10-Q 1 cotv-20180630x10q.htm 10-Q cotv_Current_Folio_10Q

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549


Form 10-Q


(Mark One)

 

    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2018

OR

 

    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Cotiviti Holdings, Inc.

(Exact name of registrant as specified in its charter)


Delaware

(State or other jurisdiction of incorporation)

 

001-37787
(Commission
File Number)

46-0595918
(IRS Employer
Identification No.)

One Glenlake Parkway
Suite 1400
Atlanta, GA
(Address of principal executive offices)

30328
(Zip Code)

 

(770) 379-2800

(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, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b‑2 of the Exchange Act. (Check one):

 

Large accelerated filer

Accelerated filer

 

 

 

 

Non-accelerated filer

☐(Do not check if a smaller reporting company)

Smaller reporting company

Emerging growth company

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

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 common stock, $0.001 par value, outstanding as of June 30, 2018 was 93,275,782.

 

 

 


 

1


 

Definitions

 

As used in this Quarterly Report on Form 10-Q for the period ended June 30, 2018 (this “Quarterly Report on Form 10‑Q” or this “Report”), the following abbreviations and terms have the meanings as listed below. Additionally, the terms “Cotiviti,” “we,” “us” and “our” refer to Cotiviti Holdings, Inc. and its consolidated subsidiaries, unless the context clearly indicates otherwise. The term “Cotiviti Holdings” refers only to Cotiviti Holdings, Inc. and not to any of its subsidiaries. Unless and as otherwise stated, any references in this Quarterly Report to any agreement means such agreement and all schedules, exhibits and attachments in each case as amended, restated, supplemented or otherwise modified to the date of filing this Quarterly Report.

 

2012 Plan: refers to the Cotiviti Holdings, Inc. 2012 Equity Incentive Plan.

 

2016 Plan: refers to the Cotiviti Holdings, Inc. 2016 Equity Incentive Plan.

 

2017 Annual Report on Form 10-K: refers to our Annual Report on Form 10-K for the year ended December 31, 2017, filed with the SEC on February 22, 2018.

 

Adjusted EBITDA: refers to net income before depreciation and amortization, interest expense, other non-operating (income) expense, income tax expense, transaction-related expenses and other, stock-based compensation, loss on extinguishment of debt and the adjustment related to the original Medicare RAC contract.

 

Affordable Care Act: refers to the Patient Protection and Affordable Care Act of 2010.

 

ASC: refers to the FASB Accounting Standards Codification.

 

ASU: refers to Accounting Standards Update issued by the FASB.

 

CMS: refers to the Centers for Medicare and Medicaid Services, the United States federal agency which administers Medicare and Medicaid.

 

Equity Plans: refers, collectively, to the 2012 Plan and the 2016 Plan.

 

EPS: refers to earnings per share.

 

ESPP: refers, collectively, to our U.S. and non-U.S. employee stock purchase plans, which became effective January 1, 2017, and were approved by our stockholders on May 25, 2017.

 

Exchange Act: refers to the United States Securities Exchange Act of 1934, as amended.

 

FASB: refers to the Financial Accounting Standards Board.

 

First Lien Credit Facilities: refers to the First Lien Term A Loans in the original principal amount of $250.0 million, the First Lien Term B Loans in the original principal amount of $550.0 million and the $100.0 million Revolver under the Restated Credit Agreement.

 

First Lien Term A Loans: refers to the First Lien Term A Loans in the original principal amount of $250.0 million under our Restated Credit Agreement.

 

First Lien Term B Loans: refers to the First Lien Term B Loans in the original principal amount of $550.0 million under our Restated Credit Agreement.

 

First Lien Term Loans: refers, collectively, to the First Lien Term A Loans and the First Lien Term B Loans under our Restated Credit Agreement.

 

GAAP: refers to generally accepted accounting principles in the United States.

 

HSR Act: refers to the Hart-Scott-Rodino Antitrust Improvements Act of 1976.

2


 

 

IT: refers to information technology.

 

LIBOR: refers to the London inter-bank offered rate.

 

Medicaid: refers to the means-tested United States government health care insurance program for people of all ages, jointly funded by state and federal governments and managed by the states. The Social Security Amendments of 1965 created Medicaid by adding Title XIX to the Social Security Act of 1935.

 

Medicare: refers to the United States government health care insurance program providing health insurance to people age 65 and older, regardless of income or medical history, as well as people of all ages with disabilities and certain medical conditions. The Social Security Amendments of 1965 created Medicare by adding Title XVIII to the Social Security Act of 1935.

 

Medicare RAC: refers to a Medicare Recovery Audit Contractor; we are one of the Medicare RACs for CMS under the Medicare Recovery Audit Program.

 

Merger Sub: refers to Rey Merger Sub, Inc., a wholly owned subsidiary of Verscend. 

 

NYSE: refers to the New York Stock Exchange, on which our shares are listed under the symbol “COTV.”

 

Restated Credit Agreement: refers to the Amended and Restated First Lien Credit Agreement, dated as of September 28, 2016, entered into by our subsidiary Cotiviti Corporation and certain other of our subsidiaries, as borrowers and/or guarantors, the lenders named therein, as lenders, and the agents named therein, pursuant to which the lenders agreed to provide the First Lien Credit Facilities comprising the First Lien Term A Loans in the original principal amount of $250.0 million, the First Lien Term B Loans in the original principal amount of $550.0 million and the $100.0 million Revolver.

 

Revolver: refers to the $100.0 million first lien revolving credit facility under our Restated Credit Agreement.

 

RowdMap: refers to RowdMap, Inc., which we acquired on July 14, 2017.

 

RowdMap Acquisition: refers to the July 14, 2017 acquisition of all of the outstanding shares of RowdMap.

 

RSUs: refers to restricted stock units.

 

Sarbanes-Oxley Act: refers to the United States Sarbanes-Oxley Act of 2002.

 

SEC: refers to the United States Securities and Exchange Commission.

 

Securities Act: refers to the United States Securities Act of 1933, as amended.

 

SG&A: refers to selling, general and administrative.

 

Tax Act: refers to the Tax Cuts and Jobs Act enacted on December 22, 2017, which among other things, reduces the federal tax rate on U.S. earnings to 21%, effective January 1, 2018, and moves from a global taxation regime to a modified territorial regime.

 

Verscend: refers to Verscend Technologies, Inc.

 

Verscend Merger: refers to the proposed merger of Cotiviti and Merger Sub pursuant to the terms of the Verscend Merger Agreement.

 

Verscend Merger Agreement: refers to the Agreement and Plan of Merger, dated June 19, 2018, by and among Cotiviti, Verscend and Merger Sub. The Verscend Merger Agreement provides that, upon the terms and subject to the satisfaction or waiver of the conditions set forth therein, Merger Sub will merge with and into Cotiviti, with Cotiviti continuing as the surviving corporation and a wholly owned subsidiary of Verscend.

3


 

Cautionary Note Regarding Forward-Looking Statements

 

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act and Section 21E of the Exchange Act. Forward-looking statements can be identified by words such as “anticipate,” estimate,” “expect,” “project,” “seek,” “plan,” “intend,” “believe,” “will,” “may,” “could,” “continue,” “likely,” “should” and similar references to future periods, or by the inclusion of forecasts or projections. Examples of forward-looking statements include, but are not limited to, statements we make regarding the outlook for our future business and financial performance.

 

Forward-looking statements are based on our current expectations and assumptions regarding our business, the economy and other future conditions. Because forward-looking statements relate to the future, by their nature, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict. As a result, our actual results may differ materially from those contemplated by the forward-looking statements. Important factors that could cause actual results to differ materially from those in the forward-looking statements include regional, national or global political, economic, business, competitive, market and regulatory conditions and the following:

 

·

risks relating to the Verscend Merger, including failure to timely complete the Verscend Merger, if at all;

 

·

system interruptions or failures, including cyber-security breaches, identity theft or other disruptions that could compromise our information;

 

·

our inability to successfully leverage our existing client base by expanding the volume of claims reviewed and cross-selling additional solutions;

 

·

our clients declining to renew their agreements with us or renewing at lower performance fee levels or a less favorable pass position;

 

·

our failure to innovate and develop new solutions for our clients;

 

·

delays in implementing our solutions;

 

·

our failure to maintain or upgrade our operational platforms;

 

·

inability to develop new clients;

 

·

improvements to healthcare claims and retail billing processes reducing the demand for our solutions or rendering our solutions unnecessary;

 

·

loss of a large client;

 

·

early termination provisions in our contracts;

 

·

our failure to accurately estimate the factors upon which we base our contract pricing;

 

·

our inability to manage our relationships with information suppliers, software vendors or utility providers;

 

·

our inability to protect our intellectual property rights, proprietary technology, information, processes and know-how;

 

·

our inability to execute our business plans including our inability to manage our growth;

 

·

our inability to successfully integrate and realize synergies from any future acquisitions or strategic partnerships;

 

·

our inability to realize the book value of intangible assets;

 

4


 

·

our being required to pay significant refunds to CMS under our Medicare RAC contracts or significant changes to the Medicare RAC program;

 

·

declines in contracts awarded through competitive bidding or our inability to re-procure contracts through the competitive bidding process;

 

·

our success in attracting and retaining qualified employees and key personnel;

 

·

our inability to expand our retail business;

 

·

fluctuations in our results of operations;

 

·

our failure to maintain effective internal controls;

 

·

litigation, regulatory or dispute resolution proceedings, including claims or proceedings related to intellectual property infringements or claims not covered by insurance;

 

·

healthcare spending fluctuations;

 

·

consolidation among healthcare payers or retailers;

 

·

slow development of the healthcare payment accuracy market;

 

·

negative publicity concerning the healthcare payment industry or patient confidentiality and privacy;

 

·

significant competition for our solutions;

 

·

risks associated with international operations;

 

·

general economic, political and market forces and dislocations beyond our control;

 

·

variations in our revenue between reporting periods due to timing issues;

 

·

our failure to comply with applicable federal, state, local and international privacy, security and data laws, regulations and standards;

 

·

changes in regulations governing healthcare administration and policies, including governmental restrictions on the outsourcing of functions such as those that we provide;

 

·

changes in tax laws and rules or in their interpretation or enforcement;

 

·

the timing and magnitude of shares purchased under our share repurchase program;

 

·

risks related to our substantial indebtedness and holding company structure;

 

·

volatility in bank and capital markets;

 

·

provisions in our amended and restated certificate of incorporation; and

 

·

other risks identified in this Report, in our 2017 Annual Report on Form 10-K and in other reports and filings filed by us with the SEC.

 

For the reasons described above, we caution you against relying on any forward-looking statements, which should also be read in conjunction with the other cautionary statements that are included elsewhere in this Quarterly Report on Form 10-Q. Any forward-looking statement made by us in this Quarterly Report on Form 10-Q speaks only as of the date on which it is made. Factors or events that could cause our actual results to differ may emerge from time to

5


 

time, and it is not possible for us to predict all of them. Given these uncertainties, you should not place undue reliance on these forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by law.

 

 

6


 

PART I - FINANCIAL INFORMATION

 

ITEM 1.   Consolidated Financial Statements

 

Cotiviti Holdings, Inc.

Consolidated Balance Sheets

(In thousands, except share and per share amounts)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 

 

December 31, 

 

 

    

2018

    

2017

 

 

 

(Unaudited)

 

 

 

 

ASSETS

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

223,927

 

$

165,518

 

Restricted cash

 

 

12,031

 

 

11,383

 

Accounts receivable, net of allowance for doubtful accounts of $29 and $176 at June 30, 2018 and December 31, 2017, respectively; and net of estimated allowance for refunds and appeals of $43,062 and $35,434 at June 30, 2018 and December 31, 2017, respectively

 

 

74,574

 

 

83,756

 

Prepaid expenses and other current assets

 

 

24,805

 

 

15,314

 

Total current assets

 

 

335,337

 

 

275,971

 

Property and equipment, net

 

 

82,549

 

 

77,340

 

Goodwill

 

 

1,252,306

 

 

1,251,364

 

Intangible assets, net

 

 

463,223

 

 

492,040

 

Other long-term assets

 

 

3,374

 

 

2,514

 

TOTAL ASSETS

 

$

2,136,789

 

$

2,099,229

 

LIABILITIES AND STOCKHOLDERS' EQUITY

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

Current maturities of long-term debt

 

$

21,125

 

$

18,000

 

Customer deposits

 

 

12,031

 

 

11,383

 

Accounts payable and accrued other expenses

 

 

27,143

 

 

25,906

 

Accrued compensation costs

 

 

33,217

 

 

42,725

 

Estimated liability for refunds and appeals

 

 

4,885

 

 

61,607

 

Total current liabilities

 

 

98,401

 

 

159,621

 

Long-term liabilities:

 

 

 

 

 

 

 

Long-term debt

 

 

738,528

 

 

749,618

 

Other long-term liabilities

 

 

6,492

 

 

5,474

 

Deferred tax liabilities

 

 

92,469

 

 

83,048

 

Total long-term liabilities

 

 

837,489

 

 

838,140

 

Total liabilities

 

 

935,890

 

 

997,761

 

Commitments and contingencies

 

 

 

 

 

 

 

Stockholders' equity:

 

 

 

 

 

 

 

Common stock ($0.001 par value; 600,000,000 shares authorized, 93,275,782 and 92,299,294 issued and outstanding at June 30, 2018 and December 31, 2017, respectively)

 

 

93

 

 

92

 

Additional paid-in capital

 

 

961,055

 

 

933,710

 

Retained earnings

 

 

243,172

 

 

172,120

 

Accumulated other comprehensive loss

 

 

(3,421)

 

 

(4,454)

 

Total stockholders' equity

 

 

1,200,899

 

 

1,101,468

 

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY

 

$

2,136,789

 

$

2,099,229

 

 

See accompanying notes to consolidated financial statements.

7


 

Cotiviti Holdings, Inc.

Consolidated Statements of Comprehensive Income

(In thousands, except share and per share amounts)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30, 

 

June 30, 

 

 

    

2018

    

2017

    

2018

    

2017

    

Net revenue

 

$

177,453

 

$

167,611

 

$

396,487

 

$

327,744

 

Cost of revenue (exclusive of depreciation and amortization, stated separately below):

 

 

 

 

 

 

 

 

 

 

 

 

 

Compensation

 

 

57,135

 

 

58,870

 

 

115,227

 

 

115,158

 

Other costs of revenue

 

 

7,626

 

 

6,123

 

 

14,099

 

 

12,809

 

Total cost of revenue

 

 

64,761

 

 

64,993

 

 

129,326

 

 

127,967

 

Selling, general and administrative expenses (exclusive of depreciation and amortization, stated separately below):

 

 

 

 

 

 

 

 

 

 

 

 

 

Compensation

 

 

32,500

 

 

25,564

 

 

67,680

 

 

50,257

 

Other selling, general and administrative expenses

 

 

18,005

 

 

15,300

 

 

36,771

 

 

32,179

 

Total selling, general and administrative expenses

 

 

50,505

 

 

40,864

 

 

104,451

 

 

82,436

 

Depreciation and amortization of property and equipment

 

 

7,200

 

 

5,896

 

 

14,442

 

 

11,471

 

Amortization of intangible assets

 

 

14,397

 

 

15,201

 

 

28,793

 

 

30,400

 

Transaction-related expenses

 

 

7,193

 

 

661

 

 

7,407

 

 

1,392

 

Total operating expenses

 

 

144,056

 

 

127,615

 

 

284,419

 

 

253,666

 

Operating income

 

 

33,397

 

 

39,996

 

 

112,068

 

 

74,078

 

Other expense (income):

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

10,174

 

 

8,538

 

 

19,351

 

 

16,959

 

Loss on extinguishment of debt

 

 

 —

 

 

3,183

 

 

 —

 

 

3,183

 

Other non-operating (income) expense

 

 

(305)

 

 

(556)

 

 

(640)

 

 

(1,009)

 

Total other expense (income)

 

 

9,869

 

 

11,165

 

 

18,711

 

 

19,133

 

Income before income taxes

 

 

23,528

 

 

28,831

 

 

93,357

 

 

54,945

 

Income tax expense

 

 

6,953

 

 

7,743

 

 

22,855

 

 

6,882

 

Net income

 

$

16,575

 

$

21,088

 

$

70,502

 

$

48,063

 

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments

 

 

402

 

 

452

 

 

610

 

 

509

 

Change in fair value of derivative instruments

 

 

423

 

 

193

 

 

423

 

 

131

 

Total other comprehensive income (loss)

 

 

825

 

 

645

 

 

1,033

 

 

640

 

Comprehensive income

 

$

17,400

 

$

21,733

 

$

71,535

 

$

48,703

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.18

 

$

0.23

 

$

0.76

 

$

0.52

 

Diluted

 

 

0.17

 

 

0.22

 

 

0.74

 

 

0.51

 

 

See accompanying notes to consolidated financial statements.

8


 

Cotiviti Holdings, Inc.

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended

 

 

 

June 30, 

 

 

    

2018

    

2017

 

Cash flows from operating activities:

 

 

 

 

 

 

 

Net income

 

$

70,502

 

$

48,063

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

 

Deferred income taxes

 

 

8,915

 

 

2,588

 

Depreciation and amortization

 

 

43,235

 

 

41,871

 

Stock-based compensation expense

 

 

17,387

 

 

4,538

 

Amortization of debt issuance costs

 

 

1,035

 

 

1,494

 

Accretion of asset retirement obligations

 

 

106

 

 

98

 

Loss on extinguishment of debt

 

 

 —

 

 

3,183

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

Accounts receivable

 

 

9,182

 

 

(19,480)

 

Other assets

 

 

(10,382)

 

 

(14,471)

 

Accrued compensation

 

 

(9,508)

 

 

(20,622)

 

Accounts payable and accrued other expenses

 

 

3,092

 

 

(194)

 

Estimated liability for refunds and appeals

 

 

(56,722)

 

 

(4,904)

 

Other long-term liabilities

 

 

1,309

 

 

372

 

Other

 

 

563

 

 

(236)

 

Net cash provided by operating activities

 

 

78,714

 

 

42,300

 

Cash flows from investing activities:

 

 

 

 

 

 

 

Expenditures for property and equipment

 

 

(21,213)

 

 

(16,593)

 

Net cash used in investing activities

 

 

(21,213)

 

 

(16,593)

 

Cash flows from financing activities:

 

 

 

 

 

 

 

Proceeds from issuance of common stock under equity plans

 

 

9,990

 

 

10,546

 

Payment of debt issuance costs

 

 

 —

 

 

(661)

 

Repayment of debt

 

 

(9,000)

 

 

(9,000)

 

Net cash provided by financing activities

 

 

990

 

 

885

 

Effect of foreign exchanges on cash and cash equivalents

 

 

(82)

 

 

199

 

Net increase in cash, cash equivalents and restricted cash

 

 

58,409

 

 

26,791

 

Cash, cash equivalents and restricted cash at beginning of period

 

 

165,518

 

 

110,635

 

Cash, cash equivalents and restricted cash at end of the period

 

$

223,927

 

$

137,426

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

 

 

Cash paid for income taxes

 

$

21,464

 

$

16,977

 

Cash paid for interest

 

 

16,908

 

 

14,343

 

Noncash investing activities (accrued property and equipment purchases)

 

 

4,200

 

 

9,340

 

 

See accompanying notes to consolidated financial statements

 

 

9


 

Table of Contents

Cotiviti Holdings, Inc.

Notes to the Financial Statements

(In thousands, except shares and per share amounts)

(Unaudited)

 

Note 1. Description of Business

 

Cotiviti Holdings, Inc. (collectively with its subsidiaries, “we,” “our,” “Cotiviti” or the “Company”) is a leading provider of payment accuracy and analytics-driven solutions that help payers, other risk-bearing healthcare organizations and retailers achieve their business objectives. Through a combination of analytics, technology and deep industry expertise, our solutions create insights that unlock value from the complex interactions between clients and their stakeholders. We serve a majority of the top 25 U.S. healthcare payers and a majority of the top ten U.S. retailers.

 

Note 2. Proposed Verscend Merger

On June 19, 2018, we entered into the Verscend Merger Agreement. The Verscend Merger Agreement provides that, upon the terms and subject to the satisfaction or waiver of the conditions set forth therein, Merger Sub will merge with and into Cotiviti, with Cotiviti continuing as the surviving corporation and a wholly owned subsidiary of Verscend. The board of directors of Cotiviti has unanimously determined that the Verscend Merger Agreement and the transactions contemplated thereby, including the Verscend Merger, are advisable, fair to and in the best interests of Cotiviti and its stockholders, and directed that the Verscend Merger Agreement be submitted to the stockholders of Cotiviti for their adoption. Under the terms of the Verscend Merger Agreement, Cotiviti stockholders will receive $44.75 in cash per share of Cotiviti common stock, without interest and less any applicable withholding taxes, and Verscend will pay all of Cotiviti’s outstanding net indebtedness, resulting in an enterprise value of approximately $4.9 billion. If the Verscend Merger is consummated, Cotiviti will cease to be a publicly traded company and will become a wholly owned subsidiary of Verscend, and our common stock will be delisted from the NYSE and deregistered under the Exchange Act.

The consummation of the Verscend Merger is subject to customary closing conditions, including, among others, the following conditions to the obligations of the parties: (i) the adoption of the Verscend Merger Agreement by the holders of a majority of Cotiviti’s common stock outstanding and entitled to vote; (ii) any applicable waiting period under the HSR Act having expired or having been terminated; (iii) the Verscend Merger having not then been enjoined, made illegal or otherwise prohibited by any applicable law or any order, judgment, decree, injunction or ruling (whether temporary, preliminary or permanent) of any governmental authority (each, a “Governmental Order”) or by any proceeding then pending by a governmental authority seeking any Governmental Order that would enjoin, make illegal or otherwise prohibit the consummation of the Verscend Merger; (iv) the truth and accuracy of the parties’ representations and warranties in the Verscend Merger Agreement, subject in certain cases to a de minimis, materiality or material adverse effect standard (each as described in the Verscend Merger Agreement); (v) with respect to Verscend’s obligations, a material adverse effect (as described in the Verscend Merger Agreement) having not occurred; and (vi) the compliance with or performance, in all material respects, of the parties’ covenants and obligations in the Verscend Merger Agreement required to be performed at or prior to the consummation of the Verscend Merger. On July 13, 2018, the U.S. Federal Trade Commission granted early termination of the waiting period under the HSR Act with respect to the Verscend Merger, thereby satisfying one of the conditions to the closing of the Verscend Merger.

If the proposed Verscend Merger is not approved by Cotiviti stockholders or if the Verscend Merger is not consummated for any other reason, Cotiviti stockholders will continue to hold their shares of common stock and will not receive any payment for such shares. Instead, Cotiviti will remain a public company, our common stock will continue to be listed and traded on the NYSE and registered under the Exchange Act, and we will continue to file periodic reports with the SEC. Under specified circumstances, upon termination of the Verscend Merger Agreement, Cotiviti may be required to pay Verscend a termination fee of $100,000, or Verscend may be required to pay Cotiviti a termination fee of $217,500.

 

We recorded approximately $7,400 of transaction costs primarily related to professional services associated with the proposed Verscend Merger as transaction-related expenses within our Consolidated Statements of Comprehensive Income during the six months ended June 30, 2018.

 

10


 

Table of Contents

Cotiviti Holdings, Inc.

Notes to the Financial Statements (continued)

(In thousands, except shares and per share amounts)

(Unaudited)

 

Note 3. Summary of Significant Accounting Policies

 

Basis of Presentation

 

Our accompanying unaudited consolidated financial statements have been prepared in accordance with GAAP. All significant intercompany balances and transactions have been eliminated in consolidation. These consolidated financial statements are unaudited and have been prepared by us following the rules and regulations of the SEC. In our opinion they reflect all adjustments, including normal recurring items, that are necessary to present fairly the results of interim periods. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted as permitted by such rules and regulations; however, we believe that the disclosures are adequate to make the information presented not misleading. Operating results for the periods presented herein are not necessarily indicative of the results that may be expected for other interim periods or the entire fiscal year. Certain prior year amounts have been reclassified to conform to the current year presentation.

 

Restricted Cash

 

In connection with providing services to certain clients, we maintain a series of lockbox accounts with certain financial institutions. These lockbox accounts exist to receive funds we collect on behalf of our clients resulting from services provided. When client funds are received and deposited into the lockbox accounts, we record a corresponding customer deposit liability. These funds are included as both restricted cash in current assets and customer deposits in current liabilities on our Consolidated Balance Sheets and are included in beginning and ending cash, cash equivalents and restricted cash on our Consolidated Statements of Cash Flows.

 

The following table reconciles cash, cash equivalents and restricted cash per the Consolidated Statements of Cash Flows to the Consolidated Balance Sheets.

  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

June 30, 2018

 

December 31, 2017

  

June 30, 2017

 

December 31, 2016

Cash and cash equivalents

 

$

223,927

 

$

165,518

 

$

137,426

 

$

110,635

Restricted cash

 

 

12,031

 

 

11,383

 

 

8,548

 

 

9,103

Customer deposits

 

 

(12,031)

 

 

(11,383)

 

 

(8,548)

 

 

(9,103)

 Total cash, cash equivalents and restricted cash

 

$

223,927

 

$

165,518

 

$

137,426

 

$

110,635

 

Recently Issued Accounting Standards

 

In February 2018, the FASB issued ASU 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (“ASU 2018-02”), which allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Act. We early adopted the provisions of ASU 2018-02 during the first quarter 2018 and as a result, we reclassified $550 from accumulated other comprehensive loss to retained earnings in the Consolidated Balance Sheets.

 

In November 2016, the FASB issued ASU 2016-18, Restricted Cash (“ASU 2016-18”), which requires that restricted cash be included with cash and cash equivalents when reconciling the beginning and end of period total amounts shown on the statement of cash flows. The guidance is effective for public companies with annual reporting periods beginning after December 15, 2017, including interim periods within those annual periods. We retrospectively adopted the provisions of ASU 2016-18 effective January 1, 2018. This guidance did not have a significant impact on our consolidated financial statements. Refer to “Restricted Cash” above for further information.

 

In February 2016, the FASB issued ASU 2016-02, Leases (“ASU 2016-02”), which changes the accounting recognition, measurement and disclosure for leases in order to increase transparency. ASU 2016-02 requires lease assets and liabilities to be recognized on the balance sheet and key information about leasing arrangements to be disclosed. The guidance is effective for public companies with annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period. Early adoption is permitted.

 

11


 

Table of Contents

Cotiviti Holdings, Inc.

Notes to the Financial Statements (continued)

(In thousands, except shares and per share amounts)

(Unaudited)

 

We have formed an internal team to evaluate and quantify the impact of this new lease guidance. As of the date of this filing, we are in process of completing our review of lease contracts and quantifying the impact under the new guidance. We are also in process of evaluating changes required to our business processes, systems and controls to support recognition and disclosure of leases. We are currently planning to elect the package of practical expedients which allows a company to not reassess prior conclusions related to contracts containing leases, lease classification and initial direct costs. We will provide additional information about the impact of this new guidance in future filings.

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASC 606”), which supersedes existing revenue recognition guidance and provides clarification of principles for recognizing revenue from contracts with customers. ASC 606 sets forth a five-step model for determining when and how revenue is recognized. The core principle of the new standard is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. Additional disclosures will be required to describe the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts. The two permitted transition methods under ASC 606 are the full retrospective method, in which case the new guidance would be applied to each prior reporting period presented and the cumulative effect of applying the standard would be recognized at the earliest period shown, or the modified retrospective method, in which case the cumulative effect of applying the standard would be recognized at the date of the initial application. The guidance is effective for public companies with annual periods beginning after December 15, 2017, including interim periods within that reporting period. We adopted the provisions of ASC 606 and related amendments as of January 1, 2018 using the modified retrospective method. The adoption of ASC 606 did not result in any significant changes to the timing of revenue recognition in prior, current or future periods therefore there was no cumulative adjustment as a result of adoption. Refer to Note 4 for more information on revenue recognition.

 

Note 4. Revenue Recognition

 

Revenue

 

Revenue is comprised of services we provide in our Healthcare and Global Retail and Other operating segments under contracts that contain various fee structures, including performance fee based contracts and fixed fee arrangements. We account for revenue in accordance with ASC 606. Through our Healthcare segment, we offer prospective and retrospective claims accuracy solutions to healthcare payers in the United States. We also provide a network efficiency solution to payers and providers as well as, on a limited basis, certain analytics-based solutions unrelated to our healthcare payment accuracy solutions in the United States. Through our Global Retail and Other segment, we provide retrospective claims accuracy solutions to retailers primarily in the United States, with additional clients in Canada and the United Kingdom. Net revenue generated in the United States accounted for approximately 99% of total net revenue for each of the three and six months ended June 30, 2018 and 2017. During the first quarter of 2018, we made the decision to exit our retail operations in the United Kingdom by the end of 2018.

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Table of Contents

Cotiviti Holdings, Inc.

Notes to the Financial Statements (continued)

(In thousands, except shares and per share amounts)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended June 30, 

 

Six Months Ended June 30, 

 

 

  

2018

  

%

  

2017

  

%

  

2018

  

%

  

2017

  

%

    

 

 

(unaudited)

 

 

 

(unaudited)

 

Healthcare

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Retrospective claims accuracy

 

$

93,529

 

52.7

 

$

86,627

 

51.7

 

$

227,452

 

57.4

 

$

164,143

 

50.1

 

Prospective claims accuracy

 

 

62,745

 

35.4

 

 

62,020

 

37.0

 

 

121,030

 

30.5

 

 

121,737

 

37.1

 

Other

 

 

5,431

 

3.0

 

 

2,912

 

1.7

 

 

13,594

 

3.4

 

 

5,482

 

1.7

 

Total Healthcare

 

 

161,705

 

91.1

 

 

151,559

 

90.4

 

 

362,076

 

91.3

 

 

291,362

 

88.9

 

Global Retail and Other

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Retrospective claims accuracy

 

 

15,748

 

8.9

 

 

15,385

 

9.2

 

 

34,411

 

8.7

 

 

35,059

 

10.7

 

Other

 

 

 —

 

 —

 

 

667

 

0.4

 

 

 —

 

 —

 

 

1,323

 

0.4

 

Total Global Retail and Other

 

 

15,748

 

8.9

 

 

16,052

 

9.6

 

 

34,411

 

8.7

 

 

36,382

 

11.1

 

Consolidated net revenue

 

$

177,453

 

100.0

 

$

167,611

 

100.0

 

$

396,487

 

100.0

 

$

327,744

 

100.0

 

 

Performance obligations – The unit of measure under ASC 606 is a performance obligation, which is a promise in a contract to transfer a distinct or series of distinct goods or services to the client. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. Our contracts have either a single performance obligation as the promise to transfer services is not separately identifiable from other promises in the contracts and is, therefore, not distinct, or have multiple performance obligations, most commonly due to the contract covering multiple service offerings. For contracts with multiple performance obligations, the contract’s transaction price can generally be readily allocated to each performance obligation based upon the selling price of each distinct service in the contract. In cases where estimates are needed to allocate the transaction price, we use historical experience and projections based on currently available information.

 

Retrospective and Prospective claims accuracy – Performance obligations for our retrospective and prospective claims accuracy solutions are satisfied at a point in time when our clients realize the economic benefits from our services. Our clients realize economic benefits when they take credits against their existing accounts payable based on when we identify cost savings, when they receive refunds based on overpayments, or when they acknowledge payment reductions based on cost savings. Clients pay for our services once they realize the economic benefit.

 

Other – Performance obligations for our other healthcare solutions are generally satisfied over time as the services are delivered. Clients generally pay once the services have been rendered, although certain clients, on a limited basis, pay in advance of the services being rendered in which case we record cash received as deferred revenue and recognize upon satisfaction of the performance obligation. 

 

Estimated Liability for Refunds and Appeals

 

Historically, there has been a certain amount of revenue with respect to which, even though we had met the requirements for revenue recognition, a claim is ultimately rejected. In such cases, our clients may request a refund or offset if their providers or vendors ultimately reject the payment inaccuracies we find or if our clients determine not to pursue reimbursement from their providers or vendors even though we may have collected fees. We record an estimate for refund liabilities as a reduction of revenue based on actual historical refund data by client type. We satisfy such refund liabilities either by offsets to accounts receivable or by cash payments to clients. We also calculate client specific refund liabilities in excess of the estimated historical refund liabilities when we determine additional amounts may ultimately be required to be returned to the client.

 

Under the Medicare Recovery Audit Program, in which we are one of the Medicare RACs for CMS, healthcare providers have the right to appeal a claim and may pursue additional appeals if the initial appeal is found in favor of CMS. We currently have Medicare RAC contracts related to CMS Regions 2 and 3; our original Medicare RAC contract was related to the former CMS Region C. We accrue an estimated liability for appeals based on the amount of fees that are subject to appeals, closures or other adjustments and those which we estimate are probable of being returned to CMS following a

13


 

Table of Contents

Cotiviti Holdings, Inc.

Notes to the Financial Statements (continued)

(In thousands, except shares and per share amounts)

(Unaudited)

 

successful appeal by the providers. Our estimates are based on our historical experience with the Medicare RAC appeal process. The liability is included in the estimated liability for refunds and appeals on our Consolidated Balance Sheets.

 

Our original Medicare RAC contract with CMS expired on January 31, 2018. In connection with the expiration of the contract, we determined that we have no obligation to CMS with respect to any appeals resolved in the providers’ favor after the expiration date and, in addition, we have no obligation to CMS in connection with the hospital settlement processes as initiated by CMS. Refer to Note 7 of the Notes to Consolidated Financial Statements included in our 2017 Annual Report on Form 10-K for further details on the hospital settlement processes. Accordingly, we released $600 and $47,156 of the total $56,089 liability to revenue during the three and six months ended June 30, 2018, respectively. The remaining estimated liability for refunds and appeals related to the original Medicare RAC contract of approximately $3,600 as of June 30, 2018 represents management’s best estimate of any appeals overturned prior to the expiration of the contract term.

 

For all refund and appeals liabilities, to the extent the amount to be returned to providers following a successful appeal process exceeds or is less than the amount recorded, revenue in the applicable period would be reduced or increased, respectively, by such amount. Any future changes to any of our client contracts may require different assumptions to be applied that could materially affect our revenue and estimated liability for refunds and appeals in future periods. We record periodic changes in refund liabilities as adjustments to revenue. The estimated liability for refunds and appeals representing our estimate of claims that may be overturned related to revenue which has already been received is included in the estimated liability for refunds and appeals in current liabilities on our Consolidated Balance Sheets. The estimated allowance for refunds and appeals representing our estimate of claims that may be overturned related to amounts in accounts receivable is included in accounts receivable on our Consolidated Balance Sheets. The table below presents the activity of the estimated liability for refunds and appeals.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

2018

    

2017

    

2018

    

2017

Balance at beginning of period

 

 

 

 

 

 

 

 

 

 

 

 

Estimated allowance for refunds and appeals

 

$

43,690

 

$

35,518

 

$

35,434

 

$

41,020

Estimated liability for refunds and appeals

 

 

9,367

 

 

61,766

 

 

61,607

 

 

62,539

Total balance at beginning of period

 

 

53,057

 

 

97,284

 

 

97,041

 

 

103,559

Provision

 

 

29,223

 

 

23,857

 

 

61,816

 

 

42,933

Refunds settled with client

 

 

(32,919)

 

 

(27,698)

 

 

(61,672)

 

 

(49,740)

Refunds recovered

 

 

(814)

 

 

(3,160)

 

 

(2,082)

 

 

(6,469)

Original Medicare RAC contract release of liability

 

 

(600)

 

 

 -

 

 

(47,156)

 

 

 -

Total balance at end of period

 

$

47,947

 

$

90,283

 

$

47,947

 

$

90,283

Less: estimated allowance for refunds and appeals

 

 

43,062

 

 

32,648

 

 

43,062

 

 

32,648

Estimated liability for refunds and appeals

 

$

4,885

 

$

57,635

 

$

4,885

 

$

57,635

 

Costs to obtain and/or fulfill a contract

 

Incremental costs of obtaining a contract include costs incurred by an entity to obtain a contract with a customer that it would not have incurred if the contract had not been obtained. A select group of employees are eligible for sales commissions, which are directly related to obtaining certain client contracts. We have recorded an asset related to the amount of commissions to be paid to employees in the future and a corresponding liability. The asset is amortized to compensation expense over the life of the underlying contract and the liability is relieved as payments are made to the employees. As of June 30, 2018, there is approximately $473 included in prepaid expenses and other current assets, $368 included in other long-term assets and $724 included in accrued compensation costs on our Consolidated Balance Sheets.

 

Accounts Receivable

 

Trade accounts receivable are recorded at the invoiced amount and do not bear interest. We accrue an allowance against accounts receivable related to fees yet to be collected, based on historical losses adjusted for current market conditions, our clients’ financial condition, the amount of any receivables in dispute, the current receivables aging and

14


 

Table of Contents

Cotiviti Holdings, Inc.

Notes to the Financial Statements (continued)

(In thousands, except shares and per share amounts)

(Unaudited)

 

current payment patterns. We record changes in our estimate to the allowance for doubtful accounts through bad debt expense and relieve the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. Write-offs for all periods presented have not been significant.

 

Unbilled receivables represent revenue recognized related to claims for which clients have received economic value that were not invoiced at the balance sheet date. Unbilled receivables were approximately $63,926 and $62,294 as of June 30, 2018 and December 31, 2017, respectively, and are included in accounts receivable on our Consolidated Balance Sheets. We record any periodic changes in unbilled receivables as adjustments to revenue.

 

Certain unbilled receivables arise when a portion of our earned fee is deferred at the time of the initial invoice. At a later date (which can be up to a year after original invoice, and at other times during the year after completion of the audit period based on contractual terms or as agreed with our client), we invoice the unbilled receivable amount. Notwithstanding the deferred due date, our clients acknowledge we have earned this unbilled receivable at the time of the original invoice, but we have agreed to defer billing the client for the related services. Unbilled receivables of this nature were approximately $3,760 and $4,958 as of June 30, 2018 and December 31, 2017, respectively, and are included in accounts receivable on our Consolidated Balance Sheets.

 

Note 5. RowdMap Acquisition

 

On July 14, 2017, we acquired all of the outstanding equity of RowdMap. Based in Louisville, Kentucky, RowdMap is a payer-provider, value-based analytics company that helps health plans and providers identify and reduce low-value care from inefficient and unnecessary services. We paid approximately $74,000 in cash, subject to certain adjustments and funded entirely with available liquidity. We also issued an aggregate of 768,021 shares of restricted common stock to certain employees of RowdMap in connection with their continued employment with us. Half of these shares were subject to continued employment and performance-based vesting requirements. In accordance with these vesting requirements, in July 2018 we issued 350,569 shares of common stock. The remaining 33,440 shares of restricted stock were cancelled as they did not meet the vesting requirements. The other half are subject to continued employment, with one-third vesting on each of the first three anniversaries of the closing of the acquisition. We record stock-based compensation expense related to this restricted stock ratably over the vesting period or as achievement of the performance criteria becomes probable. This stock-based compensation expense will not be deductible for income tax purposes. 

 

As part of the RowdMap Acquisition, we allocated the purchase price to the identifiable net assets acquired, including intangible assets and liabilities assumed, based on the estimated fair values at the date of acquisition. The excess of the purchase price over the amount allocated to the identifiable assets and liabilities was recorded as goodwill.

 

Goodwill represents the value of acquired assembled workforce, specialized processes and procedures and operating synergies, none of which qualify as separate intangible assets. We believe these specialized processes and procedures will enhance our long history of innovation and help expand our solution offerings. We determined the estimated fair values of intangible assets acquired using estimates of future discounted cash flows to be generated by the business over the estimated duration of those cash flows. We based the estimated cash flows on our projections of future revenue, operating expenses, capital expenditures, working capital needs and tax rates. We estimated the duration of the cash flows based on the projected useful lives of the assets acquired. The discount rate was determined based on specific business risk, cost of capital and other factors.

 

15


 

Table of Contents

Cotiviti Holdings, Inc.

Notes to the Financial Statements (continued)

(In thousands, except shares and per share amounts)

(Unaudited)

 

The initial purchase price allocation was preliminary and subject to change up to one year after the date of acquisition. The final allocation of the purchase price to the fair values of the assets acquired and liabilities assumed at the date of the acquisition was as follows:

 

 

 

 

 

 

 

    

July 14, 2017

 

Cash

 

$

4,107

 

Accounts receivable

 

 

2,526

 

Prepaid expenses and other assets

 

 

1,212

 

Other long-term assets

 

 

12

 

Property and equipment

 

 

263

 

Intangible assets

 

 

19,510

 

Total identifiable assets acquired

 

 

27,630

 

Accounts payable and accrued liabilities

 

 

4,491

 

Deferred tax liabilities

 

 

3,882

 

Total liabilities assumed

 

 

8,373

 

Net identifiable assets acquired

 

 

19,257

 

Goodwill

 

 

54,867

 

Net assets acquired

 

$

74,124

 

 

The $19,510 of acquired intangible assets include acquired software of $6,310 (5 year useful life) and customer relationships of $13,200 (5 year useful life).

 

For federal income tax purposes, the RowdMap Acquisition was treated as a stock acquisition. The goodwill and the intangible assets recognized are not deductible for income tax purposes.

 

In connection with the RowdMap Acquisition, a liability of $1,066 is included in accounts payable and accrued other expenses on the Consolidated Balance Sheets as of June 30, 2018, for payments due to the former stockholders of RowdMap, some of whom are now our employees.

 

We recorded approximately $700 of transaction costs primarily related to professional services associated with the acquisition as transaction-related expenses within our Consolidated Statements of Comprehensive Income during the year ended December 31, 2017.

 

The acquisition was not significant to our consolidated financial statements, therefore, pro forma results of operations related to this business acquisition have not been presented. The financial results of RowdMap have been included in our consolidated financial statements since the date of the acquisition.

 

Note 6. Property and Equipment

 

Property and equipment by major asset class for the periods presented consisted of the following:

 

 

 

 

 

 

 

 

 

 

    

June 30, 

    

December 31, 

 

 

    

2018

    

2017

 

Computer equipment

 

$

48,223

 

$

46,731

 

Software

 

 

74,647

 

 

67,511

 

Furniture and fixtures

 

 

12,776

 

 

9,199

 

Leasehold improvements

 

 

11,094

 

 

5,256

 

Projects in progress

 

 

7,445

 

 

10,295

 

Property and equipment, gross

 

$

154,185

 

$

138,992

 

Less: accumulated depreciation and amortization

 

 

71,636

 

 

61,652

 

Property and equipment, net

 

$

82,549

 

$

77,340

 

 

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Table of Contents

Cotiviti Holdings, Inc.

Notes to the Financial Statements (continued)

(In thousands, except shares and per share amounts)

(Unaudited)

 

In December 2015, we purchased a perpetual software license, which is included in the software total above. We paid for this software over a two year period ended in January 2018. As such, there is approximately $3,351 included in accounts payable and accrued other expenses on our Consolidated Balance Sheets as of December 31, 2017.

 

Total depreciation and amortization expense related to property and equipment, including capitalized software costs, was $7,200 and $5,896 for the three months ended June 30, 2018 and 2017, respectively, and $14,442 and $11,471 for the six months ended June 30, 2018 and 2017, respectively.

 

Note 7. Intangible Assets

 

Intangible asset balances by major asset class for the periods presented were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

Weighted

 

 

 

Gross

 

 

 

 

 

 

 

Net

 

Average

 

 

 

Carrying

 

Accumulated

 

 

 

 

Carrying

 

Amortization

 

 

    

Amount

    

Amortization

    

Impairment

    

Amount

    

Period

 

June 30, 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Customer relationships

 

$

650,903

 

$

216,608

 

$

 —

 

$

434,295

 

13.5

years

 

Acquired software

 

 

54,210

 

 

29,482

 

 

 —

 

 

24,728

 

6.8

years

 

Connolly trademark

 

 

4,200

 

 

 —

 

 

 —

 

 

4,200

 

indefinite-lived

 

Total

 

$

709,313

 

$

246,090

 

$

 —

 

$

463,223

 

13.0

years

 

December 31, 2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Customer relationships

 

$

650,954

 

$

190,572

 

$

1,322

 

$

459,060

 

13.5

years

 

Acquired software

 

 

54,210

 

 

25,430

 

 

 —

 

 

28,780

 

6.8

years

 

Connolly trademark

 

 

4,200

 

 

 —

 

 

 —

 

 

4,200

 

indefinite-lived

 

Total

 

$

709,364

 

$

216,002

 

$

1,322

 

$

492,040

 

13.0

years

 

 

Amortization expense was $14,397 and $15,201 for the three months ended June 30, 2018 and 2017, respectively, and $28,793 and $30,400 for the six months ended June 30, 2018 and 2017, respectively.

 

As of June 30, 2018 amortization expense for the next 5 years is expected to be:

 

 

 

 

 

 

Remainder of 2018

   

$

28,791

 

2019

 

 

57,583

 

2020

 

 

57,583

 

2021

 

 

53,260

 

2022

 

 

48,952

 

 

 

Note 8. Goodwill

 

Total goodwill on our Consolidated Balance Sheets was $1,252,306 and $1,251,364 as of June 30, 2018 and December 31, 2017, respectively.

 

Changes in the carrying amount of goodwill by our Healthcare and Global Retail and Other segments for the six months ended June 30, 2018 were as follows:

 

 

 

 

 

 

 

 

 

 

    

 

 

    

Global Retail

 

 

 

Healthcare

 

and Other

 

December 31, 2017

 

$

1,202,444

 

$

48,920

 

Measurement period adjustments

 

 

194

 

 

 —

 

Foreign currency translation

 

 

 —

 

 

748

 

June 30, 2018

 

$

1,202,638

 

$

49,668

 

 

17


 

Table of Contents

Cotiviti Holdings, Inc.

Notes to the Financial Statements (continued)

(In thousands, except shares and per share amounts)

(Unaudited)

 

There was no impairment related to goodwill for any period presented.

 

Note 9. Long‑term Debt

 

In April 2017, we entered into and executed the First Amendment Agreement to the then outstanding Restated Credit Agreement, which, among other things, provided for a 25 basis point reduction in applicable interest rate spread over LIBOR associated with the First Lien Term B Loans. As a result, we recognized a loss on extinguishment of $3,183 during the three and six months ended June 30, 2017, which consists of fees paid and write-offs of unamortized debt issuance costs and original issue discount.

 

Long‑term debt for the periods presented was as follows:

 

 

 

 

 

 

 

 

 

 

    

June 30, 

    

December 31, 

 

 

    

2018

    

2017

 

First Lien Term A Loans

 

$

228,007

 

$

234,237

 

First Lien Term B Loans

 

 

538,060

 

 

540,585

 

Revolver

 

 

 —

 

 

 —

 

Total debt

 

 

766,067

 

 

774,822

 

Less: debt issuance costs

 

 

6,414

 

 

7,204

 

Less: current portion

 

 

21,125

 

 

18,000

 

Total long-term debt

 

$

738,528

 

$

749,618

 

 

The Restated Credit Agreement includes certain binding affirmative and negative covenants, including delivery of financial statements and other reports, maintenance of existence and transactions with affiliates. The negative covenants restrict our ability, among other things, to incur indebtedness, grant liens, make investments, sell or otherwise dispose of assets or enter into a merger, pay dividends or repurchase stock. There is a required financial covenant applicable only to the Revolver and the First Lien Term A Loans, pursuant to which we agree not to permit our Secured Leverage Ratio (as defined in the Restated Credit Agreement) to exceed 5.50:1.00 through September 2018, 5.25:1.00 through September 2019 and 5.00:1.00 through June 2021. In addition, the Restated Credit Agreement includes certain events of default including payment defaults, failure to perform affirmative covenants, failure to refrain from actions or omissions prohibited by negative covenants, the inaccuracy of representations or warranties, bankruptcy and insolvency related defaults and a change of control default. We were in compliance with all such covenants as of June 30, 2018 and December 31, 2017, respectively.

 

The Restated Credit Agreement requires mandatory prepayments based upon our leverage ratio at the time payment is required and an annual excess cash flow calculation commencing with the year ended December 31, 2017. The mandatory prepayment is contingently payable in the second quarter of each year based on an annual excess cash flow calculation for the preceding year as defined within the Restated Credit Agreement. We were not required to make a mandatory prepayment during 2018.

 

As of June 30, 2018, the aggregate maturities of long‑term debt (excluding any amounts that may become payable with respect to the aforementioned mandatory prepayment provision for annual excess cash flows) for each of the next five years are expected to be $9,000 for the remainder of 2018, $24,250 in 2019, $30,500 in 2020, $183,625 in 2021 and $5,500 in 2022.

 

Note 10. Derivative Instruments

 

We are exposed to fluctuations in interest rates on our long‑term debt. We manage our exposure to fluctuations in the 3‑month LIBOR through the use of interest rate cap agreements designated as cash flow hedges. We are meeting our objective by hedging the risk of changes in cash flows related to changes in LIBOR by capping the interest on our floating rate debt linked to LIBOR to approximately 3%. We do not utilize derivatives for speculative or trading purposes.

 

18


 

Table of Contents

Cotiviti Holdings, Inc.

Notes to the Financial Statements (continued)

(In thousands, except shares and per share amounts)

(Unaudited)

 

As of June 30, 2018 and December 31, 2017, we had $435,000 in notional debt outstanding related to these interest rate caps, which cover quarterly interest payments through September 2019. The notional amount decreases over time. Refer to Note 9 for more information regarding the debt outstanding related to these agreements.

 

All of our outstanding interest rate cap contracts qualify for cash flow hedge accounting treatment in accordance with ASC 815, Derivatives and Hedging. Cash flow hedge accounting treatment allows for gains and losses on the effective portion of qualifying hedges to be deferred in accumulated other comprehensive income (loss) until the underlying transaction occurs, rather than recognizing the gains and losses on these instruments in earnings during each period they are outstanding. When the actual interest payments are made on our variable rate debt as described in Note 9 and the related derivative contract settles, any effective portion of realized interest rate hedging derivative gains and losses previously recorded in accumulated other comprehensive income (loss) is recognized in interest expense. All cash flows related to our interest rate cap agreements are classified as operating cash flows.

 

The table below reflects the effect of our derivative instruments on our Consolidated Statements of Comprehensive Income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

 

June 30, 

 

 

June 30, 

 

    

2018

    

2017

 

 

2018

 

    

2017

Interest expense

 

$

644

 

$

398

 

$

1,256

 

$

599

 

 

Any outstanding derivative instruments expose us to credit loss in the event of nonperformance by the counterparties to the agreements, but we do not expect that the counterparty will fail to meet their obligations. The amount of such credit exposure is generally the positive fair value of our outstanding contracts. To manage credit risks, we select counterparties based on credit assessments, limit our overall exposure to any single counterparty and monitor the market position of any counterparty.

 

The table below reflects quantitative information related to the fair value of our derivative instruments and where these amounts are recorded in our consolidated financial statements as of the period presented:

 

 

 

 

 

 

 

 

 

 

    

June 30, 

    

December 31, 

 

 

    

2018

    

2017

 

Liability fair value recorded in other long-term liabilities

 

$

401

 

$

951

 

Liability fair value recorded in accounts payable and accrued other expenses

 

 

836

 

 

979

 

Estimated amount of existing losses expected to be reclassified into earnings in the next 12 months

 

 

(2,306)

 

 

(2,440)

 

 

We record deferred hedge premiums which are being paid over the life of the hedge in accumulated other comprehensive income (loss) until the related hedge ultimately settles and interest payments are made on the underlying debt. As of June 30, 2018, we have made payments of $4,689 related to these deferred premiums. We expect to pay an additional $1,705 in deferred premiums through 2019 related to our outstanding interest rate cap agreements which is reflected in the fair value of these derivatives in the table above.

 

19


 

Table of Contents

Cotiviti Holdings, Inc.

Notes to the Financial Statements (continued)

(In thousands, except shares and per share amounts)

(Unaudited)

 

Comprehensive income includes changes in the fair value of our interest rate cap agreements which qualify for hedge accounting. Changes in other comprehensive income (loss) for the periods presented related to derivative instruments classified as cash flow hedges were as follows:

 

 

 

 

 

 

 

 

 

 

Three Months Ended June 30, 

 

 

    

2018

    

2017

 

 

 

 

 

 

 

 

 

Balance at beginning of period, April 1

 

$

(2,556)

 

$

(3,396)

 

Reclassifications in earnings, net of tax of $157 and $150, respectively

 

 

487

 

 

249

 

Change in fair value of derivative instrument, net of tax of $20 and $35, respectively

 

 

(64)

 

 

(56)

 

Balance at end of period, June 30

 

$

(2,133)

 

$

(3,203)

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30, 

 

 

    

2018

    

2017

 

Balance at beginning of period, January 1

 

$

(2,556)

 

$

(3,334)

 

Reclassifications in earnings, net of tax of $306 and $225, respectively

 

 

950

 

 

374

 

Change in fair value of derivative instrument, net of tax of $8 and $150, respectively

 

 

23

 

 

(243)

 

Reclassification of stranded tax effect to retained earnings upon adoption of ASU 2018-02

 

 

(550)

 

 

 —

 

Balance at end of period, June 30

 

$

(2,133)

 

$

(3,203)

 

 

 

Note 11. Fair Value Measurements

 

We measure assets and liabilities at fair value based on assumptions market participants would use in pricing an asset or liability in the principal or most advantageous market. Authoritative guidance on fair value measurements establishes a consistent framework for measuring fair value whereby inputs are assigned a hierarchical level. The hierarchical levels are:

 

Level 1: Unadjusted quoted prices in active markets for identical assets or liabilities accessible to the reporting entity at the measurement date.

 

Level 2: Observable prices, other than quoted prices included in Level 1 inputs for the asset or liability, either directly or indirectly, for substantially the full term of the asset or liability.

 

Level 3: Unobservable inputs for the asset or liability used to measure fair value to the extent observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at measurement date.

 

The following table summarizes our financial instruments measured at fair value within the Consolidated Balance Sheets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2018

 

December 31, 2017

 

 

    

Level 1

    

Level 2

    

Level 3

    

Level 1

    

Level 2

    

Level 3

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Long-term debt

 

$

 —

 

$

 

$

766,067

 

$

 

$

 

$

774,822

 

Interest rate cap agreements

 

 

 

 

1,237

 

 

 

 

 

 

1,930

 

 

 

Total

 

$

 —

 

$

1,237

 

$

766,067

 

$

 —

 

$

1,930

 

$

774,822

 

 

The fair value of our private debt is determined based on fluctuations in current interest rates, the trends in market yields of debt instruments with similar credit ratings, general economic conditions and other quantitative and qualitative factors. The carrying value of our debt approximates its fair value. Refer to Note 9 for more information on our long-term debt.

 

The fair value of the interest rate cap agreements is determined using the market standard methodology of

20


 

Table of Contents

Cotiviti Holdings, Inc.

Notes to the Financial Statements (continued)

(In thousands, except shares and per share amounts)

(Unaudited)

 

discounting the future expected variable cash receipts that would occur if interest rates rose above the strike rate of the caps. The analysis reflects the contractual terms of the derivatives, including period to maturity and remaining deferred premium payments, and uses observable market‑based inputs, including interest rates and implied volatilities. The variable cash receipts are based on an expectation of future interest rates (forward curves) derived from observable market interest rates. As such, the estimated fair values of these liabilities are classified as Level 2 in the fair value hierarchy. Refer to Note 10 for more information on our interest rate cap agreements.

 

Note 12. Income Taxes

 

The following table presents our income tax provision and effective income tax rate: 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

Six Months Ended

 

 

 

June 30, 

 

 

June 30, 

 

 

    

2018

    

2017

 

    

2018

    

2017

 

Income tax expense

 

$

6,953

 

$

7,743

 

 

$

22,855

 

$

6,882

 

Effective income tax rate

 

 

29.5

%  

 

26.9

%  

 

 

24.5

%  

 

12.5

%

 

Our effective income tax rate was 29.5% and 26.9% for the three months ended June 30, 2018 and 2017, respectively. The decrease in income tax expense of $790 was primarily the result of a reduction of the federal tax rate to 21% due to the Tax Act, a $1,277 tax benefit related to stock option exercises and vesting of restricted stock units, partially offset by additional expense of $1,940 related to nondeductible transaction-related expenses in connection with the proposed Verscend Merger. The impact of these items relative to the pre-tax income for the three months ended June 30, 2018 resulted in the increase to the effective tax rate. During the three months ended June 30, 2017, we recorded a $2,619 tax benefit related to stock option exercises and vesting of restricted stock units and a $660 tax benefit related to the filing of amended state tax returns as a result of certain tax planning. The effective tax rate for the three months ended June 30, 2017 was impacted by this tax benefit relative to the pre-tax income for the three months ended June 30, 2017.

 

Our effective income tax rate was 24.5% and 12.5% for the six months ended June 30, 2018 and 2017, respectively.  The increase in income tax expense of $15,973 was primarily the result of an increase in pre-tax income for the six months ended June 30, 2018 and additional expense of $1,940 related to nondeductible transaction-related expenses. In addition, a valuation allowance of $191 was recorded to reflect the portion of the deferred tax asset on state tax credits that is more likely than not to be realized offset by a $3,877 tax benefit related to stock option exercises and vesting of restricted stock units. The impact of these items relative to the pre-tax income for the six months ended June 30, 2018 resulted in the increase to the effective tax rate. During the six months ended June 30, 2017, we recorded a $13,041 tax benefit related to stock option exercises and vesting of restricted stock units, a tax benefit of $337 related to the settlement of an uncertain tax position due to the closure of our audit with the Internal Revenue Service, as well as a tax benefit of $660 related to the filing of amended state tax returns as a result of certain tax planning. The effective tax rate for the six months ended June 30, 2017 was impacted by these tax benefits relative to the pre-tax income for the six months ended June 30, 2017.

 

On December 22, 2017, the U.S. government enacted the Tax Act, which reduced the federal tax rate on U.S. earnings to 21%, effective January 1, 2018, and moves from a global taxation regime to a modified territorial regime. We recognized the provisional tax impacts associated with the revaluation of our net deferred tax liabilities and one-time transition tax on our unremitted foreign earnings and profits during the year ended December 31, 2017. As of June 30, 2018, we have not made any additional adjustments related to these items. Given the significant complexity of the Tax Act, anticipated guidance from the U.S. Treasury about implementing the Tax Act, and the potential for additional guidance from the SEC or the FASB related to the Tax Act, we will continue to evaluate the accounting for the tax effects related to the enactment of the Tax Act. Upon completion of our 2017 U.S. tax return, we will be able to conclude whether any further adjustments are required to our deferred tax liabilities, as well as the liability associated with the one-time mandatory tax. Any adjustments to these provisional amounts will be reported as a component of tax expense in the reporting period in which any such adjustments are determined, which will be no later than the fourth quarter of 2018.

 

We file income taxes with the U.S. federal government and various states and foreign jurisdictions. We operate in a number of state and local jurisdictions and as such are subject to state and local income tax examinations based upon various

21


 

Table of Contents

Cotiviti Holdings, Inc.

Notes to the Financial Statements (continued)

(In thousands, except shares and per share amounts)

(Unaudited)

 

statutes of limitations in each jurisdiction.

 

Note 13. Earnings per Share

 

Basic EPS is computed based on the weighted average number of shares of common stock outstanding during the period. Diluted EPS is computed based on the weighted average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period. For all periods presented, potentially dilutive outstanding shares consisted of equity incentive awards. Restricted stock issued in connection with the RowdMap Acquisition was also included in the calculation of dilutive potential common shares for each of the three and six months ended June 30, 2018. Our potential common shares consist of the incremental common shares issuable upon the exercise of stock options or vesting of RSUs and restricted stock. The dilutive effect of outstanding equity incentive awards is reflected in diluted earnings per share by application of the treasury stock method. For all periods presented, all outstanding common stock consisted of a single class.

 

Basic and diluted earnings per share are computed as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30, 

 

June 30, 

 

 

    

2018

    

2017

    

2018

    

2017

    

Net income available to common stockholders

 

$

16,575

 

$

21,088

 

$

70,502

 

$

48,063

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average outstanding shares of common stock

 

 

93,077,095

 

 

92,017,662

 

 

92,823,977

 

 

91,580,438

 

Dilutive effect of stock-based awards and restricted stock

 

 

2,628,803

 

 

3,237,257

 

 

2,753,912

 

 

3,510,428

 

Adjusted weighted average outstanding and assumed conversions for diluted EPS

 

 

95,705,898

 

 

95,254,919

 

 

95,577,889

 

 

95,090,866

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.18

 

$

0.23

 

$

0.76

 

$

0.52

 

Diluted

 

 

0.17

 

 

0.22

 

 

0.74

 

 

0.51

 

 

Employee stock options, RSUs and restricted stock that were excluded from the calculation of diluted earnings per share because their effect is anti‑dilutive for the periods presented were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30, 

 

June 30, 

 

 

    

2018

    

2017

    

2018

    

2017

    

Employee stock-based awards and restricted stock

 

1,086,664

 

572,623

 

999,705

 

467,677

 

 

Performance-based restricted stock of 32,160 shares were not included in the calculation of diluted earnings per share for each of the three and six months ended June 30, 2018 as the vesting conditions were not probable of occurring.

 

22


 

Table of Contents

Cotiviti Holdings, Inc.

Notes to the Financial Statements (continued)

(In thousands, except shares and per share amounts)

(Unaudited)

 

Note 14. Stock‑Based  Compensation

 

Stock  Options

 

The following is a summary of stock option activity under the Equity Plans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted

 

 

 

 

 

    

Weighted

    

Average

    

 

 

 

 

Average

 

Remaining

 

Aggregate

 

Outstanding

 

Exercise Price

 

Contractual Life

 

Intrinsic Value

 

Options

 

Per Share

 

(Years)

 

(in thousands)

Outstanding at December 31, 2017

4,574,607

 

$

13.89

 

6.65

 

$

85,138

Granted

601,597

 

 

34.70

 

 

 

 

 

Forfeited

(165,427)

 

 

19.90

 

 

 

 

 

Exercised

(894,119)

 

 

10.97

 

 

 

 

 

Expired

(481)

 

 

34.39

 

 

 

 

 

Outstanding at June 30, 2018

4,116,177

 

$

17.33

 

6.59

 

$

110,332

 

 

 

 

 

 

 

 

 

 

Vested and exercisable at June 30, 2018

2,412,227

 

$

11.59

 

5.47

 

$

78,499

 

Aggregate intrinsic value represents the difference between our estimated fair value of common stock and the exercise price of outstanding in‑the‑money options. The fair value per share of common stock was $44.13 as of June 30, 2018 based upon the closing price of our common stock on the NYSE. The total intrinsic value of stock options exercised was $7,232 and $8,409 for the three months ended June 30, 2018 and 2017, respectively, and $21,896 and $41,891 for the six months ended June 30, 2018 and 2017, respectively.

 

Restricted Stock  Units

 

The following is a summary of RSU activity under the 2016 Plan:

 

 

 

 

 

 

 

 

 

 

    

 

    

 

 

Weighted

 

 

 

 

 

 

Average

 

 

 

 

 

 

Grant Date Fair Value

 

 

Number of Awards

 

 

 

Per Share

Nonvested at December 31, 2017

 

379,274

 

 

 

$

33.56

Granted

 

471,355

 

 

 

 

34.65

Forfeited

 

(34,237)

 

 

 

 

34.98

Vested and converted to shares

 

(81,279)

 

 

 

 

34.38

Nonvested at June 30, 2018

 

735,113

 

 

 

$

34.09

Expected to vest at June 30, 2018

 

735,113

 

 

 

$

34.09

 

Employee  Stock  Purchase  Plan

 

We have an ESPP, which became effective January 1, 2017, for U.S. and non-U.S. employees,  both of which have a series of six month offering periods, with a new offering period beginning on the first day of January and July each year. The ESPP was adopted by our Board of Directors in August 2016 and approved by shareholders in May 2017. Employees may contribute up to 10% of their pay towards the purchase of common stock via payroll deductions to a maximum of $10 per year, or $5 per offering period. Purchase dates occur on the last business day of June and  December of each year and shares are purchased at a 10% discount off the closing price on the NYSE on the date of purchase. Employees must hold the shares purchased for a minimum of 90 days. As a result of the proposed Verscend Merger, the ESPP has been suspended indefinitely as of July 1, 2018.

 

The ESPP had 1,260,000 shares of our common stock initially reserved for issuance upon its inception. The reserve automatically increases each January by an amount equal to the lesser of 1,260,000 or approximately 1.5% of total common

23


 

Table of Contents

Cotiviti Holdings, Inc.

Notes to the Financial Statements (continued)

(In thousands, except shares and per share amounts)

(Unaudited)

 

shares outstanding on the first day of January. A summary of ESPP share reserve activity for the six months ended June 30, 2018 is as follows:

 

 

 

 

 

 

 

 

 

Shares

 

Weighted Average Price

Available for future purchases, beginning of period

 

1,197,306

 

 

 

Shares reserved for issuance

 

1,260,000

 

 

 

Common stock purchased

 

(22,066)

 

$

39.72

Available for future purchases, end of period

 

2,435,240

 

 

 

 

Stock  Compensation  Expense

 

We used the weighted average assumptions to estimate the fair value of stock options granted for the periods presented as follows:

 

 

 

 

 

 

 

 

Six Months Ended June 30, 

 

    

2018

    

Expected term (years)

 

 

6.25

 

Expected volatility

 

 

40.00

%  

Expected dividend yield

 

 

0.00

%  

Weighted average risk-free interest rate

 

 

2.56

%  

Weighted average grant date fair value

 

$

14.99

 

 

Total fair market value related to the restricted stock issued in connection with the RowdMap Acquisition is $31,785 based on the closing price of our common stock on the date of grant. For the time-based shares, stock-based compensation expense is being recorded ratably over the three year vesting period. For the performance-based shares, stock-based compensation expense will be recorded over the one year vesting period to the extent it is probable the performance criteria will be achieved. We recorded approximately $4,061 and $8,465 in stock-based compensation expense for the three and six months ended June 30, 2018, respectively, related to the performance awards that we estimate are probable of achieving the performance criteria.

 

We recorded total stock‑based compensation expense of $8,741 and $2,455 for the three months ended June 30, 2018 and 2017, respectively, and $17,387 and $4,538 for the six months ended June 30, 2018 and 2017, respectively. As of June 30, 2018, we had total unrecognized compensation cost related to 3,173,644 unvested service-based awards of $50,525 which we expect to recognize over the next 2.4 years.

 

Note 15. Segment Information

 

Operating segments are components of an enterprise for which separate financial information is available that is evaluated regularly by our Chief Operating Decision Maker in deciding how to allocate resources and in assessing financial performance. We conduct our business through two reportable business segments: Healthcare and Global Retail and Other.

 

We evaluate the performance of each segment based on segment net revenue and segment operating income. Operating income is calculated as net revenue less operating expenses and is not affected by other expense (income) or by income taxes. Indirect costs are generally allocated to the segments based on the segments’ proportionate share of revenue and expenses directly related to the operation of the segment. We do not allocate interest expense, other non-operating (income) expense or the provision for income taxes, since these items are not considered in evaluating the segment’s overall operating performance. Our Chief Operating Decision Maker does not receive or utilize asset information to evaluate performance of operating segments. Accordingly, asset related information has not been presented. Refer to Note 4 for operating segment net revenue by product type.

 

24


 

Table of Contents

Cotiviti Holdings, Inc.

Notes to the Financial Statements (continued)

(In thousands, except shares and per share amounts)

(Unaudited)

 

Our operating segment results for the periods presented were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30, 

 

June 30, 

 

 

    

2018

    

2017

    

2018

    

2017

    

 

 

(unaudited)

 

(unaudited)

 

Net Revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

Healthcare

 

$

161,705

 

$

151,559

 

$

362,076

 

$

291,362

 

Global Retail and Other

 

 

15,748

 

 

16,052

 

 

34,411

 

 

36,382

 

Consolidated net revenue

 

$

177,453

 

$

167,611

 

$

396,487

 

$

327,744

 

Operating Income

 

 

 

 

 

 

 

 

 

 

 

 

 

Healthcare

 

$

32,090

 

$

38,689

 

$

106,864

 

$

69,850

 

Global Retail and Other

 

 

1,307

 

 

1,307

 

 

5,204

 

 

4,228

 

Consolidated operating income

 

$

33,397

 

$

 39,996

 

$

112,068

 

$

74,078

 

 

 

 

 

 

 

 

 

25


 

ITEM 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion and analysis of the financial condition and results of our operations should be read together with the financial statements and the related notes of Cotiviti Holdings, Inc. included in Item 1 of this Quarterly Report on Form 10-Q and with our audited financial statements and the related notes included in our 2017 Annual Report on Form 10-K.

 

This discussion and analysis contains forward-looking statements regarding the industry outlook, our expectations for the performance of our business, our liquidity and capital resources and other non-historical statements. These forward-looking statements are subject to numerous risks and uncertainties, including but not limited to the risks and uncertainties described in “Cautionary Note Regarding Forward-Looking Statements”, in Part II, Item 1A “Risk Factors” of this Quarterly Report on Form 10-Q and in Part 1, Item 1A. “Risk Factors” included in our 2017 Annual Report on Form 10-K. Our actual results may differ materially from those contained in or implied by these forward-looking statements.

 

Overview

 

Cotiviti Holdings, Inc. (collectively with its subsidiaries, “we,” “our,” “Cotiviti” or the “Company”) is a leading provider of payment accuracy and analytics-driven solutions that help payers, other risk-bearing healthcare organizations and retailers achieve their business objectives. Through a combination of analytics, technology and deep industry expertise, our solutions create insights that unlock value from the complex interactions between clients and their stakeholders. We help our healthcare clients identify and correct payment inaccuracies, which resulted in approximately $3.4 billion in savings in 2017. We serve a majority of the top 25 U.S. healthcare payers and a majority of the top ten U.S. retailers. We operate in two segments, Healthcare and Global Retail and Other.

 

Our growth strategy for healthcare includes:

 

·

expand within our existing client base by increasing the volume of claims we review with our solutions; expanding utilization across the depth and breadth of our solutions; and cross-selling our prospective and retrospective solutions;

 

·

expand our client base;

 

·

innovate to improve and develop new solutions to expand the scope of our services; and

 

·

pursue opportunistic acquisitions and strategic partnerships in payment accuracy and adjacent markets.

 

As a result of the meaningful savings we deliver to our clients, we have increased our client base and strengthened our long-standing relationships over time with many of the leading healthcare payers in the United States. The average length of our relationships with our ten largest healthcare clients is over ten years. Additionally, we have substantially increased the annual savings captured by our healthcare clients over time.

 

We are also a leading provider of payment accuracy solutions to the retail market, primarily in the United States. Retailers process and validate extremely high volumes of transactions with disparate suppliers on varying terms. We work with retail clients to realize their negotiated allowances, concessions, rebates and other incentives associated with merchandise procurement, logistics and other service transactions. In 2017, we generated over $550 million in savings for our retail clients.

 

For a further discussion of our two operating segments, (i) Healthcare and (ii) Global Retail and Other, refer to “—Our Segments” and Note 15 to the consolidated financial statements.

 

Factors Affecting Our Results of Operations

 

Recent Developments – 2018 Highlights

 

·

On June 19, 2018, we entered into the Verscend Merger Agreement, which provides that, upon the terms and subject to the satisfaction or waiver of the conditions set forth therein, Merger Sub will merge with and into Cotiviti, with

26


 

Cotiviti continuing as the surviving corporation and a wholly owned subsidiary of Verscend. The board of directors of Cotiviti has unanimously determined that the Verscend Merger Agreement and the transactions contemplated thereby, including the Verscend Merger, are advisable, fair to and in the best interests of Cotiviti and its stockholders, and directed that the Verscend Merger Agreement be submitted to the stockholders of Cotiviti for their adoption. On July 13, 2018, the U.S. Federal Trade Commission granted early termination of the waiting period under the HSR Act with respect to the Verscend Merger, thereby satisfying one of the conditions to the closing of the Verscend Merger. Under the terms of the Verscend Merger Agreement, Cotiviti stockholders will receive $44.75 in cash per share of Cotiviti common stock, without interest and less any applicable withholding taxes, and Verscend will pay all of Cotiviti’s outstanding net indebtedness, resulting in an enterprise value of approximately $4.9 billion. If the Verscend Merger is consummated, Cotiviti will cease to be a publicly traded company and will become a wholly owned subsidiary of Verscend, and our common stock will be delisted from the NYSE and deregistered under the Exchange Act.

 

·

Our original Medicare RAC contract with CMS expired on January 31, 2018. As a result of this contract expiration, we released approximately $47.2 million in the estimated liability for refunds and appeals to revenue and we recorded $1.2 million in variable compensation costs associated with the release during the six months ended June 30, 2018.

 

·

In February 2018, we received an upgrade to our corporate credit rating from Moody’s to Ba3 which reduced the applicable margin for our First Lien Term B Loans by 25 basis points.

 

Dollar Amount of Claims Reviewed

 

Revenue in our Healthcare segment in a given period is impacted by the dollar amount of claims we review for our clients, which impacts inaccurate payments that we identify for our clients and the amount of revenue we receive under our performance fee-based contracts. The dollar amount of claims that we review is driven by the scope of claims submitted to us by our clients. The dollar amount of inaccurate payments we identify is also dependent upon the type and number of our solutions used by our clients. As a result of our long-standing relationships with our clients, we have a steady, recurring revenue base.

 

In our Global Retail and Other segment, our revenue is dependent on (i) the amount of payments that we review for our retail clients and (ii) the timing of our payment reviews, which typically are completed on a batch processing basis following the lapse of a period of time after payment.

 

Healthcare Industry and General Economic Conditions

 

A majority of our business is directly related to the healthcare industry and is affected by healthcare spending and complexity in the healthcare industry, as follows:

 

·

Healthcare Spending by Payers. Changing demographics, the shift to managed care plans within government healthcare and increased healthcare coverage may lead to an increase in healthcare spending by our payer clients. From 2006 to 2016, healthcare costs in the United States grew at a 4.5% CAGR to $3.3 trillion. According to CMS, healthcare costs are expected to continue to grow at an average annual rate of 5.6% through 2026 reaching $5.7 trillion. Our revenue is impacted by the expansion or contraction of healthcare coverage, spending and utilization, which directly affects the number of payments available for our review.

 

·

Complexity in the Healthcare Industry. We believe reimbursement models will continue to become more complex as healthcare payers accommodate new markets and lines of business and as advancements in medical care increase the number of testing and treatment options available. As reimbursement models grow more complex and healthcare coverage increases, the complexity and number of claims may also increase, which could impact the demand for our payment accuracy solutions. Also, many of the changes promulgated by the Affordable Care Act, which may be repealed or restructured under the current administration, require implementing regulations that have not yet been drafted or have been released only as proposed rules. Such changes could have a further impact on our results of operations.

 

In addition, our Global Retail and Other segment is impacted by general economic conditions. For example, in a

27


 

difficult economy, consumers may be willing to spend less and retailers may reduce their purchasing accordingly, thereby reducing their overall payments available for review. Alternatively, in an expanding economy, retailers may increase their purchasing to meet expected increasing demand resulting in increased payments subject to review using our solutions.

 

Components of Results of Operations

 

Net revenue

 

Our net revenue is generated from contracts with our clients. Our client contracts generally provide for performance fees that are based on a percentage of the inaccurate payments that we prevent through our prospective claims accuracy solutions or the payment recoveries received by our clients that use our retrospective claims accuracy solutions. We derive approximately 5% of our revenue on a “fee-for-service” basis whereby billing is based upon a flat fee or a fee per hour. Our clients may request a refund or offset if their providers or vendors ultimately reject the payment inaccuracies we find or if our clients determine not to pursue reimbursement from their providers or vendors even though we may have collected fees. We record an estimate for refund liabilities at any given time based on actual historical refund data by client type. In such cases, we record any such refund as a reduction of revenue.

 

Historically, there has been a seasonal pattern to our healthcare revenue with the revenues in the first quarter generally lower than the other quarters and revenues in the fourth quarter generally being higher than the other quarters. Accordingly, the comparison of revenue from quarter to quarter may fluctuate and is dependent on various factors, including, but not limited to: a reset of member liability; timing of special projects; implementation delays; timing of inaccurate payments being prevented or recovered; industry utilization trends; and the aforementioned seasonal considerations. Consequently, you should not rely on our revenue for any one quarter as an indication of our future performance. Additionally, we record an estimated liability for refunds and appeals which is subject to management’s assumptions. These assumptions may change from time to time and result in adjustments to revenue. Our adjustments of these estimates on a quarterly basis, to reflect actual results or updated expectations, have generally not been material to our overall business and have resulted in either a net increase or a net decrease in revenue. During the three and six months ended June 30, 2018 we recorded $0.6 million and $47.2 million, respectively, related to the release of the estimated liability for refunds and appeals under our original Medicare RAC contract, which expired on January 31, 2018.

 

Cost of revenue

 

Our cost of revenue is comprised of:

 

·

Compensation, which includes the total compensation and benefit-related expenses, including stock-based compensation expense, for employees who provide direct revenue generating services to clients; and

 

·

Other costs of revenue, which primarily include expenses related to the use of subcontractors and professional services firms, costs associated with the retrieval of medical records and facilities-related costs associated with locations that are used strictly for revenue generating activities. Cost of revenue does not include depreciation and amortization, which is stated separately in our Consolidated Statements of Comprehensive Income.

 

Selling, general and administrative expenses

 

Our SG&A expenses are comprised of:

 

·

Compensation, which includes total compensation and benefit-related expenses, including stock-based compensation expense, for our employees who are not directly involved in revenue generating activities including those involved with developing new service offerings; and

 

·

Other SG&A, which include all of our general operating costs. These costs include, but are not limited to, rent and occupancy costs for facilities associated with locations that are used for employees not serving in revenue generating roles, telecommunications costs, information technology infrastructure costs, software licensing costs, advertising and marketing expenses, costs associated with developing new service offerings and expenses related to the use of certain subcontractors and professional services firms. SG&A expenses do not include depreciation and amortization, which is stated separately in our Consolidated Statements of Comprehensive Income.

28


 

 

Depreciation and amortization of property and equipment

 

Depreciation and amortization of property and equipment consists of depreciation related to our investments in property and equipment, including claims accuracy solutions software, as well as amortization of capitalized internal-use software and software development costs.

 

Amortization of intangible assets

 

Amortization of intangible assets includes amortization of customer relationships and acquired software.

 

Transaction-related expenses

 

Transaction-related expenses consist primarily of professional services and other expenses associated with certain corporate development activity, including the proposed Verscend Merger and RowdMap Acquisition, as well as our secondary offerings in 2017.

 

Interest expense

 

Interest expense consists of accrued interest and related payments on our outstanding long-term debt as well as the amortization of debt issuance costs. Additionally, interest expense includes any effective portion of realized interest rate hedging derivative gains and losses previously recorded in accumulated other comprehensive income (loss) when the actual interest payments are made on our variable rate debt and the related derivative contract settles.

 

Loss on extinguishment of debt

 

Loss on extinguishment of debt consists of fees paid and write-offs of unamortized debt issuance costs and original issue discount in connection with the 2017 repricing of our First Lien Term B Loans.

 

Other non-operating (income) expense

 

Other non-operating (income) expense primarily consists of foreign exchange gains and losses. In addition, income received for certain sub-leases, interest income and realized gains and losses are included in other non-operating (income) expense.

 

Income tax expense

 

Income tax expense consists of federal, state, local and foreign taxes based on earnings in multiple jurisdictions. Our income tax expense is impacted by the pre-tax earnings in jurisdictions with varying tax rates and any related foreign tax credits or deductions that may be available to us. Our current and future provision for income taxes will vary from statutory rates due to the impact of changes resulting from the enactment of the Tax Act, income tax incentives and holidays, certain non-deductible expenses, valuation allowances in certain countries, withholding taxes, excess tax benefits on the exercise of stock options and vesting of restricted stock units and other discrete items.

 

Stock-based compensation expense

 

We grant equity incentive awards to certain employees, officers and non-employee directors as long-term incentive compensation. As part of the RowdMap Acquisition, we issued restricted stock to certain employees. We recognize the related expense for these awards ratably over the applicable vesting period or as achievement of performance criteria become probable. Such expense is recognized in either cost of revenue or SG&A expenses based upon the function of the optionee. The following table shows the allocation of stock-based compensation expense among our expense line items for the periods presented (in thousands):

29


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30, 

 

June 30, 

 

 

    

2018

    

2017

    

2018

    

2017

    

 

 

 

(unaudited)

 

(unaudited)

 

 

Cost of revenue

 

$

820

 

$

494

 

$

1,535

 

$

960

 

 

Selling, general and administrative expenses

 

 

7,921

 

 

1,961

 

 

15,852

 

 

3,578

 

 

Total

 

$

8,741

 

$

2,455

 

$

17,387

 

$

4,538

 

 

 

As of June 30, 2018, we had total unrecognized stock-based compensation expense related to unvested service-based awards of $50.5 million, which we expect to recognize over the next 2.4 years. Stock-based compensation expense for the six months ended June 30, 2018 includes approximately $8.5 million related to the performance-based restricted stock issued in connection with the RowdMap Acquisition that we estimate will vest based on achieving the performance criteria, of which approximately $8.2 million is included in SG&A expenses and $0.3 million is included in cost of revenue.

 

Foreign currency translation adjustments

 

The assets and liabilities of our foreign subsidiaries with a functional currency other than the U.S. Dollar are translated into U.S. Dollars using applicable exchange rates at the balance sheet date. Revenue and expenses are translated at average exchange rates effective during the year. The resulting foreign currency translation gains and losses are included as a component of other comprehensive income (loss). We had foreign currency translation adjustments of $0.4 million and $0.5 million for the three months ended June 30, 2018 and 2017, respectively. We had foreign currency translation adjustments of $0.6 million and $0.5 million for the six months ended June 30, 2018 and 2017, respectively. The translation adjustments were the result of the weakening of the U.S. Dollar against the Canadian Dollar and British Pound over the corresponding period.

 

Change in fair value of derivative instruments, net of related taxes

 

We are a party to interest rate cap agreements that hedge the potential impact fluctuations in interest rates may have on payments we make pursuant to our long-term debt. We had a net change in fair value of derivative instruments, net of related taxes, of approximately $0.4 million and $0.2 million for the three months ended June 30, 2018 and 2017, respectively. We had a net change in fair value of derivative instruments, net of related taxes, of approximately $0.4 million and $0.1 million for the six months ended June 30, 2018 and 2017, respectively. The changes were the result of fluctuations in three-month LIBOR.

 

How We Assess Our Performance

 

Adjusted EBITDA

 

We believe Adjusted EBITDA (a non-GAAP measure) is useful to investors as a supplemental measure to evaluate our overall operating performance. Management uses Adjusted EBITDA as a measurement to compare our operating performance to our peers and competitors. We define Adjusted EBITDA as net income before depreciation and amortization, interest expense, other non-operating (income) expense such as foreign currency transaction gains and losses, income tax expense, transaction-related expenses and other, stock-based compensation, loss on extinguishment of debt and the adjustment related to the original Medicare RAC contract. See the notes to our consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for additional information regarding these adjustments. Management believes Adjusted EBITDA is useful because it provides meaningful supplemental information about our operating performance and facilitates period-to-period comparisons without regard to our financing methods, capital structure or other items that we believe are not indicative of our ongoing operating performance. By providing this non-GAAP financial measure, management believes we are enhancing investors' understanding of our business and our results of operations, as well as assisting investors in evaluating how well we are executing our strategic initiatives. Management believes that Adjusted EBITDA is frequently used by securities analysts, investors and other interested parties as a supplemental measure of financial performance within our industry. In addition, the determination of Adjusted EBITDA is a similar measure in our First Lien Credit Facilities.

 

30


 

Adjusted EBITDA has important limitations as an analytical tool and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:

 

·

Adjusted EBITDA does not reflect our cash expenditures or future requirements for capital expenditures or contractual commitments;

 

·

Adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs;

 

·

Although depreciation is a non-cash charge, the assets being depreciated will often have to be replaced in the future, and Adjusted EBITDA does not reflect any cash requirements for such replacements;

 

·

Adjusted EBITDA does not reflect the impact of stock-based compensation upon our results of operations;

 

·

Adjusted EBITDA does not reflect the significant interest expense, or the cash requirements necessary to service interest or principal payments on our debt;

 

·

Adjusted EBITDA does not reflect our income tax expense or the cash requirements to pay our income taxes; and

 

·

Other companies in our industry may calculate Adjusted EBITDA differently than we do, limiting its usefulness as a comparative measure.

 

In evaluating Adjusted EBITDA, you should be aware that in the future we may incur expenses similar to those eliminated in this presentation.

 

The following table presents a reconciliation of Adjusted EBITDA to net income, the most directly comparable GAAP measure, for the periods presented:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30, 

 

June 30, 

 

 

    

2018

    

2017

    

2018

    

2017

 

(in thousands)

 

(unaudited)

 

(unaudited)

 

Net income

 

$

16,575

 

$

21,088

 

$

70,502

 

$

48,063

 

Depreciation and amortization

 

 

21,597

 

 

21,097

 

 

43,235

 

 

41,871

 

Interest expense

 

 

10,174

 

 

8,538

 

 

19,351

 

 

16,959

 

Other non-operating (income) expense(a)

 

 

(305)

 

 

(556)

 

 

(640)

 

 

(1,009)

 

Income tax expense

 

 

6,953

 

 

7,743

 

 

22,855

 

 

6,882

 

Transaction-related expenses and other(b)

 

 

7,193

 

 

661

 

 

7,407

 

 

1,392

 

Stock-based compensation(c)

 

 

8,741

 

 

2,455

 

 

17,387

 

 

4,538

 

Loss on extinguishment of debt(d)

 

 

 —

 

 

3,183

 

 

 —

 

 

3,183

 

Original Medicare RAC contract adjustment(e)

 

 

(600)

 

 

 —

 

 

(45,951)

 

 

 —

 

Adjusted EBITDA

 

$

70,328

 

$

64,209

 

$

134,146

 

$

121,879

 


(a)

Represents other non‑operating (income) expense that consists primarily of interest income and gains and losses on transactions settled in foreign currencies. Income received for certain sub‑leases is included herein.

 

(b)

Represents transaction‑related expenses primarily associated with certain corporate development activity, including the proposed Verscend Merger and RowdMap Acquisition as well as our secondary offerings in 2017.

 

(c)

Represents expense related to equity incentive awards granted to certain employees, officers and non‑employee directors as long‑term incentive compensation and restricted stock issued in connection with the RowdMap Acquisition. We recognize the related expense for these awards ratably over the vesting period or as achievement of performance criteria become probable.

 

(d)

Represents loss on extinguishment of debt that consists primarily of fees paid and write-offs of unamortized debt issuance costs and original issue discount in connection with the repricing of our First Lien Term B Loans in 2017.

 

(e)

Represents the net impact of the release of the estimated liability for refunds and appeals and related expense, under our original Medicare RAC contract, which expired on January 31, 2018. The gross revenue impact of $600 and $47,156 for the three and six months ended June 30, 2018, respectively, was previously recorded as a reduction to revenue in prior periods during the contract term.

31


 

 

Dollar Amount of Inaccurate Payments Prevented or Recovered

 

The majority of our net revenue consists of performance fees earned under our client contracts. A small portion (approximately 5%) of our revenue is derived on a “fee-for-service” basis whereby billing is based upon a subscription basis, flat fee or a fee per hour. Our performance fees generally represent a specified percentage of inaccurate payments that are either prevented prior to payment using our prospective claims accuracy solutions or recovered by our clients after they are identified using our retrospective claims accuracy solutions. For those clients where we identify any payment inaccuracies in advance of payment to the providers, the clients reduce the amount paid to the providers based upon the inaccuracies that we have identified. For those clients where we identify payment inaccuracies using our retrospective claims accuracy solutions after the client has made payment, clients generally recover claims either by taking credits against outstanding payables to healthcare providers or retail vendors, or future purchases from the related retail vendors, or receiving refunds directly from those healthcare providers or retail vendors.

 

The dollar amount of inaccurate payments prevented or recovered in a given period is impacted by the dollar amount of claims or payments reviewed, the scope of claims or payments that we review, the success of our cross-selling efforts, our ability to retain existing clients and obtain new clients and our ability to enhance our existing solutions or create new solutions.

 

We believe the dollar amount of inaccurate payments prevented or recovered is useful to measure our overall operating performance and how well we are executing on our client contracts.

 

Factors Affecting the Comparability of our Results of Operations

 

As a result of a number of factors, our historical results of operations may not be comparable to our results of operations in future periods and our results of operations may not be directly comparable from period to period. Set forth below is a brief discussion of the key factors impacting the comparability of our results of operations.

 

Debt Refinancings, Repayments and Repricing

 

In connection with our various debt refinancings, we incurred significant debt issuance costs, primarily associated with the new indebtedness. These debt issuance costs are amortized utilizing the effective interest method over the associated life of the related indebtedness and recorded as interest expense. Unamortized debt issuance costs were $6.4 million as of June 30, 2018.

 

In February 2018, we received an upgrade to our corporate credit rating from Moody’s to Ba3 which reduced the applicable margin for our First Lien Term B Loans by 25 basis points.

 

In April 2017, we entered into the First Amendment Agreement to our then outstanding Restated Credit Agreement, which, among other things, provided for lower applicable interest rates associated with the First Lien Term B Loans. As a result, we recognized a loss on extinguishment of $3.2 million during the three months ended June 30, 2017.

 

Medicare RAC Contract 

 

Our original Medicare RAC contract with CMS expired on January 31, 2018. In connection with the expiration of the contract, we determined that we have no obligation to CMS with respect to any appeals resolved in the providers’ favor after the expiration date and, in addition, we believe that we have no obligation to CMS in connection with the hospital settlement processes initiated by CMS. Refer to Note 7 of the Notes to Consolidated Financial Statements included in our 2017 Annual Report on Form 10-K for further details on the hospital settlement processes. As a result of this contract expiration, we released approximately $0.6 million and $47.2 million in the estimated liability for refunds and appeals to revenue for the three and six months ended June 30, 2018, respectively, and we recorded $1.2 million in variable compensation costs associated with the release during the six months ended June 30, 2018.

 

Stock-based compensation

 

32


 

As part of the RowdMap Acquisition, we issued restricted stock to certain employees. We recognize the related expense for these awards ratably over the applicable vesting period or as achievement of performance criteria become probable. 

 

Income tax expense

 

On December 22, 2017, the U.S. government enacted the Tax Act, which, among other things, reduced the federal tax rate on U.S. earnings to 21%, effective January 1, 2018, and moves from a global taxation regime to a modified territorial regime. 

 

Stock options result in an income tax benefit at the time of exercise and restricted stock units result in an income tax benefit at the time of vest. As a result, the timing and amount of stock option exercises and restricted stock units may result in significant changes in our effective tax rate and related income tax expense.

 

RowdMap Acquisition

 

On July 14, 2017, we acquired all of the outstanding equity of RowdMap. Results of operations for RowdMap are included in the consolidated results of operations as of and subsequent to the date of acquisition.

 

Our Segments

 

We report our results of operations in two segments, (i) Healthcare and (ii) Global Retail and Other. Through our Healthcare segment, we offer prospective and retrospective claims accuracy solutions to healthcare payers in the United States. We also provide a network efficiency solution to payers and providers as well as, on a limited basis, certain analytics-based solutions unrelated to our healthcare payment accuracy solutions in the United States. Through our Global Retail and Other segment, we provide retrospective claims accuracy solutions to retailers primarily in the United States. During the first quarter 2018, we made the decision to exit our retail operations in the United Kingdom by the end of 2018.

 

We evaluate the performance of each segment based on segment net revenue and segment operating income. The cost of revenue for each segment is based on direct expenses associated with revenue generating activities of each segment. We allocate SG&A expenses and depreciation and amortization to each segment based on the segments' proportionate share of revenue and expenses directly related to the operation of the segment as determined by management. The following table sets forth the net revenue and operating income for our Healthcare and Global Retail and Other segments for the periods presented (in thousands).

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30, 

 

June 30, 

 

 

    

2018

    

2017

    

2018

    

2017

    

 

 

(unaudited)

 

(unaudited)

 

Net Revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

Healthcare

 

$

161,705

 

$

151,559

 

$

362,076

 

$

291,362

 

Global Retail and Other

 

 

15,748

 

 

16,052

 

 

34,411

 

 

36,382

 

Consolidated net revenue

 

$

177,453

 

$

167,611

 

$

396,487

 

$

327,744

 

Operating Income

 

 

 

 

 

 

 

 

 

 

 

 

 

Healthcare

 

$

32,090

 

$

38,689

 

$

106,864

 

$

69,850

 

Global Retail and Other

 

 

1,307

 

 

1,307

 

 

5,204

 

 

4,228

 

Consolidated operating income

 

$

33,397

 

$

 39,996

 

$

112,068

 

$

74,078

 

 

33


 

The following table sets forth our segment net revenue and percentage of consolidated net revenue by product type for the periods presented (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended June 30, 

 

Six Months Ended June 30, 

 

 

  

2018

  

%

  

2017

  

%

  

2018

  

%

  

2017

  

%

    

 

 

(unaudited)

 

 

 

(unaudited)

 

Healthcare

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Retrospective claims accuracy

 

$

93,529

 

52.7

 

$

86,627

 

51.7

 

$

227,452

 

57.4

 

$

164,143

 

50.1

 

Prospective claims accuracy

 

 

62,745

 

35.4

 

 

62,020

 

37.0

 

 

121,030

 

30.5

 

 

121,737

 

37.1

 

Other

 

 

5,431

 

3.0

 

 

2,912

 

1.7

 

 

13,594

 

3.4

 

 

5,482

 

1.7

 

Total Healthcare

 

 

161,705

 

91.1

 

 

151,559

 

90.4

 

 

362,076

 

91.3

 

 

291,362

 

88.9

 

Global Retail and Other

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Retrospective claims accuracy

 

 

15,748

 

8.9

 

 

15,385

 

9.2

 

 

34,411

 

8.7

 

 

35,059

 

10.7

 

Other

 

 

 —

 

 —

 

 

667

 

0.4

 

 

 —

 

 —

 

 

1,323

 

0.4

 

Total Global Retail and Other

 

 

15,748

 

8.9

 

 

16,052

 

9.6

 

 

34,411

 

8.7

 

 

36,382

 

11.1

 

Consolidated net revenue

 

$

177,453

 

100.0

 

$

167,611

 

100.0

 

$

396,487

 

100.0

 

$

327,744

 

100.0

 

 

Results of Operations

 

Three Months Ended June 30, 2018 Compared to Three Months Ended June 30, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended June 30, 

 

Percentage

 

 

    

 

 

    

Percentage of 

    

 

 

    

Percentage of 

    

Change

 

 

 

 

 

 

Net Revenue

 

 

 

 

Net Revenue

 

Period to

 

(unaudited)

 

2018

 

 (%)

 

2017

 

 (%)

 

Period (%)

 

Net revenue

 

$

177,453

 

100.0

 

$

167,611

 

100.0

 

5.9

 

Cost of revenue (exclusive of depreciation and amortization, stated separately below):

 

 

 

 

 

 

 

 

 

 

 

 

 

Compensation

 

 

57,135

 

32.2

 

 

58,870

 

35.1

 

(2.9)

 

Other costs of revenue

 

 

7,626

 

4.3

 

 

6,123

 

3.7

 

24.5

 

Total cost of revenue

 

 

64,761

 

36.5

 

 

64,993

 

38.8

 

(0.4)

 

Selling, general and administrative expenses (exclusive of depreciation and amortization, stated separately below):

 

 

 

 

 

 

 

 

 

 

 

 

 

Compensation

 

 

32,500

 

18.4

 

 

25,564

 

15.3

 

27.1

 

Other selling, general and administrative expenses

 

 

18,005

 

10.1

 

 

15,300

 

9.1

 

17.7

 

Total selling, general and administrative expenses

 

 

50,505

 

28.5

 

 

40,864

 

24.4

 

23.6

 

Depreciation and amortization of property and equipment

 

 

7,200

 

4.1

 

 

5,896

 

3.5

 

22.1

 

Amortization of intangible assets

 

 

14,397

 

8.1

 

 

15,201

 

9.1

 

(5.3)

 

Transaction-related expenses

 

 

7,193

 

4.0

 

 

661

 

0.4

 

NM

 

Total operating expenses

 

 

144,056

 

81.2

 

 

127,615

 

76.1

 

12.9

 

Operating income

 

 

33,397

 

18.8

 

 

39,996

 

23.9

 

(16.5)

 

Other expense (income):

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

10,174

 

5.7

 

 

8,538

 

5.1

 

19.2

 

Loss on extinguishment of debt

 

 

 —

 

 —

 

 

3,183

 

1.9

 

(100.0)

 

Other non-operating (income) expense

 

 

(305)

 

(0.1)

 

 

(556)

 

(0.3)

 

(45.1)

 

Total other expense (income)

 

 

9,869

 

5.6

 

 

11,165

 

6.7

 

(11.6)

 

Income from continuing operations before income taxes

 

 

23,528

 

13.2

 

 

28,831

 

17.2

 

(18.4)

 

Income tax expense

 

 

6,953

 

3.9

 

 

7,743

 

4.6

 

(10.2)

 

Net income

 

$

16,575

 

9.3

 

$

21,088

 

12.6

 

(21.4)

 

 

Net revenue

 

Net revenue was $177.5 million for the three months ended June 30, 2018 as compared to $167.6 million for the three months ended June 30, 2017. The increase of $9.9 million was the result of increased Healthcare segment revenue of

34


 

$10.1 million and decreased Global Retail and Other segment revenue of $0.3 million. See “−Segment net revenue and operating income.”

 

Cost of revenue

 

Cost of revenue related to compensation was $57.1 million for the three months ended June 30, 2018 as compared to $58.9 million for the three months ended June 30, 2017. The decrease of $1.8 million was primarily the result of a $2.8 million decrease in payroll related expense primarily due to changes in some of our legacy variable compensation programs in order to better align our compensation structure with our business strategy. The decrease was partially offset by a $0.7 million increase in employee benefit costs due to rising healthcare coverage costs and the increase in the number of our employees. Stock-based compensation increased $0.3 million due to additional equity grants.

 

Other costs of revenue were $7.6 million for the three months ended June 30, 2018 as compared to $6.1 million for the three months ended June 30, 2017. The increase of $1.5 million was primarily the result of an increase in rent and occupancy of approximately $0.9 million as a result of relocated and expanded facility locations. In addition, professional and consulting fees increased $0.5 million.

 

Selling, general and administrative expenses

 

SG&A expenses related to compensation were $32.5 million for the three months ended June 30, 2018 as compared to $25.6 million for the three months ended June 30, 2017. The increase of $6.9 million was primarily related to a $6.0 million increase in stock-based compensation due to additional equity grants including restricted stock issued in connection with the RowdMap Acquisition. In addition, payroll related expenses increased $0.9 million due to an increase in the number of employees to support our growing operations.

 

Other SG&A expenses were $18.0 million for the three months ended June 30, 2018 as compared to $15.3 million for the three months ended June 30, 2017. The increase of $2.7 million was primarily due to an increase of $1.3 million in software licensing costs. Professional and consulting fees increased $0.8 million as we have leveraged external resources and expertise. Rent and occupancy increased approximately $0.4 million as a result of relocated and expanded facility locations. Personnel-related expenses increased approximately $0.2 million due to an increased number of employees.

 

Depreciation and amortization of property and equipment

 

Depreciation and amortization of property and equipment was $7.2 million for the three months ended June 30, 2018 as compared to $5.9 million for the three months ended June 30, 2017. The increase of $1.3 million was due to continued investments in capital expenditures over the past year.

 

Amortization of intangible assets

 

Amortization of intangible assets was $14.4 million for the three months ended June 30, 2018 as compared to $15.2 million for the three months ended June 30, 2017. The decrease was due to certain acquired software becoming fully amortized during 2017 and the impairment of intangible assets in 2017 related to our customer relationships as a result of the loss of a retail client in the United Kingdom partially offset by the addition of $19.5 million in intangible assets in connection with the RowdMap Acquisition.

 

Transaction-related expenses

 

Transaction-related expenses of $7.2 million for the three months ended June 30, 2018 were primarily associated with the proposed Verscend Merger. Transaction-related expenses of $0.7 million for the three months ended June 30, 2017 were primarily incurred in connection with our secondary offering as well as certain expenses related to corporate development activity, including the RowdMap Acquisition.

 

Interest expense

 

Interest expense was $10.2 million for the three months ended June 30, 2018 as compared to $8.5 million for the three months ended June 30, 2017. The increase of $1.7 million was primarily due to an increase in LIBOR and a $0.2

35


 

million increase in interest expense related to our interest rate cap agreements. This increase was partially offset by the lower principal balance on our First Lien Term Loans as a result of scheduled principal payments over the past year.

 

Loss on extinguishment of debt

 

Loss on extinguishment of debt was $3.2 million for the three months ended June 30, 2017 related to the payment of fees and write-off of unamortized debt issuance costs and original issue discount as a result of repricing of our First Lien Term B Loans.

 

Other non-operating income

 

We had other non-operating income of $0.3 million for the three months ended June 30, 2018 as compared to $0.6 million for the three months ended June 30, 2017. The decrease of $0.3 million was primarily due to foreign exchange gains related to our operations in India.

 

Income tax expense

 

Income tax expense was $7.0 million for the three months ended June 30, 2018 as compared to $7.7 million for the three months ended June 30, 2017. The decrease of $0.7 million was primarily the result of a reduction of the federal tax rate to 21% due to the Tax Act, a $1.3 million tax benefit related to stock option exercises and vesting of restricted stock units, partially offset by additional expense of $1.9 million related to nondeductible transaction-related expenses. The impact of the tax benefits and additional expense noted above relative to the pre-tax income for the three months ended June 30, 2018 resulted in the increase to the effective tax rate. The effective tax rate for the three months ended June 30, 2018 was 29.5% compared to 26.9% for the three months ended June 30, 2017. During the three months ended June 30, 2017, we recorded a $2.6 million tax benefit related to stock option exercises and vesting of restricted stock units and a $0.7 million tax benefit related to the filing of amended state tax returns as a result of certain tax planning.

 

Segment net revenue and operating income

 

Healthcare segment net revenue was $161.7 million for the three months ended June 30, 2018 as compared to $151.6 million for the three months ended June 30, 2017. The increase of $10.1 million was primarily due to an increase of $6.9 million in retrospective claims accuracy revenue, which includes a $0.6 million release of the estimated liability for refunds and appeals under our original Medicare RAC contract as well as the impact from improved conversions and strength in our clinical chart validation solutions. Other healthcare revenue increased $2.5 million primarily related to the impact of the RowdMap Acquisition. Prospective claims accuracy revenue increased $0.7 million primarily due to the addition of new clients partially offset by the impact of certain delays in policy adoption.

 

Global Retail and Other segment net revenue was $15.8 million for the three months ended June 30, 2018 as compared to $16.1 million for the three months ended June 30, 2017. The decrease of $0.3 million was primarily driven by the exit of non-core contracts partially offset by the timing, nature and size of the retail claims reviewed.

 

Healthcare segment operating income was $32.1 million for the three months ended June 30, 2018 as compared to $38.7 million for the three months ended June 30, 2017. The decrease in operating income of $6.6 million was primarily the result of an increase in transaction-related expenses of $6.3 million due to the proposed Verscend Merger. Stock-based compensation increased $6.2 million due to additional equity grants including the issuance of restricted stock in connection with the RowdMap Acquisition. Software licensing costs increased $1.5 million and rent and occupancy increased approximately $1.2 million as a result of relocated and expanded facility locations. Depreciation and amortization expense increased $0.5 million due to our continued investments in capital expenditures. Payroll related expenses increased $0.2 million and personnel-related expenses increased $0.3 million due to an increase in the number of employees to support our growing operation. Other variable costs increased $0.6 million.

 

Global Retail and Other segment operating income was $1.3 million for each of the three months ended June 30, 2018 and June 30, 2017. A decrease of $1.3 million in compensation related expenses as a result of changes in our variable compensation plans and a decrease of $0.2 million in software licensing costs as a result of the retail segment becoming a smaller portion of our overall business resulting in a lower allocation of corporate expenses was partially offset by the decrease in net revenue noted above and an increase in transaction-related expenses of $0.3 million due to the

36


 

proposed Verscend Merger. Additionally, professional and consulting fees increased approximately $0.7 million and rent and occupancy increased approximately $0.2 million as a result of relocated and expanded facility locations.

 

 

Six Months Ended June 30, 2018 Compared to Six Months Ended June 30, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30, 

 

Percentage

 

 

 

 

 

 

Percentage of

 

 

 

 

Percentage of

 

Change

 

 

 

 

 

 

 Net Revenue

 

 

 

 

 Net Revenue

 

Period to

 

(unaudited)

    

2018

    

 (%)

    

2017

    

 (%)

    

Period (%)

 

Net revenue

 

$

396,487

 

100.0

 

$

327,744

 

100.0

 

21.0

 

Cost of revenue (exclusive of depreciation and amortization, stated separately below):

 

 

 

 

 

 

 

 

 

 

 

 

 

Compensation

 

 

115,227

 

29.1

 

 

115,158

 

35.0

 

0.1

 

Other costs of revenue

 

 

14,099

 

3.5

 

 

12,809

 

3.9

 

10.1

 

Total cost of revenue

 

 

129,326

 

32.6

 

 

127,967

 

39.0

 

1.1

 

Selling, general and administrative expenses (exclusive of depreciation and amortization, stated separately below):

 

 

 

 

 

 

 

 

 

 

 

 

 

Compensation

 

 

67,680

 

17.1

 

 

50,257

 

15.3

 

34.7

 

Other selling, general and administrative expenses

 

 

36,771

 

9.2

 

 

32,179

 

9.9

 

14.3

 

Total selling, general and administrative expenses

 

 

104,451

 

26.3

 

 

82,436

 

25.2

 

26.7

 

Depreciation and amortization of property and equipment

 

 

14,442

 

3.6

 

 

11,471

 

3.5

 

25.9

 

Amortization of intangible assets

 

 

28,793

 

7.3

 

 

30,400

 

9.3

 

(5.3)

 

Transaction-related expenses

 

 

7,407

 

1.9

 

 

1,392

 

0.4

 

NM

 

Total operating expenses

 

 

284,419

 

71.7

 

 

253,666

 

77.4

 

12.1

 

Operating income

 

 

112,068

 

28.3

 

 

74,078

 

22.6

 

51.3

 

Other expense (income):

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

19,351

 

4.9

 

 

16,959

 

5.2

 

14.1

 

Loss on extinguishment of debt

 

 

 —

 

 —

 

 

3,183

 

1.0

 

(100.0)

 

Other non-operating (income) expense

 

 

(640)

 

(0.2)

 

 

(1,009)

 

(0.3)

 

(36.6)

 

Total other expense (income)

 

 

18,711

 

4.7

 

 

19,133

 

5.8

 

(2.2)

 

Income before income taxes

 

 

93,357

 

23.6

 

 

54,945

 

16.8

 

69.9

 

Income tax expense

 

 

22,855

 

5.8

 

 

6,882

 

2.1

 

232.1

 

Net income

 

$

70,502

 

17.8

 

$

48,063

 

14.7

 

46.7

 

 

Net revenue

 

Net revenue was $396.5 million for the six months ended June 30, 2018 as compared to $327.7 million for the six months ended June 30, 2017. The increase of $68.8 million was the result of increased Healthcare segment revenue of $70.7 million, which includes $47.2 million related to the release of the estimated liability for refunds and appeals under our original Medicare RAC contract, which expired on January 31, 2018, offset by a decrease in Global Retail and Other segment revenue of $2.0 million. See “−Segment net revenue and operating income.”

 

Cost of revenue

 

Cost of revenue related to compensation was $115.2 million for each of the six months ended June 30, 2018 and 2017. Payroll related expense decreased approximately $2.5 million primarily due to changes in some of our legacy variable compensation plans partially offset by $1.2 million in variable compensation expense related to the release of the estimated liability for refunds and appeals under our original Medicare RAC contract. In addition, employee benefit costs increased approximately $0.8 million due to rising healthcare coverage costs and the increase in the number of our employees and stock-based compensation increased $0.5 million due to additional equity grants. 

 

Other costs of revenue were $14.1 million for the six months ended June 30, 2018 as compared to $12.8 million for the six months ended June 30, 2017. The increase of $1.3 million was primarily the result of an increase of approximately $1.2 million in rent and occupancy as a result of relocated and expanded facility locations. Personnel-related

37


 

costs increased approximately $0.2 million due to an increase in the number of employees. The increase was partially offset by a decrease in professional and consulting fees of $0.1 million.  

 

Selling, general and administrative expenses

 

SG&A expenses related to compensation were $67.7 million for the six months ended June 30, 2018 as compared to $50.3 million for the six months ended June 30, 2017. The increase of $17.4 million was primarily related to a $12.3 million increase in stock-based compensation due to additional equity grants including restricted stock issued in connection with the RowdMap Acquisition. Payroll related expenses increased $4.0 million due to an increase in the number of employees to support our growing operations. Employee benefit costs increased approximately $1.1 million due to rising healthcare coverage costs and the increase in the number of employees.

 

Other SG&A expenses were $36.8 million for the six months ended June 30, 2018 as compared to $32.2 million for the six months ended June 30, 2017. The increase of $4.6 million was primarily due to an increase of $2.4 million in software licensing costs. Professional and consulting fees increased $1.1 million as we have leveraged external resources and expertise. Rent and occupancy increased approximately $0.8 million as a result of relocated and expanded facility locations. Other variable costs increased approximately $0.3 million.

 

Depreciation and amortization of property and equipment

 

Depreciation and amortization of property and equipment was $14.4 million for the six months ended June 30, 2018 as compared to $11.5 million for the six months ended June 30, 2017. The increase of $2.9 million was due to continued investments in capital expenditures over the past year.

 

Amortization of intangible assets

 

Amortization of intangible assets was $28.8 million for the six months ended June 30, 2018 as compared to $30.4 million for the six months ended June 30, 2017. The decrease of $1.6 million was due to certain acquired software becoming fully amortized during 2017 and the impairment of intangible assets in 2017 related to our customer relationships as a result of the loss of a retail client in the United Kingdom, partially offset by the addition of $19.5 million in intangible assets in connection with the RowdMap Acquisition.

 

Transaction-related expenses

 

Transaction-related expenses were $7.4 million for the six months ended June 30, 2018, primarily associated with the proposed Verscend Merger. Transaction-related expenses were $1.4 million for the six months ended June 30, 2017 primarily related to our secondary offerings as well as certain corporate development activity, including the RowdMap Acquisition.

 

Interest expense

 

Interest expense was $19.4 million for the six months ended June 30, 2018 as compared to $17.0 million for the six months ended June 30, 2017. The increase of $2.4 million was primarily due to an increase in LIBOR and a $0.7 million increase in interest expense related to our interest rate cap agreements. This increase was partially offset by the lower principal balance on our First Lien Term Loans as a result of scheduled principal payments over the past year.

 

Loss on extinguishment of debt

 

Loss on extinguishment of debt was $3.2 million for the six months ended June 30, 2017 related to the payment of fees and write-off of unamortized debt issuance costs and original issue discount as a result of repricing of our First Lien Term B Loans.

 

Other non-operating income

 

Other non-operating income was $0.6 million for the six months ended June 30, 2018 as compared to $1.0 million for the six months ended June 30, 2017. The decrease of $0.4 million was primarily due to foreign exchange gains related to our operations in India.

38


 

 

Income tax expense

 

Income tax expense was $22.9 million for the six months ended June 30, 2018 as compared to $6.9 million for the six months ended June 30, 2017. The increase of $16.0 million was primarily the result of an increase in pre-tax income for the six months ended June 30, 2018 and additional expense of $1.9 million related to nondeductible transaction-related expenses. In addition, a valuation allowance of $0.2 million was recorded to reflect the portion of the deferred tax asset on state tax credits that is more likely than not to be realized, partially offset by a $3.9 million tax benefit related to stock option exercises and vesting of restricted stock units. The impact of these items relative to the pre-tax income for the six months ended June 30, 2018 resulted in the increase to the effective tax rate. The effective tax rate for the six months ended June 30, 2018 was 24.5% compared to 12.5% for the six months ended June 30, 2017. During the six months ended June 30, 2017, we recorded a $13.0 million tax benefit related to stock option exercises and vesting of restricted stock units, a tax benefit of $0.3 million related to the settlement of an uncertain tax position due to the closure of our audit with the Internal Revenue Service as well as a tax benefit of $0.7 million related to the filing of amended state tax returns as a result of certain tax planning.

 

Segment net revenue and operating income

 

Healthcare segment net revenue was $362.1 million for the six months ended June 30, 2018 as compared to $291.4 million for the six months ended June 30, 2017. The increase of $70.7 million was primarily due to an increase of $63.3 million in retrospective claims accuracy revenue, which includes the $47.2 million release of the estimated liability for refunds and appeals under our original Medicare RAC contract as well as the impact from improved conversions and strength in our clinical chart validation solutions. Other healthcare revenue increased $8.1 million primarily related to the impact of the RowdMap Acquisition. Prospective claims accuracy revenue decreased $0.7 million due to the addition of new clients partially offset by membership and platform changes, clients exiting markets and the impact of certain delays in policy adoption. Additionally, estimated refund liabilities increased driven by the ramping of new clients and changes in estimates based on new information received.

 

Global Retail and Other segment net revenue was $34.4 million for the six months ended June 30, 2018 as compared to $36.4 million for the six months ended June 30, 2017. The decrease of $2.0 million was primarily the result of the exit of non-core contracts and the impact of large settlements in the first quarter of 2017.

 

Healthcare segment operating income was $106.9 million for the six months ended June 30, 2018 as compared to $69.9 million for the six months ended June 30, 2017. The increase in operating income of $37.0 million was the result of an increase in net revenue noted above partially offset by an increase in stock-based compensation of approximately $12.8 million due to additional equity grants including the issuance of restricted stock in connection with the RowdMap Acquisition. Compensation expense increased approximately $7.1 million due to an increase in the number of employees in our growing Healthcare segment and $1.2 million due to variable compensation expense related to the release of the estimated liability for refunds and appeals under our original Medicare RAC contract. Transaction-related expenses increased approximately $5.8 million due to the proposed Verscend Merger. Software licensing costs increased $2.6 million and rent and occupancy increased approximately $1.8 million as a result of relocated and expanded facility locations. Depreciation and amortization expense increased $1.6 million due to our continued investments in capital expenditures. Employee related expenses increased approximately $0.4 million due to an increase in the number of employees. Other variable costs increased approximately $0.4 million.

 

Global Retail and Other segment operating income was $5.2 million for the six months ended June 30, 2018 as compared to $4.2 million for the six months ended June 30, 2017. The net increase in operating income of $1.0 million was the result of a decrease of $3.5 million in compensation related expenses as a result of changes in our variable compensation plans. Additionally, software costs decreased approximately $0.3 million and depreciation and amortization expense decreased $0.3 million due to the retail segment becoming a smaller portion of our overall business and consequently resulting in a lower allocation of corporate expenses. This was partially offset by the decrease in net revenue noted above and an increase of approximately $0.8 million in professional and consulting fees. Transaction-related expenses increased approximately $0.2 million due to the proposed Verscend Merger. Rent and occupancy increased approximately $0.2 million as a result of relocated and expanded facility locations. 

 

39


 

Liquidity and Capital Resources

 

Overview

 

Our primary sources of liquidity are our existing cash and cash equivalents, cash provided by operating activities and borrowings under our credit facilities. As of June 30, 2018, we had cash and cash equivalents of $223.9 million and availability under the Revolver of $99.5 million. Our total debt principal outstanding was $768.5 million as of June 30, 2018.

 

In February 2018, we received an upgrade to our corporate credit rating from Moody’s to Ba3 which reduced the applicable margin for our First Lien Term B Loans by 25 basis points.

 

Our principal liquidity needs have been, and we expect them to continue to be, debt service, capital expenditures, working capital and potential mergers and acquisitions. Our capital expenditures support investments in our underlying infrastructure to enhance our solutions and technology for future growth. Our capital expenditures were $21.2 million and $16.6 million for the six months ended June 30, 2018 and 2017, respectively. The increase is primarily due to expenditures associated with enhancing our IT platform as well as new facility locations. Our strategy includes the expansion of our existing solutions and the development of new solutions, which will require cash expenditures over the next few years and will be funded primarily with cash provided by operating activities.

 

We believe that our cash flow from operations, availability under our First Lien Credit Facilities and available cash and cash equivalents will be sufficient to meet our liquidity needs for at least the foreseeable future. We anticipate that to the extent that we require additional liquidity, it will be funded through the incurrence of additional indebtedness, the issuance of equity financings, or a combination thereof. We cannot assure you that we will be able to obtain this additional liquidity on reasonable terms, or at all. Additionally, our liquidity and our ability to meet our obligations and fund our capital requirements are also dependent on our future financial performance, which is subject to general economic, financial and other factors that are beyond our control. Accordingly, we cannot assure you that our business will generate sufficient cash flow from operations or that future borrowings will be available from additional indebtedness or otherwise to meet our liquidity needs. If we decide to pursue one or more significant acquisitions, we may incur additional debt or sell additional equity to finance such acquisitions, which could possibly result in additional expenses or dilution.

 

Summary of Cash Flows

 

The following table provides a summary of cash flows from operating, investing and financing activities for the periods presented (in thousands):

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended

 

 

 

June 30, 

 

 

    

2018

    

2017

 

 

 

(unaudited)

 

Net cash provided by operating activities

 

$

78,714

 

$

42,300

 

Net cash used in investing activities

 

 

(21,213)

 

 

(16,593)

 

Net cash provided by financing activities

 

 

990

 

 

885

 

 

Operating Activities

 

Net cash provided by operating activities was $78.7 million and $42.3 million for the six months ended June 30, 2018 and 2017, respectively. The increase in cash provided by operating activities for the six months ended June 30, 2018 as compared to the six months ended June 30, 2017 primarily was due to a $40.1 million increase in net income adjusted for the exclusion of non-cash expenses, offset by approximately a $3.7 million decrease related to the effect of changes in operating assets and liabilities.

 

Net income adjusted for the exclusion of non-cash expenses was approximately $141.7 million for the six months ended June 30, 2018 as compared to $101.6 million for the six months ended June 30, 2017. The increase was primarily due to the release of $47.2 million in the estimated liability for refunds and appeals under our original Medicare RAC contract.

 

40


 

The effect of changes in operating assets and liabilities was a decrease of $63.0 million for the six months ended June 30, 2018 compared to a decrease of $59.3 million for the six months ended June 30, 2017. The most significant drivers contributing to this decrease relate to the following:

 

·

changes in accounts receivable primarily driven by increased revenue and timing of collections. Accounts receivable, net of the allowance for doubtful accounts, decreased $1.6 million during the six months ended June 30, 2018 as compared to an increase of $11.1 million during the six months ended June 30, 2017;

 

·

changes in accrued compensation primarily driven by timing of payments related to changes in variable compensation programs and an increase in the number of employees impacting compensation-related expenses. Accrued compensation decreased $9.5 million during the six months ended June 30, 2018 as compared to a decrease of $20.6 million during the six months ended June 30, 2017; and

 

·

the release of $47.2 million in the estimated liability for refunds and appeals under our original Medicare RAC contract.

 

Investing Activities

 

Net cash used in investing activities was $21.2 million and $16.6 million for the six months ended June 30, 2018 and 2017, respectively. The increase in cash used in investing activities during the six months ended June 30, 2018 as compared to the six months ended June 30, 2017 was due to an increase in capital expenditures primarily related to new facility locations and our ongoing investments, particularly as it relates to enhancing our information technology infrastructure and platforms to support our growing operations.

 

Financing Activities

 

Net cash provided by financing activities was $1.0 million and $0.9 million for the six months ended June 30, 2018 and 2017, respectively. The increase in cash provided by financing activities during the six months ended June 30, 2018 as compared to the six months ended June 30, 2017 was primarily due to $10.0 million in proceeds from the issuance of common stock under equity plans during the six months ended June 30, 2018 as compared to $10.5 million, partially offset by fees associated with the 2017 repricing of our First Lien Term B Loans of $0.7 million during the six months ended June 30, 2017. 

 

Off-Balance Sheet Arrangements

 

Except for operating leases and certain letters of credit entered into in the normal course of business, 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 likely to be material to investors.

 

Contractual Obligations

 

Except as set forth below, there have been no material changes to our contractual obligations as described in our 2017 Annual Report on Form 10-K.

 

In February 2018, we received an upgrade to our corporate credit rating from Moody’s to Ba3 which reduced the applicable margin for our First Lien Term B Loans by 25 basis points.

 

Critical Accounting Policies and Estimates

 

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect reported amounts and disclosure of contingent assets and liabilities. There have been no significant changes in the critical accounting policies and estimates described in our 2017 Annual Report on Form 10-K.

 

41


 

Recently Issued Accounting Pronouncements

 

See “Recently Issued Accounting Pronouncements” in Note 3 of the unaudited consolidated financial statements.

 

Available information

 

Our website address is www.cotiviti.com. Information that we furnish to or file with the SEC, including our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements, and any amendments to, or exhibits included in, those reports or statements are available for download, free of charge, on our website as soon as reasonably practicable after such materials are filed with or furnished to the SEC. From time to time, in addition to copies of all recent press releases, we also post announcements, updates, events, investor information and presentations on our website at http://investors.cotiviti.com as means of disclosing material non-public information and for complying with our disclosure obligations under Regulation FD.

 

Reports and statements that we file with or furnish to the SEC, including related exhibits, are also available on the SEC’s website at www.sec.gov. In addition, you may obtain and copy materials we furnish to or file with the SEC at the SEC’s public reference room at 100 F Street, NE, Room 1580, Washington, D.C. 20549. Information on the operation of the SEC’s public reference facilities may be obtained by calling the SEC at 1-800-SEC-0330. You may request copies of these documents, upon payment of a duplicating fee, by writing to the SEC at its principal office at 100 F Street, NE, Room 1580, Washington, D.C. 20549.

 

The contents of the websites referred to above are not incorporated into this filing. References to the URLs for these websites are intended to be inactive textual references only.

 

ITEM 3.   Quantitative and Qualitative Disclosures About Market Risk

 

Except as set forth below, there have been no material changes to our quantitative and qualitative disclosures about market risk compared to the quantitative and qualitative disclosure about market risk described in our 2017 Annual Report on Form 10-K.

 

We are exposed to interest rate risk on our First Lien Credit Facilities, which bear interest at variable rates. As of June 30, 2018, we had $768.5 million outstanding principal under our long-term debt and $435.0 million notional debt outstanding related to interest rate cap agreements. Based on our outstanding debt as of June 30, 2018, and assuming that our mix of debt instruments, interest rate caps and other variables remain the same, the annualized effect of a one percentage point change in variable interest rates would have an annualized pre-tax impact on our earnings and cash flows of approximately $7.3 million.

 

ITEM 4.   Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

Our management has evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures, as defined in Rule 13(a)-15(e) of the Exchange Act, as of the end of the period covered by this Quarterly Report on Form 10-Q pursuant to Rule 13a-15(b) of the Exchange Act. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q are effective at a reasonable assurance level in ensuring that information required to be disclosed in our Exchange Act reports is (1) recorded, processed, summarized and reported in a timely manner and (2) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. While our disclosure controls and procedures are designed to provide reasonable assurance of their effectiveness, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.

 

42


 

Changes in Internal Control over Financial Reporting

 

There were no changes to our internal control over financial reporting during the six months ended June 30, 2018 that have materially affected, or that are reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II - OTHER INFORMATION

 

ITEM 1.   Legal Proceedings

 

None.

 

ITEM 1A.   Risk Factors

 

For a discussion of potential risks and uncertainties related to our Company and our business see the information in Part I, Item 1A. “Risk Factors” of our 2017 Annual Report on Form 10-K. The following risk factors relate to the proposed Verscend Merger, and should be read in connection with the risk factors included in Part I, Item 1A. “Risk Factors” of our 2017 Annual Report on Form 10-K.

Risks Related to the Verscend Merger

The announcement and pendency of the Verscend Merger could cause disruptions in our business, which could have an adverse effect on our business and financial results.

Uncertainty about the completion or effect of the Verscend Merger may affect the relationship between us and our employees, clients and suppliers, which may have an adverse effect on our business, financial condition and results of operations. These uncertainties may cause clients, suppliers and others that deal with us to seek to change existing business relationships and to delay or defer decisions concerning us. Changes to existing business relationships, including termination or modification, could negatively affect our revenues, earnings and cash flow, as well as the market price of our common stock. Verscend may terminate the Verscend Merger Agreement under certain circumstances, including if there is a material adverse change in our business. If that were to happen, we may not be entitled to a termination fee under the Verscend Merger Agreement, or the applicable termination fee may be insufficient to compensate us.

In addition, we are dependent on the experience and industry knowledge of our officers, key management personnel and other key employees to operate our business and execute our business plans. Our current and prospective employees may experience uncertainty about their roles following the Verscend Merger, which may have an adverse effect on our ability to attract or retain key management personnel and other key employees. Our business could be negatively impacted if key employees depart because of issues related to the uncertainty and difficulty of integration or a desire not to remain with the business if the Verscend Merger is not consummated. Adverse effects arising from the pendency of the Verscend Merger could be exacerbated by any delays in consummation of the Verscend Merger or termination of the Verscend Merger Agreement.

Failure to complete the Verscend Merger, or to complete the Verscend Merger timely, could negatively impact our stock price and our future business and financial results.

The proposed Verscend Merger is subject to various closing conditions such as the approval of our stockholders, among other customary closing conditions. It is possible that our stockholders will not approve the Verscend Merger or that a governmental authority may enjoin or otherwise prohibit the consummation of the Verscend Merger. If any condition to the closing of the Verscend Merger is not satisfied or, if permissible, waived, the Verscend Merger will not be completed. In addition, satisfying the conditions to the closing of the Verscend Merger may take longer than we expect. There can be no assurance that any of the conditions to closing will be satisfied or waived or that other events will not intervene to delay or result in the failure to consummate the Verscend Merger.

If the Verscend Merger is not completed, our ongoing business may be adversely affected and we will be subject to a number of risks, including the following:

 

·

we may be required to pay Verscend a termination fee of $100 million if the Verscend Merger Agreement is terminated under certain circumstances;

·

the Verscend Merger Agreement places certain restrictions on the conduct of our business, which may have delayed or prevented us from undertaking business opportunities that, absent the Verscend Merger Agreement, may have been pursued;

·

we will be required to pay certain significant costs relating to the Verscend Merger, such as legal, accounting, financial advisor and printing fees; and

44


 

·

matters relating to the Verscend Merger (including integration planning) may require substantial commitments of time and resources by our management, which could otherwise have been devoted to other opportunities that may have been beneficial to the Company,

in each case, without realizing any of the benefits of having completed the Verscend Merger, which may adversely affect our business and financial results. The market price of our common stock might decline materially as a result of any such failures to the extent that the current market prices reflect a market assumption that the Verscend Merger will be completed. If that were to occur, it is uncertain when, if ever, the price of our common stock would return to the price levels at which shares of our common stock currently trade.

We may also be negatively impacted if the Verscend Merger Agreement is terminated and our board of directors seeks but is unable to find another strategic transaction offering equivalent or more attractive benefits than the benefits expected to be provided in the Verscend Merger, or if we or our officers or members of our board of directors become subject to litigation related to entering into or failing to consummate the Verscend Merger.

Our directors and executive officers may have interests in the Verscend Merger different from the interests of our shareholders generally.

Certain of our directors and executive officers may have interests in the Verscend Merger which are different from, or in addition to, or in conflict with, those of our stockholders generally. These interests include treatment in connection with the Verscend Merger of Company equity awards as well as certain change-in-control severance payments and benefits, transition or retention awards, or other rights held by our directors and executive officers, as applicable, and the indemnification of former directors and officers by Verscend following consummation of the Verscend Merger. Such interests and benefits could have influenced the decisions of our directors and executive officers to support or approve the Verscend Merger.

The Verscend Merger Agreement contains provisions that may discourage other companies from trying to enter into a strategic transaction with us for greater consideration.

The Verscend Merger Agreement contains provisions that may discourage a third party from submitting an alternative proposal to us during the pendency of the proposed Verscend Merger as well as afterward, should the Verscend Merger not be consummated, that might result in greater value to our shareholders than the Verscend Merger. These Verscend Merger Agreement provisions include a prohibition on soliciting, or entering into discussions with any third party regarding, any alternative proposals, subject to limited exceptions. However, our board of directors is permitted to take actions that it believes, after consultation with its advisors, are necessary to not act in a manner inconsistent with its fiduciary duties, including withdrawing or modifying its recommendation in favor of the proposed Verscend Merger, so long as Verscend has the opportunity, if it desires, to negotiate the terms of the Verscend Merger to address the basis for the board’s recommendation change.

In addition, we may be required to pay to Verscend a termination fee in cash equal to $100 million in certain circumstances.

If the Verscend Merger Agreement is terminated and we determine to seek another strategic transaction, we may not be able to negotiate a transaction on terms comparable to, or better than, the terms of the proposed Verscend Merger.

We will be subject to certain contractual restrictions while the Verscend Merger is pending.

The Verscend Merger Agreement restricts us from making certain acquisitions and divestitures, entering into certain contracts, incurring material indebtedness and expenditures, repurchasing or issuing securities outside of existing equity award programs or our existing share repurchase program, and taking other specified actions without Verscend’s consent until the earlier of the completion of the Verscend Merger or the termination of the Verscend Merger Agreement. These restrictions may, among other matters, prevent us from pursuing attractive business opportunities that may arise prior to the completion of the Verscend Merger and could have the effect of delaying or preventing other strategic transactions. Adverse effects arising from the pendency of the Verscend Merger could be exacerbated by any delays in consummation of the Verscend Merger or the termination of the Verscend Merger Agreement.

We will incur significant transaction-related expenses in connection with the Verscend Merger.  

45


 

We have incurred and expect to incur a number of non-recurring costs associated with the Verscend Merger. These costs and expenses include financial advisory, legal, accounting, consulting and other advisory fees and expenses, reorganization and restructuring costs, retention or severance and other employee benefit-related expenses, public company filing fees and other regulatory expenses, printing expenses and other related charges. Some of these costs are payable by us regardless of whether the Verscend Merger is completed.

 

ITEM 2.   Unregistered Sales of Equity Securities and Use of Proceeds

 

Recent Sales of Unregistered Securities

 

In connection with the RowdMap Acquisition in July 2017, we issued an aggregate of 768,021 shares of restricted common stock to certain employees of RowdMap in connection with their continued employment with us. Half of these shares were subject to continued employment and performance-based vesting requirements calculated as of the first anniversary of the closing of the acquisition. In accordance with these vesting requirements, a total of 350,569 shares of such restricted stock vested in July 2018. The remaining 33,440 shares of restricted stock were cancelled as the vesting requirements were not satisfied. The other half are subject to continued employment, with one-third vesting on each of the first three anniversaries of the closing of the acquisition. These issuances were made in reliance on an exemption or exclusion from the registration requirements of Regulation D promulgated under the Securities Act.

 

Issuer Purchases of Equity Securities

 

None.

 

ITEM 3.   Defaults Upon Senior Securities

 

Not applicable.

 

ITEM 4.   Mine Safety Disclosures

 

Not applicable.

 

ITEM 5.   Other Information

 

None.

 

46


 

ITEM 6.   Exhibits

 

See accompanying Exhibit Index for a list of the exhibits filed or furnished with this Quarterly Report on Form 10-Q.

 

EXHIBIT INDEX

 

 

 

 

Exhibit No.

  

Description of Exhibits

2.1†

 

Agreement and Plan of Merger, dated as of June 19, 2018, by and among Verscend Technologies, Inc., Rey Merger Sub, Inc. and Cotiviti Holdings, Inc. (the “Company”) (incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K (File No. 001-37787) filed on June 22, 2018).

 

 

 

10.1*‡

 

Transaction Bonus Agreement, dated as of June 19, 2018, between the Company and Bradley Ferguson.

 

 

 

10.2*‡

 

Transaction Bonus Agreement, dated as of June 19, 2018, between the Company and David Beaulieu.

 

 

 

10.3*‡

 

Transaction Bonus Agreement, dated as of June 19, 2018, between the Company and Jonathan Olefson.

 

 

 

10.4*‡

 

Transaction Bonus Agreement, dated as of June 19, 2018, between the Company and Nord Samuelson.

 

 

 

10.5*‡

 

Retention Agreement, dated as of June 19, 2018, between the Company and Adrienne Calderone.

 

 

 

31.1*

 

Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

31.2*

 

Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

32.1*

 

Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

 

32.2*

 

Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

 

**101.INS

 

XBRL Instance Document.

 

 

 

**101.SCH

 

XBRL Taxonomy Extension Schema Document.

 

 

 

**101.CAL

 

XBRL Taxonomy Extension Calculation Linkbase Document.

 

 

 

**101.DEF

 

XBRL Taxonomy Extension Definition Linkbase Document.

 

 

 

**101.LAB

 

XBRL Taxonomy Extension Label Linkbase Document.

 

 

 

**101.PRE

 

XBRL Taxonomy Extension Presentation Linkbase Document.

 


†  The schedules to the Agreement and Plan of Merger have been omitted from this filing pursuant to Item 601(b)(2) of Regulation S-K. The Company will furnish copies of any such schedules to the SEC upon request.

 

*  Filed herewith.

 

‡  Management contract or compensatory plan, contract or arrangement.

 

** Submitted electronically with this Report.

 

 

47


 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

 

 

 

COTIVITI HOLDINGS, INC.

 

 

 

Date: July 26, 2018

By:

/s/ BRADLEY A. FERGUSON

 

 

Name:

Bradley A. Ferguson

 

 

Title:

Senior Vice President and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer)

 

 

 

 

 

 

 

 

 

48