The principal offices of the Company are located at 300 River Place, Suite 4950, Detroit, Michigan, where it currently leases approximately 3,800 square feet of office space. Pulse leases approximately 9,000 square feet of office and manufacturing space in Concord, California. The Company believes that its current facilities provide sufficient space suitable for all of its activities and that sufficient other space will be available on reasonable terms, if needed.
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations and other sections of this report contains various “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements represent our expectations or beliefs concerning future events, including statements regarding future plans and strategy for our business, earnings and the sufficiency of our cash balances and cash generated from operating, investing, and financing activities for our future liquidity and capital resource needs. We caution that although forward-looking statements reflect our good faith beliefs and reasonable judgment based upon current information, these statements are qualified by important factors that could cause actual results to differ materially from those in the forward-looking statements, because of risks, uncertainties, and factors including, but not limited, to: the recent acquisition of Pulse and its integration into the Company; changes in the medical device and healthcare industry; the wind down of the CMS Medicare contract; the ongoing impacts of the U.S. recession; the continuing impacts of the global credit and financial crisis; and other changes in general economic conditions. Other risks and uncertainties are detailed from time to time in reports filed with or furnished to the SEC, and in particular those set forth under “Risk Factors” in Part 1 Item 1A in this annual report on Form 10-K. Given such uncertainties, you should not place undue reliance on any such forward-looking statements. Except as required by law, we may not update these forward-looking statements, even if new information becomes available in the future.
From November 1993 to June 2009, the Company’s indirect, wholly owned subsidiary, UAHC Health Plan of Tennessee, Inc. (“UAHC-TN”), was a managed care organization in the TennCare program, a State of Tennessee program that provided medical benefits to Medicaid and working uninsured recipients. On April 22, 2008, the Company learned that UAHC-TN would no longer be authorized to provide managed care services as a TennCare contractor when its present TennCare contract expired on June 30, 2009. UAHC-TN’s TennCare members transferred to other managed care organizations on November 1, 2008, after which UAHC-TN continued to perform its remaining contractual obligations through its TennCare contract expiration date of June 30, 2009. However, revenue under this contract was only earned through October 31, 2008.
On June 18, 2010, the Company entered into a Securities Purchase Agreement and a Warrant Purchase Agreement to acquire 100% of the outstanding common units and warrants to purchase common units of Pulse. The consideration paid to acquire the common units and warrants of Pulse totaled approximately $9.46 million, which consisted of (a) cash paid at closing of $3.40 million, (b) a non-interest bearing note payable of $1.75 million (secured by a subordinated pledge of all the common units of Pulse), (c) 1,608,039 shares of UAHC common stock determined based on an initial value of $1.6 million, (d) an estimated purchase price adjustment of $210,364 based on targeted levels of net working capital, cash and debt of Pulse at the acquisition date (e) and the funding of $2.5 million for certain obligations of Pulse as discussed below. The shares of UAHC common stock were issued on July 12, 2010, upon approval by the Company’s board of directors on July 7, 2010. The shares of UAHC common stock had a fair value of $1.05 million as of June 30, 2010, and a fair value of $884,000 on July 12, 2010, the date the shares were issued and recorded. The Company also assumed Pulse’s term loan to a bank of $4.25 million, after making a payment at closing as discussed below.
In connection with the acquisition of the Pulse common units, Pulse entered into a redemption agreement with the holders of its preferred units to redeem the preferred units for $3.99 million. Pulse is only allowed to redeem the preferred units if the Company makes additional cash equity contributions to Pulse in an amount necessary to fully fund each such redemption. The Company funded an initial payment of $1.75 million to the preferred unitholders on June 18, 2010. Pulse has agreed to redeem the remaining preferred units over a two-year period ending in June 2012. Finally, as an additional condition of closing, the Company funded a $750,000 payment toward Pulse’s outstanding term loan with a bank and pledged all of the common units of Pulse to the bank as additional security for the remaining $4.25 million outstanding under the loan. The initial payment of $1.75 million to the preferred unitholders and the $750,000 payment to the bank by the Company are considered additional consideration for the acquisition of Pulse. The funding of the remaining redemption payments totaling $2.24 million and the assumption of Pulse’s revolving and term loan are not included in the $9.46 million purchase price listed above.
Pulse Systems currently represents substantially all of the ongoing operations of the Company. However, the operating results of Pulse are only included in the discussion below and the accompanying financial statements since the acquisition date of June 18, 2010. In addition, Pulse’s fiscal year previously ended on December 31; however, effective upon the acquisition, Pulse’s fiscal year will end June 30 (beginning with the Company’s fiscal year ended June 30, 2010).
Review of Consolidated Results of Operations - Fiscal 2010 Compared to Fiscal 2009
The retroactive risk premium adjustment for a given year generally occurs during the third quarter of such year. This initial settlement (the “Initial CMS Settlement”) represents the updating of risk scores for the current year based on updated diagnoses from the prior year. CMS then issues a final retroactive risk premium adjustment settlement for that year in the following calendar year (the “Final CMS Settlement”).
The Company was unable to estimate the impact of either of these risk adjustment settlements primarily because of the lack of historical risk-based diagnosis code data and insufficient historical experience regarding risk premium settlement adjustments on which to base a reasonable estimate of future risk premium adjustments and, as such, recorded them upon notification from CMS of such amount. The Initial CMS Settlement related to 2008 claims recorded in fiscal year 2009 was $0.8 million. The Company will record revenue related to 2009 claims, if any, upon notification from CMS.
The net MA-SNP per member per month premium rate, based on an average membership of 231 for the year ended June 30, 2010, was $1,056 for that one-year period. The net MA-SNP per member per month premium rate, based on an average membership of 699 for the year ended June 30, 2009, was $1,598 for that one-year period.
There were no fixed administrative fees for the fiscal year ended June 30, 2010, compared to fixed administrative fees of $4.6 million for the fiscal year ended June 30, 2009. The decrease in fixed administrative fees is principally due to the discontinuance of the TennCare contract.
Variable administrative fees resulting from the modified risk arrangement (MRA) revenue were $0.3 million for the fiscal year ended June 30, 2010 compared to $0.9 million for the fiscal year ended June 30, 2009.
Total expenses were $9.3 million for the fiscal year ended June 30, 2010, compared to $26.1 million for the prior fiscal year, a decrease of $16.7 million (64%). The decrease in total expenses was primarily the result of a decrease in marketing, general and administrative expenses and the legal reserve established in fiscal 2009 of $3.1 million, net of an insurance recovery of $0.2 million resulting from the litigation settlement described in Note 14 “Legal Settlement” in Part IV Financial Statements. The decrease was also offset by costs attributable to Pulse operating results, including costs of good sold of $0.1 million and marketing, general and administrative costs of $0.1 million for the period beginning June 18, 2010 through June 30, 2010.
General and administrative expenses were $6.3 million for the fiscal year ended June 30, 2010, as compared with $12.6 million for the prior fiscal year, a decrease of $6.3 million. The decrease was principally due to reductions in labor costs, adminstrative costs and professional services expenses resulting from the TennCare contract expiration and the expiration of the Medicare contract as well as the legal fees associated with the litigation as described Note 14 “Legal Settlement” in Part IV Financial Statements.
Provision for legal settlement totaled $3.1 million, net of $0.2 million in an insurance recovery for fiscal year ended June 30, 2009. Since 2005, the Company had been a defendant in a lawsuit as described in Note 14 “Legal Settlement” in Part IV Financial Statements.
Depreciation and amortization expense was constant at $0.2 million for the fiscal year ended June 30, 2010 compared to fiscal year ended June 30, 2009.
Income tax benefit was $0 for the fiscal year ended June 30, 2010 compared to a benefit of $5,000 for the prior fiscal year. The Company’s effective tax rate for the fiscal year ended June 30, 2010 differs from the statutory rate due to the change in the valuation allowance. The Company increased its deferred tax asset valuation allowance due to uncertainties in its expected utilization, as a result of the expiration of the TennCare and the Medicare contracts.
Review of Consolidated Results of Operations - Fiscal 2009 Compared to Fiscal 2008
MA-SNP medical premiums revenues were $11.1 million for the fiscal year ended June 30, 2009 compared to $10.6 million for the fiscal year ended June 30, 2008, under UAHC-TN’s contract with CMS that began January 1, 2007. The increase in medical premiums results from additional revenue from a retroactive claims adjustment of $0.8 million received from CMS in 2009, as discussed below, partially offset by a decrease in the number of SNP members.
MA-SNP premium revenue is subject to adjustment based on the health risk of its members. This process for adjusting premiums is referred to as the CMS risk adjustment payment methodology. Under the risk adjustment payment methodology, managed care plans must capture, collect, and report diagnosis code information to CMS. After reviewing the respective submissions, CMS establishes the payments to Medicare plans generally at the beginning of the calendar year and then adjusts premiums on two separate occasions on a retroactive basis.
Fixed administrative fees were $4.6 million for the fiscal year ended June 30, 2009, a decrease of $9.9 million (68%) from fixed administrative fees of $14.5 million for the fiscal year ended June 30, 2008. The decrease in fixed administrative fees is principally due to a decrease in members resulting from the discontinuance of the TennCare contract.
Variable administrative fees resulting from the MRA revenue were $0.9 million for the fiscal year ended June 30, 2009 compared to $1.7 million for the fiscal year ended June 30, 2008. The $0.9 million in MRA revenue recorded in the second quarter of fiscal year 2009 related to fiscal year 2008.
At June 30, 2010, the Company had (i) cash and cash equivalents and short-term marketable securities of $3.5 million, compared to $17.6 million at June 30, 2009; (ii) negative working capital of ($1.0) million, compared to working capital of $12.2 million at June 30, 2009; and (iii) a current assets-to-current liabilities ratio of 0.89 to 1, compared to 2.72 to 1 at June 30, 2009.
Following its acquisition by the Company, Pulse Systems remains party to the Loan and Security Agreement, as amended (the “Loan Agreement”), with Fifth Third Bank, which currently relates to a revolving loan not to exceed $1.0 million, of which no amounts were outstanding as of the closing, and a $5.0 million term loan, with a remaining balance of $3.98 million as of June 30, 2010. The revolving loan matures June 30, 2011 and bears interest at prime plus 4% or, at the option of Pulse Systems, Adjusted LIBOR (the greater of LIBOR or 3%) plus 4%. The term loan interest rate is 9.75%. The revolving loan and term loan are secured by a lien on all of the assets of Pulse Systems.
The financial statements of the Company and the Report of the Independent Registered Public Accounting Firm thereon are filed pursuant to this Item 8 and are included in this report in Item 15 at page of this Annual Report on Form 10-K.