year ended December 31, 2005 increased $34.3
million over the prior year period, from $146.2 million to $180.5 million. The
2005 year included approximately $9.5 million in expenses related to our HMO
division, compared to only $460,000 in 2004.
Total Medical Expenses
Total medical expenses represent the total costs of providing patient care and
are comprised of two components, direct medical expenses and other medical
expenses. Medical expenses totaled $165.1 million and $137.8 million for the
years ended December 31, 2005 and 2004, respectively. Our medical expense ratio
("MER"), the ratio of total medical expense to revenue, increased from 87.1% in
2004 to 89.9% in the current year. The MER was adversely affected by a number of
factors. The costs of plan benefit enhancements designed to increase enrollment
approximated the 2005 funding increases, resulting in an incremental MER
increase of 0.9% over the prior year. Second, as discussed above, we
discontinued our relationships with three South Florida physician practices,
which operated at an MER exceeding 104% for 2005, resulting in an overall 2005
MER increase of 0.4% over 2004. The balance of the MER increase (1.5%) was due
to increased utilization and cost increases. The MER for our HMO division was
approximately 85.4%
Administrative Payroll, Payroll Taxes and Benefits
Administrative payroll, taxes and benefits include salaries and related costs
for our executive administrative and sales staff. For 2005, administrative
payroll, taxes and benefits were $6.9 million, compared to the prior year's
total of $4.4 million. Our HMO segment accounted for all of the net increase.
Marketing and Advertising
Marketing and advertising expense for 2005 was $2.8 million, compared to only
$139,000 in 2004. This represents the costs and sales commissions incurred to
launch our HMO AdvantageCare brand, and advertise and sell our new HMO product.
General and Administrative
General and administrative expenses for 2005 amounted to $5.8 million, an
increase of $1.9 million over the prior year period. This increase is primarily
attributable to the following expenses incurred in connection with the in the
development, launch and operations of our HMO, principally with respect to legal
and accounting, outsourced claims and customer services, and software
implementation.
- 43 -
Other Income and Expenses
Other income and expenses increased from an expense of $382,000 in 2004 to
income of $617,000 in 2005. Other income and expenses for 2005 included a
decrease in interest expense of $282,000 from the prior year as we repaid all of
the debt and IRS obligations in 2005. Investment income increased $349,000 for
the year while other income increased $117,000, primarily resulting from refunds
of prior year IRS interest and penalty charges relating to our discontinued
pharmacy division. Included in 2004 was a $200,000 reserve on the note
receivable from the purchaser ("Purchaser") of the pharmacy operations in 2003.
This note was due in May 2004 and was in default as of December 31, 2004. On
February 11, 2005, we and the Purchaser executed a settlement agreement
requiring the note to be repaid in monthly installments ranging from $5,000 to
$10,000, with interest at 8%, until paid in full. Approximately $52,000 of this
note plus interest was collected in 2005 and included in other income and
expenses.
Income taxes
The 2005 results included income taxes of approximately $1.5 million, as
compared to a $7.4 million tax benefit in 2004 resulting from the recognition of
a deferred tax asset, resulting in a decrease in net income from 2004 to 2005 of
approximately $8.8 million.
Liquidity and Capital Resources
Total cash and equivalents at December 31, 2006 totaled approximately $23.1
million as compared to approximately $15.6 million at December 31, 2005. As of
December 31, 2006, we had a working capital surplus of approximately $19.6
million as compared to a working capital surplus of approximately $21.1 million
as of December 31, 2005, a decrease of approximately $1.5 million or 7.2%. This
decrease is primarily a result of decreasing the current portion of the deferred
tax asset between 2005 and 2006 by $1.9 million.
The HMO is required to maintain statutory minimum net worth requirements
established by the Florida State Department of Insurance. At December 31, 2006,
the statutory minimum net worth requirements was approximately $4.8 million and
actual net deficit was approximately $1.3 million. Subsequent to year end, we
transferred approximately $6.5 million to the HMO so that the HMO complies with
all applicable statutory requirements. At December 31, 2006 the statutorily
restricted cash and cash equivalents totals $12.5 million, including the $6.5
million transferred subsequent to year end as an addition to statutory net
worth. The HMO is restricted from making dividend payments without appropriate
regulatory notifications and approvals or to the extent such dividends would put
them in non- compliance with statutory net worth requirements. At December 31,
2006, all of the HMO's cash and cash equivalents are subject to these dividend
restrictions. Statutorily restricted cash is available for us to pay the
liabilities of the HMO.
Our total stockholder equity increased approximately $1.2 million, or 4.1%, from
approximately $29.7 million at December 31, 2005 to approximately $30.9 million
at December 31, 2006.
We have an investment policy with respect to the investment of our cash and
equivalents. The investment policy goal is to obtain the highest yield possible
while investing only in highly rated instruments or investments with nominal
risk of loss of principal. The investment policy sets forth a list of "Permitted
Investments" and provides that any exceptions to the policy must be approved by
the Chief Financial Officer or the Chief Executive Officer.
At December 31, 2006, we had no outstanding debt.
Net cash provided by operating activities for the year ended December 31, 2006
constituted approximately $9.2 million. The significant sources of cash from
operating activities were:
o an increase in estimated medical expenses payable of $4.0 million;
o an increase in amounts due to CMS of $2.7 million;
o net income of $473,000
o a decrease in deferred income taxes of $353,000;
o an increase in net accounts receivable of $538,000,
o depreciation and amortization of $554,000; and
o an increase in accrued expenses of $474,000 million.
The major use of cash in operating activities was an increase in prepaid
expenses and other assets of $803,000.:
- 44 -
Our increase in estimated medical expenses payable, also known as IBNR, is
primarily attributable to the growth of the HMO. The HMO began operations in
July 2005 and had 1,400 customers at December 31, 2005. During 2006, our
customer base increased to 3,800 customers at December 31, 2006. In addition,
the HMO's medical expenses increased from $2.4 million in 2005 to $28.9 million
in 2006. These factors significantly contributed to the increase in the IBNR.
Net cash used in investing activities for the year ended December 31, 2006 was
approximately $2.0 million of which $1.9 million was related to capital
expenditures.
Net cash used in financing activities for the year ended December 31, 2006 was
approximately $377,000 which consisted of proceeds from the exercise of stock
options.
On May 6, 2005 we executed a one year unsecured commercial line of credit
agreement with a bank, which provides for borrowings and issuance of letters of
credit of up to $1.0 million. This line of credit has been extended to March
2007. The outstanding balance, if any, bears interest at the bank's prime rate.
The credit facility requires us to comply with certain financial covenants,
including a minimum liquidity requirement of $2.0 million. The availability
under the line of credit secures a $1.0 million letter of credit that we have
caused to be issued in favor of Humana. This arrangement allows for $1.0 million
of cash, which was formerly invested in a certificate of deposit and recognized
as restricted cash on our balance sheets, to be available for operations. We
have not utilized this commercial line of credit in 2006 or 2005.
Our HMO continues to require a considerable amount of capital. In 2006, we
contributed approximately $6.8 million to the HMO to finance the operations and
growth of the HMO. In the year ended December 31, 2006 the HMO's business
generated an $11.7 million segment loss before allocated overhead and income
taxes. Although we expect that revenue will exceed total medical expenses, we
anticipate that the HMO will continue to generate a loss in 2007 before
allocated overhead and income taxes. The amount of the loss will be determined
by a number of factors including medical utilization and related costs, and our
decisions related to expansion and growth efforts. We are still not in a
position to meaningfully estimate when, if ever, the HMO's business will become
profitable and/or generate cash from operations, and we may be required to fund
the development and expansion of the HMO business, including any associated
losses, for an extended period of time. Nonetheless, we anticipate that the
on-going development efforts, reserve requirements and operating costs for our
still developing HMO business can be funded by our current resources and
projected cash flows from operations until at least December 31, 2007.
ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk generally represents the risk of loss that may result from the
potential change in value of a financial instrument as a result of fluctuations
in interest rates and market prices. We do not currently have any trading
derivatives nor do we expect to have any in the future. We have established
policies and internal processes related to the management of market risks, which
we use in the normal course of our business operations.
Intangible Asset Risk
We have intangible assets and perform goodwill impairment tests whenever events
or circumstances indicate that the carrying value may not be recoverable from
estimated future cash flows. As a result of our periodic evaluations, we may
determine that the intangible asset values need to be written down to their fair
values, which could result in material charges that could be adverse to our
operating results and financial position. We evaluate the continuing value of
goodwill by using valuation techniques based on multiples of earnings, revenue,
EBITDA (i.e., earnings before interest, taxes, depreciation and amortization)
particularly with regard to entities similar to us that have recently been
acquired. We also consider the market value of our own stock and those of
companies similar to ours. As of December 31, 2006 we believe our intangible
assets are recoverable, however, changes in the economy, the business in which
we operate and our own relative performance could change the assumptions used to
evaluate intangible asset recoverability. We continue to monitor those
assumptions and their effect on the estimated recoverability of our intangible
assets.
Equity Price Risk
We do not own any equity investments, other than in our subsidiaries. As a
result, we do not currently have any direct equity price risk.
- 45 -
Commodity Price Risk
We do not enter into contracts for the purchase or sale of commodities. As a
result, we do not currently have any direct commodity price risk.
Item 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
For the Quarter Ended
-----------------------------------------------------------------------
December 31, 2006 September 30, 2006 June 30, 2006 March 31, 2006
----------------- ------------------ ------------- --------------
Net revenues $55,728,588 $60,838,341 $56,881,610 $54,767,533
Gross Profit $ 2,926,788 $ 8,642,312 $ 5,987,758 $ 5,219,023
Net (Loss)/Income $(2,720,313) $ 2,532,029 $ 404,147 $ 256,697
Net (Loss)/Income - per share - basic $ (0.05) $ 0.05 $ 0.01 $ --
Net (Loss)/Income - per share - diluted $ (0.05) $ 0.05 $ 0.01 $ --
For the Quarter Ended
-----------------------------------------------------------------------
December 31, 2005 September 30, 2005 June 30, 2005 March 31, 2005
----------------- ------------------ ------------- --------------
Net revenues $47,076,537 $44,999,881 $46,169,207 $45,519,566
Gross Profit $ 4,630,036 $ 4,858,861 $ 4,796,076 $ 4,349,473
Net (Loss)/Income $ (545,138) $ 539,493 $ 1,242,786 $ 1,144,602
Net (Loss)/Income - per share - basic $ (0.01) $ 0.01 $ 0.03 $ 0.02
Net (Loss)/Income - per share - diluted $ (0.01) $ 0.01 $ 0.02 $ 0.02
Significant Fourth Quarter Adjustments
On February 26, 2007, CMS sent a notice to all Medicare Advantage organizations
that certain formulas that had previously been provided by CMS for 2006
involving in the Part D risk corridor calculations were in error and needed to
be corrected. These formulas related to fixed and flexible capitated Part D
payment demonstration target amounts. The HMO was not impacted by these formula
errors however; the PSN, through Humana, provides drug coverage that includes
these types of arrangements. Since this formula error impacted 2006, we computed
the impact and recorded that amount as a decrease to our 2006 fourth quarter
revenue of approximately $1.2 million for the estimated amount that we will be
required to refund back to CMS through Humana.
During the fourth quarter of 2006, estimated medical claims expense related to
dates of service prior to the forth quarter exceeded the amount recorded at
September 30, 2006 by approximately $600,000. This additional amount was the
result of higher than expected utilization and settlement amounts considered in
our original estimate of medical claims incurred but not reported at the end of
the third quarter of 2006. This amount has been recorded as an increase in
direct medical expenses in the fourth quarter. In addition, we reduced the
receivable from Humana for AICDs by $620,000 to reflect the impact of ongoing
reviews of the cases in dispute.
During the fourth quarter of 2005, we made three adjustments that we deemed to
be material to the results of the quarter. One adjustment was made to record the
estimated recoveries for AICD payments totaled $2.2 million. A portion of the
charges which give rise to the estimated recoveries were recorded in prior
quarters. In addition, we increased our estimate of medical claims payable by
$400,000 and we also accrued $911,000 of payroll, payroll taxes and benefits,
primarily related to non-executive employee bonuses and costs associated with
the termination of an employee.
- 46 -
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and
Chief Financial Officer, has evaluated the effectiveness of our disclosure
controls and procedures, as defined in Rule 13a-15(e) and 15d-15(e) of the
Securities Exchange Act of 1934, as of December 31, 2006. Based on that
evaluation, our Chief Executive Officer and Chief Financial Officer have
concluded that our disclosure controls and procedures are effective to
ensure that information required to be disclosed in the reports we file or
submit under the Exchange Act is recorded, processed, summarized and
reported, within the time periods specified in the SEC's rules and forms,
and that such information is accumulated and communicated to our
management, including our Chief Executive Officer and Chief Financial
Officer, as appropriate, to allow timely decisions regarding required
disclosure.
(b) Management's Annual Report on Internal Control over Financial Reporting
Management, with the participation of the Chief Executive Officer and the
Chief Financial Officer, is responsible for establishing and maintaining
adequate internal control over financial reporting. Internal control over
financial reporting is a process designed by, or under the supervision of,
the company's principal executive and principal financial officers and
effected by the company's board of directors, management and other
personnel to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting
principles and includes those policies and procedures that:
o pertain to the maintenance of records that in reasonable
detail accurately and fairly reflect the transactions and
dispositions of the assets of the company;
o provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles, and
that receipts and expenditures of the company are being made
only in accordance with authorizations of management and
directors of the company; and
o provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use or disposition of
the company's assets that could have a material effect on the
financial statements.
Because of inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Projections of any evaluation of
effectiveness to future periods are subject to the risks that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of the Company's internal control
over financial reporting as of December 31, 2006. In making this
assessment, management used the criteria set forth by the Committee of
Sponsoring Organizations of the Treadway Commission in Internal
Control-Integrated Framework.
Based on our assessment, management believes that, as of December 31,
2006, the Company's internal control over financial reporting is
effective.
Management's assessment of the effectiveness of the Company's internal
control over financial reporting as of December 31, 2006 has been audited
by Grant Thornton LLP, our independent registered public accounting firm.
They have issued an attestation report on our assessment of the company's
internal control over financial reporting. Their report appears below.
- 47 -
(c) Attestation Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
Metropolitan Health Networks, Inc. and Subsidiaries
We have audited management's assessment, included in the accompanying
Management's Annual Report on Internal Control Over Financial Reporting,
that Metropolitan Health Networks, Inc. and subsidiaries (the Company)
maintained effective internal control over financial reporting as of
December 31, 2006, based on criteria established in Internal Control --
Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission (COSO). The Company's management is responsible
for maintaining effective internal control over financial reporting and
for its assessment of the effectiveness of internal control over financial
reporting. Our responsibility is to express an opinion on management's
assessment and an opinion on the effectiveness of the company's internal
control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance
about whether effective internal control over financial reporting was
maintained in all material respects. Our audit included obtaining an
understanding of internal control over financial reporting, evaluating
management's assessment, testing and evaluating the design and operating
effectiveness of internal control, and performing such other procedures as
we considered necessary in the circumstances. We believe that our audit
provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting
principles. A company's internal control over financial reporting includes
those policies and procedures that (1) pertain to the maintenance of
records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company; (2) provide
reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company
are being made only in accordance with authorizations of management and
directors of the company; and (3) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use, or
disposition of the company's assets that could have a material effect on
the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of
any evaluation of effectiveness to future periods are subject to the risk
that controls may become inadequate because of changes in conditions, or
that the degree of compliance with the policies or procedures may
deteriorate.
In our opinion, management's assessment that the Company maintained
effective internal control over financial reporting as of December 31,
2006, is fairly stated, in all material respects, based on criteria
established in Internal Control -- Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO).
Also, in our opinion, the Company maintained, in all material respects,
effective internal control over financial reporting as of December 31,
2006, based on criteria established in Internal Control -- Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO).
We also have also audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the consolidated
balance sheets of the Company as of December 31, 2006 and the related
consolidated statements of income, changes in stockholders' equity
(deficiency in assets) and cash flows for the year then ended and our
report dated March 19, 2007 expressed an unqualified opinion on those
financial statements.
/s/ GRANT THORNTON LLP
Miami, Florida
March 19, 2007
- 48 -
(d) Changes in Internal Control over Financial Reporting
Other than a change in the Chief Financial Officer, there were no changes
in our internal control over financial reporting during the fourth quarter
of 2006 that have materially affected, or are reasonably likely to
materially affect, the Company's internal control over financial
reporting.
PART III
ITEM 10 DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
As part of our system of corporate governance, our board of directors has
adopted a code of ethics that is specifically applicable to our Chief Executive
Officer and senior financial officers. This Code of Ethics for Senior Financial
Officers, as well as our Code of Business Conduct and Ethics, applicable to all
directors, officers and employees, are available on our web site at
http://www.metcare.com. If we make substantive amendments to this Code of
Business Conduct and Ethics or grant any waiver, including any implicit waiver,
we will disclose the nature of such amendment or waiver on our website or in a
report on Form 8-K within four days of such amendment or waiver.
Additional information concerning our Audit Committee and regarding compliance
with Section 16(a) of the Exchange Act responsive to this item is incorporated
herein by reference to our Proxy Statement to be filed with the Securities and
Exchange Commission within 120 days after the end of the fiscal year covered by
this Form 10-K with respect to our Annual Meeting of Shareholders to be held on
June 7, 2007.
ITEM 11. EXECUTIVE COMPENSATION
Information responsive to this item is incorporated herein by reference to our
Proxy Statement to be filed with the Securities and Exchange Commission within
120 days after the end of the fiscal year covered by this Form 10-K with respect
to our Annual Meeting of Shareholders to be held on June 7, 2007.
ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information is contained in our Proxy Statement with respect to security
ownership of certain beneficial owners and management and related stockholder
matters is incorporated by reference in response to this item.
ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
The information is contained in our Proxy Statement with respect to certain
relationships and related transactions and Director independence is incorporated
by reference in response to this item.
ITEM 14 PRINCIPAL ACCOUNTING FEES AND SERVICES
The information is contained in our Proxy Statement with respect to principal
accounting fees and services, is incorporated by reference in response to this
item.
- 49 -
PART IV
ITEM 15 EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as a part of this Form 10-K:
(1) Financial Statements.
- 50 -
METROPOLITAN HEALTH
NETWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
CONTENTS
Page
----
REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMS................ F-2
CONSOLIDATED FINANCIAL STATEMENTS
Balance Sheets ........................................................ F-4
Statements of Income................................................... F-5
Statements of Changes in Stockholders' Equity (Deficiency in Assets)... F-6
Statements of Cash Flows............................................... F-7
Notes to Financial Statements.......................................... F-9
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Metropolitan Health Networks, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheet of Metropolitan
Health Networks, Inc. and subsidiaries as of December 31, 2006 and the related
consolidated statements of income, changes in stockholders' equity (deficiency
in assets), and cash flows for the year then ended. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Metropolitan Health
Networks, Inc. and Subsidiaries as of December 31, 2006, and the results of
their operations and their cash flows for the year then ended in conformity with
accounting principles generally accepted in the United States of America.
Our audit was conducted for the purpose of forming an opinion on the basic
financial statements taken as a whole. Schedule I is required as part of the
basic financial statements. Such information has been subjected to the auditing
procedures applied in the audit of the basic financial statements and, in our
opinion, is fairly stated in all material respects in relation to the basic
financial statements taken as a whole.
As discussed in Note 3 to the financial statements, the Company has adopted
staff accounting bulletin 108, Considering the Effects of Prior Year
Misstatements when Qualifying Misstatements in Current Year Financial Statements
(SAB 108) in 2006. In addition; as discussed in Note 13 to the financial
statements, the Company has adopted Statement of Financial Accounting Standards
Board Statement No. 123(R), Share-Based Payments (SFAS 123R) in 2006.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of Metropolitan
Health Networks, Inc. and subsidiaries internal control over financial reporting
as of December 31, 2006, based on criteria established in Internal
Control-Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission (COSO), and our report dated March 19, 2007 expressed
an unqualified opinion theron.
/s/ GRANT THORNTON LLP
Miami, Florida
March 19, 2007
F-2
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Metropolitan Health Networks, Inc. and Subsidiaries
West Palm Beach, Florida
We have audited the accompanying consolidated balance sheet of Metropolitan
Health Networks, Inc. and subsidiaries as of December 31, 2005, and the related
consolidated statements of income, changes in stockholders' equity (deficiency
in assets), and cash flows for each of the two years in the period ended
December 31, 2005. Our audits also included the 2005 and 2004 information
presented in Schedule I. These financial statements and schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Metropolitan Health
Networks, Inc. and Subsidiaries as of December 31, 2005, and the results of
their operations and their cash flows for each of the two years in the period
ended December 31, 2005, in conformity with accounting principles generally
accepted in the United States of America. Also, in our opinion, the 2005 and
2004 information presented in Schedule I, when considered in relation to the
basic consolidated financial statements taken as a whole, present fairly in all
material respects the information set forth therein.
KAUFMAN, ROSSIN & CO., P.A.
Miami, Florida
March 11, 2006, except for the 2005 and 2004 information presented in Schedule
I, as to which the date is March 22, 2007
F-3
METROPOLITAN HEALTH NETWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
---------------------------
2006 2005
------------ ------------
ASSETS
CURRENT ASSETS
Cash and equivalents, including $12.5 in 2006 and $5.7 million in 2005
statutorily limited to use by the HMO $ 23,110,042 $ 15,572,862
Accounts receivable, net of allowance of $601,000 and $556,000 in 2006
and 2005, respectively 674,709 400,974
Due from Humana, net of allowance of $1.6 million in 2006 2,970,821 3,783,000
Inventory 284,777 201,430
Prepaid expenses 706,390 473,286
Deferred income taxes 1,600,000 3,500,000
Other current assets 1,118,099 547,976
------------ ------------
TOTAL CURRENT ASSETS 30,464,838 24,479,528
PROPERTY AND EQUIPMENT, net of accumulated depreciation and
amortization of $1,561,000 and $2,210,000, respectively 2,275,105 899,998
INVESTMENT 688,997 627,819
GOODWILL 1,992,133 1,992,133
DEFERRED INCOME TAXES 5,767,000 4,493,000
OTHER ASSETS 652,960 622,628
------------ ------------
TOTAL ASSETS $ 41,841,033 $ 33,115,106
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 887,174 $ 969,184
Accrued payroll and payroll taxes 1,810,428 1,459,098
Estimated medical expenses payable 4,743,737 694,410
Due to CMS 2,702,825 --
Accrued expenses 767,606 293,552
------------ ------------
TOTAL CURRENT LIABILITIES 10,911,770 3,416,244
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Preferred stock, par value $.001 per share; stated value $100 per share;
10,000,000 shares authorized; 5,000 issued and outstanding 500,000 500,000
Common stock, par value $.001 per share; 80,000,000 shares authorized;
50,268,964 and 49,851,526 issued and outstanding, respectively 50,269 49,851
Additional paid-in capital 41,453,311 40,182,889
Accumulated deficit (11,074,317) (11,033,878)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 30,929,263 29,698,862
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 41,841,033 $ 33,115,106
============ ============
The accompanying notes are an integral part of the consolidated financial
statements.
F-4
METROPOLITAN HEALTH NETWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31,
------------------------------------------
2006 2005 2004
------------ ------------ ------------
REVENUE $228,216,073 $183,765,191 $158,069,791
MEDICAL EXPENSES
Direct medical expenses 195,017,923 154,784,254 129,178,725
Other medical expenses 10,600,971 10,346,491 8,577,482
------------ ------------ ------------
Total Medical Expenses 205,618,894 165,130,745 137,756,207
------------ ------------ ------------
GROSS PROFIT 22,597,179 18,634,446 20,313,584
OTHER OPERATING EXPENSES
Administrative payroll, payroll taxes and benefits 10,843,979 6,866,806 4,394,415
Marketing and advertising 3,709,511 2,754,198 138,823
General and administrative 8,276,641 5,780,764 3,924,431
------------ ------------ ------------
Total Other Operating Expenses 22,830,131 15,401,768 8,457,669
------------ ------------ ------------
OPERATING (LOSS) INCOME (232,952) 3,232,678 11,855,915
OTHER INCOME (EXPENSE):
Interest income 1,057,007 449,752 100,506
Other income (expense) (16,396) 115,451 (282,689)
Recovery (reserve) on note receivable - pharmacy 17,902 51,668 (200,000)
------------ ------------ ------------
Total other income (expense) 1,058,513 616,871 (382,183)
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME
TAXES 825,561 3,849,549 11,473,732
Income tax expense (benefit) 353,000 1,467,806 (7,380,246)
------------ ------------ ------------
INCOME FROM CONTINUING OPERATIONS 472,561 2,381,743 18,853,978
DISCONTINUED OPERATIONS, NET OF TAX:
Loss from operations of business segments -- -- (31,266)
------------ ------------ ------------
Total Discontinued Operations, Net Of Tax -- -- (31,266)
------------ ------------ ------------
NET INCOME $ 472,561 $ 2,381,743 $ 18,822,712
============ ============ ============
EARNINGS PER COMMON SHARE:
INCOME FROM CONTINUING OPERATIONS:
Basic $ 0.01 $ 0.05 $ 0.42
============ ============ ============
Diluted $ 0.01 $ 0.05 $ 0.38
============ ============ ============
LOSS FROM DISCONTINUED OPERATIONS, NET OF TAX:
Basic $ -- $ -- $ --
============ ============ ============
Diluted $ -- $ -- $ --
============ ============ ============
NET EARNINGS PER SHARE:
Basic $ 0.01 $ 0.05 $ 0.42
============ ============ ============
Diluted $ 0.01 $ 0.05 $ 0.38
============ ============ ============
The accompanying notes are an integral part of the consolidated financial
statements.
F-5
METROPOLITAN HEALTH NETWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(DEFICIENCY IN ASSETS)
FOR THE YEARS ENDED DECEMBER 31, 2006, 2005, AND 2004
Common Additional
Preferred Preferred Stock Common Paid-in Prepaid Accumulated
Shares Stock Shares Stock Capital Expenses Deficit Total
--------- --------- ---------- ------- ----------- --------- ------------ -----------
BALANCES - DECEMBER 31, 2003 5,000 $500,000 38,527,699 $38,527 $31,343,887 $(146,742) $(32,238,333) $ (502,661)
Shares issued in connection with
private placement, net of offering
costs -- -- 5,004,999 5,005 2,947,995 -- -- 2,953,000
Shares issued upon conversion of -- -- --
convertible debt -- -- 1,868,055 1,869 1,013,131 -- -- 1,015,000
Exercise of options and warrants -- -- 2,269,202 2,269 1,142,972 -- -- 1,145,241
Repurchase of warrants -- -- -- -- (113,250) -- -- (113,250)
Shares issued for directors' fees -- -- 233,292 233 249,651 -- -- 249,884
Shares issued for interest expense
and late fees -- -- 1,015 1 576 -- -- 577
Shares issued in connection with -- -- --
loan extension -- -- 100,000 100 60,567 (60,667) -- --
Amortization of securities issued for -- -- --
professional services -- -- -- -- -- 110,127 -- 110,127
Tax benefit on exercise of options -- -- -- -- 882,000 -- -- 882,000
Net income -- -- -- -- -- -- 18,822,712 18,822,712
----- -------- ---------- ------- ----------- --------- ------------ -----------
BALANCES - DECEMBER 31, 2004 5,000 500,000 48,004,262 48,004 37,527,529 (97,282) (13,415,621) 24,562,630
Shares issued for compensation -- -- 47,614 48 134,702 -- -- 134,750
Exercise of options and warrants -- -- 1,799,650 1,799 1,426,658 -- -- 1,428,457
Repurchase of warrants -- -- -- -- (85,000) -- -- (85,000)
Amortization of securities issued for -- -- -- -- --
professional services -- -- -- -- -- 97,282 -- 97,282
Tax benefit on exercise of options -- -- -- -- 1,179,000 -- -- 1,179,000
Net income -- -- -- -- -- -- 2,381,743 2,381,743
----- -------- ---------- ------- ----------- --------- ------------ -----------
BALANCES - DECEMBER 31, 2005 5,000 500,000 49,851,526 49,851 40,182,889 -- (11,033,878) 29,698,862
Exercise of options and warrants -- -- 427,133 427 463,362 -- -- 463,789
Stock-based compensation expense -- -- -- -- 736,315 -- -- 736,315
Repurchase of shares from exercise of
option -- -- (94,695) (94) (326,345) -- -- (326,439)
Shares issued for directors' fees -- -- 60,000 60 88,365 -- -- 88,425
Shares issued for legal settlement -- -- 25,000 25 68,725 -- -- 68,750
Tax benefit on exercise of options -- -- -- -- 240,000 -- -- 240,000
Cumulative effect adjustment of
adopting SAB 108 -- -- -- -- -- -- (513,000) (513,000)
Net income -- -- -- -- -- -- 472,561 472,561
----- -------- ---------- ------- ----------- --------- ------------ -----------
BALANCES - DECEMBER 31, 2006 5,000 $500,000 50,268,964 $50,269 $41,453,311 $ -- $(11,074,317) $30,929,263
===== ======== ========== ======= =========== ========= ============ ===========
The accompanying notes are an integral part of the consolidated financial
statements.
F-6
METROPOLITAN HEALTH NETWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
----------------------------------------
2006 2005 2004
----------- ----------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 472,561 $ 2,381,743 $ 18,822,712
Adjustments to reconcile net income to net cash
provided by/(used in) operating activities:
Depreciation and amortization 554,354 355,318 341,772
Write- off of uncollectible accounts 1,740,000
Stock-based compensation expense 736,315 -- --
Shares issued for director fees 88,425 -- --
Shares issued for legal settlement 68,750 -- --
Reserve on note receivable - pharmacy -- -- 200,000
Amortization of discount on notes payable -- -- 52,185
Stock issued for interest and late fees -- -- 577
Stock issued for compensation and services -- 134,750 249,884
Amortization of securities issued for professional services -- 97,282 110,127
Deferred income taxes 329,000 1,467,110 (7,399,110)
Excess tax benefits from share-based compensation (240,000) -- --
Changes in operating assets and liabilities:
Accounts receivable (1,201,556) (2,709,536) 664,253
Inventory (83,347) 16,200 86,618
Prepaid expenses (233,104) (50,447) (88,153)
Other current assets (570,123) 16,014 (265,565)
Other assets (30,332) (215,936) (339,581)
Accounts payable (82,011) 128,713 (915,877)
Accrued payroll and payroll taxes 351,330 141,668 (2,989,022)
Estimated medical expenses payable 4,049,327 694,410 --
Due to CMS 2,702,825 -- --
Accrued expenses 498,054 108,820 (350,531)
----------- ----------- ------------
Total adjustments 8,677,907 184,366 (10,642,423)
----------- ----------- ------------
Net cash provided by operating activities 9,150,468 2,566,109 8,180,289
CASH FLOWS FROM INVESTING ACTIVITIES:
Short-term investments -- 1,500,000 (1,500,000)
Investments (61,177) (627,819) --
Redemption of restricted certificates of deposit -- 1,000,000 --
Capital expenditures (1,929,461) (420,998) (444,074)
----------- ----------- ------------
Net cash (used in)/ provided by investing activities (1,990,638) 1,451,183 (1,944,074)
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings on notes payable -- 282,000
Repayments on notes payable -- (1,132,000) (1,063,354)
Repayments on capital lease obligations -- -- (107,407)
Repurchase of warrants -- (85,000) (113,250)
Proceeds from exercise of stock options and warrants 137,350 1,428,457 1,145,241
Excess tax benefits from share-based compensation 240,000 -- --
Net proceeds from issuance of common stock -- -- 2,953,000
Repayments to HMO, net -- -- (164,536)
----------- ----------- ------------
Net cash provided by financing activities 377,350 211,457 2,931,694
----------- ----------- ------------
NET INCREASE IN CASH AND EQUIVALENTS 7,537,180 4,228,749 9,167,909
CASH AND EQUIVALENTS - beginning of year 15,572,862 11,344,113 2,176,204
----------- ----------- ------------
CASH AND EQUIVALENTS - end of year $23,110,042 $15,572,862 $ 11,344,113
=========== =========== ============
The accompanying notes are an integral part of the consolidated financial
statements.
F-7
METROPOLITAN HEALTH NETWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
Years ended December 31,
------------------------------------
2006 2005 2004
---------- ---------- ----------
Supplemental Disclosures:
Interest Paid $ -- $ 20,195 $ 306,020
========== ========== ==========
Supplemental Disclosure of Non-cash Investing and
Financing Activities:
Tax benefit on exercise of stock options $ -- $1,179,000 $ 882,000
========== ========== ==========
Fair value of assets received in
connection with new medical facility $ -- $ -- $ 19,758
========== ========== ==========
Conversion of debt into common stock $ -- $ -- $1,015,000
========== ========== ==========
Common stock issued for extension and
interest fees on loans payable $ -- $ -- $ 60,667
========== ========== ==========
The accompanying notes are an integral part of the consolidated financial
statements.
F-8
Metropolitan Health Networks, Inc. and Subsidiaries
Year Ended December 31, 2006
Notes to Consolidated Financial Statements
NOTE 1. ORGANIZATION AND BUSINESS ACTIVITY
Metropolitan Health Networks, Inc. (also referred to as "Metropolitan" "the
Company," "we," "us," and "our") owns and operates provider service networks
("PSN") through our wholly owned subsidiary Metcare of Florida, Inc. We also
operate a health maintenance organization ("HMO") through our wholly owned
subsidiary, METCARE Health Plans, Inc.
The PSN operates under agreements (the "Humana Agreements") with a national
health maintenance organization, Humana Inc. ("Humana") to provide medical care
to Medicare beneficiaries. To deliver care, we utilize our wholly-owned medical
practices and also have contracted directly or indirectly though Humana with
non-owned medical practices, service providers and hospitals, (collectively the
"Affiliated Providers"). The PSN operates in South Florida and Central Florida.
Approximately 86.9% of our total revenue in 2006 was through the Humana
Agreements.
Effective July 1, 2005, our wholly-owned subsidiary, METCARE Health Plans, Inc.
("the HMO"), became licensed and entered into a contract with the Centers for
Medicare and Medicaid Services ("CMS") to begin offering Medicare Advantage
plans to Medicare beneficiaries in six Florida counties. The HMO has been
operating and marketing its "AdvantageCare" branded plan since July 2005. At
December 31, 2006, the HMO offers plans in 12 counties in Florida. The HMO's
agreement with CMS is generally renewed for a one-year term each December 31
unless CMS notifies the HMO of its decision not to renew by May 1 of the
contract year, or the HMO notifies CMS of its decision not to renew by the first
Monday in June of the contract year. Approximately 12.4% of our total revenue in
2006 was earned by the HMO.
We manage the PSN and HMO as separate business segments. We identified our
segments in accordance with the aggregation provisions of Statement of Financial
Accounting Standards ("FASB") No. 131, Disclosures about Segments of an
Enterprise and Related Information, which is consistent with information used by
our Chief Executive Officer in managing our business. The segment information
aggregates products with similar economic characteristics. These characteristics
include the nature of customer groups, the nature of the services provided, and
benefits. The results of each segment are measured by income before income
taxes. We allocate all selling, general and administrative expenses, investment
and other income, interest expense, goodwill and certain other assets and
liabilities to our segments. Our segments do share overhead costs.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Consolidation
Our financial statements and accompanying notes are prepared in accordance with
accounting principles generally accepted in the United States of America
("GAAP"). The consolidated financial statements include the accounts of
Metropolitan Health Networks, Inc., and subsidiaries that we control. All
significant intercompany balances and transactions have been eliminated in
consolidation.
Use of Estimates
F-9
The preparation of financial statements in accordance with GAAP requires us to
make estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. The areas involving the most significant use
of estimates are medical expenses payable, premium revenue, the impact of risk
sharing provisions related to our Humana and Medicare contracts, amounts in
dispute with Humana, the future benefit of the deferred tax asset and the
valuation and related impairment recognition of long-lived assets, including
goodwill. These estimates are based on knowledge of current events and
anticipated future events. We adjust these estimates each period as more current
information becomes available. The impact of any changes in estimates is
included in the determination of earnings in the period in which the estimate is
adjusted. Actual results may ultimately differ materially from those estimates.
Revenue
Revenue is primarily derived from risk-based health insurance arrangements in
which the premium is fixed and is paid to us on a monthly basis. We assume the
economic risk of funding our customers' health care services and related
administrative costs. Premium revenue is recognized in the period in which
eligible individuals are entitled to receive health care services. Because we
have the obligation to fund the medical expenses we recognize gross revenue and
medical expenses for these contracts in our consolidated financial statements.
We record health care premium payments received in advance of the service period
as unearned premiums.
CMS periodically retroactively adjusts the premiums paid to us based on the
updated health status of participants (known as a medical risk adjustment or
"MRA" score). The factors considered in this update include changes in
demographic factors, risk scores, customer information and adjustments required
by the risk sharing requirements for prescription drug benefits under Part D of
the Medicare program. Retroactive customer adjustments resulting from enrollment
changes not yet processed, or not yet reported by Humana or CMS also occur.
These retroactive adjustments could, in the near term, materially impact the
revenue that has been recorded by us for both the HMO and PSN. We record any
adjustment to this revenue at the time the information necessary to make the
determination of the adjustment is received from the Humana or CMS and the
collectibility of the amount is reasonably assured.
Our PSN's wholly owned medical practices also provide medical care to non-Humana
customers on a fee-for-service basis. These services are typically billed to
patients, Medicare, Medicaid, health maintenance organizations and insurance
companies. Fee-for-service revenue is recorded at the net amount expected to be
collected from the patient or from the insurance company paying the bill. Often
this amount is less than the charge that is billed and such discounts reduce the
revenue recorded.
Investment income is recorded as earned and is included in other revenue.
Medical Expense and Medical Claims Payable
Medical expenses for both the PSN and HMO are recognized in the period in which
services are provided and include an estimate of our obligations for medical
services that have been provided to our customers but for which we have either
not yet received or processed claims, and for liabilities for physician,
hospital and other medical expense disputes. We develop estimates for medical
expense incurred but not reported using an actuarial process that is
consistently applied. The actuarial models consider factors such as time from
date of service to claim receipt, claim backlogs, care provider contract rate
changes, medical care consumption and other medical expense trends. The
actuarial process and models develop a range for medical claims payable and we
accrue to the low end of the range. In accordance with FASB Interpretation No.
14, Reasonable Estimation of the Amount of a Loss, which states that when no
amount within the range is a better estimate than any other amount, the minimum
amount should be accrued, accordingly we accrue to the low end of the range. We
estimate liabilities for physician, hospital and other medical expense disputes
based upon an analysis of potential outcomes, assuming a combination of
litigation and settlement strategies.
Each period, we re-examine previously established medical claims payable
estimates based on actual claim submissions and other changes in facts and
circumstances. As the liability recorded in prior periods become more exact, we
adjust the amount of the estimates, and include the changes in medical expense
in the period in which the change is identified. In each reporting period, our
operating results include the effects of more completely developed medical
expense payable estimates associated with previously reported periods. While we
believe our medical expenses payable are adequate to cover future claims
payments required, such estimates are based the claims experience to date and
various assumptions. Therefore, the actual liability could differ materially
from the amounts recorded.
F-10
Medical expense also includes, among other things, the expense of operating our
wholly owned practices, capitated payments made to affiliated primary care
physicians and specialists, hospital costs, outpatient costs, pharmaceutical
expense and premiums we pay to reinsurers net of the related reinsurance
recoveries. Capitation payments represent monthly contractual fees disbursed to
physicians and other providers who are responsible for providing medical care to
customers. Pharmacy expense represents payments for customers' prescription drug
benefits, net of rebates from drug manufacturers. Rebates are recognized when
the rebates are earned according to the contractual arrangements with the
respective vendors.
Both the HMO and PSN assume responsibility for the cost of all medical services
provided to the customer. To the extent that customers require more frequent or
expensive care than was anticipated, the revenue from Humana for the PSN, and
CMS for the HMO, may be insufficient to cover the costs of care provided. When
it is probable that expected future health care costs and maintenance costs will
exceed the anticipated capitated revenue on the agreement, we would recognize a
premium deficiency liability in current operations. Losses recognized as a
premium deficiency result in a beneficial effect in subsequent periods as
operating losses under these contracts are charged to the liability previously
established. There are no premium deficiency liabilities recorded at December
31, 2006, 2005 or 2004 and because our contracts renew annually, we do not
anticipate recording a premium deficiency liability, except when unanticipated
adverse events or changes in circumstances indicate otherwise.
Cash, Cash Equivalents and Investments
All highly liquid investments with original maturities of three months or less
are considered to be cash equivalents. From time to time, we maintain cash
balances with financial institutions in excess of federally insured limits.
Investments with maturities of less than one year are classified as short-term.
Inventory
Inventory consists principally of medical supplies which are stated at the lower
of cost or market with cost determined by the first-in, first-out method.
Accounts Receivable
Accounts receivable are shown net of allowances for estimated uncollectible
accounts..
The allowance for doubtful accounts is our best estimate of the amount of
probable losses in our existing accounts receivable and is based on a number of
factors, including collection history and a review of past due balances, with a
particular emphasis on past due balances greater than 90 days old. Account
balances are charged off against the allowance after all means of collection
have been exhausted and the potential for recovery is considered remote.
Property and Equipment
Property and equipment is recorded at cost. Expenditures for major betterments
and additions are charged to the asset accounts, while replacements, maintenance
and repairs, which do not extend the lives of the respective assets, are charged
to expense currently.
Long-lived assets are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount may not be recoverable. If the
sum of the expected future undiscounted cash flows is less than the carrying
amount of the asset, a loss is recognized for the difference between the fair
value and carrying value of the asset. At December 31, 2006, we are not aware of
any indicators of impairment.
We calculate depreciation using the straight-line method over the estimated
useful lives of the assets. Amortization of leasehold improvements is computed
on a straight-line basis over the shorter of the estimated useful lives of the
assets or the remaining term of the lease. The range of useful lives is as
follows:
Machinery and equipment........................................... 5 - 7 years
Computer and office equipment..................................... 3 - 7 years
Furniture and fixtures............................................ 5 - 7 years
Auto equipment.................................................... 5 years
Leasehold improvements............................................ 3 - 10 years
F-11
Investment
Our investment consists of an equity interest in a non-assessable reciprocal
insurance organization through which we have renewed our malpractice insurance
and is carried at cost. If impairment occurs that is not considered temporary,
the investment will be written down to net realizable value. At December 31,
2006, we do not believe any impairment has been incurred in connection with this
investment.
Deferred Tax Asset
Realization of our deferred tax asset is dependent on generating sufficient
taxable income in the future. The amount of the deferred tax asset considered
realizable could change in the near term if estimates of future taxable income
are modified and those changes could be material.
In the future, if we determine that we cannot, on a more likely than not basis,
realize all or part of our deferred tax assets, an adjustment to establish a
deferred tax asset valuation allowance would be charged to income in the period
in which such determination is made.
Goodwill
Goodwill represents the unamortized excess of cost over the fair value of the
net tangible and other intangible assets acquired related to the acquisition of
certain physician practices by the PSN. SFAS No. 142, Goodwill and Other
Intangible Assets, requires that we not amortize goodwill to earnings, but
instead requires that we test at least annually for impairment at a level of
reporting referred to as the reporting unit and more frequently if adverse
events or changes in circumstances indicate that the asset may be impaired.
Goodwill is assigned to the reporting unit that is expected to benefit from a
specific acquisition.
SFAS No. 142 requires a two-step process to review goodwill for impairment. The
first step is a screen for potential impairment, and the second step measures
the amount of impairment, if any. Impairment tests are performed, at a minimum,
in the fourth quarter of each year supported by our long-range business plan,
annual planning process, the market value of our shares and metrics of
comparable companies. Impairment tests completed for 2006, 2005 and 2004 did not
result in an impairment loss.
Earnings Per Share
Basic earnings per share is computed by dividing net income by the weighted
average number of common shares outstanding during the period. Diluted earnings
per share reflects the potential dilution that could occur if securities or
other contracts to issue common stock were exercised or converted into common
stock or resulted in the issuance of common stock that then shared in the
earnings of the entity.
Stock Based Compensation
Prior to January 1, 2006, we applied the intrinsic-value-based method of
accounting prescribed by Accounting Principles Board ("APB") Opinion No. 25,
Accounting for Stock Issued to Employees and related interpretations including
FASB Interpretation No. 44, Accounting for Certain Transactions involving Stock
Compensation, an interpretation of APB Opinion No. 25, to account for our
fixed-plan stock options. Under this method, compensation expense was recorded
for fixed-plan stock options only if the current market price of the underlying
stock exceeded the exercise price on the date of grant. SFAS No. 123 Accounting
for Stock-Based Compensation and SFAS No. 148 Accounting for Stock-Based
Compensation-Transition and Disclosure, an amendment to FASB Statement No. 123,
established accounting and disclosure requirements using a fair-value-based
method of accounting for stock-based employee compensation plans. As allowed by
SFAS No. 123, we had elected to continue to apply the intrinsic-value-based
method of accounting described above, and had adopted only the disclosure
requirements of these statements. Stock options issued to independent
contractors or consultants were accounted for in accordance with SFAS No. 123
and expensed when issued.
F-12
Effective January 1, 2006, we adopted the fair value recognition provisions of
SFAS No. 123(R) Share-Based Payment, using the modified prospective transition
method, therefore we have not restated prior period results. Under the
transition method, stock-based compensation expense for 2006 includes
compensation expense for all stock-based compensation awards granted prior to,
but not yet vested as of January 1, 2006, based on the grant date fair value
estimated in accordance with the original provisions of SFAS No. 123.
Stock-based compensation expense for all share-based payment awards granted
after January 1, 2006 is based on the estimated fair value as of the award at
grant-date in accordance with the provisions of SFAS No. 123(R). We recognize
these compensation costs net of an estimated forfeiture rate and recognize the
compensation costs for only those shares expected to vest. We calculate the fair
value of employee stock options using a Black-Scholes option pricing model at
the time the stock options are granted and that amount is amortized on a
straight-line basis over the vesting period of the stock options, which is
generally up to four years. We estimated the forfeiture rate based on our
historical experience.
As a result of adopting SFAS No. 123(R) on January 1, 2006, our income before
income taxes and net income for the year ended December 31, 2006, is
approximately $736,000 lower than if we had continued to account for share-based
compensation under Opinion 25.
Customer Acquisition Costs
Customer acquisition costs are those costs primarily related to the acquisition
of new and renewal business within our HMO. Such costs include broker
commissions and other costs we incur to acquire new business or renew existing
business. We expense customer acquisition costs related to our employer-group
prepaid health services policies as incurred in accordance with the Health Care
Organization Audit and Accounting Guide. The arrangement between the customer
and the HMO is typically for a one year period.
Advertising Costs
Advertising expense was approximately $1,519,618, $1,896,513 and $181,263 for
the years ended December 31, 2006, 2005 and 2004, respectively and is expensed
as incurred.
Income Taxes
We account for income taxes pursuant to SFAS No. 109, Accounting for Income
Taxes, which requires income taxes to be accounted for under the asset and
liability method. Under this method, deferred income tax assets and liabilities
are determined based upon differences between the financial statement carrying
amounts of existing assets and liabilities and their respective tax bases using
enacted tax rates in effect for the year in which the differences are expected
to reverse. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in earnings in the period that includes the enactment date.
A valuation allowance is established when it is more likely than not that some
or all of the deferred tax assets will not be realized.
Reinsurance and Capitation
We have reinsurance arrangements that provide for the reimbursement of medical
expenses based on maximum amounts per customer per year and per such customer's
lifetime. Our deductible per customer per year is $125,000 for the HMO and
ranges between $40,000 in South Florida and $125,000 in Daytona for the PSN.
Premiums paid and amounts recovered under these agreements are recorded in
medical expense.
Reclassifications
Amounts in other income (expense) were grouped together in 2004 and 2005 to
conform to the 2006 presentation since the amounts were not significant on an
individual basis.
Other Comprehensive Income
For all years presented, other than net income we had no comprehensive income
items.
New Accounting Pronouncements
In June 2006, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 48, Accounting for Uncertainty in Income Taxes -- an
interpretation of FASB Statement No. 109 ("FIN 48"). FIN 48 clarifies the
accounting for uncertainty in income taxes recognized in the financial
statements. FIN 48 proscribes a recognition threshold and measurement attribute
for the financial statement recognition and measurement of a tax position taken
or expected to be taken in the tax return. FIN 48 is effective for fiscal years
beginning after December 15, 2006 and the cumulative effect of adopting FIN 48
will be recorded in retained earnings and other accounts as applicable. We will
adopt FIN 48 as of January 1, 2007, as required. We are currently evaluating the
effect of FIN 48 will have on our financial position, liquidity and statement of
income.
F-13
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which
defines fair value, establishes a framework for measuring fair value pursuant to
generally accepted accounting principles, and expands disclosures about fair
value measurements. SFAS No. 157 does not require any new fair value
measurements, but provides guidance on how to measure fair value by providing a
fair value hierarchy used to classify the source of the information. This
statement is effective for fiscal years beginning after November 15, 2007. We
are currently assessing the potential impact that the adoption of SFAS No. 157
will have on our financial statements.
NOTE 3. CUMULATIVE EFFECT ADJUSTMENT
During 2006, we adopted the Securities and Exchange Commission's Staff
Accounting Bulletin ("SAB") 108, Considering the Effects of Prior Year
Misstatements when Qualifying Misstatements in Current Year Financial
Statements. We have determined that in 2004 we had included in our operating
loss carry forward a tax benefit of approximately $513,000 that related to a
subsidiary that had previously been liquidated. As a result of the prior
liquidation of this subsidiary, the losses related to that subsidiary were not
available to us and should not have been included in our deferred tax benefit
when that benefit was realized in 2004 as a result of a reduction of the
valuation allowance. We evaluated this matter using both the balance sheet (iron
curtain) and income statement (rollover) approaches and concluded that the
impact of this error was not material in 2004 and 2005. We have determined that
the impact of correcting this misstatement is material in 2006 and, therefore,
as allowed by SAB 108, we have recorded this as a cumulative effect change in
the Consolidated Statements of Changes in Stockholders' Equity (Deficiency in
Assets).
NOTE 4. MAJOR CUSTOMERS
Our PSN receives a monthly fee from Humana for each Humana customer that chooses
a physician that the PSN owns or has contracted with as her or his primary care
physician. The fixed monthly fee the PSN receives to cover the medical care
required of that customer is typically based on a percentage of the premium
received by Humana from CMS. Fees received by the PSN under these Humana
Agreements are reported as revenue. During 2006, CMS approved a retroactive
increase in the PSN's MRA score for 2004 and 2005 which resulted in retroactive
payments in 2006 from Humana. The retroactive payment increased 2006 revenue by
$809,000. Revenue from Humana accounted for approximately 86.9% of our total
revenue in 2006, 98% of our total revenue in 2005, and 99% of our total revenue,
excluding the discontinued segment, in 2004.
Humana may immediately terminate either of the Humana Agreements in the event
that, among other things, the PSN and/or any of its Affiliated Provider's
continued participation may adversely affect the health, safety or welfare of
any Humana customer or bring Humana into disrepute; in the event of one of the
PSN's physician's death or incompetence; if the PSN engages in or acquiesces to
any act of bankruptcy, receivership or reorganization; or if Humana loses its
authority to do business in total or as to any limited segment or business (but
only to that segment). The PSN and Humana may also terminate each of the Humana
Agreements upon 90 days' prior written notice (with a 60 day opportunity to
cure, if possible) in the event of the other's material breach of the applicable
Humana Agreement. The Humana agreements may also be terminated upon 180-day
notice of non-renewal by either party. Failure to maintain the Humana Agreements
on favorable terms, for any reason, would adversely affect our results of
operations and financial condition.
CMS
The HMO provides services to Medicare beneficiaries pursuant to the Medicare
Advantage program. Under our agreement with CMS, the HMO is paid a fixed
capitation payment each month based on the number of customers and adjusted for
demographic and health risk factors. Inflation, changes in utilization patterns
and average per capita fee-for-service Medicare costs are also considered in the
calculation of the fixed capitation payment by CMS. The initial term of the CMS
Agreement has been renewed to December 31, 2007 and is subject to annual renewal
at the election of CMS. Amounts payable under Medicare Advantage arrangements
are subject to annual revision by CMS. The HMO realized additional revenue of
approximately $53,000 in 2006 as a result of CMS retroactively approving
increases in the MRA score for 2005. Premium revenue for the HMO was
approximately 12.4% and 1.5% of our total revenue in 2006 and 2005,
respectively.
F-14
NOTE 5. ACCOUNTS RECEIVABLE
Accounts receivable consisted of the following:
December 31,
-----------------------
2006 2005
---------- ----------
Due from Humana, net of liabilities of
$16,089,000 in 2006 and $12,600,000 in 2005 $2,971,000 $3,783,000
Due from Fee For Service customers 974,000 797,000
Other 302,000 160,000
---------- ----------
4,247,000 4,740,000
Allowance for doubtful accounts (601,000) (556,000)
---------- ----------
Total $3,646,000 $4,184,000
========== ==========
Under our Agreements with Humana we have the right to offset amounts owed to us
with amounts we owe to Humana.
During 2005, the PSN incurred approximately $4.0 million of medical expenses
related to the implantation of certain Implantable Automatic Defibrillators
("AICD"). CMS has directed that the costs of certain of these procedures that
meet 2005 eligibility requirements be paid by CMS rather than billed to Medicare
Advantage plans. At December 31, 2005, we had estimated a recovery for AICD
claims we had paid at December 31, 2005 of approximately $2.2 million, which was
recorded as a reduction of medical expenses in 2005. During 2006, we continued
to work with Humana to make certain that these cases met the eligibility
criteria for payment by CMS. As a result of this effort, during 2006 we
collected approximately $260,000 of this amount and recorded a charge of $1.6
million to medical expenses to reflect management's concern about the ultimate
collectibility of this amount in light of, among other things, revised guidance
by CMS regarding its reimbursement policies. At December 31, 2006 we estimated
future recoveries of approximately $270,000 related to AICDs implanted in 2005.
NOTE 6. ESTIMATED MEDICAL EXPENSES PAYABLE
Activity in medical expenses payable is as follows:
Year Ending December 31,
---------------------------------------------
2006 2005 2004
------------- ------------- -------------
Balance at beginning of year $ 13,144,000 $ 10,947,000 $ 13,008,000
Incurred related to:
Current year 166,003,000 129,659,000 104,211,000
Prior years 1,009,000 964,000 (857,000)
------------- ------------- -------------
Total incurred 167,012,000 130,623,000 103,354,000
Paid related to:
Current year (149,073,000) (116,515,000) (93,264,000)
Prior years (14,154,000) (11,911,000) (12,151,000)
------------- ------------- -------------
Total paid (163,227,000) (128,426,000) (105,415,000)
------------- ------------- -------------
Balance at end of year $ 16,929,000 $ 13,144,000 $ 10,947,000
============= ============= =============
F-15
Estimated medical expenses payable for the PSN and HMO are as follows:
December 31,
---------------------------------------
2006 2005 2004
----------- ----------- -----------
Estimated Claims Payable
PSN $12,185,000 $12,450,000 $10,947,000
HMO 4,744,000 694,000 --
----------- ----------- -----------
$16,929,000 $13,144,000 $10,947,000
=========== =========== ===========
The unpaid claims accrual for the PSN are netted in the Due from Humana amount.
Amounts incurred related to prior years vary from previously estimated
liabilities as the claims ultimately are settled. Positive amounts reported for
incurred related to prior years result from claims being ultimately settled for
amounts more than originally estimated (unfavorable development).
The estimated medical expenses payable at December 31, 2005 ultimately settled
during 2006 for $1.0 million more than the amounts originally estimated. This
represents 0.8% of medical claim expenses recorded in 2005. The $1.0 million
change in the amount incurred related to years prior to 2006 was primarily a
result of unfavorable developments in our medical claims expense, with $743,000
of this amount related to the PSN and $266,000 related to the HMO.
As summarized in the previous table, the estimated medical expenses payable at
December 31, 2004 ultimately settled during 2005 for $964,000 more than the
amount originally estimated. This amount represents 1.0% of medical claim
expenses recorded in 2005. This difference resulted primarily from unfavorable
developments in our medical claims expense within the PSN.
Included in medical expense for 2006, 2005 and 2004 was stop loss premium
expense of $2.5 million, $1.9 million and $1.8 million and stop loss recoveries
of $1 million, $504,000 and $1 million, respectively.
NOTE 7 PRESCRIPTION DRUG BENEFITS UNDER MEDICARE PART D
On January 1, 2006, the HMO through CMS and the PSN through the Humana
Agreements began providing prescription drug benefits in accordance with the
requirements of Medicare Part D to the HMO's and PSN's Medicare Advantage
customers. The benefits covered under Medicare Part D are in addition to the
benefits covered by the HMO and the PSN under Medicare Parts A and B.
In general, pursuant to Medicare Part D, pharmacy benefits may vary in terms of
coverage levels and out-of-pocket costs for beneficiary premiums, deductibles
and co-insurance. However, all Part D plans must offer either "standard
coverage" or its actuarial equivalent (with out-of-pocket threshold and
deductible amounts that do not exceed those of standard coverage). These
"standard" benefits represent the minimum level of benefits mandated by
Congress. In addition to defined standard plans offered by the HMO, the PSN,
through the Humana Agreements, offers certain prescription drug plans containing
benefits in excess of the standard coverage limits.
The payment our HMO receives monthly from CMS for coverage under Medicare Part D
(the "CMS Payment") generally represents the HMO's bid amount for providing Part
D insurance coverage. We recognize premium revenue for the HMO's provision of
Part D insurance coverage ratably over the term of the CMS Agreement. However,
the ultimate amount of the CMS Payment is subject to 1) risk corridor
adjustments and 2) subsidies provided by CMS in order for the HMO and CMS to
share the risk associated with financing the ultimate costs of the Medicare Part
D benefit.
F-16
The CMS payment is subject to adjustment, positive or negative, based upon the
application of risk corridors that compare the prescription drug benefit costs
estimated by the HMO in making its bid to CMS (the "Estimated Costs") to actual
incurred prescription drug benefit costs (the "Actual Costs"). For 2006 and
2007, in accordance with federal regulations, the HMO will bear all gains and
losses that fall within 2.5% of its Estimated Costs. To the extent the Actual
Costs exceed the Estimated Costs by more than 2.5%, CMS may make additional
payments to the HMO. Conversely, to the extend the Estimated Costs exceed the
Actual Costs by more than 2.5%, the HMO may be required to refund to CMS a
portion of the CMS Payment. Actual Costs subject to risk sharing with CMS are
limited to the costs that are, or would have been, incurred under the CMS
standard benefit plan. We estimate and recognize an adjustment to premium
revenue from CMS related to the risk corridor payment adjustment based upon
pharmacy claims experience to date as if the CMS Agreement were to end at the
end of each reporting period. Accordingly, this estimate does not take into
consideration projected future pharmacy claims experience. It is reasonably
possible that this estimate could change in the near term by an amount that
could be material.
Certain subsidies represent reimbursements from CMS for claims the HMO paid even
though it is not ultimately required to bear the risk in connection with such
claims. These include federally reinsured claims where an HMO customer's actual
drug spending reaches Part D's annual catastrophic threshold and certain
deductible, coinsurance and co-payment amounts for low-income beneficiaries. We
account for these subsidies as current liabilities in our balance sheet and as
an operating activity in our consolidated statement of cash flows. We do not
recognize premium revenue or claims expense for these subsidies.
The HMO recognizes pharmacy benefit costs as incurred. The HMO has subcontracted
the pharmacy claims administration to a third party pharmacy benefit manager.
We also receive Medicare Part D revenue pursuant to the applicable percent of
premium provided for in the Humana Agreements. As with the HMO, we estimate the
pharmacy benefit costs as such costs are incurred by the PSN. With regards to
the estimated amount of any risk corridor adjustments, we have utilized
estimates provided by Humana to us and have performed a separate actuarial study
of any risk corridor adjustments. We have adjusted our premium revenue based on
these estimates. It is reasonably possible that this estimate could change in
the near term by an amount that could be material.
On February 26, 2007, CMS sent a notice to all Medicare Advantage organizations
that certain formulas that had previously been provided by CMS for 2006 involved
in the Part D risk corridor calculations were in error and needed to be
corrected. These formulas related to fixed and flexible capitated Part D payment
demonstration target amounts. The HMO was not impacted by these formula errors
however; the PSN, through Humana, provides drug coverage that includes these
types of arrangements. Since this formula error impacted 2006, we computed the
impact and recorded that amount as a decrease to our 2006 revenue of
approximately $1.2 million for the estimated amount that we will be required to
refund back to CMS through Humana. .
NOTE 8. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
December 31,
-------------------------
2006 2005
----------- -----------
Medical Equipment $ 74,000 $ 135,000
Furniture & Equipment 505,000 774,000
Leasehold Improvements 1,771,000 760,000
Computers and Office Equipment 1,425,000 1,380,000
Other 61,000 61,000
----------- -----------
3,836,000 3,110,000
Less Accumulated Depreciation and Amortization (1,561,000) (2,210,000)
----------- -----------
$ 2,275,000 $ 900,000
=========== ===========
Depreciation and amortization of property and equipment totaled approximately
$554,000, $345,000, and $280,000 in 2006, 2005, and 2004, respectively.
During 2006 and 2005, we disposed of fully depreciated fixed assets with
historical costs of $1,203,000 and $778,000, respectively.
F-17
NOTE 9. LINE OF CREDIT
On May 6, 2005 we executed an unsecured one year commercial line of credit
agreement with a bank, which provides for borrowings and issuance of letters of
credit of up to $1.0 million. The line of credit has been extended to March 31,
2007. The outstanding balance bears interest at the bank's prime rate and the
credit facility requires us to comply with certain financial covenants,
including a minimum liquidity requirement. The availability under the line of
credit secures a $1.0 million letter of credit that is issued in favor of
Humana. We did not use this commercial line of credit in 2006 or 2005.
NOTE 10. RELATED PARTY TRANSACTIONS
During 2005, and 2004, we paid $17,000, and $295,000, respectively, to a company
owned by a shareholder and director for services rendered as a physician in our
provider network during the time he was a director. The director resigned from
our board effective January 13, 2005.
NOTE 11. INCOME TAXES
The components of income taxes from continuing operations is as follows:
December 31,
------------------------------------
2006 2005 2004
-------- ---------- ------------
Provision (Benefit) for Income Taxes
Current
Federal $ 24,000 $ -- $ --
State -- -- --
Deferred
Federal 299,000 1,253,000 3,696,000
State 30,000 215,000 629,000
Change in Valuation Allowance -- -- (11,705,000)
-------- ---------- ------------
Income Tax Expense (Benefit) $353,000 $1,468,000 $ (7,380,000)
======== ========== ============
A reconciliation of the amount computed by applying the statutory federal income
tax rate to income from continuing operations before income taxes with our
income tax expense/(benefit) is as follows:
For the years ended December 31,
-----------------------------------
2006 2005 2004
-------- ---------- -----------
Statutory federal tax $281,000 $1,309,000 3,901,000
State income taxes, net of federal income tax benefit 30,000 140,000 417,000
Permanent differences and other 18,000 19,000 7,000
AMT tax 24,000
Change in valuation allowance -- (11,705,000)
-------- ---------- -----------
Income tax expense (benefit) $353,000 $1,468,000 ($7,380,000)
======== ========== ===========
F-18
Deferred tax assets and liabilities are as follows:
DEFERRED TAX ASSETS:
As of December 31,
-----------------------
2006 2005
---------- ----------
Allowances for doubtful accounts $ 297,000 $ 209,000
Net operating loss carryforward 6,130,000 7,593,000
Stock-based compensation expense 277,000 --
Accrued expenses 336,000 --
Depreciation and amortization 250,000 129,000
Other 77,000 100,000
---------- ----------
Total deferred tax assets 7,367,000 8,031,000
---------- ----------
DEFERRED TAX LIABILITIES: -- --
Depreciation -- 38,000
---------- ----------
Total deferred tax liabilities -- 38,000
---------- ----------
Net deferred tax asset $7,367,000 $7,993,000
========== ==========
SFAS No. 109, Accounting for Income Taxes, requires a valuation allowance to
reduce the deferred tax assets reported if, based on the weight of the evidence,
it is more likely than not that some portion or all of the deferred tax assets
will not be realized. After consideration of all the evidence, both positive and
negative (including, among others, projections of future taxable income, net
operating loss carryforwards and our profitability in recent years), we
determined that future realization of our deferred tax assets was more likely
than not and, accordingly, eliminated the valuation allowance against our
deferred tax assets as of December 31, 2004. In the event we determined that we
would not be able to realize all or part of our net deferred tax assets in the
future, an adjustment to establish a deferred tax asset valuation allowance
would be charged to income in the period such determination is made.
In, 2006, 2005 and 2004, tax benefits of $240,000, $1,179,000 and $882,000,
respectively, were recorded directly to equity as a result of the exercise of
non-qualified stock options.
At December 31, 2006, we had net operating loss carryforwards of approximately
$16.3 million expiring in various years through 2025.
NOTE 12. STOCKHOLDERS' EQUITY
As of December 31, 2006, we had designated 10,000,000 preferred shares as Series
A Preferred Stock, par value $.001, of which 5,000 were issued and outstanding.
Each share of Series A Preferred Stock has a stated value of $100 and pays
dividends equal to 10% of the stated value per annum. At December 31, 2006 and
2005, the aggregate and per share amounts of cumulative dividend arrearages were
approximately $466,667 ($93 per share) and $416,667 ($83 per share),
respectively. Each share of Series A Preferred Stock is convertible into shares
of common stock at the option of the holder at the lesser of 85% of the average
closing bid price of the common stock for the ten trading days immediately
preceding the conversion or $6.00. We have the right to deny conversion of the
Series A Preferred Stock at which time the holder shall be entitled to receive,
and we shall pay, additional cumulative dividends at 5% per annum together with
the initial dividend rate to equal 15% per annum. In the event of any
liquidation, dissolution or winding up of the Company, holders of the Series A
Preferred Stock shall be entitled to receive a liquidating distribution before
any distribution may be made to holders of our common stock. We have the right
to redeem the Series A Preferred Stock at a price equal to 105% the price paid
for the shares. The Series A Preferred Stock has no voting rights.
We have also designated 7,000 shares of preferred stock as Series B Preferred
Stock, with a stated value of $1,000 per share. No shares of series B preferred
stock have been issued.
In February 2004, we issued an aggregate of 5,004,999 shares of common stock
(the "Private Placement Shares") at a price of $0.60 per share to 24 accredited
investors and 1 non-accredited investor. We received $2,953,000 in proceeds, net
of offering costs of approximately $50,000, from the sale of these Private
Placement Shares.
F-19
Shares reserved for future issuance at December 31, 2006 is as follows:
Number of
Shares
---------
Stock Options 5,236,000
Preferred Stock 355,059
---------
Total 5,591,059
=========
Note 13. STOCK -BASED COMPENSATION
As of December 31, 2006, we had three nonqualified stock option plans, the 2001
Stock Option Plan, the Supplemental Stock Option Plan, and the Omnibus Equity
Compensation Plan (together the "Plans"). The Plans are administered by the
Compensation Committee of the Board of Directors. A total of 6,000,000 shares of
our common stock are authorized for issuance pursuant to awards granted under
the Omnibus Equity Compensation Plan. Total compensation cost that has been
charged against income in 2006 for the Plans was $736,000.
We believe that stock option awards better align the interests of our employees
with those of our shareholders. Option awards are generally granted with an
exercise price equal to the market price of our common stock at the date of
grant, generally vest ratably over 4 years of continuous service and generally
expire 10 years after the date of the grant. The options provide for accelerated
vesting if there is a change in control as defined by the Plan.
The fair value of each option award is estimated on the date of grant using the
Black-Scholes option model that uses the assumptions noted in the table below.
Because this option valuation model incorporates ranges of assumptions for
inputs those ranges are disclosed. Expected volatilities are primarily based on
implied volatilities from the historical volatility of our stock. We use
historical data to estimate option exercise and employee termination within the
valuation model. The expected terms of the options granted represent the period
of time that option grants are expected to be outstanding based on historical
data; the range given below results from certain groups of employees exhibiting
different behavior. The risk free rate for the periods within the contractual
life of the option is based on the U.S. Treasury yield curve in effect at the
time of grant.
2006 2005 2004
------------ ------------ ------------
Risk Free Interest Rate 4.56% - 4.99% 2.82% - 4.43% 1.81% - 3.39%
Expected Option Life (in years) 2 - 4.5 1 - 4.5 2 - 4.5
Expected Volatility 50% 50% 75%
Dividends to be Paid None None None
A summary of option activity under the Plans as of December 31, 2006 and the
changes during the year then ended is presented below:
F-20
Weighted
Weighted Average
Average Remaining Aggregate
Exercise Contractual Intrinsic
Options Shares Price Term Value
----------------------------------------------- --------- -------- ----------- ----------
Options outstanding at January 1, 2006 6,385,810 $1.63
Granted during the year 400,000 $2.19
Exercised (427,133) $1.14
Forfeited (400,800) $2.82
Expired (722,366) $2.43
--------- -----
Outstanding at December 31, 2006 5,235,511 $1.52 5.60 $8,555,339
========= ===== ==== ==========
Vested or expected to vest at December 31, 2006 4,979,935 $1.49 4.39 $8,274,699
========= ===== ==== ==========
Exercisable at December 31, 2006 3,531,674 $1.30 4.26 $6,684,406
========= ===== ==== ==========
The weighted average grant date fair value of options grants during the years
2006, 2005 and 2004 was $0.84, $0.88 and $0.90, respectively. The fair value of
non vested shares is determined based on the opening trading price of our shares
at grant date. The aggregate intrinsic value of shares exercised in 2006 was
approximately $749,000.
A summary of the status of our non vested shares as of December 31, 2006 and
changes during the year then ended is presented below:
Weighted
Average
Grant Date
Non Vested Options Shares Fair Value
------------------------------- --------- ----------
Non vested at January 1, 2006 2,337,782 $0.94
Granted 400,000 $0.84
Vested (912,911) $0.84
Forfeited (121,034) $1.13
---------
Non vested at December 31, 2006 1,703,837 $0.96
=========
As of December 31, 2006, there was $716,637 of total unrecognized compensation
cost related to non-vested share-based compensation arrangements granted under
the Plans. That cost is expected to be recognized over a weighted average period
of 1.8 years. The total fair value of shares vested during the year ended
December 31, 2006 was $769,114.
Cash received from option exercise under all share based payment arrangements
for the year ended December 31, 2006 was $137,000. A tax benefit of $240,000 was
realized from option exercise of the share-based payment arrangements in 2006.
It is our policy to issue new shares to satisfy share option purchases.
The following table illustrates the effect on net income and earnings per share
if we had applied the fair value recognition provisions of Statement 123 to
options granted under our Plans in all periods presented prior to the adoption
of Statement 123(R). For purposes of this pro forma disclosure, the value of the
options is estimated using a Black-Scholes option-pricing formula and amortized
to expense over the options' vesting periods.
F-21
For the years ended
December 31,
------------------------
2005 2004
---------- -----------
Net Income $2,381,743 $18,822,712
Less: Total stock-based employee compensation
expense determined using the fair value
method, net of related tax (967,904) (141,398)
---------- -----------
Adjusted net income $1,413,839 $18,681,314
========== ===========
Earnings per share:
Basic, as reported $ 0.05 $ 0.42
========== ===========
Basic, pro forma $ 0.03 $ 0.41
========== ===========
Diluted, as reported $ 0.05 $ 0.38
========== ===========
Diluted, pro forma $ 0.03 $ 0.37
========== ===========
NOTE 14. EARNINGS PER SHARE
The following table sets forth the computations of basic earnings per share and
diluted earnings per share:
For the years ended December 31,
---------------------------------------
2006 2005 2004
----------- ----------- -----------
Income from continuing operations $ 472,561 $ 2,381,743 $18,853,978
Loss from discontinued operations, net of tax -- -- (31,266)
----------- ----------- -----------
Net Income 472,561 2,381,743 18,822,712
Less: Preferred stock dividend (50,000) (50,000) (50,000)
----------- ----------- -----------
Income available to common shareholders $ 422,561 $ 2,331,743 $18,772,712
=========== =========== ===========
Denominator:
Weighted average common shares outstanding 50,032,555 48,975,803 45,123,843
=========== =========== ===========
Basic earnings per common share $ 0.01 $ 0.05 $ 0.42
=========== =========== ===========
Income available to common shareholders $ 422,561 $ 2,331,743 $18,772,712
Effect of Dilutive securities:
Preferred stock dividends -- -- 50,000
Interest on convertible securities -- -- 2,565
----------- ----------- -----------
$ 422,561 $ 2,331,743 $18,825,277
=========== =========== ===========
Denominator:
Weighted average common shares outstanding 50,032,555 48,975,803 45,123,843
Common share equivalents of outstanding stock:
Convertible preferred -- -- 1,301,876
Convertible debt -- -- 91,081
Options and warrants 1,440,061 2,031,593 3,511,503
----------- ----------- -----------
Weighted average common shares outstanding 51,472,616 51,007,396 50,028,303
=========== =========== ===========
Diluted earnings per common share $ 0.01 $ 0.05 $ 0.38
=========== =========== ===========
Securities that would potentially dilute basic earnings per share in the future
were not included in the computation of diluted earnings per share because to do
so would have been anti-dilutive. The anti-dilutive securities consist of the
following:
o Options where the exercise price exceeds the average stock price for
the year are considered antidilutive and are excluded form the above
calculation. These options totaled 557,275 in 2006, 973,325 in 2005
and 3,204,800 in 2004. The weighted average exercise price of the
options was $4.10 in 2006, $3.49 in 2005, and $2.16 in 2004.
F-22
o The Series A preferred stock.
NOTE 15. STATUTORY CAPITAL REQUIREMENTS
The HMO is required to maintain statutory minimum net worth requirements
established by the Florida State Department of Insurance. At December 31, 2006,
the statutory minimum net worth requirement was approximately $4.8 million and
actual statutory net deficit was approximately $1.3 million. Subsequent to year
end, we transferred $6.5 million to the HMO so that it complies with all
applicable statutory requirements. At December 31, 2006, the statutorily
restricted cash and cash equivalents were $12.5 million, including the $6.5
million transferred subsequent to year end. The HMO is restricted from making
dividend payments without appropriate regulatory notifications and approvals or
to the extent such dividends would put them out of compliance with statutory
capital requirements. At December 31, 2006, all of the HMO's cash and cash
equivalents are subject to these dividend restrictions. Statutorily restricted
cash is available for us to pay the liabilities of the HMO. The GAAP deficit for
the HMO is approximately $200,000. The difference between the GAAP and statutory
deficit is primarily certain assets of the HMO, such as specific accounts
receivables and fixed assets that are not admitted assets for statutory
purposes.
Included in other assets on the consolidated balance sheets is a statutorily
required $500,000 deposit with the Florida State Department of Insurance.
NOTE 16. EMPLOYEE BENEFIT PLAN
We adopted a tax qualified employee savings and retirement plan covering our
eligible employees, the Metropolitan Health Network 401(k) Plan (the "401(k)
Plan") as of July 1, 2004. The 401(k) Plan is intended to qualify under Section
401 of the Internal Revenue Code (the "Code") and contains a feature described
in Code Section 401(k) under which a participant may elect to reduce their
taxable compensation by the statutorily prescribed annual limit of $15,000 (for
the year ending December 31, 2006). Under the 401(k) Plan, new employees are
eligible to participate after three consecutive months of service. At our
discretion, we may make a matching contribution and a non-elective contribution
to the 401(k) Plan. We expensed approximately $148,000, $125,000 and $75,000 for
purposes of making matching contributions for the 2006, 2005 and 2004 plan
years, respectively. The rights of the participants in the 401(k) Plan to our
contributions do not fully vest until such time as the participant has been
employed by us for three years.
NOTE 17. COMMITMENTS AND CONTINGENCIES
Leases
We lease office and medical facilities under various non-cancelable operating
leases through 2012. Approximate future minimum payments under these leases for
the years subsequent to December 31, 2006 are as follows:
Sublease Net Minimum
Buildings Equipment Amount Payment
---------- --------- -------- -----------
2007 $1,308,000 $167,000 $111,000 $1,364,000
2008 1,258,000 154,000 111,000 1,301,000
2009 1,132,000 127,000 114,000 1,145,000
2010 1,000,000 48,000 117,000 931,000
2011 627,000 21,000 120,000 528,000
2012 475,000 -- 93,000 382,000
---------- --------- -------- -----------
Total $5,800,000 $517,000 $666,000 $5,651,000
========== ========= ======== ===========
The renewal option on the leases range from 3 to 5 years and contain escalation
clauses of up to 5%. Rental expense for 2006, 2005 and 2004 was $1.9 million,
$1.4 million and $1.2 million, respectively.
F-23
In connection with the sale of the pharmacy division, we have subleased pharmacy
facilities to the purchaser of the pharmacy division. In the event of such
purchaser's default, we could potentially be responsible to fulfill these lease
commitments.
Administrative Services Agreement
In 2005 we engaged a third party service provider (the "service provider") to
provide various administrative and management services, including, but not
limited to, claims processing and adjudication, certain management information
services, regulatory reporting and customer services pursuant to the terms of an
Administrative Services Agreement (the "Services Agreement"). The initial term
of the Services Agreement is for five years and it expires on June 30, 2010 and
thereafter is automatically renewable for additional one-year terms unless
terminated by either party. We compensate the service provider for its
management services based upon the number of enrolled customers subject to
monthly minimum payments. The minimum monthly fee was $25,000 per month through
June 30, 2006 and increased to $60,000 per month for the remaining four years.
In addition, the service provider is compensated for providing additional
programming services on an hourly basis. During 2006 and 2005, the Company paid
an aggregate of $751,000 and $487,000 for services in accordance with the
Services Agreement.
Litigation
Pursuant to an unanimous written consent of our Board of Directors dated July
22, 1999, a former President and former Chairman of the Board (the "Former
Officer") of the Company was granted 1,500,000 shares of our common stock as
collateral for his personal guarantee of a loan provided to us. The consent
provided that upon release of the personal guarantee, the shares are to be
returned to us and was signed by the Former Officer. Effective January 28, 2000,
the Former Officer resigned and included in a Board resolution relating to his
resignation the 1,500,000 shares being held as collateral pursuant to the
financing were specifically addressed and identified as being due back to us
when the shares were released as collateral against the loan. On May 25, 2006,
Metropolitan Health Networks received a demand letter from an attorney
representing this Former Officer. Pursuant to the letter, the attorney claimed
that the 1,500,000 restricted shares in our common stock was valued at $2.49 as
of May 24, 2006 with a market value of $3,735,000. The Former Officer offered to
tender the shares back to us in exchange for payment of $1.00 per share.
Principally, the dispute between the parties centers around whether the Former
Officer received an outright grant in the shares or whether he received a
conditional grant and is required to return the shares to us without
compensation. We have responded to the demand letter requesting that the Former
Officer provide further documentation regarding his purported ownership of the
shares. The Former Officer responded to the letter, refusing to provide any
information and threatening to file a lawsuit on July 19, 2006. The body of the
complaint provided with the Former Officer's response asserts two counts, one
for breach of contract and one for specific performance. Each count alleges that
we breached our contract with the Former Officer by refusing to remove the
restrictions on the shares. The Company was served with the complaint on March
13, 2007. We believe, based on current facts and the advice of counsel, that
this matter will not have a material adverse effect on our financial position or
the results of our operations.
We are also a party to certain other claims arising in the ordinary course of
business. We believe that the outcome of these matters will not have a material
adverse effect on our financial position or the results of our operations.
NOTE 18. SEGMENTS
We operate in two segments for purposes of presenting financial information and
evaluating our performance, the Provider Service Network (the "PSN") (managed
care and direct medical services) and the HMO. The HMO division began operations
July 2005.
F-24
YEAR ENDED DECEMBER 31, 2006 PSN HMO Total
-------------------------------------- ------------ ------------ ------------
Revenues from external customers $199,981,000 $ 28,235,000 $228,216,000
Interest (expense) income -- 424,000 424,000
Depreciation and amortization 224,000 152,000 376,000
Segment profit (loss) before allocated
overhead and income tax 19,884,000 (11,700,000) 8,184,000
Allocated corporate overhead 4,049,000 3,309,000 7,358,000
Segment profit (loss) after allocated
overhead and before income 15,835,000 (15,009,000) 826,000
Segment assets 18,070,000 15,131,000 33,201,000
Included in allocated corporate overhead in 2006 was approximately $8,003,000 of
operating costs, inclusive of depreciation and amortization of approximately
$178,000. This amount was reduced by interest income of of approximately
$633,000. Corproate assets are approximately $8,640,000.
YEAR ENDED DECEMBER 31, 2005 PSN HMO Total
-------------------------------------- ------------ ----------- ------------
Revenue from external customers $180,940,000 $ 2,825,000 $183,765,000
Interest (expense) income (3,000) 75,000 72,000
Depreciation and amortization 60,000 16,000 76,000
Segment profit (loss) before allocated
overhead and income taxes 15,488,000 (6,599,000) 8,889,000
Allocated corporate overhead 3,268,000 1,771,000 5,039,000
Segment profit (loss) after allocated
overhead and before income taxes 12,220,000 (8,370,000) 3,850,000
Segment assets 18,006,000 6,644,000 24,650,000
Included in allocated corporate overhead in 2005 were operating expenses of
$5,587,000, inclusive of depreciation and amortization of $279,000. This amount
was adjusted by interest income of $374,000 and interest expense was $11,000.
Corporate assets were approximately $8,465,000.
YEAR ENDED DECEMBER 31, 2004 PSN Pharmacy HMO Total
-------------------------------------- ------------ -------- ---------- ------------
Revenue from external customers $158,070,000 $ -- $ -- $158,070,000
Interest (expense) income (24,000) 13,000 27,000 16,000
Depreciation and amortization 108,000 -- -- 108,000
Segment profit (loss) before allocated
overhead 17,242,000 (31,000) (433,000) 16,778,000
Segment tax expense (benefit) 6,488,000 (12,000) (163,000) 6,313,000
Allocated corporate overhead 5,133,000 -- 203,000 5,336,000
Segment profit (loss) after allocated
overhead and before income taxes 12,109,000 (31,000) (636,000) 11,442,000
Segment assets 16,277,000 1,000 2,727,000 19,005,000
Included in allocated corporate overhead in 2004 were operating expenses of
$4,927,000, inclusive of depreciation and amortization of $234,000. This amount
was adjusted by interest income of $73,000 and interest expense of $296,000.
Corporate assets were approximately $9,032,000.
F-25
NOTE 19. VALUATION AND QUALIFYING ACCOUNTS
Activity in our Valuation and Qualifying Accounts consists of the following:
Years Ended December 31,
---------------------------------------
2006 2005 2004
---------- ----------- ------------
Allowance for doubtful trade accounts
- continuing
operations:
Balance at beginning of period $ 556,000 $ 2,921,000 $ 2,539,000
Charged to costs and expenses -- -- --
Increase (Deductions) 45,000 (2,365,000) 382,000
---------- ----------- ------------
Balance at end of period $ 601,000 $ 556,000 $ 2,921,000
========== =========== ============
Allowance for note receivable:
Balance at beginning of period $ 161,000 $ 200,000 $ --
Charged to costs and expenses -- -- 200,000
Increase (Deductions) (18,000) (39,000) --
---------- ----------- ------------
Balance at end of period $ 143,000 $ 161,000 $ 200,000
========== =========== ============
Allowance for AICD receivable:
Balance at beginning of period $ -- $ -- $ --
Charged to costs and expenses 1,621,000 -- --
Increase (Deductions) -- -- --
---------- ----------- ------------
Balance at end of period $1,621,000 -- --
========== =========== ============
Deferred tax asset valuation allowance:
Balance at beginning of period $ -- $ -- $ 11,705,000
Additions -- -- --
Deductions -- -- (11,705,000)
---------- ----------- ------------
Balance at end of period $ -- $ -- $ --
========== =========== ============
(2) Financial schedules required to be filed by Item 8 of this form, and by
Item 15(d) below:
Schedule I Condensed Financial Information of Registrant
All other financial schedules have been omitted as the required information is
inapplicable or has been included in the Notes to Consolidated Financial
Statements.
F-26
METROPOLITAN HEALTH NETWORKS, INC.
EXHIBIT INDEX
Year Ended December 31, 2006
(3) Exhibits
3.1 Articles of Incorporation, as amended (1)
3.2 Amended and Restated Bylaws (2)
10.1 Physician Practice Management Participation Agreement, dated August 2,
2001, between Metropolitan of Florida, Inc. and Humana, Inc. (3)
10.2 Letter of Agreement, dated February 2003, between Metropolitan of Florida,
Inc. and Humana, Inc. (4)
10.3 Physician Practice Management Participation Agreement, dated December 1,
1998, between Metcare of Florida, Inc. and Humana, Inc.(5)
10.4 Supplemental Stock Option Plan (6)
10.5 Omnibus Equity Compensation Plan (7)
10.6 Amended and Restated Employment Agreement between Metropolitan and Michael
M. Earley dated January 3, 2005 (9)
10.7 Amended and Restated Employment Agreement between Metropolitan and Robert
J. Sabo dated November 9, 2006 (10)
10.8 Amended and Restated Employment Agreement between Metropolitan and Roberto
L. Palenzuela dated January 3, 2005 (9)
10.9 Amended and Restated Employment Agreement between Metropolitan and Debra
A. Finnel dated January 3, 2005 (9)
10.10 Employment Agreement between Metcare of Florida, Inc. and Jose A. Guethon,
M.D. (5)
10.11 Form of Option Award Agreement for Option Grants to Directors pursuant to
the Omnibus Compensation Plan (5)
10.12 Form of Option Award Agreement for Option Grants to Key Employees pursuant
to the Omnibus Compensation Plan (5)
10.13 Form of Option Award Agreement for Option Grants to Employees pursuant to
the Omnibus Compensation Plan (5)
10.14 Agreement between Metcare of Florida, Inc. and the Centers for Medicare
and Medicaid Services (5)
10.15 Transition and Severance Agreement between Metropolitan and David S.
Gartner, dated August 18, 2006. (11)
14.1 Code of Business Conduct and Ethics (5)
21.1 List of Subsidiaries (8)
31.1 Certification of the Chief Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002*
31.2 Certification of the Chief Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002*
32.1 Certification of the Chief Executive Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002**
32.2 Certification of the Chief Financial Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002**
----------
* filed herewith
** furnished herewith
(1) Incorporated by reference to Metropolitan's Registration Statement on Form
8-A12B filed with the Commission on November 19, 2004 (No. 001-32361).
(2) Incorporated by reference to Metropolitan's Current Report on Form 8-K
filed with the Commission on September 30, 2004.
(3) Incorporated by reference to Metropolitan's Amendment to Registration
Statement on Form SB-2/A filed with the Commission on August 2,. 2001 (No.
333-61566). Portions of this document were omitted and were filed
separately with the SEC on or about August 2, 2001 pursuant to a request
for confidential treatment.
(4) Incorporated by reference to Metropolitan's Amendment to Annual Report for
the year ended December 31, 2003 on Form 10-K/A filed with the Commission
on July 28, 2004. Portions of this document have been omitted and were
filed separately with the SEC on July 28, 2004 pursuant to a request for
confidential treatment.
- 51 -
(5) Incorporated by reference to our Annual Report on Form 10-K for the year
ended December 31, 2005, as filed with the Commission on March 16, 2006.
(6) Incorporated by reference to Metropolitan's Amendment to Annual Report for
the year ended December 31, 2003 on Form 10-K/A filed with the Commission
on July 28, 2004.
(7) Incorporated by reference to Metropolitan's Registration Statement on Form
S-8 filed with the Commission on February 24, 2005 (No. 333-122976).
(8) Incorporated by reference to our Annual Report on Form 10-K for the year
ended December 31, 2003, as filed with the Commission on March 22, 2004.
(9) Incorporated (by reference to our Annual Report on Form 10-K for the year
ended December 31, 2004, as filed with the Commission on March 22, 2005.
(10) Incorporated by reference to Metropolitan's Current Report on Form 8-K
filed with the Commission on October 20, 2006.
(11) Incorporated by reference to Metropolitan's Current Report on Form 8-K
filed with the Commission on August 18, 2006.
- 52 -
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Exchange Act of 1934,
as amended, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, this 23 rd day of March
2007.
METROPOLITAN HEALTH NETWORKS, INC.
By: /s/ MICHAEL M. EARLEY
------------------------------------
Michael M. Earley, Chairman and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
this report has been signed below by the following persons in the capacities and
on the dates indicated.
March 23, 2007 /s/ MICHAEL M. EARLEY
----------------------------------------
Michael M. Earley
Chairman and Chief Executive Officer
March 23, 2007 /s/ ROBERT J. SABO
----------------------------------------
Robert J. Sabo
Chief Financial Officer
March 23, 2007 /s/ DEBRA A. FINNEL
----------------------------------------
Debra A. Finnel
President, Chief Operating Officer and
Director
March 23, 2007 /s/ KARL M. SACHS
---------------------------------------
Karl M. Sachs
Director
March 23, 2007 /s/ MARTIN W. HARRISON
----------------------------------------
Martin W. Harrison
Director
March 23, 2007 /s/ ERIC HASKELL
----------------------------------------
Eric Haskell
Director
March 23, 2007 /s/ BARRY T. ZEMAN
----------------------------------------
Barry T. Zeman
Director
March 23, 2007 /s/ DAVID A. FLORMAN
----------------------------------------
David A. Florman
Director
March 23, 2007 /s/ ROBERT E. SHIELDS
----------------------------------------
Robert E. Shields
Director
- 53 -
METROPOLITAN HEALTH NETWORKS, INC. - PARENT COMPANY ONLY
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEETS
December 31,
---------------------------
2006 2005
------------ ------------
ASSETS
CURRENT ASSETS
Prepaid expenses $ 289,610 $ 40,075
Deferred income taxes 1,600,000 3,500,000
------------ ------------
TOTAL CURRENT ASSETS 1,889,610 3,540,075
PROPERTY AND EQUIPMENT, net of accumulated depreciation and
amortization of $449,232 and $1,272,492, respectively 946,446 394,990
INVESTMENT IN AND ACCOUNTS WITH SUBSIDIARIES 23,284,788 22,123,846
DEFERRED INCOME TAXES 5,767,000 4,493,000
OTHER ASSETS 37,349 36,825
------------ ------------
TOTAL ASSETS $ 31,925,193 $ 30,588,736
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 14,560 $ 183,514
Accrued payroll and payroll taxes 714,752 576,345
Accrued expenses 266,619 130,015
------------ ------------
TOTAL CURRENT LIABILITIES 995,930 889,874
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Preferred stock, par value $.001 per share; stated value $100 per share;
10,000,000 shares authorized; 5,000 issued and outstanding 500,000 500,000
Common stock, par value $.001 per share; 80,000,000 shares authorized;
50,268,964 and 49,851,526 issued and outstanding, respectively 50,269 49,851
Additional paid-in capital 41,453,311 40,182,889
Accumulated deficit (11,074,317) (11,033,878)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 30,929,263 29,698,862
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 31,925,193 $ 30,588,736
============ ============
- 54 -
METROPOLITAN HEALTH NETWORKS, INC. - PARENT COMPANY ONLY
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF INCOME
Years Ended December 31,
----------------------------------------
2006 2005 2004
----------- ----------- ------------
REVENUE $ 744 $ 3,497 $ 111
OTHER OPERATING EXPENSES
Administrative payroll, payroll taxes and benefits 4,253,552 2,492,131 2,076,643
Marketing and advertising 3,842 16,225 2,817
General and administrative 3,745,719 3,078,799 2,824,135
----------- ----------- ------------
Total Other Operating Expenses 8,003,113 5,587,155 4,903,595
----------- ----------- ------------
OPERATING INCOME (LOSS) (8,002,369) (5,583,658) (4,903,484)
OTHER INCOME (EXPENSE):
Interest income 632,612 374,389 73,349
Interest expense (8,981) (11,371) (319,958)
Other income (expense) 2,432 129,913 13,344
Recovery (reserve) on note receivable - pharmacy 17,902 51,668 (200,000)
----------- ----------- ------------
Total other income (expense) 643,965 544,599 (433,265)
LOSS FROM OPERATIONS BEFORE INCOME TAXES (7,358,403) (5,039,059) (5,336,749)
Income tax benefit (3,146,366) (1,921,357) (13,706,030)
----------- ----------- ------------
LOSS BEFORE EQUITY IN NET INCOME OF SUBSIDIARY (4,212,037) (3,117,702) 8,369,281
EQUITY IN NET INCOME OF SUBSIDIARIES 4,684,598 5,499,445 10,453,431
----------- ----------- ------------
NET INCOME $ 472,561 $ 2,381,743 $ 18,822,712
=========== =========== ============
- 55 -
METROPOLITAN HEALTH NETWORKS, INC. - PARENT COMPANY ONLY
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF CASH FLOWS
Years Ended December 31,
----------------------------------------
2006 2005 2004
----------- ----------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 472,561 $ 2,381,743 $ 18,822,712
Adjustments to reconcile net income to net cash
used in operating activities:
Equity in net income of subsidiaries (4,684,598) (5,499,445) (10,453,431)
Depreciation and amortization 181,358 172,034 327,238
Stock-based compensation expense 736,315 -- --
Reserve on note receivable - pharmacy -- -- 200,000
Amortization of discount on notes payable -- -- 52,185
Stock issued for interest and late fees -- -- 577
Tax benefit from exercise of options (240,000) -- --
Stock issued for compensation and services 157,176 134,750 249,884
Amortization of securities issued for professional services -- 97,282 110,127
Deferred income taxes 329,000 1,467,110 (7,399,110)
Intercompany tax allocation (3,499,368) (3,389,163) (6,325,782)
Changes in operating assets and liabilities:
Prepaid expenses (249,535) 200,722 (55,695)
Other current assets -- 900 (900)
Other assets (4,689) (1,824) --
Accounts payable (168,954) (136,442) 70,368
Accrued payroll and payroll taxes 138,409 179,704 (1,248,982)
Accrued expenses 160,604 76,475 (10,209)
----------- ----------- ------------
Total adjustments (7,144,282) (6,697,897) (24,483,730)
----------- ----------- ------------
Net cash used in operating activities (6,671,721) (4,316,154) (5,661,018)
----------- ----------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment in and accounts with Subsidiaries 7,023,023 4,197,529 3,023,850
Capital expenditures (728,652) (92,832) (294,526)
----------- ----------- ------------
Net cash provided by investing activities 6,294,371 4,104,697 2,729,324
----------- ----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings on notes payable -- -- 282,000
Repayments on notes payable -- (1,132,000) (1,063,354)
Repayments on capital lease obligations -- -- (107,407)
Repurchase of warrants -- (85,000) (113,250)
Proceeds from exercise of stock options and warrants 137,350 1,428,457 1,145,241
Tax benefit from exercise of options 240,000 -- --
Net proceeds from issuance of common stock -- -- 2,953,000
Repayments to HMO, net -- -- (164,536)
----------- ----------- ------------
Net cash provided by financing activities 377,350 211,457 2,931,694
----------- ----------- ------------
NET INCREASE IN CASH AND EQUIVALENTS -- -- --
CASH AND EQUIVALENTS - beginning of year -- -- --
----------- ----------- ------------
CASH AND EQUIVALENTS - end of year $ -- $ -- $ --
=========== =========== ============
- 56 -
METROPOLITAN HEALTH NETWORKS, INC. - PARENT COMPANY ONLY
NOTES TO CONDENSED FINANCIAL INFORMATION
NOTE 1. BASIS OF PRESENTATION
Parent Company Only financial statements should be read in conjunction with the
Company's consolidated financial statements.
For purposes of these condensed financial statements, MHN's investments in
subsidiaries is accounted for by the equity method.
- 57 -