Pediatrix Medical Group - 10-Q quarterly report FY

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     The following discussion highlights the principal factors that have affected our financial condition and results of operations, as well as our liquidity and capital resources for the periods described. This discussion should be read in conjunction with the unaudited condensed consolidated financial statements and the notes thereto included in this Quarterly Report. In addition, reference is made to our audited consolidated financial statements and notes thereto and related Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our most recent Annual Report on Form 10-K. As used in this Quarterly Report, the terms “Pediatrix”, the “Company”, “we”, “us” and “our” refer to Pediatrix Medical Group, Inc. and its consolidated subsidiaries (“PMG”), together with PMG’s affiliated professional associations, corporations and partnerships (“affiliated professional contractors”). PMG has contracts with its affiliated professional contractors, which are separate legal entities that provide physician services in certain states and Puerto Rico.

     The following discussion contains forward-looking statements. Please see the Company’s most recent Annual Report on Form 10-K, including the section entitled “Risk Factors,” for a discussion of the uncertainties, risks and assumptions associated with these forward-looking statements. In addition, please see “Caution Concerning Forward-Looking Statements” below.

     During the nine months ended September 30, 2005 and 2004, we completed the acquisition of twelve and eight physician group practices, respectively. Our results of operations for the three and nine months ended September 30, 2005 and 2004 include the results of operations for these physician group practices from their respective dates of acquisition, and therefore are not comparable in some material respects.

     On July 14, 2005, our Board of Directors awarded shares of restricted stock to key employees under the Company’s 2004 Incentive Compensation Plan. Thus, for the three and nine months ended September 30, 2005, we incurred equity-based compensation expense as discussed in Note 6 of the Notes to the Condensed Consolidated Financial Statements. In prior periods, stock option awards, which did not require us to recognize equity-based compensation expense in our condensed consolidated statements of income, were the only form of equity-based compensation utilized by our Board. Accordingly, our results of operations for the three and nine month periods ended September 30, 2004 do not reflect any equity-based compensation expense.

          Three Months Ended September 30, 2005 as Compared to Three Months Ended September 30, 2004

     Our net patient service revenue increased $19.8 million, or 12.5%, to $178.1 million for the three months ended September 30, 2005, as compared to $158.3 million for the same period in 2004. Of this $19.8 million increase, $12.2 million, or 61.6%, was attributable to revenue generated from acquisitions completed after June 30, 2004. Same-unit net patient service revenue increased $7.6 million, or 4.9%, for the three months ended September 30, 2005. The net increase in same-unit net patient service revenue was primarily the result of: (i) increased revenue of approximately $4.4 million from a 4.0% increase in neonatal intensive care unit patient days; (ii) increased revenue of approximately $3.5 million from volume growth in maternal-fetal, metabolic screening and other services, including hearing screens and newborn nursery services provided by existing practices; (iii) increased revenue of approximately $470,000 related to hospital contract administrative fees due to expanded services in existing practices; and (iv) a net decrease in revenue of approximately $770,000 due to a decline in revenue caused by a greater percentage of our patients being enrolled in government sponsored programs partially offset by improved managed care contracting and the flow through of revenue from modest price increases. Payments received from government-sponsored programs are substantially less than payments received from commercial insurance payors for equivalent services. This modest shift in our payor mix resulted in an increase in our estimated provision for contractual adjustments and uncollectibles for the three months ended September 30, 2005 as compared to the same period in 2004. Same units are those units at which we provided services for the entire current period and the entire comparable period.

     Practice salaries and benefits increased $10.5 million, or 11.8%, to $99.1 million for the three months ended September 30, 2005, as compared to $88.6 million for the same period in 2004. The increase was primarily attributable to: (i) costs associated with new physicians and other staff of $7.2 million to support acquisition-related growth and volume growth at existing units; (ii) an increase in incentive compensation of $2.3 million as a result of same unit growth and operational improvements at the physician practice level; and (iii) equity-based compensation of $1.0 million related to awards of restricted stock.

     Practice supplies and other operating expenses increased $1.1 million, or 19.0%, to $7.0 million for the three months ended September 30, 2005, as compared with $5.9 million for the same period in 2004. The increase was primarily attributable to additional professional fees, maintenance costs and supply costs to support new and existing physician practices.

     General and administrative expenses include all billing and collection functions and all other salaries, benefits, supplies and operating expenses not specifically related to the day-to-day operations of our physician group practices. General and administrative expenses increased $4.9 million, or 24.3%, to $24.9 million for the three months ended September 30, 2005, as compared to $20.0 million for the same period in 2004. This $4.9 million increase was primarily due to: (i) equity-based compensation of $3.7 million related to awards of restricted stock and (ii) a $1.2 million increase in salaries and benefits and other general and administrative expenses related to the continued growth of the Company.

     Depreciation and amortization expense increased by approximately $40,000, or 1.8%, to $2,340,000 for the three months ended September 30, 2005, as compared to $2,300,000 for the same period in 2004. This increase was primarily attributable to amortization of identifiable intangible assets related to our acquisitions.

     Income from operations increased $3.3 million, or 7.9%, to $44.8 million for the three months ended September 30, 2005, as compared with $41.5 million for the same period in 2004. Our operating margin decreased to 25.2% for the three months ended September 30, 2005, as compared to 26.2% for the same period in 2004. This net decline in our operating margin of 1.0% is attributable to a 2.7% decrease in operating margin due to equity-based compensation of $4.7 million related to awards of restricted stock offset by improvements in operating margin of approximately 1.7% related to improved management of general and administrative expenses and a decrease in practice salaries and benefits as a percentage of revenue.

     We recorded net interest expense of $100,000 for the three months ended September 30, 2005, as compared with net interest expense of $202,000 for the same period in 2004. The decrease in net interest expense is primarily due to higher investment income on outstanding investment balances for the three months ended September 30, 2005 as compared to the prior year period. Interest expense for the three months ended September 30, 2005 consisted primarily of interest charges, commitment fees and amortized debt costs associated with our $225 million revolving credit agreement (“Line of Credit”).

     Our effective income tax rate was 37.25% for the three months ended September 30, 2005 and 2004.

     Net income increased to $28.1 million for the three months ended September 30, 2005, as compared to $25.9 million for the same period in 2004. As compared to the 2004 period, net income for the three months ended September 30, 2005 was reduced by the $3.0 million after-tax impact of equity-based compensation expense related to awards of restricted stock.

     Diluted net income per common and common equivalent share was $1.16 on weighted average shares of 24.1 million for the three months ended September 30, 2005, as compared to $1.04 on weighted average shares of 25.0 million for the same period in 2004. Diluted net income per common and common equivalent share of $1.16 for the three months ended September 30, 2005 includes the impact of equity-based compensation related to awards of restricted stock. The net decrease in weighted average shares outstanding was primarily due to the impact of shares repurchased during the fourth quarter of 2004 offset in part by the exercise of employee stock options and the issuance of shares under our employee stock purchase plans.

          Nine Months Ended September 30, 2005 as Compared to Nine Months Ended September 30, 2004

     Our net patient service revenue increased $57.4 million, or 12.5%, to $516.0 million for the nine months ended September 30, 2005, as compared to $458.6 million for the same period in 2004. Of this $57.4 million increase, $30.2 million, or 52.6%, was attributable to revenue generated from acquisitions completed after June 30, 2004. Same-unit net patient service revenue increased $27.2 million, or 6.2%, for the nine months ended September 30, 2005. The net increase in same-unit net patient service revenue was primarily the result of: (i) increased revenue of approximately $14.6 million from a 4.7% increase in neonatal intensive care unit patient days; (ii) increased revenue of approximately $12.7 million from volume growth in maternal-fetal services, metabolic screening services and other services, including hearing screens and newborn nursery services provided by existing practices; (iii) increased revenue of approximately $2.2 million related to hospital contract administrative fees due to expanded services in existing practices; and (iv) a net decrease in revenue of approximately $2.3 million due to a decline in revenue caused by a greater percentage of our patients being enrolled in government sponsored programs partially offset by improved managed care contracting and the flow through of revenue from modest price increases. Payments received from government-sponsored programs are substantially less than payments received from commercial insurance payors for equivalent services. This shift in our payor mix resulted in an increase in our estimated provision for contractual adjustments and uncollectibles for the nine months ended

September 30, 2005 as compared to the same period in 2004. Same units are those units at which we provided services for the entire current period and the entire comparable period.

     Practice salaries and benefits increased $36.1 million, or 13.9%, to $295.0 million for the nine months ended September 30, 2005, as compared to $258.9 million for the same period in 2004. The increase was primarily attributable to: (i) costs associated with new physicians and other staff of $27.5 million to support acquisition-related growth and volume growth at existing units; (ii) an increase in incentive compensation of $7.6 million as a result of same unit growth and operational improvements at the physician practice level; and (iii) equity-based compensation of $1.0 million related to awards of restricted stock.

     Practice supplies and other operating expenses increased $2.9 million, or 16.9%, to $20.1 million for the nine months ended September 30, 2005, as compared with $17.2 million for the same period in 2004. The increase was primarily attributable to additional professional fees, maintenance costs and supply costs to support new and existing physician practices.

     General and administrative expenses include all billing and collection functions and all other salaries, benefits, supplies and operating expenses not specifically related to the day-to-day operations of our physician group practices. General and administrative expenses increased $15.9 million, or 26.7%, to $75.3 million for the nine months ended September 30, 2005, as compared to $59.5 million for the same period in 2004. This $15.9 million increase is due to: (i) a $6.2 million increase in salaries and benefits and other general and administrative expenses associated with the continued growth of the Company; (ii) a $6.0 million increase in our estimated liability reserves as a result of a settlement offer we made in connection with our pending national Medicaid and TRICARE investigation; and (iii) equity-based compensation of $3.7 million related to awards of restricted stock.

     Depreciation and amortization expense increased by $516,000, or 7.4%, to $7.5 million for the nine months ended September 30, 2005, as compared to $7.0 million for the same period in 2004. This increase was primarily attributable to amortization of identifiable intangible assets related to our acquisitions.

     Income from operations increased $2.0 million, or 1.7%, to $118.0 million for the nine months ended September 30, 2005, as compared with $116.0 million for the same period in 2004. Our operating margin decreased to 22.9% for the nine months ended September 30, 2005, as compared to 25.3% for the same period in 2004. The decrease in our operating margin is primarily attributable to: (i) the $6.0 million adjustment related to the settlement offer we made in connection with our pending national Medicaid and TRICARE investigation; and (ii) equity-based compensation of $4.7 million related to awards of restricted stock.

     We recorded net interest expense of $1.4 million for the nine months ended September 30, 2005, as compared with net interest expense of $500,000 for the same period in 2004. The increase in net interest expense is primarily due to increased borrowings under our Line of Credit to fund acquisitions made since the third quarter of 2004 and to repurchase shares of our common stock during the fourth quarter of 2004. Interest expense for the nine months ended September 30, 2005 consisted primarily of interest charges, commitment fees and amortized debt costs associated with our Line of Credit.

     Our effective income tax rate was 37.25% for the nine months ended September 30, 2005 and 2004.

     Net income increased to $73.2 million for the nine months ended September 30, 2005, as compared to $72.5 million for the same period in 2004. As compared to the 2004 period, net income for the nine months ended September 30, 2005 was reduced by: (i) the $3.8 million after-tax impact of the adjustment related to the settlement offer we made in connection with our pending national Medicaid and TRICARE investigation; and (ii) the $3.0 million after-tax impact of equity-based compensation expense related to awards of restricted stock.

     Diluted net income per common and common equivalent share was $3.07 on weighted average shares of 23.8 million for the nine months ended September 30, 2005, as compared to $2.88 on weighted average shares of 25.2 million for the same period in 2004. Diluted net income per common and common equivalent share of $3.07 for the nine months ended September 30, 2005 includes: (i) the impact of the adjustment related to the settlement of our pending national Medicaid and TRICARE investigation; and (ii) the impact of equity-based compensation related to awards of restricted stock. The net decrease in weighted average shares outstanding was primarily due to the impact of shares repurchased during 2004 offset in part by the exercise of employee stock options and the issuance of shares under our employee stock purchase plans.

     As of September 30, 2005, we had approximately $4.8 million of cash and cash equivalents on hand as compared to $7.0 million at December 31, 2004. In addition, we had working capital of approximately $9.1 million at September 30, 2005, a decrease of $12.1 million from working capital of $21.2 million at December 31, 2004. This decrease in working capital was primarily the result of funds used for the acquisition of physician group practices and the repayment of our Line of Credit exceeding funds generated from operations and proceeds from the exercise of stock options and the issuance of stock under our employee stock purchase plans during the nine months ended September 30, 2005.

     Our net cash provided from operating activities was $114.6 million for the nine months ended September 30, 2005, as compared to net cash provided from operating activities of $80.3 million for the same period in 2004. The improvement in our cash flow from operations for the nine months ended September 30, 2005 is primarily due to improved operating results excluding the non-cash impact of equity-based compensation expense and changes in our working capital components. For the nine months ended September 30, 2005, our significant working capital component changes are related to accounts receivable, accounts payable and accrued expenses, and income taxes payable.

     During the nine months ended September 30, 2005, accounts receivable increased by $2.0 million, as compared to an increase of $14.2 million for the same period in 2004. Our days sales outstanding, or DSO, for accounts receivable at September 30, 2005 was 56.8 days, a decrease from 61.6 days at December 31, 2004. During the same period, we experienced a net increase in cash flow from operating activities related to accounts payable and accrued expenses of $6.2 million primarily due to the $6.0 million increase in our estimated liability reserves as a result of a settlement offer we made in connection with our pending national Medicaid and TRICARE investigation. In addition, we realized an increase in income taxes payable which increased our cash flow from operating activities by $24.3 million. This increase in cash flow is primarily due to the timing of our tax payments.

     Our accounts receivable are principally due from managed care payors, government payors, and other third party insurance payors. We track our collections from these sources, monitor the age of our accounts receivable, and make all reasonable efforts to collect outstanding accounts receivable through our systems, processes and personnel at our corporate and regional billing and collection offices. We use customary collection practices, including the use of outside collection agencies, for accounts receivable due from private pay patients when appropriate. Almost all of our accounts receivable adjustments consist of contractual adjustments due to the difference between gross amounts billed and the amounts allowed by our payors. Any amounts written off related to private pay patients are based on the specific facts and circumstances related to each individual patient account.

     We maintain professional liability insurance policies with third-party insurers, subject to deductibles, exclusions and other restrictions. We self-insure our liabilities to pay deductibles under our professional liability insurance coverage through a wholly-owned captive insurance subsidiary. We record a liability for self-insured deductibles and an estimate of liabilities for claims incurred but not reported based on an actuarial valuation using historical loss patterns. Effective May 1, 2005, we obtained professional liability coverage that expires on May 1, 2006 with substantially similar terms as our previous policy which includes a provision which may result in additional premiums or a return of premiums based on our actual losses.

     During the nine months ended September 30, 2005, our net cash flows used in financing activities consisted primarily of repayments on our Line of Credit partially offset by proceeds from the exercise of employee stock options and the purchase of common stock by employees participating in our employee stock purchase plans.

     On March 11, 2005, we exercised an option under our Line of Credit to increase the aggregate commitments thereunder from $150 million to $225 million. Our Line of Credit matures in July 2009 and includes a $25 million subfacility for the issuance of letters of credit. At our option, the Line of Credit bears interest at (i) the base rate (defined as the higher of the Federal Funds Rate plus .5% or the Bank of America prime rate) or (ii) the Eurodollar rate plus an applicable margin rate ranging from .75% to 1.75% based on our consolidated leverage ratio. Our Line of Credit is collateralized by substantially all of our assets. We are subject to certain covenants and restrictions specified in the Line of Credit, including covenants that require us to maintain a minimum level of net worth and that restrict us from paying dividends and making certain other distributions as specified therein. Failure to comply with these covenants and restrictions would constitute an event of default under the Line of Credit, notwithstanding our ability to meet our debt service obligations. Our Line of Credit includes various customary remedies for our lenders following an event of default. At September 30, 2005, we were in compliance with the financial covenants and other restrictions applicable to us under the Line of Credit. At September 30, 2005, we had no outstanding principal balance on our Line of Credit and outstanding letters of credit of $16.0 million, which reduced the amount available on our Line of Credit.

     The exercise of employee stock options and the purchase of common stock by employees participating in our employee stock purchase plans generated cash proceeds of $34.2 million during the nine months ended September 30, 2005, as compared to $27.3 million for the same period in 2004. Since stock option exercises are dependent on several factors, including the market price of our common stock, we cannot predict the timing and amount of any proceeds from future exercises.

     During the nine months ended September 30, 2005, cash generated from our operating activities along with cash on hand were primarily used to fund the acquisition of twelve physician group practices for $85.7 million, make repayments on our Line of Credit of $54.0 million and to fund capital expenditures in the amount of $5.6 million. Our capital expenditures were for computer and office equipment, software, furniture and other improvements at our corporate and regional offices.

     On November 2, 2005, we announced that our Board of Directors authorized a share repurchase program that allows us to repurchase up to $50 million of the Company’s common stock. The program allows us to make open market purchases of the Company’s shares from time to time subject to price, market and economic conditions and trading restrictions.

     We anticipate that funds generated from operations, together with our current cash on hand, short-term investments and funds available under the Line of Credit, will be sufficient to complete our $50 million share repurchase program and finance our working capital requirements, fund anticipated acquisitions and capital expenditures, and meet our contractual obligations for at least the next 12 months.

     Certain information included or incorporated by reference in this Quarterly Report may be deemed to be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements may include, but are not limited to, statements relating to our objectives, plans and strategies, and all statements (other than statements of historical facts) that address activities, events or developments that we intend, expect, project, believe or anticipate will or may occur in the future are forward-looking statements. These statements are often characterized by terminology such as “believe,” “hope,” “may,” “anticipate,” “should,” “intend,” “plan,” “will,” “expect,” “estimate,” “project,” “positioned,” “strategy” and similar expressions and are based on assumptions and assessments made by our management in light of their experience and their perception of historical trends, current conditions, expected future developments and other factors they believe to be appropriate. Any forward-looking statements in this Quarterly Report are made as of the date hereof, and we undertake no duty to update or revise any such statements, whether as a result of new information, future events or otherwise. Forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties. Important factors that could cause actual results, developments and business decisions to differ materially from forward-looking statements are described in the Company’s most recent Annual Report on Form 10-K, including the section entitled “Risk Factors.”

     Our Line of Credit and an aircraft operating lease agreement are subject to market risk and interest rate changes. The Line of Credit bears interest at our option at (i) the base rate (defined as the higher of the Federal Funds Rate plus .5% or the Bank of America prime rate) or (ii) the Eurodollar rate plus an applicable margin rate ranging from .75% to 1.75% based on our consolidated leverage ratio. The aircraft operating lease bears interest at a LIBOR-based variable rate. We had no outstanding principal balance under our Line of Credit at September 30, 2005. The outstanding balance related to the aircraft operating lease totaled approximately $4.5 million at September 30, 2005. Considering the total outstanding balance under the operating lease at September 30, 2005 of approximately $4.5 million, a 1% change in interest rates would result in an impact to income before income taxes of approximately $45,000 per year.

     We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the foregoing, the Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective as of September 30, 2005.

     There have been no changes in our internal control over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

     In June 2002, we received a written request from the Federal Trade Commission (the “FTC”) to submit information on a voluntary basis in connection with an investigation of issues of competition related to our May 2001 acquisition of Magella and our business practices generally. In February 2003, we received additional information requests from the FTC in the form of a Subpoena and Civil Investigative Demand. Pursuant to these requests, we produced documents and information relating to the acquisition and our business practices in certain markets. We have also provided on a voluntary basis additional information and testimony on issues related to the investigation. At this time, the investigation remains active and ongoing and we are cooperating fully with the FTC.

     Beginning in April 1999, we received requests from various federal and state investigators for information relating to our billing practices for services reimbursed by Medicaid, and the United States Department of Defense’s TRICARE program for military dependants and retirees. Since then, a number of the individual state investigations were resolved through agreements to refund certain overpayments and reimburse certain costs to the states. In June 2003, we were advised by a United States Attorney’s Office that it was conducting a civil investigation with respect to our Medicaid billing practices nationwide. This federal Medicaid investigation, the TRICARE investigation, and related state inquiries are being coordinated together and are active and ongoing.

     In July 2005, we were informed by the United States Attorney’s Office that the federal Medicaid investigation was initiated as a result of a complaint filed under seal by a third party, known as “qui tam” or “whistleblower” complaint, under the federal False Claims Act which permits private individuals to bring confidential actions on behalf of the government. Because the qui tam complaint is under seal, we have not been able to review it; however, we have been informed by the United States Attorney’s Office that its civil investigation encompasses all matters raised by the complaint.

     In April 2005, we made a settlement offer to federal and state authorities in connection with these matters. In accordance with Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies,” as a result of this offer, we increased our reserves relating to these matters by $6.0 million during the three months ended March 31, 2005. Although we continue to cooperate fully with federal and state authorities, there can be no assurance that our present offer will result in a settlement of these matters and the eventual resulting losses will not exceed our established reserves.

     Currently, we cannot predict the timing or outcome of any of these pending investigations and inquiries and whether they will have, individually or in the aggregate, a material adverse effect on our business, financial condition, results of operations or the trading price of our common stock.

     We also expect that additional audits, inquiries and investigations from government authorities and agencies will continue to occur in the ordinary course of our business. Such audits, inquiries and investigations and their ultimate resolutions, individually or in the aggregate, could have a material adverse effect on our business, financial condition, results of operations or the trading price of our common stock.

     In the ordinary course of our business, we become involved in pending and threatened legal actions and proceedings, most of which involve claims of medical malpractice related to medical services provided by our affiliated physicians. Our contracts with hospitals generally require us to indemnify them and their affiliates for losses resulting from the negligence of our affiliated physicians. We may also become subject to other lawsuits which could involve large claims and significant defense costs. We believe, based upon our review of pending actions and proceedings, that the outcome of such legal actions and proceedings will not have a material adverse effect on our business, financial condition, results of operations or the trading price of our common stock. The outcome of such actions and proceedings, however, cannot be predicted with certainty and an unfavorable resolution of one or more of them could have a material adverse effect on our business, financial condition, results of operations or the trading price of our common stock.

     Although we currently maintain liability insurance coverage intended to cover professional liability and certain other claims, this coverage generally must be renewed annually and may not continue to be available to us in future years at acceptable costs and on favorable terms. In addition, we cannot assure that our insurance coverage will be adequate to cover liabilities arising out of claims asserted against us in the future where the outcomes of such claims are unfavorable. With respect to professional liability insurance, we self-insure our liabilities to pay deductibles through a wholly-owned captive insurance subsidiary. Liabilities in excess of our insurance coverage, including coverage for professional liability and other claims, could have a material adverse effect on our business, financial condition and results of operations.

     See Exhibit Index.

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.