Pediatrix Medical Group - 10-Q quarterly report FY

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 T No £

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (Check one):

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date:

     The calculations of basic and diluted net income per share for the three months ended March 31, 2006 and 2005 are as follows:

     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.

     On April 4, 2006, we announced that our Board of Directors authorized a two-for-one stock split of the Company’s common stock. Shareholders of record at the close of business on April 13, 2006 received one additional share of Pediatrix common stock for each share held of record on that date. The shares were issued on April 27, 2006. All share and per share amounts presented have been adjusted to reflect the effect of the two-for-one stock split.

     Effective January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123R (“FAS 123R”) “Share-Based Payment.” This statement requires us to expense equity-based awards to our employees. Our results of operations for the three months ended March 31, 2006 include equity-based compensation expense related to stock options and restricted stock awarded under our stock incentive plans (the “Stock Incentive Plans”) and employee stock purchases under our stock purchase plans (the “Stock Purchase Plans”). For the three months ended March 31, 2005, our results of operations do not reflect any equity-based compensation expense.

     During the three months ended March 31, 2006 and 2005, we completed the acquisition of three and five physician group practices, respectively. Our results of operations for the three months ended March 31, 2006 and 2005 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.

     Our net patient service revenue increased $23.5 million, or 14.3%, to $187.7 million for the three months ended March 31, 2006, as compared to $164.2 million for the same period in 2005. Of this $23.5 million increase, $12.3 million, or 52.3%, was attributable to revenue generated from acquisitions completed after December 31, 2004. Same-unit net patient service revenue increased $11.2 million, or 6.9%, for the three months ended March 31, 2006. The net increase in same-unit net patient service revenue was primarily the result of: (i) increased revenue of approximately $4.8 million from a 4.3% increase in neonatal intensive care unit patient days; (ii) increased revenue of approximately $4.0 million from volume growth in maternal-fetal, pediatric cardiology, metabolic screening and other services, including hearing screens and newborn nursery services; and (iii) a net increase in revenue of approximately $2.4 million due to improved managed care contracting, the flow through of revenue from modest price increases and the slight impact from a new billing code implemented by the American Medical Association in early 2006 offset, in part, by a decline in revenue caused by a greater percentage of our patients being enrolled in government-sponsored programs. 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 March 31, 2006 as compared to the same period in 2005. 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 $14.7 million, or 15.0%, to $112.5 million for the three months ended March 31, 2006, as compared to $97.8 million for the same period in 2005. The increase was primarily attributable to: (i) costs associated with new physicians and other staff of $11.0 million to support acquisition-related growth and volume growth at existing units; (ii) an increase in incentive compensation of $2.6 million as a result of same-unit growth and operational improvements at the physician practice level; and (iii) equity-based compensation for our regional operations employees of $1.1 million related to our Stock Incentive Plans and Stock Purchase Plans.

     Practice supplies and other operating expenses increased $1.6 million, or 24.8%, to $7.8 million for the three months ended March 31, 2006 as compared with $6.2 million for the same period in 2005. The increase was primarily attributable to supply and maintenance costs, professional fees, and other 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 decreased $891,000, or 3.2%, to $27.2 million for the three months ended March 31, 2006, as compared to $28.1 million for the same period in 2005. This $891,000 net decrease was primarily due to the $6.0 million estimated liability reserve we recorded for the three months ended March 31, 2005 relating to our national Medicaid and Tricare investigation offset by (i) equity-based compensation for our administrative employees of $3.9 million related to our Stock Incentive Plans and Stock Purchase Plans; 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 decreased by $299,000, or 11.3%, to $2.3 million for the three months ended March 31, 2006, as compared to $2.6 million for the same period in 2005. This decrease was primarily attributable to the completion of amortization of certain intangibles during the three months ended March 31, 2006.

     Income from operations increased $8.5 million, or 28.9%, to $37.8 million for the three months ended March 31, 2006, as compared with $29.3 million for the same period in 2005. Our operating margin increased to 20.1% for the three months ended March 31, 2006, as compared to 17.9% for the same period in 2005. This net increase in our operating margin of 2.2% percentage points is attributable to (i) a 3.7 percentage point improvement in our operating margin due to the $6.0 million estimated liability reserve we recorded for the three months ended March 31, 2005 relating to our national Medicaid and Tricare investigation, (ii) a decline in operating margin of 2.7 percentage points due to equity-based compensation of $5.0 million related to our Stock Incentive Plans and Stock Purchase Plans; and (iii) a 1.2% percentage point improvement in operating margin related to improved management of general and administrative expenses, excluding the impact of the $6.0 million estimated liability adjustment recorded during the three months ended March 31, 2005 and the $3.9 million of equity-based compensation recognized during the three months ended March 31, 2006.

     We recorded net investment income of $41,000 for the three months ended March 31, 2006, as compared with net interest expense of $663,000 for the same period in 2005. The increase in net investment income is primarily due to a lower average outstanding balance on our revolving credit facility (“Line of Credit”) and higher investment income on outstanding investment balances for the three months ended March 31, 2006 as compared to the prior year period. Interest expense for the three months ended March 31, 2006 consisted of interest charges, commitment fees and amortized debt costs associated with our Line of Credit and interest charges associated with an aircraft operating lease.

     Our effective income tax rate was 37.3% for the three months ended March 31, 2006 and 2005.

     Net income increased to $23.8 million for the three months ended March 31, 2006, as compared to $18.0 million for the same period in 2005. Net income for the three months ended March 31, 2005 was reduced by the $3.8 million after-tax impact of the $6.0 million estimated liability reserve we recorded relating to our national Medicaid and Tricare investigation. Net income for the three months ended March 31, 2006 was reduced by the $3.1 million after-tax impact of the $5.0 million of equity-based compensation expense related to our Stock Incentive Plans and Stock Purchase Plans.

     Diluted net income per common and common equivalent share was $.49 on weighted average shares outstanding of 48.8 million for the three months ended March 31, 2006, as compared to $.38 on weighted average shares outstanding of 46.9 million for the same period in 2005. The net increase in weighted average shares outstanding was primarily due to the exercise of employee stock options, the impact of restricted stock awarded in July 2005 and the issuance of shares under our Stock Purchase Plans offset by shares repurchased during the fourth quarter of 2005.

     As of March 31, 2006, we had approximately $4.5 million of cash and cash equivalents on hand as compared to $11.2 million at December 31, 2005. In addition, we had working capital of approximately $34.5 million at March 31, 2006, an increase of $36.7 million from a working capital deficit of $2.2 million at December 31, 2005. This increase in working capital was primarily the result of funds generated from operations, borrowings on our Line of Credit and proceeds from the exercise of stock options under our Stock Incentive Plans offset by funds used for the acquisition of physician group practices during the three months ended March 31, 2006.

     Our net cash used in operating activities was $11.2 million for the three months ended March 31, 2006, as compared to net cash provided from operating activities of $656,000 for the same period in 2005. The decline in our cash flow from operations for the three months ended March 31, 2006 is primarily due to changes in our working capital components and the change in presentation of excess tax benefits in our condensed consolidated statement of cash flows as required by FAS 123R, partially offset by improved operating results which include the impact of approximately $5.0 million of non-cash equity-based compensation expense. For the three months ended March 31, 2006, our significant working capital component changes are related to accounts receivable, accounts payable and accrued expenses, and income taxes payable.

     During the three months ended March 31, 2006, accounts receivable increased by $4.0 million, as compared to a decrease of $2.5 million for the same period in 2005. Our days sales outstanding, or DSO, for accounts receivable at March 31, 2006 were 55.5 days, a decrease from 57.8 days at December 31, 2005. The net increase in accounts receivable during the three months ended March 31, 2006 is due to an increase in patient service revenue related to acquisitions completed during the fourth quarter of 2005 and the first quarter of 2006 partially offset by the decline in our DSO.

     During the three months ended March 31, 2006, we experienced a net decrease in cash flow from operating activities related to accounts payable and accrued expenses of $42.6 million. This decrease is primarily due to the decrease in our liabilities for performance-based compensation and 401(k) matching contributions. Our annual payments due to affiliated physicians under our performance-based incentive compensation program and our annual 401(k) matching contributions are made during the first quarter of each year.

     During the three months ended March 31, 2006, cash flow from operations related to income taxes payable increased by $2.8 million, compared to an increase of $10.5 for the same period in 2005. This change is related to the timing of the Company’s tax payments and the change in presentation of excess tax benefits as required by FAS 123R. Effective January 1, 2006, the excess tax benefits related to the exercise of stock options and the vesting of restricted stock are treated as a cash inflow from financing activities rather than a component of cash provided from operating activities. This change in cash flow presentation had the effect of decreasing cash flows from operating activities and increasing cash flows from financing activities by $7.8 million for the three months ended March 31, 2006. The tax benefit included in cash provided from operating activities for the three months ended March 31, 2005 was $3.6 million.

     We typically experience negative cash flow from operations during the first quarter of each year due to the above-mentioned factors.

     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, 2006, we obtained professional liability coverage that expires on May 1, 2007.

     During the three months ended March 31, 2006, our net cash flows provided from financing activities consisted primarily of borrowings on our Line of Credit, proceeds from the exercise of employee stock options, and the excess tax benefit of stock option exercises and the vesting of restricted stock.

     Our $225 million 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 March 31, 2006, we believe we were in compliance with the financial covenants and other restrictions applicable to us under the Line of Credit.

At March 31, 2006, we had an outstanding principal balance of $41.0 million under our Line of Credit and outstanding letters of credit of $16.0 million, which reduced the amount available on our Line of Credit.

     During the three months ended March 31, 2006, cash generated from our operating activities along with cash on hand and borrowings on our Line of Credit were used to fund the acquisition of three physician group practices for $63.3 million and fund capital expenditures in the amount of $1.6 million. Our capital expenditures were for medical equipment, computer and office equipment, software, furniture and other improvements at our office-based practices and our corporate and regional offices.

     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 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. The outstanding principal balance under our Line of Credit was $41.0 million at March 31, 2006. The outstanding balance related to the aircraft operating lease totaled approximately $4.3 million at March 31, 2006. Considering the total outstanding balance under these instruments at March 31, 2006 of approximately $45.3 million, a 1% change in interest rates would result in an impact to income before income taxes of approximately $453,000 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 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 March 31, 2006.

     Effective January 1, 2006, the Company implemented a new payroll system to process employee payroll information. Management has reviewed the changes in internal controls associated with the new payroll system and plans to complete its testing of the internal control changes as part of its annual assessment of internal control over financial reporting for 2006.

     There have been no other 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 Healthcare Corporation (“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.

     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. We have confirmed that the civil investigation encompasses all matters raised by the complaint.

     On February 8, 2006, we announced that we had reached an agreement in principle on the amount of a financial settlement with federal and state authorities that would resolve the Medicaid, TRICARE and state billing investigations, subject to, among other things, completion of negotiation and approval of a final settlement agreement, including a corporate integrity agreement with the Office of Inspector General of the Department of Health and Human Services. In accordance with Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies,” as a result of this agreement in principle, our reserves relating to these matters were increased to $25.1 million as disclosed in Note 5 to the condensed consolidated financial statements. Despite the agreement in principle on the financial portion of the settlement, there can be no assurance that a final settlement agreement will be reached.

     Currently, except as set forth above, 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 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 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, results of operations or the trading price of our common stock.

     There have been no material changes to the risk factors previously disclosed in the Company’s most recent Annual Report on Form 10-K.

     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.