UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

 

For the quarterly period ended June 30, 2015

 

OR

 

For the transition period from      to      .

Commission file number: 001-36520

ADEPTUS HEALTH INC.

(Exact name of registrant as specified in its charter)

 

(972) 899-6666

(Registrant’s telephone number, including area code)

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 ☒ No ◻ 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ◻ 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ◻ No ☒ 

The number of shares of the registrant’s Class A common stock, par value $0.01 per share, outstanding was 11,563,069 as of July 20, 2015.  The number of shares of the registrant’s Class B common stock, par value $0.01 per share, outstanding was 9,208,227 as of July 20, 2015. 

 

---

 

 

 

---

 

ADEPTUS HEALTH INC. and SUBSIDIARIES

FORM 10-Q

INDEX 

 

 

---

 

GENERAL

Unless the context otherwise indicates or requires, references in this Quarterly Report on Form 10-Q to the “Company,” “we,” “us” and “our” refer to Adeptus Health Inc. and its consolidated subsidiaries after giving effect to the Reorganization Transactions (“Reorganization”) described herein and the Initial Public Offering (“IPO”) described herein and to Adeptus Health LLC and its consolidated subsidiaries prior to the Reorganization and IPO.  

On June 30, 2014, we completed our initial public offering of 5,321,414 shares of our Class A common stock at a price to the public of $22.00 per share and received net proceeds of approximately $96.2 million, after deducting underwriting discounts and commissions and offering expenses. We used the net proceeds from the initial public offering to purchase limited liability company units of Adeptus Health LLC, or LLC Units, from Adeptus Health LLC. Adeptus Health LLC used the proceeds it received as a result of our purchase of LLC Units to cause First Choice ER, LLC to reduce outstanding borrowings under its senior secured credit facility, to make a $2.0 million one-time payment to an affiliate of a significant stockholder in connection with the termination of an advisory services agreement and for general corporate purposes. An additional 313,586 shares were also sold by an affiliate of a significant stockholder.

On May 11, 2015, we completed a public offering of 1,572,296 shares of our Class A common stock at a price to the public of $63.75 per share and received net proceeds of approximately $94.5 million, after deducting underwriting discounts and commissions and offering expenses. We used the net proceeds from the offering to purchase, for cash, 1,572,296 LLC Units. An additional 842,704 shares were also sold by an affiliate of a significant stockholder.

FORWARD-LOOKING STATEMENTS

In addition to historical information, this Quarterly Report on Form 10-Q may contain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which are subject to the “safe harbor” created by those sections. All statements, other than statements of historical facts included in this Form 10-Q, including statements concerning our plans, objectives, goals, beliefs, business strategies, future events, business conditions, our results of operations, financial position and our business outlook, business trends and other information, may be forward-looking statements. Words such as “estimates,” “expects,” “contemplates,” “will,” “anticipates,” “projects,” “plans,” “intends,” “believes,” “forecasts,” “may,” “should” and variations of such words or similar expressions are intended to identify forward-looking statements. The forward-looking statements are not historical facts, and are based upon our current expectations, beliefs, estimates and projections, and various assumptions, many of which, by their nature, are inherently uncertain and beyond our control. Our expectations, beliefs, estimates and projections are expressed in good faith and we believe there is a reasonable basis for them. However, there can be no assurance that management’s expectations, beliefs, estimates and projections will result or be achieved and actual results may vary materially from what is expressed in or indicated by the forward-looking statements.

There are a number of risks, uncertainties and other important factors, many of which are beyond our control, that could cause our actual results to differ materially from the forward-looking statements contained in this Form 10-Q. Such risks, uncertainties and other important factors that could cause actual results to differ include, among others, the risks, uncertainties and factors set forth under Part I., Item 1A.“Risk Factors” in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2014, subsequent filings and in this report, as such risk factors may be updated from time to time in our periodic filings with the SEC, and are accessible on the SEC’s website at www.sec.gov, and also include the following:

 

---

 

We caution you that the risks, uncertainties and other factors referenced above may not contain all of the risks, uncertainties and other factors that are important to you. In addition, we cannot assure you that we will realize the results, benefits or developments that we expect or anticipate or, even if substantially realized, that they will result in the

---

 

consequences or affect us or our business in the way expected. There can be no assurance that (i) we have correctly measured or identified all of the factors affecting our business or the extent of these factors’ likely impact, (ii) the available information with respect to these factors on which such analysis is based is complete or accurate, (iii) such analysis is correct or (iv) our strategy, which is based in part on this analysis, will be successful. All forward-looking statements in this report apply only as of the date of this report or as the date they were made and, except as required by applicable law, we undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise.

 

 

 

---

 

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

Adeptus Health Inc. and Subsidiaries

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

 

 

The accompanying notes are an integral part of these unaudited financial statements.

 

---

 

Adeptus Health Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except share data)

 

 

The accompanying notes are an integral part of these unaudited financial statements.

---

 

Adeptus Health Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited)

(In thousands)

 

 

 

 

 

 

 

 

 

The accompanying notes are an integral part of these unaudited financial statements.

 

 

---

 

Adeptus Health Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

(In thousands)

The accompanying notes are an integral part of these unaudited financial statements.

 

 

---

 

Adeptus Health Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

 

 

See Note 12 for Supplemental Cash Flow Information and Supplemental Noncash Activities

The accompanying notes are an integral part of these unaudited financial statements.

 

 

---

 

NOTE 1—ORGANIZATION 

Adeptus Health Inc. (the "Company") was incorporated as a Delaware corporation on March 7, 2014 for the purpose of facilitating an initial public offering of common equity. The Company is a holding company with its sole material asset being a controlling equity interest in Adeptus Health LLC. As the sole managing member of Adeptus Health LLC, the Company operates and controls all of the business and affairs of Adeptus Health LLC and, through Adeptus Health LLC and its subsidiaries, conducts its business. Prior to the initial public offering, the Company had not engaged in any business or other activities except in connection with its formation and the initial public offering.

Adeptus Health LLC is a leading patient-centered healthcare organization expanding access to the highest quality emergency medical care through its network of freestanding emergency rooms and partnerships with premier healthcare providers.  In Texas, Adeptus Health or its predecessors began operations in 2002 and owns and operates First Choice Emergency Room.  In Colorado, in partnership with University of Colorado Health, Adeptus Heath operates UCHealth Emergency Rooms.  Together with Dignity Health, the Company also owns and operates Dignity Health Arizona General Hospital and freestanding emergency rooms in Arizona.  First Choice Emergency Room is the largest network of independent freestanding emergency rooms in the United States, delivering both major and minor emergency medical services for adult and pediatric patients. First Choice Emergency Room has experienced rapid growth in recent periods, growing from 14 freestanding facilities at the end of 2012 to 55 freestanding facilities at the end of 2014, and to 68 freestanding facilities at June 30, 2015. The Company’s facilities are currently located in Houston, Dallas/Fort Worth, San Antonio and Austin, Texas.  In Colorado, facilities are located in Colorado Springs and Denver.  In Arizona, Dignity Health Arizona General Hospital, a full service general hospital, along with a freestanding emergency room are located in the Phoenix, Arizona market. 

On June 24, 2014, the Company’s registration statement on Form S-1 (File No. 333-196142) relating to its initial public offering of Class A common stock was declared effective by the Securities and Exchange Commission (“SEC”). The Company sold 4,900,000 shares of Class A common stock in its public offering.  An additional 735,000 shares were sold to the public, of which 313,586 shares were sold by a significant stockholder and 421,414 shares were sold by the Company with the proceeds received by the Company used to purchase an equivalent number of LLC Units from such significant stockholder.  The Company’s stock began trading on the New York Stock Exchange on June 25, 2014 under the symbol “ADPT,” and the initial public offering closed on June 30, 2014.

In connection with the initial public offering, the limited liability company agreement of Adeptus Health LLC was amended and restated to, among other things, modify its capital structure by replacing the different classes of interests previously held by the Adeptus Health LLC owners to a single new class of units called “LLC Units.” In addition, each LLC Unit holder received on a one-for-one basis one share of the Company’s Class B common stock, which entitles the holder to vote on all matters of Adeptus Health Inc. but has no economic rights.  One of the then-existing owners converted a portion of its interest into 4,895,521 shares of the Company’s Class A common stock, which is referred to as the merged entity. The Company and its then-existing owners also entered into an exchange agreement under which they have the right to exchange their LLC Units and shares of Class B common stock for shares of Class A common stock on a one-for-one basis, subject to customary conversion rate adjustments for stock splits, stock dividends and reclassifications. These transactions are collectively referred to as the “Reorganization Transactions.”

In May 2015, an existing stockholder of ADPT (the “Selling Stockholder”) and the Company sold 750,329 and 1,349,671 shares, respectively, of the Company’s Class A common stock in an underwritten public offering at a price of $63.75 per share.  In connection with the offering, the underwriters exercised in full their option to purchase an additional 222,625 from the Company and 92,375 from the Selling Stockholder.  As a result, the total offering size was 2,415,000 shares of common stock.  The Company used the net proceeds from its issuance of and sale of Class A common stock, par value $0.01 per share, to purchase, for cash, 1,572,296 limited liability company units of Adeptus

---

 

Health LLC, its direct subsidiary, from certain of the unit holders of Adeptus Health LLC, including certain of its directors and executive officers.  The Company did not receive any of the proceeds from the sale of shares of common stock of the Company by the Selling Stockholder. 

The Company consolidates the financial results of Adeptus Health LLC and its subsidiaries and records non-controlling interest for the economic interest in Adeptus Health LLC held by the non-controlling unit holders. The non-controlling interest ownership percentage as of June 30, 2015 was 44.3%.

Prior to the initial public offering, the Company borrowed under the Senior Secured Credit Facility (See Note 8 Debt for further information) to fund a dividend of $60.0 million to the then-existing  owners which was paid in connection with the consummation of the initial public offering. The Company used proceeds from the initial public offering to repay indebtedness under the Senior Secured Credit Facility from this borrowing.

 

NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation 

The accompanying unaudited condensed consolidated financial statements and footnotes have been prepared pursuant to the rules and regulations of the SEC. Certain information and note disclosures normally included in audited financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted pursuant to those rules and regulations. We believe that the disclosures made are adequate to make the information not misleading.

The condensed consolidated financial statements included herein reflect all adjustments (consisting of normal, recurring adjustments) which are, in the opinion of management, necessary to state fairly the results for the interim periods presented. All intercompany balances and transactions have been eliminated in consolidation. The results of operations for the interim periods presented are not necessarily indicative of the operating results to be expected for any subsequent interim period or for the fiscal year.

These condensed consolidated financial statements and related notes should be read in conjunction with the Company’s December 31, 2014 audited consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014 filed with the SEC on February 27, 2015.

Accounting Policies and Use of Estimates

The preparation of financial statements in conformity with GAAP requires our management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Significant accounting policies and estimates include: the useful lives of fixed assets, revenue recognition, allowances for doubtful accounts, leases, reserves for employee health benefit obligations, stock-based compensation, and other contingencies.  Actual results could differ from these estimates. For greater detail regarding these accounting policies and estimates, refer to our Annual Report on Form 10-K  for the fiscal year ended December 31, 2014.

Segment and Geographic Information

The Company’s chief operating decision maker is our Chief Executive Officer, who reviews financial information presented on a company-wide basis. As a result, the Company determined that it has a single reporting segment and operating unit structure.

---

 

All of the Company’s revenue for the three and six months ended June 30, 2015 was earned in the United States.

Cash and Cash Equivalents and Concentrations of Risk 

The Company includes all securities with a maturity date of six months or less at date of purchase as cash equivalents. The Company currently has no cash equivalents. The Company maintains its cash in bank deposit accounts, which, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts and does not believe it is exposed to any significant risk related to uninsured bank deposits.

Restricted Cash 

The Company is required to restrict cash for letters of credit related to the Master Funding and Development Agreements, as amended, for the first $250.0 million in facility fundings. See Note 11 (Commitments and Contingencies) for more information. Each letter of credit is issued in an amount equal to approximately 50% of one year's base rent relating to completed facilities. As of June 30, 2015 and December 31, 2014, total restricted cash was $7.8 million and $4.8 million, respectively.

Patient Revenue and Accounts Receivable 

Revenues consist primarily of net patient service revenues, which are based on the facilities’ established billing rates less allowances and discounts, principally for patients covered under contractual programs with private insurance companies. Revenue is recognized when services are rendered to patients. Charges for all services provided to insured patients are initially billed and processed by the patients' insurance provider. The Company has agreements with insurance companies that provide for payments to the Company at amounts different from its established rates or as determined by the patient's out of network benefits. Differences between established rates and those set by insurance programs, as well as charity care, employee and prompt pay adjustments, are recorded as adjustments directly to patient service revenue. Amounts not covered by the insurance companies are then billed to the patients. Estimated uncollectible amounts from insured patients are recorded as bad debt expense in the period the services are provided. Collection of payment for services provided to patients without insurance coverage is done at the time of service.

With respect to management and contract service revenues, amounts are recognized as services are provided. The Company is party to two management services agreements under which it provides management services to a hospital facility and freestanding emergency room facilities. As compensation for these services, the Company charges the managed entities a management fee based on a fixed percentage of each entity’s net revenue. The Company also holds minority ownership in these entities.

---

 

Net patient service revenue by major payor source for the three and six months ended June 30, 2015 and 2014 were as follows (in thousands):  

The Company receives payments from third-party payors that have contracts with the Company in Texas and Colorado prior to the contribution of its Colorado facilities to University of Colorado Health (UCHealth) as further described in footnote 4. As of June 30, 2015, the Company has a contract with Blue Cross Blue Shield of Texas and two MultiPlan arrangements whereby the Company accesses a number of third-party payors at in-network rates. Four major third-party payors accounted for 85.1%, 82.0%, 85.6% and 84.6% of patient service revenue for the three and six months ended June 30, 2015 and 2014, respectively. These same payors also accounted for 77.2%  and 80.0% of accounts receivable as of June 30, 2015 and December 31, 2014, respectively. The following table sets forth the percentage of patient service revenue earned by major payor source:

Accounts receivable are reduced by an allowance for doubtful accounts. In establishing the Company's allowance for doubtful accounts, management considers historical collection experience, the aging of the account, the payor classification, and patient payment patterns. Amounts due directly from patients represent the Company's highest collectability risk. There were not any significant changes in the estimates or assumptions underlying the calculation of the allowance for doubtful accounts for the three and six months ended June 30, 2015 and 2014.

The Company writes off as bad debt expense uncollectible accounts receivable arising from patient responsibility after all collection efforts have been exhausted and it has been determined such accounts will not be collected. Bad debt write-offs of approximately $8.6 million, $2.5 million, $10.6 million and $5.4 million were recorded for the three and six months ended June 30, 2015, and 2014, respectively.

---

 

The Company treats anyone that is emergent, including patients that may be eligible for Medicare or Medicaid. These services are provided at no charge to the patient. Total charity care was approximately 9.0%,  7.7%,  8.9% and 7.9% of patient service revenue for the three and six months ended June 30, 2015 and 2014, respectively.

Advertising Costs 

Advertising costs are expensed as incurred. Advertising expense for the three and six months ended June 30, 2015 and 2014, was approximately $0.9 million, $0.7 million, $2.3 million and $1.8 million, respectively, and is included as a component of general and administrative expenses within the unaudited condensed consolidated statements of operations.

Medical Supplies Inventory 

Inventory is carried at the lower of cost or market using the first-in, first-out method and consists of a standard set of medical supplies held in stock at all facilities.

Property and Equipment 

Property and equipment are stated at cost, less accumulated depreciation and amortization computed using the straight-line method over the estimated useful life of each asset. Leasehold improvements are amortized over the shorter of the noncancelable lease term or the estimated useful life of the improvements. When assets are retired, the cost and applicable accumulated depreciation are removed from the respective accounts, and the resulting gain or loss is recognized. Expenditures for normal repairs and maintenance are expensed as incurred. Material expenditures that increase the life of an asset are capitalized and depreciated over the estimated remaining useful life of the asset.

Amortization of assets acquired under capital leases is included as a component of depreciation and amortization expense in the accompanying unaudited condensed consolidated statements of operations. Amortization is calculated using the straight-line method over the shorter of the useful lives or the term of the underlying lease agreements.

Fair Value of Financial Instruments 

The carrying amounts of the Company's financial instruments, including cash, receivables, accounts payable and accrued liabilities approximate their fair value due to their relatively short maturities. At June 30, 2015 and December 31, 2014, the carrying value of the Company's long-term debt was based on the current interest rates and approximates its fair value.

Derivative Instruments and Hedging Activities 

The Company recognizes all derivative instruments as either assets or liabilities in the balance sheet at their respective fair values. For derivatives not designated as a hedging instrument, changes in the fair value are recorded in net earnings immediately. For derivatives designated in hedging relationships, changes in the fair value are either offset through earnings against the change in fair value of the hedged item attributable to the risk being hedged or recognized in accumulated other comprehensive income, to the extent the derivative is effective at offsetting the changes in cash flows being hedged until the hedged item affects earnings.

The Company only enters into derivative contracts that it intends to designate as a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (cash flow hedge). For all hedging relationships, the Company formally documents the hedging relationship and its risk-management objective and strategy for undertaking the hedge, the hedging instrument, the hedged transaction, the nature

---

 

of the risk being hedged, how the hedging instrument's effectiveness in offsetting the hedged risk will be assessed prospectively and retrospectively, and a description of the method used to measure ineffectiveness. The Company also formally assesses, both at the inception of the hedging relationship and on an ongoing basis, whether the derivatives that are used in hedging relationships are highly effective in offsetting changes in cash flows of hedged transactions. For derivative instruments that are designated and qualify as part of a cash flow hedging relationship, the effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income and reclassified into earnings in the same period or years during which the hedged transaction affects earnings. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings.

The Company discontinues hedge accounting prospectively when it determines that the derivative is no longer effective in offsetting cash flows attributable to the hedged risk, the derivative expires or is sold, terminated, or exercised or the cash flow hedge is dedesignated because a forecasted transaction is not probable of occurring.

In all situations in which hedge accounting is discontinued and the derivative remains outstanding, the Company continues to carry the derivative at its fair value on the balance sheet and recognizes any subsequent changes in its fair value in earnings. When it is probable that a forecasted transaction will not occur, the Company discontinues hedge accounting and recognizes immediately in earnings gains and losses that were accumulated in other comprehensive income related to the hedging relationship.

Lease Accounting 

The Company determines whether to account for its facility leases as operating or capital leases depending on the underlying terms of the lease agreement. This determination of classification is complex and requires significant judgment relating to certain information including the estimated fair value and remaining economic life of the facilities, the Company's cost of funds, minimum lease payments and other lease terms. The lease rates under the Company's lease agreements are subject to certain conditional escalation clauses that are recognized when probable or incurred and are based on changes in the consumer price index or certain operational performance measures. As of June 30, 2015, the Company leased 67 facilities, 66 of which the Company classified as operating leases and one of which the Company classified as a capital lease.

Income Taxes 

We provide for income taxes using the asset and liability method. This approach recognizes the amount of federal, state and local taxes payable or refundable for the current year, as well as deferred tax assets and liabilities for the future tax consequence of events recognized in the consolidated financial statements and income tax returns. Deferred income tax assets and liabilities are adjusted to recognize the effects of changes in tax laws or enacted tax rates.

A valuation allowance is required when it is more-likely-than-not that some portion of the deferred tax assets will not be realized. Realization is dependent on generating sufficient future taxable income.

We file a consolidated federal income tax return. State income tax returns are filed on a separate, combined or consolidated basis in accordance with relevant state laws and regulations. LPs, LLPs, LLCs and other pass-through entities that we consolidate file separate federal and state income tax returns. We include the allocable portion of each pass-through entity’s income or loss in our federal income tax return. We allocate the remaining income or loss of each pass-through entity to the other partners or members who are responsible for their portion of the taxes.

Estimated taxes of approximately $6.3 million, $0.04 million, $6.8 million and $0.2 million are included in the provision for income taxes in the financial statements for the three and six months ended June 30, 2015 and 2014, respectively. The Company's estimate of the potential outcome of any uncertain tax positions is subject to management's

---

 

assessment of relevant risks, facts, and circumstances existing at that time. The Company uses a more likely than not threshold for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.

To the extent that the Company's assessment of such tax position changes, the change in estimate is recorded in the period in which the determination is made. The Company reports tax related interest and penalties as a component of the provision for income tax and operating expenses, respectively, if applicable. The Company has not recognized any uncertain tax positions.

Deferred Rent 

The Company records rent expense for operating leases on a straight-line basis over the life of the related leases. The Company has certain facility and equipment leases that allow for leasehold improvements allowance, free rent, and escalating rental payments. Straight-line expenses that are greater than the actual amount paid are recorded as deferred rent and amortized over the life of the lease.

Variable Interest Entities

The Company follows the guidance in ASC 810-10-15-14-in order to determine if we are the primary beneficiary of a variable interest entity (“VIE”) for financial reporting purposes.  We consider whether we have the power to direct the activities of the VIE that most significantly impact the economic performance of the VIE and whether we have the obligation to absorb losses or the right to receive returns that would be significant to the VIE. We consolidate a VIE when we are the primary beneficiary of the VIE. At June 30, 2015, the Company determined that it has one joint venture interest which it considers a VIE for which we are not the primary beneficiary.  Accordingly, we account for this investment in joint venture using the equity method.

Investment in Unconsolidated Joint Ventures

Investments in unconsolidated companies in which the Company exerts significant influence but does not control or otherwise consolidate are accounted for using the equity method. As of June 30, 2015, the Company accounted for 13 freestanding facilities associated with our joint venture with University of Colorado Health and our Arizona hospital and its freestanding facility associated with our joint venture with Dignity Health using the equity method. The Company has an ownership interest of 49.9% in each joint venture.

These investments are included as investment in unconsolidated joint ventures in the accompanying unaudited condensed consolidated balance sheets.

Equity in earnings of unconsolidated joint ventures consists of (i) the Company’s share of the income (loss) generated from its non-controlling equity investment in one full-service healthcare hospital facility and freestanding emergency room in Arizona, and (ii) the Company’s preferred return and its share of the income (loss) generated from its non-controlling equity investment in 13 freestanding emergency rooms in Colorado. Because the operations are central to the Company’s business strategy, equity in earnings of unconsolidated joint ventures is classified as a component of operating income in the accompanying unaudited condensed consolidated statements of operations. The Company has contracts to manage the facilities, which results in the Company having an active role in the operations of the facilities and devoting a significant portion of its corporate resources to the fulfillment of these management responsibilities.

 

Recent Accounting Pronouncements 

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers” (Topic 606), which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it

---

 

becomes effective. The new standard will become effective for the Company on January 1, 2018. Early application is permitted to the original effective date of January 1, 2017. The standard permits the use of either the retrospective or cumulative effect transition method. The Company is evaluating the effect that ASU 2014-09 will have on its consolidated financial statements and related disclosures. The Company has not yet selected a transition method nor has it determined the effect of the standard on its ongoing financial reporting.

In February 2015, the FASB issued ASU No. 2015-02, “Consolidation: Amendments to the Consolidation Analysis” (Topic 810). This standard modifies existing consolidation guidance for reporting organizations that are required to evaluate whether they should consolidate certain legal entities. ASU 2015-02 is effective for fiscal years and interim periods within those years beginning after December 15, 2015 and requires either a retrospective or a modified retrospective approach to adoption. Early adoption is permitted.  We are currently evaluating the potential impact of this standard on our consolidated financial position, results of operations and cash flows.

In April 2015, the FASB issued ASU No. 2015-03, "Simplifying the Presentation of Debt Issuance Costs" (Subtopic 835-30), which changes the presentation of debt issuance costs in financial statements. ASU No. 2015-03 requires an entity to present such costs in the balance sheet as a direct deduction from the related debt liability rather than as an asset. Amortization of the costs will continue to be reported as interest expense. ASU No. 2015-03 is effective for annual reporting periods beginning after December 15, 2015. Early adoption is permitted. The new guidance will be applied retrospectively to each prior period presented. The Company will implement the provisions of ASU 2015-03 as of January 1, 2016.

We do not believe any other recently issued, but not yet effective, revisions to authoritative guidance will have a material effect on our condensed consolidated financial position, results of operations or cash flows.

NOTE 3—PROPERTY AND EQUIPMENT

Property and equipment consisted of the following (in thousands):

 

Assets under capital leases totaled approximately $4.2 million as of June 30, 2015 and December 31, 2014, respectively, and were included within the buildings component of net property and equipment. Accumulated depreciation associated with these capital lease assets totaled approximately $0.4 million and $0.3 million as of June 30, 2015 and December 31, 2014, respectively.

---

 

NOTE 4—INVESTMENT IN UNCONSOLIDATED JOINT VENTURES

On October 22, 2014, the Company announced its expansion into Arizona through a joint venture with Dignity Health, one of the nation’s largest health systems. The partnership started with Dignity Health Arizona General Hospital, a full-service healthcare hospital facility in Laveen, Arizona, and includes providing for additional access to emergency medical care in the Phoenix area.  Dignity Health Arizona General Hospital is a full-service healthcare hospital facility, licensed by the state as a general hospital. Spanning 39,000 square-feet, the hospital has 16 inpatient rooms, two operating rooms for inpatient and outpatient surgical procedures, an emergency department, a high-complexity laboratory and a full radiology suite. Patients have full access to the Dignity Health area facilities and physicians, and the hospital will provide Phoenix-area residents with 24/7 access to emergency medical care.

During the quarter ended June 30, 2015, the Company grew its existing partnership with Dignity Health in Arizona with the opening of a freestanding facility in Arizona.

On April 21, 2015, the Company announced the formation of a joint venture with University of Colorado Health (UCHealth) to enhance access to emergency medical care in Colorado.  Under the joint venture, UCHealth will hold a controlling interest in the Company’s freestanding emergency rooms and future facilities throughout Colorado Springs, northern Colorado and the Denver Metro area.

The Company contributed the 12 existing freestanding emergency rooms it held in Colorado and the related business associated with these facilities to the joint venture.  The contribution of the controlling interest in these facilities and their operations was deemed a change of control for accounting purposes, and as such, the Company has recorded a gain of $24.3 million on the contribution of the previously fully owned facilities during the quarter ended June 30, 2015.

Pursuant to the terms of the joint venture agreement, the Company receives an annual preferred return up to a specified amount on its investment in the joint venture prior to proportionate distributions to the partners.

The Company accounts for these joint ventures under the equity method of accounting as an investment in unconsolidated joint ventures, as the Company’s level of influence is significant but does not reach the threshold of controlling the entity.

The following summarizes the unaudited results of operations of our equity method investees, which represents 100% of their activities for the periods presented  (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

---

 

NOTE 5—GOODWILL AND OTHER INTANGIBLE ASSETS

The following table summarizes the change in goodwill during the six months ended June 30, 2015 (in thousands):  

 

 

The following table summarizes the change in intangible assets during the six months ended June 30, 2015 (in thousands):

 

 

 

 

 

 

 

 

 

NOTE 6—DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

As of June 30, 2015, the Company maintained one interest rate cap agreement with notional amount totaling $37.5 million. This agreement has the economic effect of capping the LIBOR variable component of the Company's interest rate at a maximum of 3.00% on an equivalent amount of the Company's Term Loan debt. The cap agreement was entered into in November 2013 at a cost of $0.09 million and expires on November 30, 2016. This cap agreement is designated as a cash flow hedge and, as a result, changes in the fair values of this cap agreement are reported in other comprehensive income. As of June 30, 2015, approximately $0.1 million of deferred losses on derivative instruments are included in other comprehensive income. The cap agreement does not contain credit-risk contingent features.

The following table summarizes the Company's derivative instruments (in thousands):  

 

 

 

 

NOTE 7—ACCOUNTS PAYABLE AND ACCRUED EXPENSES

Accounts payable and accrued expenses consisted of the following (in thousands):

 

 

---

 

 

 

   

 

NOTE 8—DEBT

The components of debt consisted of the following (in thousands):

 

On October 31, 2013, the Company entered into a Senior Secured Credit Facility (the “Facility”) for a $75.0 million term loan which matures on October 31, 2018. The Facility includes an additional $165.0 million delayed draw term loan commitment, which expired in April 2015, and a $10.0 million revolving commitment that matures on October 31, 2018. All of the Company's assets are pledged as collateral under the Facility. The borrowing under the Facility is used by the Company to provide financing for working capital, capital expenditures and for new facility expansion and replaced the Company's existing credit facility.

On March 31, 2014, the Company amended the Facility to, among other things, increase the maximum aggregate amount permitted to be funded by Medical Properties Trust (“MPT”) under the MPT Agreements to $250.0 million. See Note 11 (Commitments and Contingencies) for more information.

On June 11, 2014, the Company entered into a second amendment to the Facility to, among other things, provide for a borrowing under the delayed draw term loan in an aggregate principal amount of up to $75.0 million, up to $60.0 million in principal amount of which will be used to make specified distributions and up to $10.0 million in principal amount of which will be used to repay certain revolving loans.  On June 11, 2014, the Company drew $75.0 million and made the $60.0 million dividend distribution on June 24, 2014.

On April 20, 2015, the Company amended the Facility to, among other things, increase the maximum aggregate amount permitted to be funded by MPT under the MPT Agreements to $500.0 million.

Borrowings under the Facility bear interest, at our option, at a rate equal to an applicable margin over (a) a base rate determined by reference to the highest of (1) the prime rate, (2) the federal funds effective rate plus 0.50% and (3) LIBOR for an interest period of one month plus 1%, or (b) LIBOR for the applicable interest period. The margin for the Facility is 6.50% in the case of base rate loans and 7.50% in the case of LIBOR loans. The Facility includes an unused line fee of 0.50% per annum on the revolving commitment and delayed draw term loan commitment, a draw fee of 1.0% of the principal amount of each borrowing on the delayed draw term loan and an annual Agency fee of $0.1 million. In April 2015, the Company drew $30.0 million on the delayed draw term loan prior to its expiration. At December 31, 2014, the Company had $80.2 million available under the delayed draw term commitment. The Company had approximately $9.5 million and $4.0 million available under the revolving commitment at June 30, 2015 and December 31, 2014, respectively.

The original principal amount of the term loan requires quarterly installments of $0.5 million on the last day of each fiscal quarter commencing with the fiscal quarter ending December 31, 2015 and escalating to $0.9 million for each fiscal quarter ending after December 31, 2016. The delayed draw term loan requires quarterly installments in an amount based on the repayment calculation contained in the Facility on the last day of each fiscal quarter commencing with the

---

 

fiscal quarter ending December 31, 2015. The Company is required to repay the aggregate principal amount of all revolving loans outstanding on the maturity date, October 31, 2018.

The Facility contains certain affirmative covenants, negative covenants, and financial covenants which are measured on a quarterly basis. As of June 30, 2015, the Company was in compliance with all covenant requirements.

In June 2015, the Company entered into a twelve month finance agreement totaling approximately $0.8 million, with a fixed interest rate of 3.5%, to finance the renewal of certain insurance policies. In 2014, the Company entered into finance agreements totaling approximately $1.9 million to finance the renewal of certain insurance policies. The finance agreements have fixed interest rates ranging between 2.49% and 3.25% with principal being repaid over 9 to 11 months. In October 2013, the Company renewed certain insurance policies and entered into a finance agreement totaling approximately $0.8 million. The finance agreement has a fixed interest rate of 1.93% with principal being repaid over 9 months.

NOTE 9—TRANSACTIONS WITH RELATED PARTIES

The Company made payments to a significant shareholder of the Company for management services and reimbursement of certain expenses related to an advisory services agreement. The total amount paid to this related party was approximately $2,000,  $25,000,  $4,000 and $0.6 million for the three and six months ended June 30, 2015 and 2014, respectively.  In connection with the consummation of the initial public offering, the advisory services agreement was terminated and the Company paid a one-time termination payment fee of $2.0 million in July 2014.

The Company made payments for contractor services to various related-party vendors, which totaled approximately $9,000,  $14,000,  $19,000 and $30,000 for the three and six months ended June 30, 2015 and 2014, respectively.

We entered into a license and master services agreement with IO Phoenix One, LLC, or IO, an affiliate of a significant shareholder on November 22, 2013, pursuant to which IO stores and maintains our data centers and modules at its Phoenix, Arizona location. We pay approximately $7,000 per month in license fees with an initial term of 36 months.

NOTE 10—EMPLOYEE BENEFIT PLANS

The Company provides a 401(k) savings plan to all employees who have met certain eligibility requirements, including performing one month of service with the Company. The 401(k) plan permits matching and discretionary employer contributions. During the six months ended June 30, 2015 and 2014, the Company contributed approximately $0.9 million and $0.5 million to the 401(k) Plan for 2014 and 2013 matching contributions, respectively.

NOTE 11—COMMITMENTS AND CONTINGENCIES

Litigation and Asserted Claims 

The Company is a defendant in various legal proceedings arising in the ordinary course of business. While, management believes the outcome of pending litigation and claims will not have a material adverse effect on the Company's consolidated financial condition, operations, or cash flows, litigation is subject to inherent uncertainties. 

Insurance Arrangements 

The Company is self-insured for employee health benefits. Accruals for losses are provided based upon claims experience and actuarial assumptions, including provisions for incurred but not reported losses. At both June 30, 2015

---

 

and December 31, 2014, the Company has an accrual of approximately $0.7 million for incurred but not reported claims, which is included in accrued compensation within the condensed consolidated balance sheets.

The Company is insured for worker's compensation claims up to $1.0 million per accident and per employee with a policy limit of $1.0 million. The Company submits periodic payments to its insurance broker based upon estimated payroll. Worker's compensation expense for the three and six months ended June 30, 2015 and 2014 was approximately $0.1 million, $0.1 million, $0.1 million and $0.2 million. The Company is insured for professional liability claims up to $1.0 million per incident and $3.0 million per facility with an aggregate policy limit of $20.0 million.

Leases 

The Company leases certain medical facilities and equipment under various noncancelable operating leases. In June 2013, the Company entered into an initial MPT Agreement (the “Initial MPT Agreement”) with an affiliate of Medical Properties Trust (“MPT”) to fund future facility development and construction. The lessor to the MPT Agreement will acquire parcels of land, fund the ground-up construction of new freestanding emergency room facilities and lease the facilities to the Company upon completion of construction. Under the terms of the agreement, the lessor is to fund all hard and soft costs, including the project purchase price, closing costs and pursuit costs for the assets relating to the construction of up to twenty-five facilities with a maximum aggregate funding of $100.0 million. Each completed project will be leased for an initial term of 15 years, with three 5-year renewal options. The Company follows the guidance in ASC 840, Leases, and ASC 810, Consolidation, in evaluating the lease as a build-to-suit lease transaction to determine whether the Company would be considered the accounting owner of the facilities during the construction period. In applying the accounting guidance, the Company concluded that the one facility completed in 2013 under this arrangement qualified for capitalization.

In July 2014, the Company entered into an additional Master Funding and Development Agreement (the “Additional MPT Agreement” and, together with the Initial MPT Agreement, the “MPT Agreements”) with MPT to fund future new freestanding emergency rooms and hospitals. This agreement is separate from and in addition to the Company’s Initial MPT Agreement. The Additional MPT Agreement allows for an additional maximum aggregate funding of $150.0 million. All other material terms remain consistent with the Initial MPT Agreement.

On April 20, 2015, the Company entered into an amendment to the Additional MPT Agreement which adds an additional aggregate funding of $250.0 million, increasing the maximum aggregate funding under all of the MPT Agreements to $500.0 million. All newly constructed facilities under the MPT Agreements will have initial terms of 15 years, with three five-year renewal options.

In addition to the MPT Agreements, the Company has entered into similar agreements with certain developers to fund and lead the development efforts on the construction of future facilities. As of June 30, 2015, the Company had total receivables of $10.0 million from the lessor to the MPT agreements and certain other developers for soft costs incurred for facilities currently under development.

The Company leases approximately 80,000 square feet for its corporate headquarters. Lease expense associated with this lease was $0.4 million, $0.4 million, $0.8 million and $0.6 million for the three and six months ended June 30, 2015 and 2014, respectively.

---

 

Future minimum lease payments required under noncancelable operating leases and future minimum, capital lease payments as of June 30, 2015 were as follows (in thousands):  

 

 

Rent expense totaled approximately $7.1 million, $2.8 million, $14.3 million and $4.7 million for the three and six months ended June 30, 2015 and 2014, respectively and is included as a component of other operating expenses within the unaudited condensed consolidated statements of operations.  The Company has sublease agreements with the joint ventures in Arizona and Colorado, under which the Company subleases certain freestanding emergency room facilities, ground leases and equipment leases to the joint ventures.  Under these agreements, the Company received $2.5 million and $3.2 million during the three and six months ended June 30, 2015, respectively, as rental income which is accounted for as a reduction of rent expense.

NOTE 12—SUPPLEMENTAL CASH FLOW INFORMATION

Supplemental cash flow information and supplemental noncash activities consisted of the following for the six months ended June 30 (in thousands):

 

 

 

 

 

 

NOTE 13—STOCK BASED COMPENSATION

In connection with the initial public offering, the Company’s Board of Directors adopted the Adeptus Health Inc. 2014 Omnibus Incentive Plan (the “Omnibus Incentive Plan”).  The Omnibus Incentive Plan provides for the granting of stock options, restricted stock and other stock-based or performance-based awards to directors, officers, employees, consultants and advisors of the Company and its affiliates. The total number of shares of Class A common

---

 

stock that may be issued under the Omnibus Incentive Plan is 1,033,500.  At June 30, 2015, 193,547 stock-based awards had been issued under the Omnibus Incentive Plan (excluding forfeitures) and 839,953 stock-based awards remained available for equity grants.

During the three months ended June 30, 2015 and 2014, the Company issued, 5,273 and 11,934 restricted shares of Class A common stock, respectively. The fair value of these restricted shares of Class A common stock issued during the three months ended June 30, 2015 ranged from $92.44 to $93.72 per share, and these shares vest on January 1, 2016.  During the six months ended June 30, 2015 and 2014, the Company issued 149,741 and 11,934 restricted shares of Class A common stock, respectively. The fair value of these restricted shares of Class A common stock issued during the six months ended June 30, 2015 ranged from $35.03 to $93.72 per share, and these shares vest over a period of six months to 4 years.

The Company also has one legacy equity-compensation plan, under which it has issued agreements awarding incentive units (restricted units) in the Company to certain employees and non-employee directors. In conjunction with the Reorganization Transactions, these restricted units were replaced with LLC Units with consistent restrictive terms. The restricted units are subject to such conditions as continued employment, passage of time and/or satisfaction of performance criteria as specified in the agreements. The restricted units vest over 3 to 4 years from the date of grant. The Company used a waterfall calculation, based on the capital structure and payout of each class of debt and equity, and a present value pricing model less marketability discount to determine the fair values of the restricted units. The Company did not issue any incentive units under the legacy plan during the three and six months ended June 30, 2015 and 2014.

The Company recorded compensation expense of $0.6 million, $0.2 million, $1.1 million and $0.3 million, adjusted for forfeitures, during the three and six months ended June 30, 2015 and 2014, respectively, related to restricted units with time-based vesting schedules. Compensation expense for the value of the portion of the time-based restricted unit that is ultimately expected to vest is recognized using a straight-line method over the vesting period, adjusted for forfeitures.  On February 18, 2015, our Board of Directors accelerated the vesting of all performance-based units. As a result of the acceleration, the Company recognized $0.1 million of additional stock-based compensation expense for the six months ended June 30, 2015.

 

 

14. INCOME TAXES

The Company makes estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of certain tax assets and liabilities, which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes.

The Company’s provision for income taxes in interim periods is based on our estimated annual effective tax rate. The estimated annual effective tax rate calculation does not include the effect of discrete events that may occur during the year. The effect of these events, if any, is recorded in the quarter in which the event occurs.

Prior to the Reorganization, we were not a federal taxpayer. The Company’s effective tax rate for the period differs from the statutory rates due primarily to state taxes that are not based on pre-tax income/(loss) but on gross margin resulting in state tax expense with little relation to pre-tax income and even in periods of pretax losses.

The Company’s deferred tax assets of $70.6 million are composed of $47.0 million due to the underlying basis difference in Adeptus Health LLC, $23.0 million related to the tax receivable agreement and $0.6 million related to taxable losses.

---

 

Tax Receivable Agreement

Upon the consummation of the Company’s initial public offering, the Company entered into a tax receivable agreement with the LLC Unit holders after the closing of the offering that provides for the payment from time to time by the Company to the LLC Unit holders of 85% of the amount of the benefits, if any, that the Company is deemed to realize as a result of increases in tax basis and certain other tax benefits related to exchanges of LLC Units pursuant to the exchange agreement, including tax benefits attributable to payments under the tax receivable agreement.  These payment obligations are obligations of the Company.  For purposes of the tax receivable agreement, the benefit deemed realized by the Company was computed by comparing its actual income tax liability (calculated with certain assumptions) to the amount of such taxes that the Company would have been required to pay had there been no increase to the tax basis of the assets of Adeptus Health LLC as a result of the exchanges and had the Company not entered into the tax receivable agreement. The step-up in basis will depend on the fair value of the LLC Units at conversion.

As of June 30, 2015, the Company has recorded an estimated payable pursuant to the tax receivable agreement of $71.6 million related to certain transactions in conjunction with the initial and secondary public offerings that are expected to give rise to certain tax benefits in the future.

 

15. NET INCOME (LOSS) PER SHARE

Prior to the consummation of the Company’s initial public offering, the Company did not have outstanding common stock. However, in conjunction with the closing of the initial public offering, an existing owner exchanged their LLC Units for shares of the Company’s Class A common stock.  Basic net income (loss) per share is computed by dividing the net income (loss) by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share is computed by using the weighted average number of common shares outstanding, including potential dilutive shares of common stock assuming the dilutive effect of outstanding stock options and restricted stock using the treasury stock method. 

---

 

The following table sets forth the computation of basic and diluted net income (loss) per common share:

 

 

Earnings per share information is not applicable for reporting periods prior to the initial public offering. The shares of Class B common stock do not share in the earnings or losses of Adeptus Health Inc. and are therefore not participating securities. Accordingly, basic and diluted net loss per share of Class B common stock has not been presented.

 

16. SUBSEQUENT EVENTS

On July 27, 2015, an existing stockholder of ADPT (the “Selling Stockholder”) and the Company offered 1,079,649 and 2,320,351 shares, respectively, of the Company’s Class A common stock in an underwritten public offering,  at a price of $105.00 per share.  In connection with the offering, the underwriters have the option to purchase an additional 510,000 shares from the Company and Selling Stockholder at the public offering price, less the underwriting discount. The Company intends to use the net proceeds from this offering to purchase, for cash, 2,320,351 limited liability company units of Adeptus Health LLC, its direct subsidiary, from certain of the unit holders of Adeptus Health LLC, including certain of its directors and executive officers.  The Company will not receive any of the proceeds from the sale of the shares being sold by the Selling Stockholder.