Astrana Health, Inc. quarterly report, Q3 FY2015

Business context and reporting period

This is Apollo Medical Holdings, Inc.’s unaudited Form 10-Q for the quarter and nine months ended December 31, 2014, comparing with the corresponding 2013 periods. The filing identifies the registrant as Apollo Medical Holdings, Inc.; it does not identify the company as Astrana Health. The company provides integrated healthcare services, including hospitalist care, physician-group management, clinics, accountable care, hospice and home health, primarily in California. It changed its fiscal year-end to March 31 in May 2014.

Financial performance and liquidity

For the nine months, cost of services was $15.51 million and general and administrative expense was $8.35 million. The company attributed improved year-to-date operating results primarily to $5.38 million of Medicare Shared Savings Program (MSSP) revenue; the filing says this revenue carried substantially lower service costs than other revenue. Quarterly operating losses widened in dollars despite revenue growth, as costs and expenses increased faster than revenue.

At December 31, 2014, cash and cash equivalents were $6.95 million, total current assets were $10.66 million, and current liabilities were $6.33 million. Total liabilities were $16.49 million, and stockholders’ deficit was $1.47 million. Borrowings were approximately $8.6 million, comprising notes and lines of credit and convertible notes, net of discounts. Cash increased $0.12 million over the nine months. Investing activities used $2.67 million, principally for acquisitions; financing activities provided $2.14 million.

Material changes versus the prior comparable period

• Revenue growth reflects acquired operations, higher patient lives in MMG, and the $5.38 million MSSP award recognized in the nine-month period. The acquisitions of AKM, SCHC, BCHC and HCHHA contributed $4.25 million of revenue from their closing dates through December 31, 2014.
• Cost of services increased with acquired operations and higher patient lives and claims. Year-to-date cost of services declined as a share of revenue, which management attributed principally to the lower cost of MSSP shared-savings revenue; quarterly cost of services rose to 79.7% of revenue from 71.7%.
• General and administrative expense increased, including higher legal and professional fees, growth-related staffing and facilities costs, and acquired-company expenses. Depreciation and amortization also increased following acquisitions.
• Interest expense rose, primarily because of increased borrowings under the 2014 NNA financing. Non-cash fair-value gains on warrant and conversion-feature liabilities partially offset other expense.

Outlook, risks and unusual items

• Management stated that current cash, together with operating cash flow, was expected to meet working-capital needs for the foreseeable future, while cautioning that future financing might not be available on acceptable terms or at all. No quantified earnings or revenue guidance was provided.
• The company recognized $5.38 million of MSSP revenue after CMS reported $10.98 million of program savings for 2012. Management did not anticipate additional MSSP revenue in fiscal 2015; savings for later service periods were not estimable.
• Revenue was concentrated: two payers represented 41.2% and 22.2% of nine-month revenue. Two payers accounted for 22.7% and 16.2% of accounts receivable at December 31, 2014.
• Medical liabilities rose to $1.81 million from $0.55 million, including estimated incurred-but-not-reported claims and risk-pool obligations. Reserve estimates depend on utilization, payment patterns and other assumptions; the company reported no institutional stop-loss coverage.
• The company disclosed arbitration proceedings brought by competing physician groups alleging improper solicitation and misrepresentations. It said the likelihood and amount of any loss could not yet be determined and stated it intended to defend the claims. It also described ordinary-course malpractice claims and cautioned that insurance might not cover all future liabilities.
• Disclosure controls and internal control over financial reporting were deemed ineffective as of December 31, 2014, due to three material weaknesses: inadequate written control documentation, insufficient segregation of accounting duties, and insufficient review and supervision. Management reported remediation efforts underway.
• The NNA debt facilities are secured and include covenants and restrictions; the company reported compliance with the amended covenants as of December 31, 2014. NNA financing also includes warrants and conversion features whose fair values depend on Level 3 assumptions, including share-price volatility and down-round financing probabilities.
• Subsequent events included amendments and waivers to NNA-related agreements, a new Bay Area hospitalist management agreement whose consolidation impact was still under evaluation, and a consulting agreement at $25,000 per month.

Important facts for investors to verify

• How much of ongoing revenue and operating performance is sustainable without the one-time $5.38 million MSSP award, and whether later MSSP savings generate revenue.
• Acquired businesses’ continuing contribution, integration costs, contingent payments and the assumptions underlying goodwill and intangible-asset valuations.
• Medical-claims reserve adequacy, risk-pool exposure and payer concentration, particularly given the significant increase in medical liabilities and receivables.
• Cash conversion and financing needs, including debt service, covenant terms, the 2016 maturity of the 9% convertible notes, and the terms and potential dilution of NNA warrants and convertible notes.
• Progress in remediating the disclosed material weaknesses and any subsequent changes in control effectiveness.
• Developments and potential financial exposure in the arbitration proceedings and other legal or malpractice claims.