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[February 28, 2014]
AMERICAN CARESOURCE HOLDINGS, INC. - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations.
(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion should be read in conjunction with our consolidated financial statements, which present our results of operations for the twelve month periods ended December 31, 2013 and 2012 as well as our financial position at December 31, 2013 and 2012, contained elsewhere in this Annual Report on Form 10-K. Some of the information contained in this discussion and analysis or set forth elsewhere in this Annual Report on Form 10-K, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks and uncertainties. You should review the "Special Note Regarding Forward Looking Statements" and "Risk Factors" sections of this Annual Report for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.
Company Overview American CareSource Holdings, Inc. ("ACS," "the Company," the "Registrant," "we," "us," or "our") works to help its clients control healthcare costs by offering cost containment strategies, primarily through the utilization of a comprehensive national network of ancillary healthcare service providers. The Company markets its services to a number of healthcare companies including third party administrators ("TPAs"), insurance companies, large self-funded organizations, various employer groups and preferred provider organizations ("PPOs"). The Company offers payors this solution by: • lowering its payors' ancillary care costs through its network of high quality, cost effective providers that the Company has under contract at more favorable terms than they could generally obtain on their own; • providing payors with a comprehensive network of ancillary healthcare service providers that is tailored to each payor's specific needs and is available to each payor's members for covered services; • providing payors with claims management, reporting, processing and payment services; • performing network/needs analysis to assess the benefits to payors of adding additional/different service providers to the payor-specific provider networks; and • credentialing network service providers for inclusion in the payor-specific provider networks.
The Company has assembled a network of ancillary healthcare service providers that supplement or support the care provided by hospitals and physicians and includes 31 service categories. We have a dedicated provider development function, whose primary responsibility is to contract with providers and strategically grow our network of ancillary service providers.
We secure contracts with ancillary service providers by offering them the following: • inclusion in a nationwide network that provides exposure to our client payors and their aggregate member lives; • an array of administrative and back-office services, such as collections and appeals; • increased claims volume through various "soft steerage" mechanisms; and • advocacy in the claims appeals process.
Payors route healthcare claims to us after service has been performed by participant providers in our network. We process those claims and charge the payor according to its contractual rate for the services according to our contract with the payor. In processing the claim, we are paid directly by the payor or the insurer for the service. We then pay the provider of service according to its independently-negotiated contractual rate. We assume the risk of generating positive margin, the difference between the payment we receive for the service and the amount we are obligated to pay the provider of service.
20-------------------------------------------------------------------------------- Table of Contents The Company recognizes revenues for ancillary healthcare services when services by providers have been authorized and performed, the claim has been billed to the payor and collections from payors are reasonably assured. Cost of revenues for ancillary healthcare services consist of amounts due to providers for providing ancillary healthcare services, client administration fees paid to our client payors to reimburse them for routing the claims to us for processing, and the Company's related direct labor and overhead of processing invoices, collections and payments. The Company is not liable for costs incurred by independent contract service providers until payment is received by it from the payors. The Company recognizes actual or estimated liabilities to independent contract service providers as the related revenues are recognized.
The Company is seeking growth in the number of client payors and service provider relationships it secures by focusing on providing in-network services for its payors and aggressively pursuing additional TPAs, self-insured employers and other direct payors as its primary sales targets. The Company believes this strategy should increase the volume of claims the Company can process in addition to the expansion in the number of lives that are eligible to receive ancillary healthcare benefits. No assurances can be given that the Company can expand its service provider or payor relationships, nor that any such expansion will result in an improvement in the results of operations of the Company.
In addition, under the medical loss ratio ("MLR") regulations included in the Affordable Care Act, it is possible that a portion of the fees our existing and prospective payors are contractually required to pay us and that do not qualify as 'incurred claims' may not be included as expenditures for activities that improve healthcare quality. Such a determination may make it more difficult for us to retain existing clients and/or add new clients, because our clients' or prospective clients' MLR may otherwise not meet the specified targets. This may reduce our net revenues and profit margins.
Financial and Operational Overview The Company has experienced significant revenue declines over the past four years, primarily related to the declines in the business of our two significant legacy clients, both of which are PPOs. Due to a variety of factors affecting the healthcare industry, including but not limited to healthcare legislation, the economy, industry consolidation, change in strategic direction of our clients and for other reasons, revenue from each of our two significant legacy clients continued to decline resulting in year-over-year declines in our revenue from those accounts. Because of the significance of the revenue concentration from these two clients (from approximately 98% in 2008 to 26% 2013), the declines of their business have had a significant negative impact on our operating results and cash position over the past four years, despite our new business development efforts. Revenue recognized from one of these clients was $1.0 million in 2013 and we do not expect any revenue from this client in 2014.
While we have entered into a new agreement with the other, the agreement does not provide for any minimum level of volume, and we cannot be certain of any level of continued revenue from such relationship, despite our efforts to create new revenue streams. During the period from 2008 to 2013 (excluding the addition of any entities affiliated with either of our two significant legacy clients), we added 40 new clients, which contributed $19.4 million and $20.4 million of gross revenue in 2013 and 2012, respectively.
In 2010, we began focusing our sales efforts on TPAs, insurance companies, self-funded organizations, employer groups and direct payors, as we believe we can more competitively impact those relationships. TPAs, in their fiduciary capacity, assist their clients (primarily employer groups) with cost containment; the ancillary network solution we provide is a valuable component to add to a TPA's portfolio. There are approximately 500 TPAs nationwide, with approximately 20% of those being our target market. According to research reported by the Employee Benefit Research Institute, as recently as 2011, approximately 59% of employees with health insurance were covered by a self-insured plan. In light of changes in healthcare legislation and the size of the self-insured market, we believe that TPAs are an important element of that market, with needs that we can address, primarily from a cost containment standpoint. Our client base currently includes 28 TPAs, which generated $15.6 million and $17.4 million of gross revenue in 2013 and 2012, respectively The Company believes that it has a unique business model and offers a solid value proposition to our client payors, as well as our providers, by delivering superior discounts through our network of contracted ancillary healthcare service providers. During 2013, we made progress in adding new client relationships, but do not believe that the revenue from those accounts will offset the losses from our two significant client relationships and declines from our other legacy accounts. We will continue to opportunistically investigate strategic initiatives that will grow our revenue base, while controlling non-variable costs consistent with our existing revenue streams.
Nevertheless, until we can replace a greater amount of the revenue than we have lost from our two significant legacy clients, we will continue to experience operating losses and we will continue to reduce our existing cash reserves for operating and investing activities.
21-------------------------------------------------------------------------------- Table of Contents Year Ended December 31, 2013 Compared to Year Ended December 31, 2012 The following table sets forth a comparison of our results of operations for the following periods presented (in thousands): Change 2013 2012 $ % Net revenue $ 26,751 $ 34,902 $ (8,151 ) (23.4 )% Variable costs: Provider payments 19,762 25,660 5,898 23.0 Administrative fees 1,083 1,551 468 30.2 Total variable costs 20,845 27,211 6,366 23.4 Percent of net revenue 77.9 % 78.0 % Variable flowthrough 5,906 7,691 (1,785 ) (23.2 ) Variable margin 22.1 % 22.0 % Non-variable costs: Claims administration 2,106 2,232 126 5.6 Provider development 599 800 201 25.1 Sales & marketing 1,900 2,268 368 16.2 Finance & administration 4,266 4,573 307 6.7 Total non-variable costs 8,871 9,873 1,002 10.1 Percent of net revenue 33.2 % 28.3 % Loss before depreciation, amortization, and income taxes (2,965 ) (2,182 ) (783 ) (35.9 ) Percent of net revenue (11.1 )% (6.3 )% Depreciation and amortization 795 878 83 9.5 Income tax provision 25 31 6 (19.4 ) Net loss $ (3,785 ) $ (3,091 ) $ (694 ) (22.5 )% The following discussion compares the historical results of operations on a basis consistent with generally accepted accounting principles ("GAAP") for the years ended December 31, 2013 and 2012.
Net Revenues The Company's net revenues are generated from ancillary healthcare service claims. Revenue is recognized when we bill our client payors for services performed and collection is reasonably assured. The Company estimates revenues using average historical collection rates. When estimating collectibility, we assess the impact of items such as non-covered benefits, denied claims, deductibles and co-payments. Periodically, revenues and related estimates are adjusted to reflect actual cash collections so that revenues recognized accurately reflect cash collected. There are no assurances that actual cash collections will meet or exceed estimated cash collections.
22-------------------------------------------------------------------------------- Table of Contents The following table sets forth a comparison of our net revenues and billed claims for the years ended December 31, (in thousands): Net Revenue Billed Claims Volume Change Change (in thousands) 2013 2012 $ % 2013 2012 Claims % Legacy clients: Material Client (45 )% (46 )% Relationship $ 5,905 $ 10,704 $ (4,799 ) 19 35 (16 ) MultiPlan, Inc.
(formerly Viant Holdings, Inc.) 1,008 2,941 (1,933 ) (66 ) 4 14 (10 ) (71 ) All other clients 20,125 21,533 (1,408 ) (7 ) 99 111 (12 ) (11 ) Total gross revenue 27,038 35,178 (8,140 ) (23 ) 122 160 (38 ) (24 ) Provision for refunds (287 ) (276 ) (11 ) 4 - - - nm Net Revenue $ 26,751 $ 34,902 $ (8,151 ) (23 )% 122 160 (38 ) (24 )% In addition, the following table sets forth a comparison of processed and billed claims for the years ended December 31, (in thousands): Change (in thousands) 2013 2012 Claims % Processed 149 201 (52 ) (26 )% Billed 122 160 (38 ) (24 ) Following is a discussion of the changes in net revenue for the year ended December 31, 2013 as compared to 2012: Material Client Relationship The decline in billed claims volume from our relationship with one of our material clients for the year ended December 31, 2013 is due to, among others, the following factors: • The client continues to suffer attrition in its network client base, as it continues to re-focus its business strategy resulting in declines in claims volume.
• Revenue from the client specifically related to dialysis services declined 78%, or approximately $2.7 million, for the year ended December 31, 2013, as compared to 2012.
• Laboratory service claims from the client declined 72% for the year ended December 31, 2013, as compared to 2012. The declines in claim count resulted in estimated declines in revenue of approximately $313,000 in 2013, as compared to 2012.
• Under our new agreement executed on December 31, 2012, the client has more flexibility to utilize ancillary care providers with which it is directly contracted or that are accessible through other provider networks.
The performance of the client account during 2013 was, and will continue to be, affected by attrition in its own network client base, its internal strategic initiatives and the actual utilization of our network of ancillary healthcare providers over other networks the client has access to. Despite the new agreement the Company and this client entered into on December 31, 2012, and our continued efforts to secure new revenue-generating opportunities, we cannot be certain of any level of continued volume from this client.
23-------------------------------------------------------------------------------- Table of Contents MultiPlan, Inc. (formerly Viant Holdings, Inc.) The decline in net revenue and billed claims volume from our relationship with MultiPlan, Inc. ("MultiPlan") is due to the acquisition by MultiPlan of Viant Holdings, Inc. As part of that transition, MultiPlan moved its payors and employer groups to its existing networks. While we did not receive a formal termination notice from MultiPlan, the transition was substantially completed as of December 31, 2012. We recognized $1.0 million in revenue in 2013 as the final employer groups transitioned to MultiPlan networks. The expectation is that all claims volume and related revenue from this client will cease sometime in 2014.
All Other Clients Our other clients consist of various relationships with PPOs, TPAs, insurance companies and direct payors which we have contracted from 2005 through the current period. Through our client service group, we maintain contact with these clients to determine if opportunities exist to serve the accounts and generate incremental revenue. Such opportunities include the addition of incremental employer groups by our clients that previously did not access our network of ancillary service provider, addressing system and work-flow issues that will improve claims volume and/or collections, focusing sales efforts on certain specialties that provide greater savings for our clients and development of our ancillary service provider network to address specific client needs.
For the year ended December 31, 2013, revenue for this client group decreased 7%, or $1.4 million, when compared to the prior year. The decrease in revenue for this client group during 2013 is due to the following factors: • Revenue from one of our PPO clients declined $1.3 million, which is primarily attributable to their employer groups not utilizing our network of ancillary providers, as well as experiencing attrition within its own client base.
• Revenue from five of our other clients declined $2.7 million related to increased competition from the national carriers, attrition within their client bases and increased price competition.
The aforementioned declines were partially offset by the following: • Revenue from two of our clients increase a combined $2.0 million as a direct result of efforts from our client services group, which resulted in one client adding employer groups that previously were not utilizing our network of ancillary providers and improvement to the other client's collection percentage, and related revenue, during 2013 as compared to 2012.
• One of the clients we implemented at the end of the third quarter of 2012, which was a TPA, contributed incremental revenue of $625,000 in 2013 compared to the prior year.
The following tables detail the change in revenue generated from different client types for the years ended December 31,: 2013 2012 Change ($ in thousands) Count Revenue % of revenue Count Revenue % of revenue $ % TPAs * 28 $ 15,591 57.7 % 27 $ 17,379 49.4 % $ (1,788 ) (10 )% PPOs 11 7,565 28.0 11 14,845 42.2 (7,280 ) (49 ) Direct/Insurance Companies 2 3,679 13.6 3 2,800 8.0 879 31 Other 3 203 0.7 2 154 0.4 49 32 Gross revenue, before provision for refunds $ 27,038 100.0 % $ 35,178 100.0 % $ (8,140 ) (23 )% * This group includes a TPA controlled by our most significant client. The TPA generated revenue of approximately $602,000 and $1.3 million in 2013 and 2012, respectively.
Variable Costs Variable costs are comprised of payments to our providers and administrative fees paid to our clients for converting claims to electronic data interchange and routing them to both the Company for processing and to their payors for payment. Payments to providers are the most significant variable cost and it consists of our payments for ancillary care services in accordance with contracts negotiated separately with providers for specific ancillary services.
24-------------------------------------------------------------------------------- Table of Contents The following tables set forth a comparison of the variable cost components of our cost of revenues, for the periods presented ended December 31,: Change ($ in thousands) 2013 % of net revenue 2012 % of net revenue $ % Provider payments $ 19,762 73.9 % $ 25,660 73.5 % $ (5,898 ) (23 )% Administrative fees 1,083 4.0 1,551 4.4 (468 ) (30 ) Total variable costs $ 20,845 77.9 % $ 27,211 77.9 % $ (6,366 ) (23 )% Provider payments The 23% decrease in provider payments in 2013 is consistent with the decline in revenue as discussed above. The decrease in provider payments as a percentage of net revenues compared to the same prior year period is primarily due to the combination of the mix of clients that utilized our network of ancillary service providers and the mix of ancillary service categories utilized. The mix of clients and service categories shifted to those that historically contribute higher margins relative to other clients and categories.
Administrative fees Administrative fees paid to clients as a percent of net revenues declined to 4.0% in 2013 compared to 4.4% in 2012. The decrease is due to a change in mix from clients with higher administrative fees to clients with lower administrative fees.
Non-variable Costs Non-variable costs are those that are not contingent on claims activity and are primarily fixed in nature, but can be adjusted. They are comprised of such expenses as salaries and benefits, professional fees, consulting costs, non-cash equity compensation costs and travel and entertainment expenses. A significant driver of these costs are headcount, as payroll, commissions and related benefits (including non-cash equity compensation) accounted for approximately 59% of our non-variable cost structure during 2013. Our average headcount of full-time employees ("FTE's") was 49 and 56 at December 31, 2013 and 2012, respectively.
Following is a discussion of the changes in non-variable costs and related drivers: Claims administration Our claims administration function consists of our operations and information technology groups. Our operations group is responsible for most aspects of claims management and processing, including billing and quality assurance. In addition, our operations group is responsible for credentialing contracted ancillary service providers. The cost of our operations group is adjusted consistent with the level of claims we process and bill. Our information technology group is responsible for maintaining and enhancing the technological capabilities and applications of the claims management process, is not solely driven by claims volume.
During the twelve months ended December 31, 2013, the costs related to the claims administration function decreased 6% partially due to a decrease in outsourced claims processing costs of $52,000, consistent with the decline in claims volume. Additionally, headcount decreased by one FTE, through natural attrition, within the information technology group, which contributed to the reduction in costs year-over-year.
Provider Development Our provider development function is responsible for developing our network of ancillary healthcare service providers, which includes contracting with providers to be included in the network and maintaining a relationship with existing providers, all for the purpose of enhancing our ancillary service provider network for our client payors. We customize networks for our clients, thus as new client contracts are secured, our recruiting activities will increase.
The 25% decrease in costs related to the provider development function during the year ended December 31, 2013 as compared to the year ended December 31, 2012 is primarily the result of a headcount reduction of one FTE, through natural attrition, reduced legal fees and travel expenses.
25-------------------------------------------------------------------------------- Table of Contents Sales and Marketing Our sales and marketing function consists of our sales and client services groups, as well as the strategic development group. Our sales group is primarily responsible for securing new client contracts, while our client services group maintains our existing client relationships, as well as attempts to generate incremental growth from those relationships. The strategic development group is responsible for executing the strategic objectives as dictated by the Board of Directors and executive management.
The 16% decrease in costs related to sales and marketing during the twelve months ended December 31, 2013 as compared to the same prior year period was the result of a reduction in total consulting fees of approximately $123,000 and a headcount reduction of two FTE's, when compared to the same prior year period.
Finance and Administration Our finance and administration function consists primarily of human resources, finance and accounting, and performance management as well as our former Chief Executive Officer, former President and Chief Operating Officer and Chief Financial Officer.
For the year ended December 31, 2013, costs related to the finance and administration function decreased 7%, as compared to the same prior year period.
A decrease of approximately $307,000, year-over-year, is the result of a reduction in professional fees related to strategic consulting, audit fees, legal consultation regarding employment issues and legal review of various client contracts. A severance charge of approximately $216,000 was recorded in the second quarter of 2013, but was offset by the decrease in expenses discussed above.
Selling, General and Administrative Expenses Following is a table showing the components of selling, general and administrative ("SG&A") expenses as presented per the Statement of Operations for the periods presented ending December 31,: Change ($ in thousands) 2013 2012 $ % Sales and marketing $ 1,900 $ 2,268 $ 368 16 % Finance and administration 4,266 4,573 307 7 Selling, general and administrative expenses $ 6,166 $ 6,841 $ 675 10 % Percentage of total net revenues 23.0 % 19.6 % SG&A expenses as a percentage of total net revenues increased during the year ended December 31, 2013 compared to the prior year, due primarily to the decline in net revenues compared to the same prior year period.
Income Tax Provision For the years ended December 31, 2013 and 2012, we recorded an income tax provision of approximately $25,000 and $31,000, respectively. The effective income tax rates for 2013 and 2012 were different from the statutory United States federal income tax rate of 34% due primarily to the establishment of a deferred income tax valuation allowance of approximately $2.8 million in 2011 and an increase in the allowance by approximately $1,009,000 and $845,000 in 2013 and 2012, respectively.
26-------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources As of December 31, 2013 the Company had working capital of $5.6 million compared to $9.0 million at December 31, 2012. Our cash and cash equivalents balance decreased to $6.2 million as of December 31, 2013 compared to $10.7 million at December 31, 2012. We continued to experience a decline in claims volume and resulting revenue, resulting in a net loss during the year ended December 31, 2013 which expended cash despite various cost containment measures.
During the third quarter we invested $500,000 in a project with a strategic partner that is expected to facilitate the future implementation of new business. Additionally, the decline in our cash balance is also attributable to the timing of payments to providers during January 2013 related to cash received from payors in December 2012. The payments made totaled $1.2 million. Following are the components of our cash flows for the year ended December 31, 2013: Year ended December 31, 2013 Loss before income taxes $ (3,760 ) Depreciation and amortization 795 Non-cash stock-based compensation expense 299 Investment in joint project with strategic partner (500 ) Capital expenditures (primarily software development costs) (315 ) Other working capital changes (1,017 ) Decrease in cash for the year ended December 31, 2013 $ (4,498 ) We believe our current cash balance of $6.2 million as of December 31, 2013 will be sufficient to meet our anticipated cash needs for working capital, capital expenditures, strategic initiatives and other activities through the foreseeable future. Our continuing losses will also continue to reduce our available cash.
We have reduced our non-variable cost structure to preserve our existing cash balances for investments in the business model and/or other strategic initiatives. However; we will need to increase our client base significantly or identify alternative business opportunities in order to stop the reduction in our available cash. If we are unable to do so, we might be required to access additional capital either through debt or equity markets. If additional financing is required, there cannot be assurances that we would be successful in obtaining sufficient capital financing on commercially reasonable terms or at all, or, if we did obtain capital financing, that it would not be dilutive to current shareholders. We do not have any lines of credit, credit facilities or outstanding bank indebtedness as of December 31, 2013.
Inflation Inflation did not have a significant impact on the Company's costs during the years ended December 31, 2013 and December 31, 2012, respectively. The Company continues to monitor the impact of inflation in order to minimize its effects through pricing strategies, productivity improvements and cost reductions.
Off-Balance Sheet Arrangements The Company did not have any off-balance sheet arrangements at December 31, 2013 or December 31, 2012 or for the periods then ended.
27-------------------------------------------------------------------------------- Table of Contents Critical Accounting Policies Critical accounting policies are those that require application of management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods.
The Company's significant accounting policies are described in the Notes to the Consolidated Financial Statements located elsewhere in this Annual Report on Form 10-K. Not all of these significant accounting policies require management to make difficult, subjective or complex judgments or estimates. However, the following accounting policies are deemed to be critical by our management: Revenue recognition.
The Company recognizes revenue on the services that it provides, which includes (i) providing payor clients with a comprehensive network of ancillary healthcare providers, (ii) providing claims management, reporting, processing and payment services, (iii) providing network/need analysis to assess the benefits to payor clients of adding additional/different service providers to the client-specific provider networks and (iv) providing credentialing of network services providers for inclusion in the client payor-specific provider networks. Revenue is recognized when services are delivered, which occurs after processed claims are billed to the client payors and collections are reasonably assured. The Company estimates revenues and costs of revenues using average historical collection rates and average historical margins earned on claims. Periodically, revenues are adjusted to reflect actual cash collections so that revenues recognized accurately reflect cash collected.
The Company determines whether it is acting as a principal or agent in the fulfillment of the services rendered. After careful evaluation of the key gross and net revenue recognition indicators, the Company acknowledges that while the determination of gross versus net reporting is highly judgmental in nature, the Company has concluded that its circumstances are most consistent with those key indicators that support gross revenue reporting.
Following are the key indicators that support the Company's conclusion that it acts as a principal when settling claims for service providers through its contracted service provider network: • The Company is the primary obligor in the arrangement. The Company has assessed its role as primary obligor as a strong indicator of gross reporting. The Company believes that it is the primary obligor in its transactions because it is responsible for providing the services desired by its client payors. The Company has distinct, separately negotiated contractual relationships with its client payors and with the ancillary health care providers in its networks. The Company does not negotiate "on behalf of" its client payors and does not hold itself out as the agent of the client payors when negotiating the terms of the Company's ancillary healthcare service provider agreements. The Company's agreements contractually prohibit client payors and service providers to enter into direct contractual relationships with one another. The client payors have no control over the terms of the Company's agreements with the service providers. In executing transactions, the Company assumes key performance-related risks. The client payors hold the Company responsible for fulfillment, as the provider, of all of the services the client payors are entitled to under their contracts; client payors do not look to the service providers for fulfillment. In addition, the Company bears the pricing/margin risk as the principal in the transactions. Because the contracts with the client payors and service providers are separately negotiated, the Company has complete discretion in negotiating both the prices it charges its client payors and the financial terms of its agreements with the service providers. Since the Company's profit is the spread between the amounts received from the client payors and the amount paid to the service providers, it bears significant pricing/margin risk. There is no guaranteed mark-up payable to the Company on the amount the Company has contracted. Thus, the Company bears the risk that amounts paid to the service provider will be greater than the amounts received from the client payors, resulting in a loss or negative claim.
• The Company has latitude in establishing pricing. As stated above, the Company has complete latitude in negotiating the price to be paid to the Company by each client payor and the price to be paid to each contracted service provider. This type of pricing latitude indicates that the Company has the risks and rewards normally attributed to a principal in the transactions.
28-------------------------------------------------------------------------------- Table of Contents • The Company changes the product or performs part of the services. The Company provides the benefits associated with the relationships it builds with the client payors and the services providers. While the parties could deal with each other directly, the client payors would not have the benefit of the Company's experience and expertise in assembling a comprehensive network of service providers, in claims management, reporting and processing and payment services, in performing network/needs analysis to assess the benefits to client payors of adding additional/different service providers to the client payor-specific provider networks, and in credentialing network service providers.
• The Company has complete discretion in supplier selection. The Company has complete discretion in supplier selection. One of the key factors considered by client payors who engage the Company is to have the Company undertake the responsibility for identifying, qualifying, contracting with and managing the relationships with the ancillary healthcare service providers. As part of the contractual arrangement between the Company and its client payors, the payors identify their obligations to their respective covered persons and then work with the Company to determine the types of ancillary healthcare services required in order for the payors to meet their obligations. The Company may select the providers and contract with them to provide services at its discretion.
• The Company is involved in the determination of product or service specifications. The Company works with its client payors to determine the types of ancillary healthcare services required in order for the payors to meet their obligations to their respective covered persons. In some respects, the Company is customizing the product through its efforts and ability to assemble a comprehensive network of providers for its payors that is tailored to each payor's specific needs. In addition, as part of its claims processing and payment services, the Company works with the client payors, on the one hand, and the providers, on the other, to set claims review, management and payment specifications.
• The supplier (and not the Company) has credit risk. The Company believes it has some level of credit risk, but that risk is mitigated because the Company does not remit payment to providers unless and until it has received payment from the relevant client payors following the Company's processing of a claim.
• The amount that the Company earns is not fixed. The Company does not earn a fixed amount per transaction nor does it realize a per-person per-month charge for its services.
The Company has evaluated the other indicators of gross and net revenue recognition, including whether or not the Company has general inventory risk. The Company does not have any general inventory risk, as its business is not related to the manufacture, purchase or delivery of goods and it does not purchase in advance any of the services to be provided by the ancillary healthcare service providers. While the absence of this risk would be one indicator in support of net revenue reporting, as described in detail above, the Company has carefully evaluated all of the key gross and net revenue recognition indicators and has concluded that its circumstances are most consistent with those key indicators that support gross revenue reporting.
The Company records a provision for refunds based on an estimate of historical refund amounts. Refunds are paid to payors for overpayments on claims, claims paid in error, and claims paid for non-covered services. In some instances, we will recoup payments made to the ancillary service provider if the claim has been fully resolved. The evaluation is performed periodically and is based on historical data. We present revenue net of the provision for refunds on the consolidated statements of operations.
Intangible assets consist of ancillary provider network and internally developed claims payment and billing software. The software has been fully amortized using the straight-line method over its expected useful life of 5 years. The ancillary provider network is being amortized using the straight-line method over their expected useful lives of 15 years. Experience to date is that approximately 2-8% annual turnover or attrition of provider contracts occurs each year. The ancillary provider network is being accounted for on a pooled basis and the actual cancellation rates of provider contracts that were acquired are monitored for potential impairment or amortization adjustment, if warranted. We have performed an impairment assessment based on projected future cash flows and determined no impairment exists as of December 31, 2013 and 2012. The cost of adding additional providers is considered an ongoing operating expense, and is captured on the Statement of Operations under "Claims administration and provider development".
29-------------------------------------------------------------------------------- Table of Contents Deferred Income Taxes.
Income taxes are accounted for under the asset and liability method. Deferred taxes arise because of different treatment between financial statement accounting and tax accounting, known as "temporary differences". The Company records the tax effect of these temporary differences as "deferred tax assets" (generally items that can be used as a tax deduction or credit in the future periods) and "deferred tax liabilities" (generally items that we received a tax deduction for, which have not yet been recorded in the statements of operations). The deferred tax assets and liabilities are measured using enacted tax rules and laws that are expected to be in effect when the temporary differences are expected to be recovered or settled. The realization of the deferred tax assets, including net operating loss carryforwards, is subject to our ability to generate sufficient taxable income during the periods in which the temporary differences become realizable. In evaluating whether a valuation allowance is required, we consider all available positive and negative evidence, including prior operating results, the nature and reason of any losses, our forecast of future taxable income, and the dates of which any deferred tax assets are expected to expire. These assumptions require a significant amount of judgment, including estimates of future taxable income. The estimates are based on our best judgment at the time made based on current and projected circumstances and conditions. Based on estimates impacted by such factors as revenue declines of our two most significant client accounts and the impact of operating results, we determined that a valuation allowance was appropriate. In 2011, a valuation allowance in the amount of $2.8 million was established against the net deferred tax assets with the exception of the Texas tax credit carryforward of approximately $232,000. The valuation allowance against the net deferred tax assets increased by approximately $1.0 million to $4.6 million and the Texas tax credit carryforward was approximately $228,000 as of December 31, 2013.
Pending Accounting Pronouncements None.
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