ITEM 1. Business
Company Overview
Rural/Metro Corporation was founded in 1948 as an Arizona private fire protection services business providing services to residential and commercial property owners on a subscription fee basis. In 1983 the Company began its expansion into the ambulance services industry, which involved the acquisition of various ambulance service providers throughout the United States for a period of time ending in 1998. For the fiscal year ended June 30, 2010, we provided ambulance services and other services to more than one million individuals in approximately 440 communities nationwide and generated net revenue of $530.8 million, of which ambulance services and other services represented 86.3% and 13.7%, respectively.
All references to the “Company,” “we,” “our,” “us,” “R/M,” or “Rural/Metro” refer to Rural/Metro Corporation, and its predecessors, operating divisions, direct and indirect subsidiaries and affiliates, as the context requires. Rural/Metro Corporation, a Delaware corporation, is a holding company. All services, operations and management functions are provided through its subsidiaries and affiliated entities. The website for Rural/Metro Corporation is located at www.ruralmetro.com. The information in our website is not incorporated in, and is not a part of, this Report.
The following is a brief summary of our businesses, including the types of services, our customers, the payers for our ambulance services and other information about us for the fiscal year ended June 30, 2010:
Ambulance Services
Types of Services:
• Emergency Transports
• Non-emergency Transports
• Wheelchair Transports
• Event Standby Services
Customers:
• Municipalities, Counties, Fire Districts
• Government Agencies
• Hospitals
• Nursing Homes
• Specialty Healthcare Facilities
Payers:
• Medicare
• Medicaid
• Commercial Insurance
• Self-Pay Individuals
Number of Contracts:
• 103 exclusive emergency
• 760 non-emergency arrangements
Volume:
• 1.1 million transports annually
Employees:
• 1,888 Paramedics
• 3,126 EMTs
Fire Services
Types of Services:
• Fire Protection and Suppression
• Forestry
• Airport Rescue and Firefighting
• Industrial Complex Fire Protection
Customers:
• Fire Districts
• Individuals
• Industrial and Commercial Facilities
• Municipalities
• Government Agencies
Employees:
• 840 Firefighters
Ambulance Industry Overview
Services
We estimate expenditures for emergency and non-emergency ambulance services in the United States to be approximately $14 billion annually. Ambulance services are provided by municipalities, private providers, hospitals and volunteer organizations. Non-emergency ambulance services are primarily provided by private providers. There are a limited number of regional ambulance providers and we are one of only two national providers.
We believe the following are key factors affecting the ambulance service industry:
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Aging U.S. population. According to the U.S. Census Bureau, about 72 million Americans, or 19% of the U.S. population, will be age 65 or older in 2030 as compared to 40 million, or 13% in 2010. As of June 30, 2010, approximately 43% of our annual ambulance transports were for patients age 65 or older. We expect that the continued growth in the number of people over the age of 65 will fuel demand for ambulance services.
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Increased interfacility use of ambulance services. The increased availability of specialized treatment healthcare facilities, nursing homes and home care have contributed to greater demand for non-emergency ambulance services between facilities.
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Municipalities under budgetary pressure. Municipalities are under significant budgetary pressures due to declining tax revenues and lower reimbursements from state and federal governments. Those municipalities are looking for ways to pass on their costs in ways such as ride along fees for fire department employees, dispatch fees, franchise fees, and reduced subsidies.
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Healthcare legislation. We expect the overall effect of the recent Federal healthcare legislation to be positive. According to healthcare industry reports, approximately 32 million people who currently have no health insurance will become covered under the new law, with most people required to obtain insurance beginning as early as 2014. We believe that more individuals covered by some form of insurance will help us further reduce our exposure to uncompensated care.
Business Segments
As of June 30, 2010, we had four regional reporting segments that corresponded with the manner in which the associated operations were managed and evaluated by our chief operating decision maker. Although some of our operations did not align with our segments’ geographic designation, all operations were structured to capitalize on management’s strengths. Those segments comprised operations within the following areas:
Segment
States
Mid-Atlantic
New York, Northern Ohio
South
Alabama, Florida (fire), Georgia, Indiana, Kentucky, Louisiana, Mississippi, Missouri,
New Jersey, North Dakota, Oregon (fire), Southern Ohio, Tennessee
Southwest
Arizona
West
California, Central Florida (ambulance), Colorado, Nebraska, Oregon (ambulance),
South Dakota, Washington
Each reporting segment provides ambulance services while our other services are predominately in the South and Southwest segments.
Effective July 1, 2010, we realigned our reporting segments. Our reporting segments will be organized geographically as follows:
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East Zone - Connecticut, Delaware, Illinois, Indiana, Iowa, Kentucky, Maine, Maryland, Massachusetts, Michigan, Minnesota, New Hampshire, New Jersey, New York, Ohio, Pennsylvania, Rhode Island, Vermont, Virginia, Wisconsin, West Virginia and the District of Columbia.
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West Zone - Alaska, California, Colorado, Hawaii, Idaho, Montana, Nebraska, Nevada, North Dakota, Oregon, South Dakota, Utah, Washington and Wyoming.
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South Zone - Alabama, Arkansas, Florida, Georgia, Louisiana, Mississippi, Missouri, North Carolina, South Carolina and Tennessee.
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Southwest Zone - Arizona, Kansas, New Mexico, Oklahoma and Texas.
Although each state (and the District of Columbia) has been assigned to an operating zone, we currently have operations in the following 20 states: Alabama, Arizona, California, Colorado, Florida, Georgia, Indiana, Kentucky, Louisiana, Mississippi, Missouri, Nebraska, New Jersey, New York, North Dakota, Ohio, Oregon, Tennessee, South Dakota and Washington.
Beginning in the first quarter of fiscal 2011, we will recast prior period information to reflect the changes in reporting segments.
Ambulance Services
We generally provide two primary levels of ambulance services-Advanced Life Support (“ALS”) and Basic Life Support (“BLS”). We staff our ALS ambulances with either two paramedics or one paramedic and one Emergency Medical Technician (“EMT”) and equip them with ALS equipment (such as cardiac monitors/defibrillators, advanced airway management equipment and oxygen delivery systems) as well as pharmaceuticals and medical supplies. We staff our BLS ambulances with two EMTs and equip them with medical supplies and equipment necessary to administer first aid and basic medical treatment. Ambulance services encompass both emergency response and non-emergency response services, including critical care, inter-facility and to a lesser extent wheelchair transports.
Emergency Response Services-Governmental
We provide emergency response services under long-term, exclusive contracts with counties, municipalities, fire districts and other governmental agencies. Our agreements typically require that we respond to all emergency calls in a designated area within a specified response time.
None of these contracts accounted for more than 10% of our annual net revenue during each of the last three fiscal years. These contracts, which are similar to licenses, grant us the right to provide emergency ambulance services. The contracts typically set forth performance criteria, such as response times, staffing levels, types of vehicles and equipment, quality assurance, indemnity and insurance coverage. The rates we may charge under a contract for emergency ambulance services depend largely on:
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patient mix;
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the nature of services rendered; and
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any applicable federal, state or county authority to regulate rates.
Counties, fire districts and municipalities award emergency ambulance service contracts through a competitive bidding process. Generally, our emergency contracts extend for three to five years for the initial term, with options for earned extensions of one to three years thereafter. In some instances in which we are the incumbent provider, the county or municipality may elect to renegotiate our existing contract rather than re-bid the contract at the end of any earned extensions.
Under many of our contracts, the local fire department is the first responder to an emergency scene. In these situations, the fire department begins stabilization of the patient. Upon arrival, our crew members deploy portable life support equipment, ascertain the patient’s medical condition and, if required, administer ALS interventions, including tracheal intubation, cardiac monitoring, defibrillation of certain cardiac dysrhythmias and the administration of medications and intravenous solutions under the direction of a physician. The crew also may perform BLS services, including cardiopulmonary resuscitation, basic airway management and basic first aid. As soon as medically appropriate, the patient is placed on a portable gurney and transferred into the ambulance. While one crew member monitors and treats the patient, the other crew member drives the ambulance to a hospital designated either by the patient or applicable medical protocol. While on scene or en route, the ambulance crew alerts the hospital regarding the patient’s medical condition and, if necessary, the attending ambulance crew member consults an emergency physician as to treatment. Upon arrival at the hospital, care is transferred to the hospital staff.
Non-Emergency Response Services-Healthcare Facilities
We provide non-emergency response services and critical care transfers to healthcare facilities, hospitals, nursing homes and other specialty care providers or at the request of a patient. These services are typically managed by the facility discharge planners, nurses or physicians who are responsible for requesting ambulance services. Non-emergency medical transportation services may be scheduled in advance or provided on an as-needed basis. Quality of service, reliability and name recognition are critical factors in obtaining non-emergency business.
We utilize either ALS or BLS ambulance units to provide non-emergency ambulance services based on the nature of the patient’s medical condition. These services may be provided when a home-bound patient requires examination or treatment at a healthcare facility or when a hospital patient requires tests or treatments, dialysis and chemotherapy at another facility. These services are administered by an EMT or paramedic.
We also provide critical care transfer services to medically unstable patients (such as cardiac patients and neonatal patients) who require critical care while being transported between healthcare facilities. Critical care services differ from ALS or BLS services in that the ambulance may be equipped with additional medical equipment and may be staffed by a medical specialist provided by us or by a healthcare facility. Staffing may also include registered nurses, respiratory therapists, neo-natal nurse specialists and/or specially trained paramedics.
Fire Protection Services
We provide subscription fire protection services to residential and commercial property owners in emerging communities or unincorporated areas where neither a public sector nor volunteer fire department operates. We also provide such services to industrial sites, airports and other self-contained facilities on a national basis.
Other Services
We provide other services such as home health care services and protection services on a limited basis.
Billing and Collections
We provide ambulance services on a fee-for-service basis and record revenue based on the level of medical service we provide. Additionally, our fee-for service revenue may be supplemented by the communities we serve in the form of a subsidy, which further supports the level of medical services we provide.
We maintain five billing processing centers across the United States and a centralized self-pay collection center. We receive payment for our services from third-party payers, including federal and state government-funded programs primarily under Medicare and Medicaid, commercial insurance companies, individual patients and to a lesser extent, community subsidies. See “Regulatory Matters-Medicare, Medicaid and Other Government Reimbursement Programs.”
We have substantial experience in processing claims to third-party payers and employ a billing staff trained in third-party coverage and reimbursement procedures. Our integrated billing and collection system tailors the submission of claims to Medicare, Medicaid and other third-party payers and has the capability to electronically submit claims to the extent third-party payers’ systems permit. The system also provides for tracking of accounts receivable and status pending payment. In addition, the self-pay collection center utilizes an automated predictive dialer that pre-selects and dials accounts based on their status within the billing and collection cycle. We believe the automated predictive dialer enhances the efficiency of the collection staff.
Companies in the ambulance service industry may experience significant levels of uncompensated care compared to companies in other segments of the healthcare industry. Collection of complete and accurate patient billing information during an emergency service call is sometimes difficult, and incomplete information hinders post-service collection efforts. Uncompensated care generally is higher with respect to revenue derived directly from patients than for revenue derived from third-party payers, and generally is higher for services resulting from emergency calls than for non-emergency response requests. See “Risk Factors-Risks Related to the Health Care Industry” in Item 1A
ITEM 1A. Risk Factors
You should carefully consider the risks and uncertainties described below, in addition to the information set forth elsewhere in this report, when evaluating our business, industry and capital structure. Additional risks and uncertainties not presently known or that we may currently believe to be immaterial may also materially and adversely affect us. Any of the following risks and uncertainties could materially and adversely affect our business, financial condition or results of operations.
Risks Related to Our Business
Our results of operations and growth could be adversely affected if we lose existing contracts or fail to renew existing contracts on favorable terms.
A significant portion of our growth historically has resulted from increases in the number of emergency and non-emergency transports under our existing contracts with municipalities, counties and fire districts to provide emergency and other services. Substantially all of our net revenue for fiscal year 2010 was generated under existing contracts. Our contracts generally range from three to five years in length. Most of our contracts are terminable by either party upon notice of as little as 30 days. Further, certain of our contracts expire during each fiscal period, and we may be required to seek renewal of certain of these contracts through a formal bidding process that often requires written responses to a Request for Proposal (“RFP”). Even if any of our contracts are renewed, a renewal contract may contain terms that are not as favorable to us as the terms of our current contract. We cannot assure you that we will be successful in retaining or renewing our existing contracts or that the loss or renewal terms of contracts would not have a material adverse effect on us. There is also no assurance that we will experience growth in the number of transports under our existing contracts.
Our growth strategy involves significant risks, and if we are unable to manage them effectively, our business may be materially harmed.
In addition to organic growth, the Company’s strategy includes growth through strategic business acquisitions. These growth plans may strain our financial resources. The Company competes for acquisition opportunities with other companies, some of which have significantly greater financial resources. Therefore, there is a risk that the Company may be unable to complete a particular acquisition that it determines to be important to the growth strategy because another company may be able to pay more for a potential acquisition candidate or may be able to use its financial resources to acquire a potential acquisition candidate before the Company is able to arrange the requisite financing for such acquisition. Even if the Company completes a desirable business acquisition on favorable terms, the Company may not be able to successfully integrate newly-acquired business operations into its existing business operations on a timely basis. The process of identifying, negotiating and closing acquisition transactions is a challenging, time-consuming and costly process, as is the process of integrating newly-acquired business operations. Accordingly, the acquisition process will require a significant amount of management attention and other administrative resources and could result in disruptions to the Company’s ongoing business operations. In addition, successful integration of acquired businesses requires the dedication of significant management resources that may temporarily detract attention from the Company’s and the acquired company’s day-to-day business. If management is not able to integrate the organization, operation and systems of an acquired business in a timely and efficient manner, the anticipated benefits of a completed acquisition may not be fully realized.
We are subject to decreases in our revenue as a result of changes in payer mix.
We are subject to risks related to changes in the mix of insured versus uninsured patients that receive our medical services. If our mix of uninsured patients to insured patients increases, we may be adversely affected because we have greater difficulty recovering our full fees for services rendered to uninsured patients. Our credit risk related to services provided to uninsured individuals is exacerbated because communities are required to provide emergency response services regardless of an individual’s ability to pay. We also believe uninsured patients are more likely to dial 911 to seek care for minor conditions because they frequently do not have a primary care physician with whom to consult. An increase in individuals utilizing our services that do not have an ability to pay could materially and adversely affect our results of operations. The current economic downturn has resulted in rising unemployment, which may result in a higher number of uninsured individuals and individuals that do not have the ability to pay our standard rates.
The cost of our services is funded substantially by government and private insurance programs. If this funding is reduced or becomes limited or unavailable to our customers, our business may be adversely impacted.
The current economic downturn could result in increased budget pressures and reductions or re-allocations in government spending. Such budget pressures and reductions or other changes in spending may negatively impact
contract retention and renewal with governmental entities, and may also result in a reduction in Medicaid reimbursement and covered services in an attempt to contain Medicaid costs. Furthermore, as a result of the economic downturn, third-party payers, including Medicare, Medicaid and private health insurance providers are increasingly challenging amounts paid for healthcare-related services. We cannot assure you that reimbursement will be available or that payers’ reimbursement policies will not have a material adverse effect on our ability to provide our services on a profitable basis, if at all.
We are in a highly competitive industry; if we do not compete effectively, we could lose business or fail to grow.
The market for providing ambulance services to counties, municipalities, fire districts and hospitals and other healthcare providers is highly competitive. We compete to provide ambulance services with governmental entities, hospitals, local and volunteer and private providers, including national providers such as American Medical Response. In many communities, our primary competitor in providing ambulance service is the local fire department, which in many cases has traditionally acted as first responder during emergencies and has been able to expand its scope of services to include emergency ambulance transports. In order to compete successfully, we must make continuing investments in our fleet, facilities and operating systems.
Some of our current competitors and certain potential competitors may have access to greater capital and other resources than we do. Counties, municipalities, fire districts and healthcare providers that currently contract for ambulance services could choose to provide ambulance services directly in the future. We may experience increased competition from fire departments in providing emergency medical transportation service. We cannot assure you that we will be able to compete successfully to provide our medical transportation services.
If fuel prices increase significantly, our results of operations could be adversely affected.
We are subject to risk with respect to purchases of fuel. Prices and availability of petroleum products are subject to political, economic, weather-related, and market factors that are generally outside of our control, and each of which may lead to an increase in the cost of fuel. Because our operations are dependent on fuel, significant increases in fuel costs could materially and adversely affect our results of operations and financial condition if we are unable to pass increased costs on to payers through rate increases or fuel surcharges. Fuel surcharges that can be collected do not always fully offset the increase in the cost of fuel. To the extent we are not able to successfully negotiate such rate increases or fuel surcharges, our results of operations may be adversely affected by increases in fuel price.
Some state and local governments regulate our rate structures and may limit our ability to increase our rates or maintain a satisfactory rate structure.
State or local government regulations or administrative policies regulate the rates we can charge in some states for non-emergency ambulance services. In addition, in some service areas in which we are the exclusive provider of services, the municipality or fire district sets the rates for emergency ambulance services pursuant to a master contract and otherwise establishes the rates for non-emergency ambulance services. In areas where our rates are regulated, there is no assurance we will receive ambulance service rate increases on a timely basis to offset increases in the cost to perform our services, or at all. If we are not able to obtain timely rate increases it could have a material adverse effect on our revenues, profits and cash flows.
If we fail to implement our business strategy, our financial performance and our growth could be materially and adversely affected.
Our future financial performance and success are dependent in large part upon our ability to implement our business strategy successfully. Implementation of our business strategy could be affected by a number of factors beyond our control, such as increased competition, legal developments, government regulation, general economic
conditions or increased operating costs or expenses. In addition, to the extent we have misjudged the nature and extent of industry trends or our competition; we may have difficulty in achieving our strategic objectives. Any failure to implement our business strategy successfully may adversely affect our business, financial condition and profitability. Our long-term growth may also be adversely affected. Even if we are able to implement some or all of the initiatives of our business plan successfully, our operating results may not improve to the extent we anticipate, or at all.
Our business depends on numerous complex information systems, and any failure to successfully maintain these systems or implement new systems could materially and adversely affect our operations.
We depend on complex, integrated information systems and standardized procedures for operational and financial information and billing operations. We may experience unanticipated delays, complications and expenses in implementing, integrating and operating our systems. Any interruption in operations during periods of implementation would adversely affect our ability to properly allocate resources and process billing information in a timely manner, which could result in customer dissatisfaction and interruption in our cash flow. We also use the development and implementation of sophisticated and specialized technology to differentiate our services from our competitors and improve our profitability. The failure to implement and maintain operational, financial and billing information systems successfully could have an adverse effect on our ability to obtain new business, retain existing business and maintain or increase our profit margins.
The reserves we establish with respect to our losses covered under our insurance programs are subject to inherent uncertainties, and we could be required to increase our reserves, which would adversely affect our results of operations.
In connection with our insurance programs, we establish reserves for losses and related expenses which represent our expectations of the ultimate resolution and administration costs of losses we have incurred in respect of our liability risks. Our reserves are based on estimates involving actuarial and statistical projections, at a given point in time. However, insurance reserves inherently are subject to uncertainty. Our reserves are based on historical claims, demographic factors, industry trends, severity and exposure factors and other actuarial assumptions calculated by an independent actuary firm. The independent actuary firm performs studies of projected ultimate losses on an annual basis and provides quarterly updates to those projections. We use these actuarial estimates to determine appropriate reserves. Our reserves could be significantly affected if current and future occurrences differ from historical claim trends and expectations. While we monitor claims closely when we estimate reserves, the complexity of the claims and the wide range of potential outcomes may hamper timely adjustments to the assumptions we use in these estimates. Actual losses and related expenses may deviate, individually and in the aggregate, from the reserve estimates reflected in our financial statements. If we determine that our estimated reserves are inadequate, we will be required to increase reserves at the time of the determination which would result in a reduction in our net income in the period in which the deficiency is determined. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Estimates and Policies-Insurance Reserves” and Note 9 of the notes to our financial statements included in Item 8 of this report.
We may be subject to claims for which we are not insured or for which our insurance coverage is inadequate.
In recent years, physicians, hospitals and other participants in the healthcare industry have become subject to an increasing number of lawsuits alleging medical malpractice and related legal theories such as negligent hiring, supervision and credentialing. Similarly, ambulance transport services may result in lawsuits concerning vehicle collisions and personal injuries, patient care incidents or mistreatment and employee job-related injuries. Some of these lawsuits may involve large claim amounts and substantial defense costs, which may not be covered by our insurance policies or for which we may not have established adequate reserves.
In the normal course of our business, we are involved in lawsuits, claims, audits and investigations, including those arising out of our billing and marketing practices, employment disputes, contractual claims and other
business disputes for which we may have no insurance coverage, and which are not subject to actuarial estimates. The outcome of these matters could have a material effect on our results of operations in the period when we identify the matter, and the ultimate outcome could have a material adverse effect on our financial position, results of operations, or cash flows.
We obtain insurance coverage from third party insurers to supplement our self insurance program and to cover periods prior to our implementation of the program. To the extent we hold policies to cover certain claims, but either did not obtain sufficient insurance limits, or did not buy an extended reporting period policy, where applicable, or the issuing insurance company is no longer viable, we may be responsible for losses attributable to such claims. While we believe our commercial insurance company providers currently are creditworthy, there can be no assurance that such insurance companies will remain so in the future. If our insurers do not make payments in respect of claims, we may be required to do so, which could have a material adverse effect on our financial condition, results of operations and cash flow.
Many of our employees are represented by labor unions and any unfavorable labor agreements or work stoppage could adversely affect our business, financial conditions, results of operations and reputation.
Approximately 41% of our employees are covered by one or more of 22 collective bargaining agreements as of June 30, 2010. Six of these collective bargaining agreements, covering 829 employees, are subject to renegotiation in fiscal 2011. Although we believe our relations with our employees are good, we cannot assure you that we will be able to negotiate a satisfactory renewal of these collective bargaining agreements or that our employee relations will remain stable. If we are unable to negotiate a timely renewal of one or more agreements, the employees covered by the agreement may enter into a strike or other work stoppage. Such a stoppage could have a material adverse effect on our business, financial conditions, results of operations and reputation.
We depend on our senior operational personnel and may not be able to retain those employees or recruit additional qualified personnel, which could adversely affect our business.
We depend on our senior operational personnel. The loss of services of any of the members of our senior operational personnel could adversely affect our business until a suitable replacement can be found. If we were required to find a suitable replacement for one of our senior managers, there could be a limited number of persons with the requisite skill to serve in the position, and we cannot assure you that we will be able to identify or employ such qualified personnel on acceptable terms.
Risks Related to the Healthcare Industry
We conduct business in a heavily regulated industry and state and federal legislation and regulations may have significant and unforeseeable impact on our operations.
The ambulance industry is heavily regulated by the federal and state governments, with a substantial portion of our revenues coming from governmental sources. Congress and state legislatures have consistently fought to curb spending in governmental programs and in the past there have been frequent and significant changes in the methods and standards used by federal and state government agencies to reimburse and to regulate the operation of ambulance and other health care providers. Further, governmental payor programs are subject to statutory and regulatory changes, administrative rulings, interpretations of policy, determinations by intermediary entities and government funding restrictions, all of which may materially increase or decrease the rates of payment and cash flow to ambulance providers. There is no assurance that payments made under such programs will remain at levels comparable to the present levels or be sufficient to cover our fixed and operating costs.
PPACA expands coverage to 30 million uninsured Americans through a combination of tax increases and reductions in Medicare and Medicaid spending. A significant portion of such savings are expected to be generated through recoupment and penalties associated with enhanced fraud and abuse enforcement. The federal
legislation contains over 1,000 rulemaking opportunities for the Secretary of DHHS, thus, the full impact of the law on our operations cannot be currently ascertained and may have a material impact on our operations.
There is no reason to believe that substantial additional changes in federal and state laws and regulations will not occur in the future. From time to time, legislative proposals are made at the federal and state level to engage in broader reform of the healthcare industry, including proposals to contain healthcare costs, to provide health insurance, promote competition in the healthcare industry and to impose additional requirements and restrictions on healthcare insurers, providers and other healthcare entities. The content, timing or effects of future health care reform efforts on us cannot be predicted. Broadly speaking, provisions of federal and state laws which encourage or mandate health care coverage for individuals can be expected to benefit us. However, revisions to the Medicare and Medicaid reimbursement programs could reduce our revenues.
We monitor and evaluate the impact of federal and state laws and related regulations and will continue to do so in order to assess their effects on our current and projected operations, financial performance and financial condition, however, we cannot predict with any reasonable degree of certainty or reliability any interim or ultimate effects of future federal or state health care legislation and regulations.
We conduct business in a heavily regulated industry and if we fail to comply with applicable laws and government regulations, we could incur penalties or be required to make significant changes to our operations.
The healthcare industry is heavily regulated and closely scrutinized by federal, state and local governments. Comprehensive statutes and regulations govern the manner in which we provide and bill for services, our contractual relationships, our marketing activities and other aspects of our operations. Failure to comply with these laws can result in civil and criminal penalties such as fines, damages and exclusion from the Medicare and Medicaid programs. The risk of being found in violation of these laws and regulations is increased by the fact that many of them have not been fully interpreted by the regulatory authorities or the courts, and their provisions are sometimes open to a variety of interpretations. Any action against us for the violation of these laws or regulations, even if we successfully defend against it, could cause us to incur significant legal expenses and divert our management’s attention from the operation of our business. The parties with whom we contract are also subject to ethical guidelines and operational standards of professional and trade associations and private accreditation agencies. Compliance with these guidelines and standards is often required by our contracts with our customers or to maintain our reputation. The failure by the parties with whom we contract to comply with such guidelines and standards could have a material adverse effect on our business, financial conditions, results of operations and reputation.
The laws, regulations and standards governing the provision of healthcare services may change significantly in the future. New or changed healthcare laws, regulations or standards could materially and adversely affect our business. A review of our business by judicial, law enforcement, regulatory or accreditation authorities could result in a determination that could adversely affect our operations.
We are subject to comprehensive and complex laws and rules that govern the manner in which we bill and are paid for our services by third-party payers, and the failure to comply with these rules, or allegations that we have failed to do so, can result in civil or criminal sanctions, including exclusion from federal and state healthcare programs.
Like most healthcare providers, the majority of our services are paid for by private or governmental third-party payers, such as insurance companies, Medicare and Medicaid. These third-party payers typically have differing and complex billing and documentation requirements that we must meet in order to receive payment for our services. Reimbursement to us is typically conditioned on providing the correct procedure and diagnostic codes and properly documenting the services, including the level of service provided, medical necessity for the services and the identity of the practitioner who provided the service.
We must also comply with numerous other laws applicable to our documentation and the claims we submit for payment, including but not limited to (1) “coordination of benefits” rules that dictate which payer we must bill first when a patient has potential coverage from multiple payers; (2) requirements that we obtain the signature of the patient or patient representative, when possible, or document why we are unable to do so, prior to submitting a claim; (3) requirements that we make repayment to any payer which pays us more than the amount to which we were entitled; (4) requirements that we bill a hospital or nursing home, rather than Medicare, for certain ambulance transports provided to Medicare patients of such facilities; (5) requirements that our electronic claims for payment be submitted using certain standardized transaction codes and formats; and (6) laws requiring us to handle all health and financial information of our patients in a manner that complies with specified security and privacy standards.
Governmental and private third party payers and other enforcement agencies carefully audit and monitor our compliance with these and other applicable rules, and in some cases in the past have found that we were not in compliance. We have received in the past, and expect to receive in the future, repayment demands from third party payers based on allegations that our services were not medically necessary, were billed at an improper level, or otherwise violated applicable billing requirements. Our failure to comply with the billing and other rules applicable to us could result in non-payment for services rendered or refunds of amounts previously paid for such services. In addition, non-compliance with these rules may cause us to incur civil and criminal penalties, including fines, imprisonment of our management or employees, and exclusion from government healthcare programs such as Medicare and Medicaid, under a number of state and federal laws. These laws include the federal False Claims Act, the Health Insurance Portability and Accountability Act of 1996, the federal Anti-Kickback Statute, The Civil Monetary Penalties Law and other provisions of federal, state and local law.
In addition, from time to time we self-identify practices that may have resulted in Medicare or Medicaid overpayments or other regulatory compliance issues. For example, we have previously identified situations in which we may have inadvertently utilized incorrect billing codes for some of the services we have billed to government programs such as Medicare or Medicaid. In such cases, if appropriate, it is our practice to disclose the issue to the affected government programs and to refund any resulting overpayments. Although the government usually accepts such disclosures and repayments without taking further enforcement action, it is possible that such disclosures or repayments will result in allegations by the government that we have violated the False Claims Act or other laws, leading to investigations and possibly civil or criminal enforcement actions.
If our operations are found to be in violation of these or any of the other laws which govern our activities, any resulting penalties damages, fines or other sanctions could adversely affect our ability to operate our business and our financial results.
Our contracts with healthcare facilities and our marketing practices are subject to the federal Anti-Kickback Statute.
We are subject to the federal Anti-Kickback Statute, which prohibits the knowing and willful offer, payment, solicitation or receipt of any form of “remuneration” in return for, or to induce, the referral of business or ordering of services paid for by Medicare or other federal programs. “Remuneration” potentially includes discounts and in-kind goods or services, as well as cash. Certain federal courts have held that the Anti-Kickback Statute can be violated if “one purpose” of a payment is to induce referrals. Violations of the Anti-Kickback Statute can result in imprisonment, civil or criminal fines or exclusion from Medicare and other governmental programs. In 1999, the OIG issued an Advisory Opinion indicating that discounts provided to health facilities on the transports for which they are financially responsible potentially violate the Anti-Kickback Statute when the ambulance company also receives referrals of Medicare and other government-funded transports from the facility. The OIG has clarified that not all discounts violate the Anti-Kickback Statute, but that the statute may be violated if part of the purpose of the discount is to induce the referral of the transports paid for by Medicare or other federal programs, and the discount does not meet certain “safe harbor” conditions. In the Advisory Opinion and subsequent pronouncements, the OIG has provided guidance to ambulance companies to help them avoid unlawful discounts.
Like other ambulance companies, we have provided discounts to our healthcare facility customers (nursing homes and hospitals) in certain circumstances. We have attempted to comply with applicable law when such discounts are provided. However, the government has alleged in the past that certain of our hospital and nursing home contracts contained discounts in violation of the federal Anti-Kickback Statute.
There can be no assurance that investigations or legal action related to our contracting practices will not be pursued against us. If we are found to have violated the Anti-Kickback Statute, we may be subject to civil or criminal penalties, including exclusion from the Medicare or Medicaid programs, or may be required to enter into settlement agreements with the government to avoid such sanctions. Typically, such settlement agreements require substantial payments to the government in exchange for the government to release its claims, and may also require us to enter into a Corporate Integrity Agreement (“CIA”).
In addition to our contracts with healthcare facilities, other marketing practices or transactions we enter into may implicate the Anti-Kickback Statute. Although we have attempted to structure our past and current marketing initiatives and business relationships to comply with the Anti-Kickback Statute, we cannot assure you that the OIG of the DHHS or other authorities will not find that our marketing practices and relationships violate the statute.
If we fail to comply with the terms of our settlement agreements with the federal government, we could be subject to additional litigation or other governmental actions which could be harmful to our business.
In the last five years, we have entered into three settlement agreements with the United States government. In connection with the settlement agreements, we have entered into two CIAs, each of which is still in effect. Pursuant to the CIAs, we are required to establish and maintain compliance programs, which include, among other things, the appointment of a compliance officer and committee; the training of employees nationwide; enhancing procedures relating to certain of our contracting processes, including tracking contractual arrangements; review by an independent review organization; and reporting of certain reportable events. We cannot assure you that the CIAs or the compliance programs we have initiated have prevented, or will prevent, any repetition of the conduct or allegations that were the subject of these settlement agreements, or that the government will not raise similar allegations in other jurisdictions or for other periods of time. If such allegations are raised, or if we fail to comply with the terms of the settlement agreement or CIAs, we may be subject to fines and other contractual and regulatory remedies specified in the settlement agreements and/or CIAs or by applicable laws, including exclusion from the Medicare program and other federal and state healthcare programs. Such actions could have a material adverse effect on the conduct of our business, our financial condition or our results of operations.
We may not be able to successfully recruit and retain paramedics and EMT professionals with the qualifications and attributes desired by us and our customers.
Our ability to recruit and retain paramedics and EMT professionals significantly affects our business. Due to the geographic and demographic diversity of the communities we serve, medical personnel shortages in some of our market areas can make the recruiting and retention of full-time personnel more difficult and costly. Moreover, we compete with other entities, both municipal and private, to recruit and retain qualified paramedics and EMTs to deliver ambulance services. Failure to retain or replace our medical personnel or to attract new personnel, or the additional cost of doing so may have an adverse effect on our business, financial condition and results of operations.
Risks Related to Our Capital Structure
Our indebtedness could adversely affect our financial condition and our ability to operate our business
At June 30, 2010, we had total debt of $269.0 million, including $174.9 million of borrowing under the term loan portion of our senior secured credit facility, $93.5 million of senior discount notes and no borrowings outstanding under our $40.0 million revolving credit facility (the “2009 Credit Facility”), other than letters of credit issued
under the $25.0 million letter of credit subline. In addition, subject to restrictions in the indenture governing our notes and the credit agreement governing our senior secured credit facility, we may incur additional debt. Our level of debt obligation could have important consequences, including the following:
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It may be difficult to satisfy our principal and interest obligations;
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It may be difficult to obtain additional financing for working capital, capital expenditures, debt service requirements or other general corporate purposes; and
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It may be difficult to capitalize on business opportunities and to react to competitive pressures, as compared to our competitors.
Furthermore, the borrowings under our senior secured credit facility bear interest at variable rates. If these rates were to increase significantly, to the extent not hedged, our debt service costs would increase and could have a potential material effect on our cash flows.
Our ability to generate sufficient cash depends on numerous factors beyond our control, and we may be unable to generate sufficient cash flow to service our debt obligations.
Our business may not generate sufficient cash flow from operating activities. Our ability to make payments on and to refinance our debt and to fund planned capital expenditures and acquisitions will depend on our ability to generate cash in the future. To some extent, this is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. Lower net revenues generally will reduce our cash flow.
If we are unable to generate sufficient cash flow to service our debt and meet our other commitments, we may need to refinance all or a portion of our debt, sell material assets or operations or raise additional debt or equity capital. We cannot assure you that we could effect any of these actions on a timely basis, on commercially reasonable terms or at all, or that these actions would be sufficient to meet our capital requirements. In addition, the terms of our existing or future debt agreements may restrict us from effecting any of these alternatives.
Restrictive covenants in our senior secured credit facility and the indenture governing our senior discount notes may restrict our ability to pursue our business strategies.
Our 2009 Credit Facility and the indentures governing our senior discount notes limit our ability, among other things, to:
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Incur additional debt or issue certain preferred stock;
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Pay dividends or make distributions to our stockholders;
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Repurchase, issue, or redeem our capital stock;
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Make investments;
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Incur liens;
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Make capital expenditures;
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Enter into transactions with our stockholders, other businesses, and affiliates;
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Sell certain assets;
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Acquire the assets of, or merge or consolidate with, other companies; and
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Incur restrictions on the ability of our subsidiaries to make distributions or transfer assets to us.
The restrictions could limit our ability to plan for or react to market conditions or meet extraordinary capital needs or otherwise restrict corporate activities.
In addition, the 2009 Credit Facility requires us to meet certain financial ratios and restricts our ability to make capital expenditures or prepay certain other debt. We may not be able to maintain these ratios and have had, and in the future may need, to seek waivers or amendments relating to these ratios. Our 2009 Credit Facility and indentures also require us to provide financial statements and related reports within certain timeframes.
Our ability to comply with these covenants may be affected by events beyond our control, and any material deviations from our forecasts could require us to seek waivers or amendments of covenants, alternative sources of financing or reductions in expenditures. We cannot assure you that any waivers, amendments or alternative financings could be obtained, or, if obtained, would be on terms acceptable to us.
If a breach of any covenant or restriction contained in our financing agreements results in an event of default, those lenders could discontinue lending, accelerate the related debt (which would accelerate other debt) and declare all borrowings outstanding thereunder to be due and payable. In addition, the lenders could terminate any commitments they had made to supply us with additional funds. In the event of a default on our debt, we may not have or be able to obtain sufficient funds to make any accelerated debt payments, which could result in a reorganization of the Company.
We may be unable to fully realize the benefits of our net operating loss (“NOL”) carryforwards if an ownership change occurs.
If we were to experience a “change in ownership” under Section 382 of the U.S. Internal Revenue Code (“Section 382”), the NOL carryforward limitations under Section 382 would impose an annual limit on the amount of the future taxable income that may be offset by our NOL generated prior to the change in ownership. In general, a change in ownership occurs when, as of any testing date, there has been a cumulative change in the stock ownership of the corporation held by 5% stockholders of more than 50 percentage points over an applicable three-year rolling period. For these purposes, a 5% stockholder is generally any person or group of persons that at any time during an applicable three-year rolling period has owned 5% or more of the outstanding common stock of Rural/Metro Corporation. Additionally, persons who own less than 5% of the outstanding common stock are grouped together as one or more “public group” 5% stockholders. Under Section 382, stock ownership would be determined under complex attribution rules and generally includes shares held directly, indirectly (though intervening entities) and constructively (by certain related parties and certain unrelated parties acting as a group).
Rural/Metro Corporation is the sole obligor of the senior discount notes, and our subsidiaries do not guarantee our obligations under the senior discount notes or have any obligation with respect to the senior discount notes; consequently, the senior discount notes are structurally subordinated to the debt and liabilities of our subsidiaries.
Our senior discount notes are structurally subordinated to all debt and liabilities (including trade payables) of our subsidiaries. Holders of our senior discount notes will participate with all other holders of our unsecured indebtedness in the assets remaining after our subsidiaries have paid all their debts and liabilities. Our subsidiaries may not have sufficient funds to make payments to us, and holders of senior discount notes may receive less, ratably, than the holders of debt of our subsidiaries and other liabilities. Accordingly, if our subsidiaries have their debt accelerated, we may not be able to repay our indebtedness under the senior discount notes. The indenture governing the senior discount notes contains a waiver by the trustee and holders of the senior discount notes of any rights to make a claim for substantive consolidation of us with any of our subsidiaries in any bankruptcy or similar proceeding. As of June 30, 2010, (i) on an unconsolidated basis, we had $93.5 million of senior indebtedness, consisting of the senior discount notes, but excluding the guarantee of borrowings under the 2009 Credit Facility, and (ii) Rural/Metro LLC had approximately $269.0 million of indebtedness, including $174.9 million of borrowings under the 2009 Credit Facility. In addition, as of June 30, 2010, an additional $15.4 million would have been available for borrowing under the revolving credit portion of the 2009 Credit Facility.
We may not pay dividends.
We have never paid any cash dividends on our common stock. We currently plan to retain any earnings for use in our business rather than to pay cash dividends. Payments of any cash dividends in the future will depend on our financial condition, results of operations and capital requirements as well as other factors deemed relevant by our Board of Directors. The indentures governing our Senior Discount Notes due 2016 and our 2009 Credit Facility contain restrictions on our ability to pay cash dividends, and any future borrowings may contain similar restrictions.
It may be difficult for a third party to acquire us and this could depress our stock price.
We are a Delaware company which has adopted a Shareholder Rights Plan pursuant to which we issued one preferred stock purchase right for each outstanding share of common stock. The rights will cause substantial dilution to a person or group that attempts to acquire us in a manner or on terms not approved by our Board of Directors. Consequently, our Shareholder Rights Plan could make it difficult for a third party to acquire us, even if doing so would benefit security holders. Certain anti-takeover provisions under Delaware law to which we are subject and certain provisions of our charter could also make it more difficult for a third party to acquire us. The anti-takeover effects of these provisions and those of our Shareholder Rights Plan could depress our stock price and may result in the entrenchment of existing management, regardless of their performance.
ITEM 1B.
ITEM 1B. Unresolved Staff Comments
None.
ITEM 2.
ITEM 2. Properties
Facilities
We lease an office building at 9221 E. Via de Ventura, Scottsdale, Arizona for our corporate headquarters. Real estate for our operations is described below:
Leased Facilities
We lease approximately 244 operational and administrative facilities used primarily for ambulance services sub-stations, fleet maintenance, billing offices, and fire services sub-stations. We believe our existing facilities are adequate to meet current needs and that suitable space is available to meet projected needs. Our leases expire at various dates through April 2023. Rent expense from continuing operations totaled $13.8 million, $13.6 million and $12.2 million for fiscal 2010, 2009 and 2008, respectively.
Owned Facilities
We own 14 properties including ambulance services sub-stations, operational and administrative facilities and land totaling $8.6 million of net book value on our balance sheet.
Equipment
We operate approximately 1,789 vehicles. Of these 1,176 are ambulances, 99 are wheelchair vans, 151 are fire apparatus and 363 are support vehicles. As of June 30, 2010, we owned 96% of the vehicles that we operate. The average age of our ambulance fleet and fire apparatus is 8.8 years and 16.4 years, respectively. We use a combination of in-house and outsourced maintenance services to maintain our fleet, depending on the size of the market and the availability of quality outside maintenance services.
ITEM 3.
ITEM 3. Legal Proceedings
Legal Proceedings
From time to time, the Company is a party to, or otherwise involved in, lawsuits, claims, proceedings, investigations and other legal matters that have arisen in the ordinary course of conducting its business. The Company cannot predict with certainty the ultimate outcome of any of these lawsuits, claims, proceedings, investigations and other legal matters which it is a party to, or otherwise involved in, due to, among other things, the inherent uncertainties of litigation, government investigations and proceedings and legal matters in general. The Company is also subject to requests and subpoenas for information in independent investigations. An unfavorable outcome in any of the lawsuits pending against the Company or in a government investigation or proceeding could result in substantial potential liabilities and have a material adverse effect on the Company’s business, financial condition, results of operations and cash flows. Further, these proceedings and investigations, and the Company’s actions in response to them, could result in substantial potential liabilities, additional defense and other costs, increase the Company’s indemnification obligations, divert management’s attention, and/or adversely affect the Company’s ability to execute its business and financial strategies.
Regulatory Compliance
The Company is subject to numerous laws and regulations of federal, state and local governments. These laws and regulations include, but are not limited to, matters such as licensure, accreditation, government healthcare program participation requirements, reimbursement for patient services and Medicare and Medicaid fraud and abuse. Within the healthcare industry, government investigations and allegations concerning possible violations of fraud and abuse statutes and regulations by healthcare providers is ongoing. From time to time, the Company is subject to investigations relating to Medicare and Medicaid laws pertaining to its industry. The Company cooperates fully with the government agencies that conduct these investigations. Violations of these laws and regulations could result in exclusion from government healthcare programs together with the imposition of significant fines and penalties, as well as significant repayments for patient services previously billed. Under the Company’s existing compliance program, the Company initiates its own investigations and conducts audits to examine compliance with various policies and regulations, including periodic reviews of the levels of service and corresponding rates the Company bills to various payers. Internal investigations or audits may result in significant repayment obligations for patient services previously billed or the modification of estimates relating to reimbursements. For example, in the quarter ended March 31, 2010, following a review of certain claims in the Company’s Mid-Atlantic segment, a reserve was established in the amount of $1.5 million for a change in estimate relating to levels of service on claims for which the Company was previously reimbursed. The Company believes that it is substantially in compliance with fraud and abuse statutes and their applicable governmental interpretation.
In fiscal 2007, we negotiated a settlement in connection with the U.S. government investigation into alleged discounts made in violation of the federal Anti-Kickback Statute related to our discontinued operations in the State of Texas. The government alleged that certain of our contracts with medical facilities in effect in Texas prior to 2002 contained discounts in violation of the federal Anti-Kickback Statute. In connection with the settlement of the matter, we entered into a Corporate Integrity Agreement (“CIA”), which is effective for a period of five years, beginning April 18, 2007. Pursuant to the CIA, we are required to maintain a compliance program that includes, among other things, the appointment of a compliance officer and committee; the training of employees nationwide; enhancing procedures relating to certain of our contracting processes, including tracking contractual arrangements; review by an independent review organization; and reporting of certain reportable events. These requirements are currently a part of our ongoing compliance program.
We are cooperating with an investigation by the U.S. government regarding our operations in the State of Ohio in connection with allegations of certain billing inaccuracies. Specifically, the government alleges that certain services performed between 1997 and 2001 did not meet Medicare medical necessity and reimbursement requirements. The government has examined sample records for each of the years stated above. We do not agree
with the allegations and believe that there are errors in the sampling methodology performed by the government. Although we continue to disagree with the government’s allegations, we are engaged in settlement negotiations with the government and have made a preliminary offer of $2.4 million in exchange for a full release relating to the government’s allegations. Although there can be no assurances that a settlement agreement will be reached, any such settlement agreement would likely require us to make a substantial payment to the government and may require us to enter into a CIA or similar arrangement. If a settlement is not reached, the government has indicated that it will pursue further civil action. At this time it is not possible to predict the ultimate conclusion of this investigation.
ITEM 4.
ITEM 4. [Reserved]
PART II
ITEM 5.
ITEM 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is traded on the Nasdaq Capital Market (“Nasdaq”) under the symbol “RURL”.
The following table sets forth the high and low sale prices of the common stock for the fiscal quarters indicated.
On August 31, 2010, the closing sale price of our common stock was $7.46 per share, and there were 2,567 holders of record of our common stock.
Dividend Policy
We currently intend to retain any future earnings to reinvest in existing operations, fund acquisitions, support our business and reduce our debt. The payment of dividends to our shareholders is limited by our Credit Facility Agreement and Senior Discount Notes. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources” for further discussion. We did not pay dividends in fiscal 2010 or fiscal 2009 and do not intend to pay cash dividends on our common stock in the foreseeable future. Any future decision to pay dividends will be at the discretion of our board of directors and will depend upon, our financial condition, results of operations, capital requirements and contractual restrictions.
Equity Compensation Plan Information
The following table represents securities authorized for issuance under all of our existing equity compensation plans at June 30, 2010:
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Rural/Metro Corporation 1992 Stock Option Plan;
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Rural/Metro Corporation 2000 Non-Qualified Stock Option Plan; and
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Rural/Metro Corporation 2008 Incentive Stock Plan.
(1) This includes options to purchase common stock awarded under the 1992 Stock Option Plan and the 2000 Non-Qualified Stock Option Plan (the “2000 Plan”), as well as restricted stock units and stock appreciation rights awarded under the 2008 Incentive Stock Plan. For a description of these plans, refer to Note 15 to our Consolidated Financial Statements for the year ended June 30, 2010.
(2) This weighted average exercise price does not include outstanding restricted stock units.
(3) The 2000 Plan did not require stockholder approval, and was not approved by the stockholders when it was originally adopted. In November 2007, the 2000 Plan was modified to provide that no future option grants will be made pursuant to the 2000 Plan unless stockholders approve an amendment to the 2000 Plan to permit future option grants.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
We did not purchase any of our equity securities, nor did we sell any shares in a transaction not registered under the Securities act of 1933, as amended, during the fourth quarter of fiscal 2010, which ended on June 30, 2010.
ITEM 6.
ITEM 6. Selected Financial Data
The following selected financial data are derived from our consolidated financial statements. The selected financial data for fiscal years ended June 30, 2009, 2008, 2007 and 2006 have been recast for operations discontinued during fiscal 2010 and for the retrospective application of new accounting guidance for noncontrolling interests which we were subject to beginning July 1, 2009. The information set forth below should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited consolidated financial statements and notes thereto appearing elsewhere in this report (in thousands, except per share amounts):
(1) Income from continuing operations and income from continuing operations attributable to Rural/Metro for the year ended June 30, 2010 includes a loss on debt extinguishment of $14.2 million and a related income tax benefit of $5.2 million.
Quarterly Results
The following table summarizes our unaudited quarterly operating results for each quarter of fiscal 2010 and 2009 (in thousands, except per share amounts). Net revenue and operating income included in the table relate to our continuing operations and exclude service areas classified as discontinued operations. Fiscal 2009 has been recast to reflect operations classified as discontinued during fiscal 2010 and for the retrospective application of new accounting guidance for noncontrolling interests which we were subject to beginning July 1, 2009.
(a) Income from continuing operations for the second quarter of fiscal 2010 included $13.8 million of loss on debt extinguishment and a related income tax benefit of $5.9 million. The remaining $0.4 million of loss on debt extinguishment for fiscal 2010 was included in the third quarter.
(b) Operating income and Income from continuing operations for the fourth quarter of fiscal 2010 included $1.2 million of goodwill impairment.
(c) Net income for the fourth quarter of fiscal 2009 included a $1.0 million decrease in the income tax provision related to recognition of certain income tax credits.
ITEM 7.
ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This discussion and analysis should be read in conjunction with our Selected Financial Data and our consolidated financial statements and notes appearing elsewhere herein.
Management’s Overview
During fiscal 2010, our focus remained on implementing the Company’s strategic and operating activities, including operational excellence in patient care delivery, revenue cycle management, new emergency revenue generation and continued expansion of the non-emergency business within existing markets. We achieved these through continued focus on billing initiatives aimed at reducing uncompensated care and increasing average patient charge (“APC”), responsiveness to customer needs and investments in technology designed to maximize billing performance. Our continued focus on these items has contributed to a 7.9% growth in net revenue and 18.3% growth in adjusted EBITDA, as defined below, in fiscal 2010 as compared to fiscal 2009.
We continue to focus on expanding our profit margin by increasing our gains in non-emergency market share and increasing transports through hospital-outsourced opportunities and partnerships with public systems. We believe this strategy will allow for our continued growth in this challenging economy. Cash flow remains strong at $37.5 million of cash flow from operations for fiscal 2010, which continued to support our goals to reduce debt and enhance the long-term value of our Company for investors.
2009 Debt Refinancing
In fiscal 2010, we effected a refinancing of our 2005 Credit Facility by terminating and extinguishing our Term Loan B, Revolving Credit Facility and our Senior Subordinated Notes. These instruments were replaced by the 2009 Credit Facility and a cash collateralized letter of credit facility. The refinancing resulted in a loss on the debt extinguishment of $14.2 million. The new facility provides for extended maturities as well as increased flexibility with respect to the principal reduction on our other debt instruments. We expect that cash paid for interest will decrease approximately $2.0 million annually under the new credit facility.
Looking Ahead
The increased flexibility in our capital structure afforded by the 2009 debt refinancing allows us to pursue acquisitions of ambulance transport and other service line business and consolidate business in the fragmented ambulance transport market. We intend to pursue acquisitions that are accretive to our profitability and leverage our strengths. We are well positioned to grow our business both organically and strategically.
It is important to note that the ambulance industry has recently experienced some changes in the Medicare reimbursement environment. These changes include the lack of an annual CPI adjustment for calendar year 2010 and the final phase-in of the national Medicare fee schedule on December 31, 2009. In addition, CMS issued a proposed rule that would update the Medicare fee schedule to be subject to a multifactor productivity reduction that could result in a negative ambulance inflation factor effective January 2011. We believe that these changes in the reimbursement environment may adversely affect the growth rate on our net medical transport APC.
Executive Summary
We provide services, which consist primarily of emergency and non-emergency ambulance services, to approximately 440 communities in 20 states within the United States. We provide these services under contracts with governmental entities, hospitals, nursing homes, and other healthcare facilities and organizations. As of June 30, 2010, we had approximately 103 exclusive contracts to provide emergency medical ambulance services and approximately 760 contracts to provide non-emergency medical ambulance and wheelchair services. For fiscal 2010 and 2009, respectively, 43.4% and 44.3% of our transports were generated from emergency ambulance services. Non-emergency ambulance services, including critical care transfers and other interfacility
transports, comprised 56.6% and 55.7% of our transports for the same periods. All ambulance related services generated 86.3% and 85.0% of net revenue for fiscal 2010 and 2009, respectively. The remainder of our net revenue was generated from private fire protection services, airport fire and rescue, home healthcare services, and other services.
Key Factors and Metrics We Use to Evaluate Our Operations
The key factors we use to evaluate our operations focus on the number of ambulance transports we provide, the amount we expect to collect per transport and the costs we incur to provide these services.
The following is a summary of certain key operating statistics (adjusted EBITDA from continuing operations in thousands):
(1) Net Medical Transport APC is defined as gross medical ambulance transport revenue less provisions for contractual allowances applicable to Medicare, Medicaid and other third-party payers and uncompensated care divided by medical transports from continuing operations. For fiscal year 2008, the calculation excludes $1.7 million of the effect of the alleged overpayment claims in Tennessee. See Note 18 the Consolidated Financial Statements filed with this Annual Report on Form 10-K.
(2) Days Sales Outstanding is calculated using the average accounts receivable balance on a rolling 13-month basis and net revenue on a rolling 12-month basis and has not been adjusted to eliminate discontinued operations.
(3) See the discussion below of Adjusted Earnings Before Interest, Taxes, Depreciation and Amortization including goodwill impairment.
(4) Defined as emergency and non-emergency medical patient transports from continuing operations.
Adjusted Earnings Before Interest, Taxes, Depreciation and Amortization (“Adjusted EBITDA”)
EBITDA from continuing operations attributable to Rural/Metro (“EBITDA”) is defined by us as income (loss) from continuing operations before Interest Expense (Income), Taxes and Depreciation and Amortization, less Income Attributable to Noncontrolling Interest. Adjusted EBITDA from continuing operations attributable to Rural/Metro (“Adjusted EBITDA”) excludes share-based compensation expense, goodwill impairment and loss on debt extinguishment. Adjusted EBITDA is commonly used by management and investors as a measure of leverage capacity, debt service ability and liquidity. Adjusted EBITDA is not considered a measure of financial performance under GAAP, and the items excluded from Adjusted EBITDA are significant components in understanding and assessing our financial performance. Adjusted EBITDA should not be considered in isolation or as an alternative to such GAAP measures as net income, cash flows provided by or used in operating, investing or financing activities or other financial statement data presented in our financial statements as an indicator of financial performance or liquidity. Since Adjusted EBITDA is not a measure determined in accordance with GAAP and is susceptible to varying calculations, Adjusted EBITDA, as presented, may not be comparable to other similarly titled measures of other companies.
The following table sets forth our EBITDA and adjusted EBITDA, as well as a reconciliation to (loss) income from continuing and discontinued operations, the most directly comparable financial measures under GAAP (in thousands):
Factors Affecting Operating Results
Net Change in Contracts
Our operating results are affected directly by the number of net new contracts we have in a period, reflecting the effects of both new contracts and contract expirations. We regularly bid for new contracts, frequently in a formal competitive bidding process that often requires written responses to a Request for Proposal, or RFP, and in any fiscal period, certain of our contracts will expire. We may elect not to seek extension or renewal of a contract if we determine that we cannot do so on favorable terms. With respect to expiring contracts we would like to renew, we may be required to seek renewal through an RFP, and we may not be successful in retaining any such contracts, or retaining them on terms that are as favorable as present terms.
Ability to Effect Rate Increases
To offset higher costs of uncompensated care and other direct operating costs, such as labor, we submit requests to increase commercial insurance rates to the state or local government agencies that regulate ambulance service rates. Our ability to negotiate rate increases on a timely basis to offset increases in our cost structure may impact our operating performance.
Uncompensated Care
When we contract with municipal, county or other governing authorities as an exclusive provider of emergency ambulance services, we are required to provide services to their citizens regardless of the ability or willingness of patients to pay. While we make every attempt to negotiate subsidies to support the level of medical services we provide, not all authorities will agree to provide such subsidies. As a result, we incur write-offs for uncompensated care in the normal course of providing ambulance services. The following table shows the source of our uncompensated care write-offs as a percentage of total uncompensated care write-offs:
The majority, 63%, of our uncompensated care write-offs in fiscal 2010 were generated from self-pay accounts. The balance of our uncompensated care write-offs in fiscal 2010 were from: (1) commercial insurance (20%); (2) co-pays and deductibles (9%); and (3) Medicare or Medicaid denials (8%). These components are described in detail below:
Commercial Insurance: We have seen an increase in commercial insurance carriers following Medicare proof of medical necessity standards for non-emergency transport reimbursement. In the event commercially insured patients are transported and their insurance companies subsequently inform us the transports were not covered services, the unpaid balances become self-pay accounts.
Co-pays/Deductibles: Co-pay and deductible amounts under Medicare and commercial insurance programs are the responsibility of the patient. Medicare co-pay and deductible levels have remained consistent when compared to the prior year; however, changes in employer-provided healthcare insurance coverage levels may result in higher co-pays and deductibles to the employee under commercial insurance programs. These co-pay and deductible amounts become self-pay accounts.
Medicare/Medicaid Denials: We make every effort to determine medical necessity prior to transporting a patient; however, there are times when Medicare, Medicaid or a commercial insurance provider may, on a retrospective review, deem the transport not medically necessary and deny reimbursement. In these cases, the unpaid balances become self-pay accounts.
While we make every attempt to negotiate subsidies to support the level of medical services we provide, not all authorities will agree to provide such subsidies.
In terms of transport volume, the self-pay patients we transport who are uninsured or otherwise have no ability to pay for our services have decreased as a percentage of our transport mix in fiscal 2010 to 8.8% as compared to 9.6% in fiscal 2009. Although we are not seeing an impact at this time and believe we have measures in place to promptly identify negative payer mix trends, we do recognize that a weakened economy combined with significant loss of jobs and related employee benefits may shift our current transport mix to a higher volume of uninsured and underinsured claims. If this occurs, we may see higher uncompensated care write-offs as a result of a reduction in collections based on historical collections trends for this payer mix; which would in turn impact our cash flows from operations and overall liquidity.
Other factors that may, positively or negatively, impact the overall dollars associated with uncompensated care include: (1) rate increases and (2) changes in transport volumes among the payer groups.
On a periodic basis, we evaluate our cost structure within each area we serve and, as appropriate, request rate increases. Ambulance rate increases generate additional revenue only from certain commercial insurance programs and self-pay patients, due to the fixed rates, co-pay amounts and deductibles of payers such as Medicare, Medicaid and certain commercial insurance. Rate increases applied to patients who are self-pay patients can compound an already challenging collection process. Increasing the dollars per transport on this payer group may, in turn, result in an increase in the uncompensated care.
From quarter to quarter, the number of patients we transport within each payer group can vary. A shift in payer mix may increase or decrease levels of uncompensated care. For instance, if we experience a shift from the Medicare payer group to the commercial insurance payer group, we might expect to see a decrease in our uncompensated care write-offs due to a higher historical collection pattern associated with the commercial insurance payers.
Work Force Management
Our business strategy focuses on optimizing the deployment of our work force in order to meet contracted response times and otherwise maintain high levels of quality care and customer service. A key measure is our ability to efficiently and effectively manage labor resources and enhance operating results. Several factors may influence our labor management efforts, including our ability to maximize our mix of emergency and non-emergency response business, significant wait times associated with emergency rooms that delay redeployment, and market-specific shortages of qualified paramedics and emergency medical technicians that affect temporary wages. We also may experience increases in overtime and training wages due to growth in transport volume related to new contracts, expansion in existing markets and seasonal transport demand patterns.
Results of Operations
Fiscal 2010 Compared To Fiscal 2009-Consolidated
Overview
The following table sets forth a comparison of certain items from our consolidated statements of operations for fiscal 2010 and 2009. The comparison includes the line items expressed as a percentage of net revenue as well as the dollar value and percentage change in each line item (in thousands, except per share amounts):
# - Variances over 100% not displayed.
Net Revenue
The following table shows a comparison of consolidated net revenue (in thousands):
Ambulance Services
The increase in ambulance services revenue is due to $37.4 million in same service area revenue and $2.6 million from new emergency and non-emergency contracts in our Tennessee, Kentucky and Oregon markets. The increase in same service area revenue included $25.1 million in net medical transport APC and $13.5 million in medical transport volume. The increase related to net medical transport APC is inclusive of a $1.5 million decrease for a reserve established for a change in estimate related to an internal review of levels of service on claims that were previously reimbursed and a $0.9 million increase related to a supplemental payment received from the New York Medicaid program.
Below are two tables providing fiscal year comparative transport data. The first table summarizes medical transport volume into same service area and new contracts, while the second table summarizes total transport volume into emergency and non-emergency.
# - Variances over 100% not displayed.
The change in our same service area medical transports includes a decrease of approximately 5,100 transports related to the discontinuation of service on an emergency contract in Orange County, Florida. Absent the discontinuation of this contract, transport volume increased 4.6%. New contract transport growth was related to our new emergency and non-emergency contracts in our Tennessee, Kentucky and Oregon markets. Our growth in Kentucky was due to 3,100 transports in fiscal 2010 related to our purchase of the assets of a medical transportation services provider and we anticipate providing 12,000 transports annually related to that business. Additionally, in July 2010 we were awarded a contract to provide emergency transport services in DeKalb County, Georgia, where we expect to provide 26,800 transports annually.
Contractual Allowances and Uncompensated Care
Contractual allowances applicable to Medicare, Medicaid and other third-party payers related to continuing operations, which are reflected as a reduction of gross ambulance services revenue, totaled $370.9 million and
$321.8 million for fiscal 2010 and 2009, respectively. The increase of $49.1 million was the result of rate increases, changes in payer mix in certain markets, changes in service level mix and increased transport volume. Uncompensated care as a percentage of gross ambulance services revenue declined to 13.0% for fiscal 2010 from 13.6% in fiscal 2009. The decline in uncompensated care reflects our continued focus on billing and collections efforts. (See Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, Executive Summary, Uncompensated Care)
Both contractual allowances and uncompensated care are reflected as a reduction of gross ambulance services revenue. A reconciliation of gross ambulance services revenue to net ambulance services revenue is included in the table below (in thousands):
Net Medical Transport APC
Our net medical transport APC increased $23 to $393 compared to $370 for fiscal 2009. The 6.2% increase was primarily due to improved collections and rate increases.
Other Services
The $1.0 million decrease in other services revenue was primarily due to the discontinuation of shuttle services previously performed for a customer.
Operating Expenses
Payroll and Employee Benefits
The increase in payroll and employee benefits expense was primarily due to a $7.0 million increase in health insurance expense, $3.3 million increase in workers compensation expense including $0.5 million related to actuarial claims adjustments ($2.2 million of unfavorable actuarial claims adjustments in the current year compared to unfavorable actuarial claims adjustments of $1.7 million in the prior year), $0.9 million of severance expense, $0.9 million of increased pension expense, with the balance due to increased direct labor costs associated with higher transport volumes. We have experienced a rise in employee health insurance expense with an increase in the frequency of claims in excess of $50,000. These claims expenses are driven by higher costs from specialized care including cancer treatment and neonatal care.
Depreciation and Amortization
The increase in depreciation and amortization was primarily due to additional capital expenditures during the year.
Other Operating Expenses
The $6.3 million increase in other operating expenses was primarily due to increases of $2.1 million in vehicle and equipment expense, $2.1 million in professional fees and $1.7 million in non-capital equipment purchases. The professional fee increase was primarily related to legal and other professional service fees related to our review of various governance and operational items.
General/Auto Liability
The increase in general/auto liability insurance was primarily due to $2.7 million of increases related to current year claims estimates offset by a change in actuarial adjustments of $0.4 million year to year (fiscal 2010 positive adjustment of $1.3 million compared to a fiscal 2009 positive adjustment of $1.7 million).
Goodwill Impairment
During our annual goodwill impairment testing, we determined that the carrying value of the net assets of a reporting unit in the South reporting segment exceeded the estimated fair value. As a result, a goodwill impairment charge of $1.2 million was recorded. The decline in fair value of the reporting unit is primarily related to a trend in declining profitability and a future planned change in utilization of existing resources in this reporting unit. We will continue to monitor the performance of this reporting unit to determine if any interim review of remaining goodwill is warranted. The remaining goodwill related to this reporting unit after the impairment charge is $1.0 million.
Gain on Sale of Assets
During fiscal 2010 and 2009, we entered into transactions to sell certain of our previously written-off self-pay accounts receivable to an unrelated third party.
Interest Expense
The decrease in interest expense was related to the December 2009 restructuring of our debt.
Loss on Debt Extinguishment
A $14.2 million loss on debt extinguishment was recorded in connection with the December 2009 refinancing of the 2005 Credit Facility and Senior Subordinated Notes. The loss consisted of the write-off of unamortized debt issuance costs and a portion of the third-party and lender fees incurred to effect the refinancing. The refinancing is discussed in Note 11 in the Notes to the Consolidated Financial Statements filed with this Annual Report on Form 10-K.
Net Income Attributable to Noncontrolling Interest
Noncontrolling interest relates to the City of San Diego’s portion (50%) of the San Diego Medical Services Enterprise, LLC fiscal year-to-date net income.
Income Tax Provision
During fiscal 2010, we recorded a $4.4 million income tax provision related to continuing operations, resulting in an effective rate of 41.2% of pre-tax income. During fiscal 2009, we recorded a $7.4 million income tax provision related to continuing operations, resulting in an effective rate of 49.6% of pre-tax income. The effective rate differed from the federal statutory rate of 35.0% primarily as a result of increases for the portion of non-cash interest expense related to our Senior Discount Notes, which is not deductible for income tax purposes until interest is paid in cash, non-deductible executive compensation, state income taxes, and a goodwill impairment recorded in fiscal 2010. Additionally, our effective tax rate included a reduction related to pretax income that was attributable to the noncontrolling interest in our joint venture with the City of San Diego. See Note 12 to our Consolidated Financial Statements filed with this Annual Report on Form 10-K for a full reconciliation of differences from the statutory federal tax rate.
In fiscal 2010, the tax provision included a $0.6 million benefit related to prior year executive compensation that was deductible in fiscal 2010 as a result of the resignation of our chief executive officer and a $0.1 million benefit for wage tax credits. The income tax provision for fiscal 2009 reflects a $1.0 million benefit for wage tax credits related to our participation in Federal and state wage tax incentive programs in the state of New York
from 2002 through 2008. The income tax provision for fiscal 2009 also reflects a $0.4 million benefit resulting from the release of valuation allowances for two states where the Company determined that realization of these deferred tax assets is more likely than not.
The continuing operations tax provision for fiscal 2010 and fiscal 2009 included deferred income tax expense of $2.9 million and $8.1 million, respectively. The deferred income tax expense results primarily from utilization of tax benefits, primarily related to net operating loss carryforwards generated in prior years, and did not require a current cash payment.
As of June 30, 2010, we maintained a valuation allowance of $8.1 million against deferred tax assets related to state net operating loss carryforwards that we do not believe will be realized.
Discontinued Operations
During fiscal 2010, the Company exited fire protection contracts in Florida and Wisconsin and ambulance services contracts in Utah and Georgia. The financial results of these service areas are included within income (loss) from discontinued operations.
Loss from discontinued operations for fiscal 2010 was $0.5 million and included an income tax benefit of $0.3 million.
Loss from discontinued operations for fiscal 2009 was $0.9 million and included an income tax benefit of $0.5 million. The loss from discontinued operations before the income tax benefit was due primarily to $0.4 million recorded as a result of increasing our Medicare reserve contingency related to the Ohio compliance matter, a portion of which related to our former Marion, Ohio operation.
Fiscal 2010 Compared To Fiscal 2009-Segments
Overview
As of June 30, 2010, we had four regional reporting segments that correspond with the manner in which our operations are managed and evaluated by our Chief Executive Officer. Although some of our operations do not align with the segments’ geographic designation, all operations have been structured to capitalize on management’s strengths. These segments comprise operations within the following areas:
Segment
States
Mid-Atlantic
New York, Northern Ohio
South
Alabama, Florida (fire), Georgia, Indiana, Kentucky, Louisiana, Mississippi, Missouri,
New Jersey, North Dakota, Oregon (fire), Southern Ohio, Tennessee
Southwest
Arizona
West
California, Central Florida (ambulance), Colorado, Nebraska, Oregon (ambulance),
South Dakota, Washington
Each reporting segment provides ambulance services, while our other services are provided predominantly in the South and Southwest segments. Effective July 1, 2010, we realigned our reporting segments geographically.
The accounting policies used in the preparation of our consolidated financial statements have been followed in the preparation of the accompanying financial information for each reporting segment. For management purposes, our measure of segment profitability is defined as income from continuing operations before depreciation and amortization, including goodwill impairment, interest expense (income), income taxes and noncontrolling interests. Additionally, corporate overhead allocations have been included within segment profits. Segment results presented below reflect continuing operations only. For a reconciliation of segment profit, refer to Note 19 of the Consolidated Financial Statements filed with this Annual Report on Form 10-K.
Mid-Atlantic
The following table presents financial results and key operating statistics for the Mid-Atlantic operations (in thousands, except medical transports, Net Medical Transport APC and DSO):
Revenue
The increase in ambulance services revenue was primarily due to $5.9 million of increases in net medical transport APC and $0.9 million in increased medical transport volume. The net medical transport volume is inclusive of a $1.5 million decrease ($7 reduction in APC) for a reserve established for a change in estimate related to an internal review of levels of service on claims that were previously reimbursed and a $0.9 million increase ($4 increase in APC) related to a supplemental payment received from the New York Medicaid program. Medical transports increased due to increased emergency and non-emergency transport volume in our Ohio and New York markets. The net medical transport APC increase was primarily due to improvement in collections.
Payroll and employee benefits
Payroll and employee benefits was $48.2 million, or 51.9% of net revenue for fiscal 2010, compared to $45.5 million, or 52.7% of net revenue, for fiscal 2009. The increase is primarily due to $0.7 million of increased health insurance expense and $0.6 million of severance expense. The remainder of the change in payroll and employee benefits expense is primarily related to increases in transports and unit hours as well as annual merit increases.
Operating Expenses
Operating expenses, including general/auto liability expenses was $17.7 million for fiscal 2010, or 19.1% of net revenue, compared to $15.9 million, or 18.4% of net revenue for fiscal 2009. The increase was due to $0.8 million of increased general/auto liability insurance expense, $0.5 million of non-capital equipment purchases and less significant changes in operational expenses primarily to support new technology, increased transports and unit hour volume.
South
The following table presents financial results and key operating statistics for the South operations (in thousands, except medical transports, Net Medical Transport APC and DSO):
Revenue
The increase in ambulance services revenue was primarily due to a $9.7 million increase in same service area revenue and a $1.9 million increase related to new emergency and non-emergency contracts in Kentucky and Tennessee. The new contracts in Kentucky included 3,100 transports related to our purchase of the assets of a medical transportation services provider and we anticipate providing 12,000 transports annually related to that business. Additionally, in July 2010 we were awarded a contract to provide emergency transport services in DeKalb County, Georgia, where we expect to provide 26,800 transports annually.
The increase in same service area revenue was primarily due to a $8.5 million increase in medical transport volume and a $1.7 million increase in net medical transport APC. The increase in medical transports was due to growth in non-emergency transport volume in our Georgia, Kentucky, Alabama and Southern Ohio markets related to concentrated marketing efforts to expand our non-emergency business. The increase in net medical transport APC is primarily due to changes in service level mix and rate increases.
Other services revenue growth is primarily due to increases in master fire contract revenue related to additional services performed for an industrial fire protection customer.
Payroll and employee benefits
Payroll and employee benefits was $93.4 million, or 64.9% of net revenue, for fiscal 2010, compared to $82.9 million, or 63.4% of net revenue, for the same period in the prior year. The increase was due to $2.3 million of increased health insurance expense, $1.1 million of increased workers compensation insurance expense as well as expenses related to increased transports, unit hours and annual merit increases.
Operating Expenses
Operating expenses, including general/auto liability expenses, for fiscal 2010 was $29.6 million, or 20.6% of net revenue compared to $27.6 million, or 21.1% of net revenue, for the same period in the prior year. The increase was primarily due to $1.0 million in increased general/auto liability insurance expense and less significant changes in operational expenses primarily to support new technology, increased transports and unit hour volume.
Southwest
The following table presents financial results and key operating statistics for the Southwest operations (in thousands, except medical transports, Net Medical Transport APC and DSO):
Revenue
The increase in ambulance services revenue was primarily due to a $15.3 million increase in net medical APC and $0.5 million increase in medical transport volume. The increase in net medical transport APC was primarily due to collection rate increases as well as rate increases.
The decrease in other services revenue was related to decreased fire subscription revenue due to a decreasing subscriber base primarily in our southern Arizona market.
We were notified that we had not been selected as the continuing ambulance provider for the City of Peoria, Arizona effective with the expiration of our current contract on August 18, 2010. This contract accounts for approximately 8,500 emergency transports and $4.6 million of net revenue annually. The Southwest segment will be affected by the reduction of revenue related to this contract beginning with the first quarter of fiscal 2011.
Payroll and employee benefits
Payroll and employee benefits was $100.7 million, or 54.1% of net revenue for fiscal 2010, compared to $96.8 million, or 56.3% of net revenue, for fiscal 2009. The increase was primarily due to $1.4 million of increased health insurance expense, $0.9 million of increased pension expense, $0.6 million of increased workers compensation expense as well as increased expenses related to increased transports, unit hours and annual merit increases.
Operating Expenses
Operating expenses, including general/auto liability expenses increased to $43.5 million for fiscal 2010, or 23.4% of net revenue, compared to $39.8 million, or 23.2% of net revenue, for fiscal 2009. The increase was due to $1.8 million of increased vehicle and equipment and station expenses, $1.0 million in increase in general/auto liability insurance expense and $0.6 million of non-capital equipment.
West
The following table presents financial results and key operating statistics for the West operations (in thousands, except medical transports, Net Medical Transport APC and DSO):
Revenue
The increase in ambulance services revenue was primarily due to a $5.5 million increase in same service area revenue and a $0.6 million increase related to new emergency and non-emergency contracts in Oregon. The increase in same service area revenue included a $4.4 million increase in net medical transport APC and a $1.4 million increase in medical transport volume. Medical transports increased primarily due to non-emergency transports in San Diego. The change in our same service area medical transports also includes a decrease of approximately 5,100 transports related to the discontinuation of service on an emergency contract in Orange County, Florida. The increase in net medical transport APC is primarily due to rate increases and changes in service level mix.
The decrease in other services revenue is primarily related to the discontinuation of shuttle services previously performed for a customer.
Payroll and employee benefits
Payroll and employee benefits was $61.9 million, or 57.4% of net revenue for fiscal 2010, compared to $59.6 million, or 58.1% of net revenue, for fiscal 2009. The increase was primarily due to $1.0 million of increased health insurance expense and $0.6 million in increased workers compensation expense as well as increased expenses related to increased transports, unit hours and annual merit increases.
Operating Expenses
Operating expenses, including general/auto liability expenses was $32.0 million for fiscal 2010, or 29.7% of net revenue, compared to $33.1 million, or 32.2% of net revenue, for fiscal 2009. The decrease was due to a $0.6 million decrease in general/auto liability insurance expense as well as other less significant decreases in operating expenses.
Results of Operations
Fiscal 2009 Compared To Fiscal 2008-Consolidated
Overview
The following table sets forth a comparison of certain items from our consolidated statements of operations for fiscal 2009 and 2008. The comparison includes the line items expressed as a percentage of net revenue as well as the dollar value and percentage change in each line item (in thousands, except per share amounts):
# - Variances over 100% not displayed.
Net Revenue
The following table shows a comparison of consolidated net revenue (in thousands):
Ambulance Services
The increase in ambulance services revenue was primarily related to a $9.7 million increase in same service area revenue, $3.9 million from new emergency and non-emergency contracts in our Tennessee, Washington, Colorado and Oregon markets; and $1.7 million related to a reserve for contractual allowances pursuant to an alleged overpayment of Medicare claims in Tennessee for the period 2004 and 2005 that was recorded in the previous fiscal year. The increase in same service area revenue included $14.5 million in net medical transport APC and $0.5 million in master contract and standby revenue offset by $4.8 million of decreases in transport volume and a $1.7 million decrease in subsidy revenue. The decrease in subsidy revenue was primarily the result of two counties in our Georgia market requiring cities to contract separately for services combined with the discontinuation of an industrial EMS contract in our Southern Arizona market.
Below are two tables providing fiscal year comparative transport data. The first table summarizes medical transport volume into same service area and new contracts, while the second table summarizes total transport volume into emergency, non-emergency and wheelchair.
# - Variances over 100% not displayed.
The decrease in same service area medical transports was primarily related to the discontinuation of service on two emergency contracts in Tempe, Arizona and Orange County, Florida. Combined, these contracts total approximately 27,400 transports annually. Absent the discontinuation of these contracts, transport volume increased 2.4%. New contract transport growth was related to our new emergency and non-emergency contracts in our Washington, Colorado, Tennessee and Oregon markets.
Contractual Allowances and Uncompensated Care
Contractual allowances applicable to Medicare, Medicaid and other third-party payers related to continuing operations, which are reflected as a reduction of gross ambulance services revenue, totaled $321.8 million and $295.9 million for fiscal 2009 and 2008, respectively. The increase of $25.9 million was the result of rate
increases, changes in payer mix in certain markets, changes in service level mix, increased transport volume and the effect of a $1.7 million reserve to contractual allowances pursuant to an alleged overpayment of Medicare claims in Tennessee for the period 2004 through 2005 that was recorded in the previous fiscal year. Uncompensated care as a percentage of gross ambulance services revenue declined to 13.6% for fiscal 2009 from 14.2% in fiscal 2008. The decline in uncompensated care reflects our continued focus on billing and collections efforts.
Both contractual allowances and uncompensated care are reflected as a reduction of gross ambulance services revenue. A reconciliation of gross ambulance services revenue to net ambulance services revenue is included in the table below (in thousands):
Net Medical Transport APC
Our net medical transport APC for fiscal 2009 was $370 compared to $354 for fiscal 2008. The 4.5% increase was primarily due to improved collections and rate increases.
Other Services
The $1.7 million increase in other services revenue was primarily due to a $2.1 million increase in master fire contract fees primarily related to the conversion of a subscription fire area to a master contract and rate increases on our specialty fire contracts offset by decreases in fire response and forestry fee revenue.
Operating Expenses
Payroll and Employee Benefits
The increase in payroll and employee benefits was due to $6.5 million of net changes in workers compensation actuarial adjustments from year to year (fiscal 2009 negative adjustment of $1.7 million compared to a positive adjustment of $4.8 million in fiscal 2008), and a $1.5 million increase in health insurance expense, offset by a $1.8 million decrease in current-year workers compensation claims expense, with the rest of the increase due to cost of living increases and higher unit hour volume.
Depreciation and Amortization
The increase in depreciation and amortization was primarily due to additional capital expenditures during the year.
Other Operating Expenses
The decrease in other operating expenses was primarily due to a $2.9 million increase in station expense offset by a $2.2 million decrease in fuel expense and a $2.1 million decrease in professional fees.
General/Auto Liability
The decrease in general/auto liability expense was primarily due to $3.1 million of decreases related to current year claims estimates and a net positive change in actuarial adjustments of $0.4 million from year to year (fiscal 2009 positive adjustment of $1.7 million compared to a fiscal 2008 positive adjustment of $1.3 million).
Gain on Sale of Assets
During fiscal 2009, we entered into additional transactions to sell certain of our previously written-off self-pay accounts receivable to an unrelated third party. The resulting gains totaled $0.6 million.
During fiscal 2008, we sold certain of our previously written-off self-pay accounts receivable to an unrelated third party. The resulting gains totaled $2.1 million, $1.7 million of which were recorded in continuing operations and $0.4 million of which were recorded in discontinued operations.
Interest Expense
The decrease in interest expense was related to decreased interest on the Term Loan B due to lower balances, offset by increases related to the continued non-cash accretion of our Senior Discount Notes.
Net Income Attributable to Noncontrolling Interest
Net income attributable to noncontrolling interest relates to the City of San Diego’s portion (50%) of the San Diego Medical Services Enterprise, LLC fiscal year-to-date net income.
Income Tax Provision
During fiscal 2009, we recorded a $7.4 million income tax provision related to continuing operations, resulting in an effective rate of 49.6% of pre-tax income. During fiscal 2008, we recorded a $4.7 million income tax provision related to continuing operations, resulting in an effective rate of 50.7% of pre-tax income. The effective rate differed from the federal statutory rate of 35.0% primarily as a result of increases for the portion of non-cash interest expense related to our Senior Discount Notes, which is not deductible for income tax purposes, non-deductible executive compensation, and state income taxes. Additionally, our effective tax rate included a reduction related to pretax income that was attributable to the minority interest in our joint venture with the City of San Diego. See Note 12 to our Consolidated Financial Statements filed with this Annual Report on Form 10-K for a full reconciliation of differences from the statutory federal tax rate.
The income tax provision for fiscal 2009 reflects a $1.0 million benefit for wage tax credits related to our participation in Federal and state wage tax incentive programs in the state of New York from 2002 through 2008. The income tax provision for fiscal 2009 also reflects a $0.4 million benefit resulting from the release of valuation allowances for two states where the Company determined that realization of these deferred tax assets is more likely than not.
The continuing operations tax provision for fiscal 2009 and fiscal 2008 included deferred income tax expense of $8.1 million and $3.3 million, respectively. The deferred income tax expense results primarily from utilization of tax benefits, primarily related to net operating loss carryforwards generated in prior years, and did not require a current cash payment.
As of June 30, 2009, we maintained a valuation allowance of $7.5 million against deferred tax assets related to state net operating loss carryforwards that we do not believe will be realized.
Discontinued Operations
During fiscal 2010, we exited fire protection contracts in Florida and Wisconsin and ambulance services contracts in Utah and Georgia. The financial results of these service areas are included within income (loss) from discontinued operations. The financial results for fiscal 2009 and 2008 were recast to reflect the operations classified as discontinued in fiscal 2010.
During fiscal 2009, we exited ambulance transportation markets in Columbus and Marion, Ohio, and Roswell, New Mexico. The financial results of these service areas are included within income (loss) from discontinued operations.
Loss from discontinued operations for fiscal 2009 was $0.9 million and included an income tax benefit of $0.5 million. The loss from discontinued operations before the income tax benefit was due primarily to $0.4 million recorded as a result of increasing our Medicare reserve contingency related to the Ohio compliance matter, a portion of which related to our former Marion, Ohio operation.
Income from discontinued operations for fiscal 2008 was $0.3 million and included an income tax provision of $0.2 million. Income from this period included a $0.6 million gain of nonrefundable fire subscription prepayments upon the termination of our contract in Queen Creek, Arizona effective January 1, 2008, and a gain of $0.4 million on the sale of self pay receivables. Those gains were partially offset by an additional pre-tax reserve of $0.7 million for a change in estimate related to a Medicaid intermediary’s review of service levels provided to certain patients in our Baltimore, Maryland and Washington DC operations, which were discontinued in fiscal 2004.
Fiscal 2009 Compared To Fiscal 2008-Segments
Overview
As of June 30, 2010, we had four regional reporting segments that correspond with the manner in which our operations are managed and evaluated by our Chief Executive Officer. Although some of our operations do not align with the segments’ geographic designation, all operations have been structured to capitalize on management’s strengths. These segments comprise operations within the following areas:
Segment
States
Mid-Atlantic
New York, Northern Ohio
South
Alabama, Florida (fire), Georgia, Indiana, Kentucky, Louisiana, Mississippi, Missouri,
New Jersey, North Dakota, Oregon (fire), Southern Ohio, Tennessee
Southwest
Arizona
West
California, Central Florida (ambulance), Colorado, Nebraska, Oregon (ambulance),
South Dakota, Washington
Each reporting segment provides ambulance services, while our other services are provided predominantly in the South and Southwest segments.
Effective July 1, 2010, we realigned our reporting segments geographically and now refer to them as operating zones.
The accounting policies used in the preparation of our consolidated financial statements have been followed in the preparation of the accompanying financial information for each reporting segment. For management purposes, our measure of segment profitability is defined as income from continuing operations before depreciation and amortization, including goodwill impairment, interest expense (income), income taxes and noncontrolling interests. Additionally, corporate overhead allocations have been included within segment profits. Segment results presented below reflect continuing operations only.
Mid-Atlantic
The following table presents financial results and key operating statistics for the Mid-Atlantic operations (in thousands, except medical transports, Net Medical Transport APC and DSO):
Revenue
The increase in ambulance services revenue was due to $4.4 million of increases in net medical transport APC, offset by $1.5 million of decreases related to medical transport volume. The decrease in medical transports primarily reflected competitive pressure in our non-emergency markets. The net medical transport APC increased due to rate increases and collection rate increases.
Payroll and employee benefits
Payroll and employee benefits was $45.5 million, or 52.7% of net revenue for fiscal 2009, compared to $43.4 million, or 52.0% of net revenue, for fiscal 2008. The $2.1 million increase was primarily due to a $1.0 million increase in worker’s compensation expense, and $0.5 million increase in health insurance expense, with the remainder of the increase related to changes in cost-of-living adjustments, unit hours and training.
Operating Expenses
Operating expenses, including general/auto liability expenses was $15.9 million for fiscal 2009, or 18.4% of net revenue, compared to $17.0 million, or 20.4% of net revenue for fiscal 2008. The decrease of $1.1 million was primarily due to a $0.9 million decrease in general/auto liability expense, a $0.7 million decrease in vehicle and equipment expenses offset by $0.4 million related to a Medicare reserve contingency for the Ohio compliance matter.
In addition, corporate overhead allocations decreased, primarily due to decreased professional fees.
South
The following table presents financial results and key operating statistics for the South operations (in thousands, except medical transports, Net Medical Transport APC and DSO):
Revenue
The increase in ambulance services revenue was due to a $10.0 million increase in same service area revenue, a $2.0 million increase related to new contract revenue in Tennessee and a $1.7 million increase related to a reserve for contractual allowances pursuant to an alleged overpayment of Medicare claims in Tennessee for the period 2004 and 2005 that was recorded in fiscal 2008. The same service area revenue increase included $8.0 million in medical transport volume and $2.1 million in net medical APC offset by a $1.0 million decrease in subsidy revenue. The decrease in subsidy revenue was a result of two counties in our Georgia market requiring cities to contract separately for service. The increase in net medical transport APC was due to rate increases and changes in service level mix. The increase in medical transports was due to growth in non-emergency transport volume in our Tennessee (including those generated from the new contract mentioned above), Alabama, Georgia and Kentucky markets as a result of concentrated marketing efforts to expand our non-emergency business. The increase in wheelchair transports resulted from providing a full complement of services in our Tennessee and Alabama markets.
Other services revenue increased $1.5 million due to increases in fire services revenue. The increase included $0.9 million related to fire subscription revenue and $0.6 million related to rate increases on our specialty fire contracts.
Payroll and employee benefits
Payroll and employee benefits was $82.9 million, or 63.4% of net revenue, for fiscal 2009, compared to $72.3 million, or 62.1% of net revenue, for the same period in the prior year. The $10.6 million increase was due to a $1.6 million increase in health insurance expense and a $1.4 million increase in workers compensation expense, with the remainder of the increase related to changes in cost-of-living adjustments, unit hours and training.
Operating Expenses
Operating expenses, including general/auto liability expenses, for fiscal 2009 was $27.6 million, or 21.1% of net revenue compared to $24.4 million, or 20.9% of net revenue, for the same period in the prior year. The $3.2 million increase was primarily due to $1.6 million of increases in vehicle and equipment expense primarily related to increased transport volume, $1.3 million increase in station expense and $0.4 million related to a Medicare reserve contingency for the Ohio compliance matter.
In addition, corporate overhead allocations decreased, primarily due to decreased professional fees.
Southwest
The following table presents financial results and key operating statistics for the Southwest operations (in thousands, except medical transports, Net Medical Transport APC and DSO):
Revenue
The decrease in ambulance services revenue was primarily due to a $7.0 million decrease related to medical transport volume and a $0.8 million decrease in subsidy revenue related to the discontinuation of an industrial EMS contract in our Southern Arizona market, offset by $5.1 million of increases in net medical transport APC. Medical transports decreased primarily due to the discontinuation of service on an emergency contract in Tempe, Arizona, which had approximately 7,700 transports annually combined with transport volume decreases in the emergency sector due to fewer temporary residents and leisure travelers. The increase in net medical transport APC was primarily due to rate increases and collection rate increases.
Other services revenue remained consistent with the prior year, with increased master fire contract revenue being offset by decreases in fire subscription and fire and forestry fee revenue.
Payroll and employee benefits
Payroll and employee benefits was $96.8 million, or 56.3% of net revenue for fiscal 2009, compared to $98.4 million, or 56.5% of net revenue, for fiscal 2008. The $1.6 million decrease was due to a $1.5 million increase in workers compensation expense and a $0.7 million increase in health insurance expense, offset by changes in cost-of-living adjustments, unit hours and training.
Operating Expenses
Operating expenses, including general/auto liability expenses, was relatively consistent at $39.8 million for fiscal 2009, or 23.2% of net revenue, compared to $40.0 million, or 22.9% of net revenue, for the same period in the prior year. The current year included $1.5 million of decreases in vehicle and equipment expenses offset by increases of $1.3 million in other operating expenses.
In addition, corporate overhead allocations decreased, primarily due to decreased professional fees.
West
The following table presents financial results and key operating statistics for the West operations (in thousands, except medical transports, Net Medical Transport APC and DSO):
Revenue
The increase in ambulance services revenue was primarily due to a $1.9 million increase in revenue from new emergency and non-emergency contracts in our Washington, Colorado and Oregon markets offset by a $1.4 million decrease in same service area revenue. Same service area revenue included $7.1 million related to decreased transport volume offset by a $5.7 million increase in net medical transport APC and a $0.4 million increase in master contracts. Medical transports decreased primarily due to the discontinuation of an emergency
contract in Orange County, Florida, which had approximately 19,700 transports annually. This contract was not put out for RFP, and the transports related to this service area are currently serviced by the local fire department. The increase in the net medical APC was due to rate increases and increases related to service level mix and collection rate.
We notified Salt Lake City, Utah, that we would exit the market at the conclusion of our contract term in December 2009. Our decision was based on the inability during our four years in the market to secure a license to provide non-emergency ambulance services. Receiving such a license would have required a change to state law that, in our opinion, was not forthcoming. The Utah market accounted for transports and net revenue of 10,755 and $4.2 million in 2009, respectively, and 11,179 and $3.5 million in 2008, respectively. This market was reclassified to discontinued operations in the second quarter of fiscal 2010.
Payroll and employee benefits
Payroll and employee benefits was $59.6 million, or 58.1% of net revenue for fiscal 2009, compared to $57.6 million, or 56.7% of net revenue, for fiscal 2008. The $2.0 million increase was primarily due to $1.0 million of increases in workers compensation expense and $0.7 million of increases in health insurance, with the remainder of the increase related to changes in cost-of-living adjustments, unit hours and training.
Operating Expenses
Operating expenses, including general/auto liability expenses was $33.1 million for fiscal 2009, or 32.2% of net revenue, compared to $34.2 million, or 33.7% of net revenue, for fiscal 2008. The $1.1 million decrease was primarily due to a $0.5 million decrease in vehicle and equipment expenses and other less significant decreases in other operating expenses.
In addition, corporate overhead allocations decreased, primarily due to decreased professional fees.
Critical Accounting Estimates and Policies
Our discussion and analysis of financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of our financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosures of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, general liability and workers’ compensation claim reserves and deferred tax asset recoverability. We base our estimates on historical experience and various assumptions we believe are reasonable under the circumstances. The results form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
We have identified the following accounting estimates and policies as critical to understanding our results of operations. The discussion below is not intended to represent a comprehensive list of our accounting estimates and policies. For a detailed discussion on the application of these and other accounting policies, see Note 1 to our Consolidated Financial Statements.
Revenue Recognition
A significant portion of our revenue is generated in the highly regulated and complex healthcare industry. Ambulance services revenue is recognized when services are provided to our patients and are recorded net of estimated contractual allowances applicable to Medicare, Medicaid and other third-party payers and net of estimates for uncompensated care. We use sophisticated financial models to estimate the provisioning for both
contractual allowances and uncompensated care by looking at current service levels, payer mix known at the time of transport and incorporating historical trend information by service area. The evaluation of these data points, along with our interpretation of Medicare, Medicaid and various commercial insurance provider rules and regulations is highly complicated and subjective. If our interpretation or our analysis surrounding historical data is incorrect, revenue could be overstated or understated. For fiscal 2010, a 1% change in our estimate of revenue collectability would impact the Company by $9.5 million of net revenue.
Revenue generated under fire protection service contracts is recognized over the life of the contract. Fire subscription fees, which are generally received in advance, are deferred and recognized on a pro rata basis over the term of the subscription agreement, which is generally one year. Additionally, we charge enrollment fees for new subscribers under our fire protection service contracts. Such fees are deferred and recognized over the estimated customer relationship period of nine years.
Insurance Reserves
In the ordinary course of our business, we are subject to accident, injury and professional liability claims. Additionally, certain of our operational contracts, as well as laws in certain of the areas where we operate, require that specified amounts of insurance coverage be maintained. In order to minimize the risk of exposure and comply with such legal and contractual requirements, we carry a broad range of insurance policies, including comprehensive general liability, automobile, property damage, professional, workers’ compensation and other lines of coverage. We typically renew each of these policies annually and purchase limits of coverage at levels management believes are appropriate, taking into account historical and projected claim trends, reasonable protection of our assets and operations and the economic conditions in the insurance market. Depending upon the specific line of coverage, the total limits of insurance maintained may be achieved through a combination of primary policies, excess policies and self-insurance.
We retain certain levels of exposure with respect to our general liability and workers’ compensation programs and purchase coverage from third party insurers for exposures in excess of those levels. In addition to expensing premiums and other costs relating to excess coverage, we establish reserves for claims, both reported and an estimate of incurred but not reported claims, on a gross basis using currently available information as well as our historical claims experience. We also recognize a receivable from our insurers for amounts expected to be recovered in excess of our retention. We periodically evaluate the financial capacity of our insurers to assess the recoverability of the related receivables.
We engage third-party administrators (“TPAs”) to manage claims resulting from our general liability and workers’ compensation programs. The TPAs establish initial loss reserve estimates at the time a claim is reported and then monitor the development of the claim over time to confirm that such estimates continue to be appropriate. Management periodically reviews the claim reserves established by the TPAs and engages independent actuaries to assist with the evaluation of the adequacy of its reserves on at least a semi-annual basis. The Company adjusts its claim reserves with an associated increase or decrease to expense as new information on the underlying claims is obtained.
Property and Equipment
We exercise judgment with regard to property and equipment in the following areas: (1) determining whether an expenditure is eligible for capitalization or if it should be expensed as incurred, (2) estimating the useful life of a capitalized asset, and (3) if events or changes in circumstances warrant an assessment, determining if and to what extent a tangible long-lived asset has been impaired. The accuracy of our judgments impacts the amount of depreciation expense we recognize, the amount of our gain or loss on the disposal of these assets, whether or not an asset is impaired and, if an asset is impaired, the amount of the loss related to the impaired asset that is recognized.
Our judgments about useful lives as well as the existence and degree of asset impairments could be affected by future events, such as discontinued operations, obsolescence, new regulations and new taxes, and other economic factors. We do not anticipate that our current estimates are reasonably likely to change in the future.
Expenditures associated with the repair or maintenance of a capital asset are expensed as incurred. Expenditures that are expected to provide future benefits to the Company or that extend the useful life of an existing asset are capitalized. The useful lives that we assign to property and equipment represent the estimated number of years that the property and equipment is expected to contribute to the revenue generating process based on our current operating strategy. We believe that the useful lives of our property and equipment expire evenly over time. Accordingly, we depreciate our property and equipment on a straight-line basis over their useful lives.
Goodwill
Our goodwill balances are reviewed for impairment annually (and at interim periods if events or changes in circumstances indicate that the goodwill may be impaired) using a two-step process. The first step of the goodwill impairment test, used to identify potential impairment, compares the estimated fair value of a reporting unit with its carrying amount, including goodwill. The fair value of a reporting unit is determined by a market approach based on each reporting unit’s estimated discount rate and long-term growth rate or by (or in combination with) an income approach based on discounted estimated future cash flows from each reporting unit. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is not considered to be impaired and the second step of the impairment test is unnecessary. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test must be performed to measure the amount of impairment loss, if any. The second step of the goodwill impairment test compares the implied fair value of reporting unit goodwill with the carrying amount of that goodwill. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination. If the carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. The estimated fair value of our reporting units could change if there were future changes in our capital structure, cost of debt, interest rates, capital expenditure levels, ability to perform at levels that were forecasted or changes in our market capitalization. We perform our annual impairment test as of June 30.
Defined Benefit Pension Plan
We have one defined benefit pension plan covering eligible employees of one of our subsidiaries, primarily those covered by collective bargaining agreements. Eligibility is achieved upon the completion of one year of service. Participants become fully vested in their accrued benefit after the completion of five years of service. The amount of benefit is determined using a two-part formula, one of which is based upon compensation and the other which is based upon a flat dollar amount.
We use an actuarial model to estimate our benefit obligation and the associated pension cost. The key assumptions used in this model are the discount rate for the benefit obligation and the expected long-term rate of return on plan assets. The discount rate is derived from a model that applies the spot rates of an expected yield curve to the estimated timing and amount of future benefit payments. A 1% decrease in the discount rate would increase pension cost in the following year by $0.9 million and would increase the projected benefit obligation by $3.3 million. A 1% increase in the discount rate would decrease pension cost in the following year by $0.7 million and would decrease the projected benefit obligation by $2.4 million.
The expected long-term rate of return on plan assets is estimated based upon current plan asset allocation, historical and expected returns on various asset categories and multiple investment scenarios. A 1% increase or decrease in this assumption would affect pension cost in the following year by $0.1 million and would not affect the projected benefit obligation.
Income Taxes
We account for income taxes using the asset and liability method. Under this method, deferred tax assets and liabilities are recorded for the future tax consequences attributable to differences between the financial statement carrying amounts of assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a tax rate change on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date. We record valuation allowances to reduce net deferred tax assets to the amount considered more likely than not to be realized. Changes in estimates of future taxable income can materially change the amount of such valuation allowances.
We are subject to federal income taxes and state income taxes in those jurisdictions in which we operate. We exercise judgment with regard to income taxes in the following areas: (1) interpreting whether expenses are deductible in accordance with federal income tax and state income tax codes, (2) estimating annual effective federal and state income tax rates and (3) assessing whether deferred tax assets are, more likely than not, expected to be realized. The accuracy of these judgments impacts the amount of income tax expense we recognize each period.
As a matter of law, we are subject to examination by federal and state taxing authorities. We have estimated and provided for income taxes in accordance with settlements reached with the Internal Revenue Service in prior audits. Although we believe that the amounts reflected in our tax returns substantially comply with the applicable federal and state tax regulations, both the IRS and the various state taxing authorities can and have taken positions contrary to our position based on their interpretation of the law. A tax position that is challenged by a taxing authority could result in an adjustment to our income tax liabilities and related tax provision.
We measure and record tax contingency accruals in accordance with accounting principles generally accepted in the United States (“GAAP”) which prescribes a threshold for the financial statement recognition and measurement of a tax position taken or expected to be taken in a return. Only positions meeting the “more likely than not” recognition threshold at the effective date may be recognized or continue to be recognized.
Liquidity and Capital Resources
Our ability to service our long-term debt, to remain in compliance with the various restrictions and covenants contained in our debt agreements and to fund working capital, capital expenditures and business development efforts will depend on our ability to generate cash from operating activities which in turn is subject to, among other things, future operating performance as well as general economic, financial, competitive, legislative, regulatory and other conditions, some of which may be beyond our control.
We have available to us, upon compliance with certain conditions, a $40.0 million Revolving Credit Facility due December 2013, less any letters of credit outstanding under the $25.0 million letter of credit sub-line. There were $24.6 million of letters of credit outstanding under the sub-line of the revolving credit facility at June 30, 2010. No other amounts were outstanding under the Revolving Credit Facility as of June 30, 2010. We anticipate renewing the letters of credit.
In addition to the scheduled principal payments, we are required to make an excess cash flow payment, as defined under our 2009 Credit Facility, of $1.9 million within 90 days of June 30, 2010. The excess cash flow payment will be applied to the principal balance of our Term Loan due 2014.
Cash Flows
The table below summarizes cash flow information for fiscal 2010, 2009 and 2008 (in thousands):
Operating Activities
We had working capital of $36.4 million as of June 30, 2010, including cash and cash equivalents of $20.2 million, compared to working capital of $60.7 million, including cash and cash equivalents of $37.1 million, as of June 30, 2009. The decrease in working capital is primarily related to the reclassification of $20.4 million of cash and cash equivalents as noncurrent restricted cash on the Consolidated Balance Sheets to guarantee the cash collateralized letter of credit facility. Absent the amounts related to restricted cash, working capital decreased $3.9 million, which is primarily being driven by the timing of payments on accrued liabilities.
Effective March 2010, the non-cash accretion of the 12.75% Senior Discount Notes ceased and cash interest began to accrue. The first $6.0 million semi-annual interest payment is due in September 2010.
The $17.3 million increase in cash flow from operating activities from fiscal 2008 to fiscal 2009 was attributable to a $0.9 million increase in earnings, a $9.9 million increase in non-cash expenses and $6.3 million of net cash inflows resulting in changes in operating assets and liabilities. The increase in non-cash expenses was primarily related to a $6.3 million change in insurance reserves adjustments, an increase of $1.7 million in depreciation and amortization, a $1.2 million increase in accretion of the 12.75% Senior Discount Notes, a $0.8 million increase in noncontrolling interest and a $0.2 million increase in stock-based compensation expense partially offset by a $0.3 million decrease in loss on sale of property and equipment. The net cash inflows in operating assets and liabilities was primarily due to a $9.6 million decrease in accounts receivable, a $4.2 million decrease in deferred income taxes, a $2.7 million increase in deferred revenue and a $1.0 million decrease in prepaid expenses offset by a $3.9 million decrease in other liabilities, a $2.9 million decrease in accrued liabilities, a $2.4 million change in other assets, a $0.9 million decrease in accounts payable, a $0.6 million increase in insurance deposits and a $0.4 million increase in inventory.
Investing Activities
Net cash used in investing activities for fiscal 2010 primarily reflects the use of $20.4 million for deposits of restricted cash in connection with our cash collateralized letter of credit facility and $15.5 million of capital expenditures. Capital expenditures in fiscal 2009 were $16.7 million.
The $3.4 million increase in cash used in investing activities from fiscal 2008 to fiscal 2009 was attributable to a $3.4 million increase in capital expenditures.
Financing Activities
Net cash used in financing activities for fiscal 2010 primarily reflects the use of cash for the repayment of debt and for payment of debt refinancing transaction fees partially offset by cash inflows due to borrowings under our 2009 Credit Facility. See discussion of our debt and the debt refinancing transaction in Note 11 to the consolidated financial statements filed with this Annual Report on Form 10-K. Additionally, we made $2.4 million in distributions to the City of San Diego.
The $2.3 million increase in cash used in financing activities from fiscal 2008 to fiscal 2009 was primarily due to a $2.0 million increase in principal payments under the company’s credit facility and a $0.8 million increase in distributions to noncontrolling shareholders partially offset by $0.9 million in cash paid for debt issuance costs in fiscal 2008.
2009 Credit Facility
Rural/Metro Operating Company, LLC (“Rural/Metro LLC”), maintains senior secured credit facilities (collectively, the “2009 Credit Facility”) in an aggregate amount of up to $220.0 million, comprised of a $180.0 million Term Loan B facility due December 2014 (the “Term Loan due 2014”), a $40.0 million revolving credit facility due December 2013 (the “Revolving Credit Facility”) which includes a $25.0 million letter of credit sub-line (the “Letter of Credit Sub-line”). For a complete discussion of our 2009 Credit Facility, see Note 11 to the Consolidated Financial Statements filed with this Annual Report on Form 10-K.
Debt Covenants
The 2009 Credit Facility and Senior Discount Notes include various financial and non-financial covenants applicable to the Company’s wholly-owned subsidiary, Rural/Metro LLC, as well as quarterly and annual financial reporting obligations.
Specifically, the 2009 Credit Facility requires Rural/Metro LLC and its subsidiaries to meet certain financial tests, including an interest expense leverage ratio, a total leverage ratio, and a senior secured leverage ratio. The 2009 Credit Facility also contains covenants which, among other things, limit the incurrence of additional indebtedness, dividends, transactions with affiliates, asset sales, acquisitions, mergers, prepayments of other indebtedness, liens and encumbrances, capital expenditures, business activities by the Company, as a holding company, and other matters customarily restricted in such agreements. The financial covenants related to the Senior Discount Notes are similar to or less restrictive than those under the 2009 Credit Facility. We are in compliance with our covenants at June 30, 2010 and anticipate continuing compliance. The table below sets forth information regarding certain of the financial covenants under the 2009 Credit Facility.
(1) Calculated using a Term Loan due 2014 balance of $179.1 million. See discussion in Note 11 to the Consolidated Financial Statements filed with this Annual Report on Form 10-K.
(2) Measured annually at June 30.
Contractual Obligations and Other Commitments
We have certain contractual obligations related to our debt instruments and lease obligations that come due at various times over the periods presented below. In addition we have other commitments in the form of standby letters of credit and performance bonds. The following table illustrates the expiration of our contractual obligations as well as other commitments as of June 30, 2010 (in thousands):
(1) Calculated using stated coupon rates for fixed rate debt and interest rates applicable at June 30, 2010 for variable rate debt.
In addition, as of June 30, 2010, we had $5.1 million of income taxes payable related to uncertain tax positions. We do not expect to make cash payments related to this liability during the next twelve months. Beyond the next twelve months, timing of cash payments are uncertain and therefore no such payments are reflected in the above table.
We intend to renew letters of credits and performance bonds annually.
Indemnifications
We are a party to a variety of agreements entered into in the ordinary course of business pursuant to which we may be obligated to indemnify the other parties for certain liabilities that arise out of or relate to the subject matter of the agreements. Some of the agreements we entered into require us to indemnify other parties against losses due to property damage including environmental contamination, personal injury, failure to comply with applicable laws, our negligence or willful misconduct or breach of representations and warranties and covenants.
Additionally, some of our customer agreements require us to provide certain assurances related to the performance of our services. Such assurances, from time to time, obligate us to; (i) pay penalties for failure to meet response times or other requirements, (ii) lease, sell or assign equipment or facilities (either temporarily or permanently) in the event of uncured material defaults or other certain circumstances, or (iii) provide performance bonds or letters of credit issued in favor of the customer to cover costs resulting, under certain circumstances, from an uncured material default. With respect to such performance bonds, we are also required to indemnify the surety company for losses paid as a result of any claims made against such bonds.
We provide for indemnification of directors, officers and other persons in accordance with limited liability agreements, certificates of incorporation, bylaws, articles of association or similar organizational documents, as the case may be. In addition, we have entered into indemnification agreements with our directors and certain of our officers. We maintain directors’ and officers’ insurance which should enable us to recover a portion of any future amounts paid.
In addition to the above, from time to time we provide standard representations and warranties to counterparties in contracts in connection with sales of our securities and the engagement of financial advisors and also provide indemnities that protect the counterparties to these contracts in the event they suffer damages as a result of a breach of such representations and warranties or in certain other circumstances relating to the sale of securities or their engagement by us.
While our future obligations under certain agreements may contain limitations on liability for indemnification, other agreements do not contain such limitations and under such agreements it is not possible to predict the maximum potential amount of future payments due to the conditional nature of our obligations and the unique facts and circumstances involved in each particular agreement. Historically, payments made by us under any of these indemnities have not had a material effect on our business, financial condition, results of operations or cash flows. Additionally, we do not believe that any amounts that we may be required to pay under these indemnities in the future will be material to our business, financial condition, results of operations or cash flows.
Recent Accounting Pronouncements
See Note 1 to our Consolidated Financial Statements filed with this Annual Report on Form 10-K for a summary of recent accounting pronouncements.
ITEM 7A.
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk
Interest Rates
Our primary exposure to market risk consists of changes in interest rates on our borrowing activities. Current amounts outstanding under our Term Loan due 2014 and the 2009 Revolving Credit Facility bear interest at LIBOR plus 5.00% (subject to a LIBOR floor of 2.00%) or, at Rural/Metro, LLC’s option, the Alternate Base Rate plus 4.00%. Due to the 2.00% floor in LIBOR rate, our interest expense will not increase with an increase in LIBOR until LIBOR exceeds 2.00%. Based on amounts outstanding under our 2009 Credit Facility at June 30, 2010, a 1% increase in the LIBOR rate over 2.00% would increase our interest expense on an annual basis by approximately $1.8 million. If LIBOR exceeds 3.00%, our interest rate cap effectively hedges any rate increase above 3.00% for its notional amount of $60.0 million. For the remainder of the Term Loan due 2014, for a 1% increase in LIBOR over 3%, interest expense would increase by $1.2 million. The remainder of our debt is primarily at fixed interest rates. We monitor the risk associated with interest rate changes and may enter into additional hedging transactions, such as interest rate swap or cap agreements, to mitigate the related exposure. In addition, we are exposed to the risk of interest rate changes on our short-term investment activities. We had no amounts invested in auction rate securities at June 30, 2010.
Fuel Costs
Changes in the price of diesel fuel can have a material effect on our costs, and we are subject to inflationary pressure principally associated in recent periods with rapid increases in diesel fuel for our ambulances. More than 58% of our ambulance transport revenue for fiscal 2010 was generated from government-funded programs such as Medicare and Medicaid, which do not automatically allow us to offset inflationary cost increases with rate increases. Although we have been successful in offsetting some inflationary fuel costs through operating efficiencies and successfully negotiating rate increases under some of our contracts with third-party insurance payers, there is no assurance that we will be able to offset future increases in fuel costs through similar efficiencies or rate increases. A $1 per gallon increase in the price of diesel fuel would increase our annual fuel expense by approximately $4.2 million.
ITEM 8.
ITEM 8. Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of June 30, 2010 and 2009
Consolidated Statements of Operations for the Years Ended June 30, 2010, 2009 and
Consolidated Statements of Changes in Stockholders’ Equity (Deficit) and Comprehensive Income (Loss) for the Years Ended June 30, 2010, 2009 and 2008
Consolidated Statements of Cash Flows for the Years Ended June 30, 2010, 2009 and
Notes to Consolidated Financial Statements
Quarterly Financial Data
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of Rural/Metro Corporation:
In our opinion, the accompanying consolidated balance sheets and the related consolidated statement of operations, of changes in stockholder’s equity (deficit) and comprehensive income (loss) and of cash flows present fairly, in all material respects, the financial position of Rural/Metro Corporation and its subsidiaries at June 30, 2010 and June 30, 2009, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 2010 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 30, 2010, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
As discussed in Note 12 to the consolidated financial statements, the Company changed the manner in which it accounts for uncertainty in income taxes in the year ended 2008.
As discussed in Note 1 to the consolidated financial statements, the Company changed the manner in which it accounts for noncontrolling interests in the year ended 2010.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP
Phoenix, AZ
September 8, 2010
RURAL/METRO CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
See accompanying notes
RURAL/METRO CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
See accompanying notes
RURAL/METRO CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ DEFICIT
AND COMPREHENSIVE INCOME
(in thousands, except share amounts)
See accompanying notes
RURAL/METRO CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
See accompanying notes
RURAL/METRO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) The Company and its Significant Accounting Policies
Nature of Business and Operations
Rural/Metro Corporation, a Delaware corporation, and its subsidiaries (collectively, the “Company”) is a leading provider of medical ambulance response services, which consist primarily of emergency and non-emergency response services. These services are provided under contracts with governmental entities, hospitals, nursing homes and other healthcare facilities and organizations. The Company also provides private fire protection and related services on a subscription fee basis to residential and commercial property owners and under long-term master fire contracts with fire districts, industrial sites and airports. These services consist primarily of fire suppression, fire prevention and first responder medical care.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company, its wholly-owned subsidiaries and a variable interest entity; which it controls. All material intercompany accounts and transactions have been eliminated.
Fiscal Years
The Company’s fiscal year ends on June 30. Fiscal 2010, 2009 and 2008 refer to the fiscal years ended June 30, 2010, 2009 and 2008, respectively.
Use of Estimates
The preparation of financial statements in accordance with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses recognized during the reporting period. Significant estimates have been made by management in connection with the measurement of contractual allowances applicable to Medicare, Medicaid and other third-party payers, the estimate for uncompensated care, the valuation allowance for deferred tax assets, workers’ compensation and general liability self-insured claim reserves, fair values of reporting units for purposes of goodwill impairment testing and future cash flows associated with long-lived assets. Actual results could differ from these estimates.
Concentrations of Credit Risk
Financial instruments, which potentially subject the Company to concentrations of credit risk, consist principally of cash and cash equivalents and accounts receivable. The Company places its cash with federally insured institutions and monitors the amount of credit exposure with any one institution. Concentrations of credit risk with respect to accounts receivable are limited due to the large number of customers and their geographical dispersion.
Reclassifications and Adjustments of Financial Information
The accompanying consolidated financial statements reflect certain reclassifications for the adoption of the new accounting guidance related to noncontrolling interests as described below in Recent Accounting Pronouncements and operations that were classified as discontinued in fiscal 2010 as described in Note 20. These reclassifications have no effect on previously reported earnings per share.
RURAL/METRO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
During the fourth quarter of 2010, the Company determined that certain equipment leases were incorrectly accounted for as operating leases and certain capital costs were improperly recognized as operating expenses. The Company assessed the materiality of these errors on prior periods’ consolidated financial statements and on each quarter of fiscal 2010 in accordance with the SEC’s Staff Accounting Bulletin (“SAB”) No. 99 and SAB No. 108 and concluded that these errors were not material to any such periods. The cumulative effect of the errors was recorded as an adjustment in the fourth quarter of 2010. The effect of these adjustments to the Consolidated Statement of Operations for the quarter ended June 30, 2010 was to decrease operating expenses by $0.3 million, to increase interest expense by $0.1 million and to decrease net income by $0.1 million. The adjustment did not impact income (loss) from discontinued operations. The effect of these adjustments to the Statement of Cash Flows for the quarter ended June 30, 2010 was to decrease cash provided by operating activities by $0.5 million, to increase cash used in investing activities by $0.3 million, and to increase cash used in financing activities by $0.2 million.
Net Revenue
Ambulance services revenue is recognized when services are provided and are recorded net of estimated contractual allowances applicable to Medicare, Medicaid and other third-party payers and net of estimates for uncompensated care. Such contractual allowances applicable to continuing operations totaled $370.9 million, $321.8 million and $295.9 million in fiscal 2010, 2009 and 2008, respectively, and estimates for uncompensated care, which totaled $123.4 million, $116.5 million and $116.1 million in fiscal 2010, 2009 and 2008, respectively, are reflected as reductions to revenue in the accompanying Consolidated Statement of Operations.
Revenue generated under fire protection service contracts is recognized over the life of the contract. Subscription fees, which are generally received in advance, are deferred and recognized on a pro rata basis over the term of the subscription agreement, which is generally one year. Additionally, the Company charges an enrollment fee for new subscribers under its fire protection service contracts. Such fees are deferred and recognized over the estimated customer relationship period of nine years. Other services revenue primarily consists of dispatch, fleet, billing, training and home health care service fees, which are recognized when the services are provided.
Cash and Cash Equivalents
The Company considers all highly liquid financial instruments with original maturities of three months or less when purchased to be cash equivalents. Under the Company’s cash management practices, outstanding checks are netted against cash when there is a sufficient balance of cash available in the Company’s bank accounts to cover the outstanding amount and a legally enforceable right of offset exists. Where there is no legally enforceable right of offset against cash balances and a form of overdraft protection does not exist, outstanding checks are classified as accounts payable within the Consolidated Balance Sheets and the change in the related balances is reflected in operating activities on the Consolidated Statement of Cash Flows. There were no overdraft balances included in accounts payable in the Company’s Consolidated Balance Sheets as of June 30, 2010 and 2009.
Restricted Cash
The Company classifies cash and cash equivalents which are restricted for use by contractual obligations or the Company’s intentions as restricted cash. The restricted cash is classified as current or noncurrent on the Company’s Consolidated Balance Sheets based on the expected timing of the expiration or termination of the contractual restriction or in the case of the Company’s intent, the expected timing of the use of the restricted cash. The Company classifies changes in restricted cash on its Consolidated Statements of Cash Flows as an
RURAL/METRO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
investing activity due to the restricted cash placement in interest-bearing accounts or certificates of deposit. Refer to Note 11 for a further discussion of restricted cash transactions.
Allowance for Uncompensated Care
Accounts receivable represent amounts due from customers and are recorded at the time that the Company’s services are provided. Accounts receivable balances are presented net of both estimated contractual allowances applicable to Medicare, Medicaid and other third-party payers and estimates for uncompensated care. Estimates for uncompensated care are based on historical collection trends, credit risk assessments applicable to certain types of payers and other relevant information. Accounts receivable are written-off against the allowance for uncompensated care when the Company has determined the balance will not be collected. A summary of activity in the Company’s allowance for uncompensated care during fiscal 2010, 2009 and 2008 is as follows (in thousands):
Inventories
Inventories, which consist of medical and fleet supplies, are stated at the lower of cost or market value. Cost is determined on a first in, first-out basis.
Property and Equipment
Property and equipment is carried at cost less accumulated depreciation and is depreciated over the estimated useful lives using the straight-line method. Equipment and vehicles are depreciated over three to twelve years and buildings are depreciated over ten to thirty years. Leasehold improvements are capitalized and depreciated using the straight-line method over the shorter of the contractual lease terms or the estimated useful lives. Depreciation expense from continuing operations was $15.8 million, $14.0 million and $12.2 million in fiscal 2010, 2009 and 2008, respectively. Maintenance and repairs which do not improve or extend the useful life of assets are expensed as incurred. The cost and accumulated depreciation applicable to assets retired are removed from the accounts and the gain or loss, if any, is recognized in income as realized.
Goodwill
Goodwill represents the excess of the cost of an acquired company over the net of the amounts assigned to assets acquired and liabilities assumed. Goodwill is evaluated for impairment annually or whenever events or changes in circumstances make it likely that impairment may have occurred. The Company performs its annual goodwill two-step impairment test as of the end of its fiscal year. In the first step, the fair value of the reporting unit is compared to the carrying value of its net assets including goodwill. The fair value of a reporting unit is determined by a market approach based on each reporting unit’s estimated discount rate and long-term growth rate or by (or in combination with) an income approach based on discounted estimated future cash flows from
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
each reporting unit. If the fair value of the reporting unit exceeds the carrying value of the net assets of the reporting unit, goodwill is not impaired and no further testing is required. If the carrying value of the net assets of the reporting unit exceeds the fair value of the reporting unit, then a second step must be performed in order to determine the implied fair value of the goodwill and to compare it to the carrying value of goodwill. If the carrying value of goodwill exceeds its implied fair value, then an impairment loss equal to the difference is recorded. The determination of fair value requires the Company to make significant judgments and estimates about future events. The estimated fair value of our reporting units could change if there were future changes in our capital structure, cost of debt, interest rates, capital expenditure levels, ability to perform at levels that were forecasted or changes in the market capitalization of the Company. Due to the inherent uncertainty involved in making these estimates, actual results could differ materially from the estimates. The Company evaluated the significant judgments used to determine the fair value of each reporting unit, both individually and in the aggregate and concluded they are reasonable.
Based on the results of the impairment test performed as of June 30, 2010, the Company determined that goodwill related to a reporting unit in the South reporting segment was partially impaired and recorded a loss of $1.2 million. For details on the fiscal 2010 impairment, refer to Note 5.
Impairment of Other Long-Lived Assets
The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the related carrying amounts may not be recoverable, by comparing the carrying amount of such assets to the undiscounted future cash flows expected to result from the use and eventual disposition of the asset or asset group. In cases where the undiscounted future cash flows are less than the related carrying amount, an impairment loss is recognized for an amount equal to the excess of the carrying value over the amount by which the carrying amount exceeds the fair value. The fair value is based on quoted market prices or, in instances where quoted market prices are not available, the present value of future cash flows using a discount rate commensurate with the risks involved.
Income Taxes
Income taxes are accounted for using the asset and liability method. Under this method, deferred income tax assets and liabilities are recognized for the expected future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets are also recognized for net operating loss, capital loss and tax credit carryforwards. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which the related temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is provided for those deferred tax assets for which realization of the related benefits is unlikely.
The Company measures and records tax contingency accruals in accordance with accounting principles generally accepted in the United States (“GAAP”) which prescribes a threshold for the financial statement recognition and measurement of a tax position taken or expected to be taken in a return. Only positions meeting the “more likely than not” recognition threshold may be recognized or continue to be recognized.
Derivatives and Hedging
The Company may utilize derivative financial instruments to reduce its exposure to certain market risks such as interest rate risk and fuel price risk. All derivative instruments are recognized on the Company’s Consolidated Balance Sheet at fair value. The Company formally documents all derivative instruments designated as hedging
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instruments. The effective portion of the gain or loss on derivative instruments designated as cash flow hedges is recorded in other comprehensive income and reclassified into earnings in the same period during which the hedged transaction affects earnings. Other gains or losses on derivative instruments are recognized in current earnings. Refer to Note 10 for a detailed discussion of derivative instruments.
Earnings per Share
Basic earnings per common share is computed by dividing income attributable to Rural/Metro applicable to common shareholders by the weighted average number of common shares outstanding. Diluted earnings per common share is computed based on the weighted-average number of common shares outstanding after consideration of the dilutive effect of stock options, stock appreciation rights and restricted stock units.
Share-based Compensation
Share-based compensation expense is based on the grant-date fair value of the share-based award and the estimated number of awards that are expected to vest. That expense is recognized over the period during which an employee is required to provide service in exchange for the award, which is usually the vesting period.
Recent Accounting Pronouncements
In February 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2010-09, Subsequent Events-Amendments to Certain Recognition and Disclosure Requirements (“ASU 2010-09”). ASU 2010-09 reiterates that an SEC filer is required to evaluate subsequent events through the date that the financial statements are issued and removes the requirement for an SEC filer to disclose the date through which subsequent events have been evaluated. The updated guidance was effective upon issuance. The Company adopted the ASU in the third quarter of fiscal 2010. The adoption did not have a material effect on the Company’s consolidated financial statements and related disclosures.
In January 2010, the FASB issued ASU 2010-06, Improving Disclosures About Fair Value Measurements (“ASU 2010-06”). ASU 2010-06 amends Accounting Standards Codification (“ASC”) 820, Fair Value Measurements and Disclosures to add new requirements for disclosures about transfers into and out of Levels 1 and 2 and separate disclosures about purchases, sales, issuances, and settlements relating to Level 3 measurements. It also clarifies existing fair value disclosures about the level of disaggregation and about inputs and valuation techniques used to measure fair value. The ASU is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures for Level 3 activity, which are effective for interim reporting periods for fiscal years beginning after December 15, 2010. Accordingly, the Company adopted the ASU in the third quarter of fiscal 2010, except for the disclosures for Level 3 activity which are not yet required. The adoption of the ASU did not have a material impact on the Company’s consolidated financial statements and related disclosures. The Company does not expect that the adoption of the Level 3 activity disclosures will have a material impact on its consolidated financial statements and related disclosures. See Note 3 for a discussion of the fair value of the Company’s assets and liabilities.
In December 2009, the FASB issued ASU 2009-17, Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities (“ASU 2009-17”). ASU 2009-17 amends ASC 810, Consolidation to include the new guidance issued in August 2009 that changes the accounting and disclosure requirements for the consolidation of variable interest entities (“VIE”). The ASU changes the approach to determining the primary beneficiary of a VIE and requires entities to more frequently assess whether they must consolidate VIEs. The ASU is effective for annual periods beginning after November 15, 2009. Accordingly, the Company will adopt the ASU in fiscal 2011. The Company does not expect the adoption of the ASU to have a material effect on its consolidated financial statements and related disclosures.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
In September 2009, the FASB issued ASU 2009-12, Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent) (“ASU 2009-12”). ASU 2009-12 permits the use of net asset value per share as a practical expedient for measuring fair value of certain investments. The ASU also requires disclosures by major category of these investments. ASU 2009-12 is effective for interim and annual reporting periods ending after December 15, 2009, with early adoption permitted. The Company adopted the ASU in the second quarter of fiscal 2010 and the adoption did not have a material effect on its consolidated financial statements and related disclosures.
In August 2009, the FASB issued ASU 2009-05, Measuring Liabilities at Fair Value (“ASU 2009-05”). ASU 2009-05 clarifies how the fair value of liabilities should be measured and establishes a hierarchy for using different valuation methods. This ASU is effective for the first interim reporting period beginning after August 26, 2009. The Company adopted the ASU in the second quarter of fiscal 2010 and the adoption did not have a material effect on its consolidated financial statements and related disclosures.
In December 2008, the FASB issued a staff position that provides additional guidance regarding annual disclosures about plan assets of defined benefit pension or other postretirement plans. The additional guidance is codified under ASC 715-20-65. This additional guidance is effective for financial statements issued for fiscal years ending after December 15, 2009. Accordingly, the Company has adopted the guidance in fiscal 2010. The Company’s adoption of the new guidance did not have a material effect on its consolidated financial statements and the Company has made the required disclosures.
In December 2007, the FASB issued new guidance on business combinations. The new guidance is codified under ASC 805, Business Combinations. The new guidance establishes accounting standards for all transactions or other events in which an entity (the acquirer) obtains control of one or more businesses (the acquiree) including mergers and combinations achieved without the transfer of consideration. The new guidance applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008, which for the Company is fiscal year 2010. The Company’s adoption of the new guidance did not have a material effect on its consolidated financial statements and related disclosures.
In December 2007, the FASB issued new guidance that establishes accounting and reporting standards for the noncontrolling interest (previously referred to as minority interest) in a subsidiary and for the deconsolidation of a subsidiary. The new guidance is codified under ASC 810-10-65. The new guidance, which was effective for the Company on July 1, 2009, was applied prospectively upon adoption except for the presentation and disclosure provisions, which require retrospective application for all periods presented. The presentation provisions require that (1) the noncontrolling interest be reclassified to equity, (2) consolidated net income be adjusted to include the net income attributed to the noncontrolling interest and (3) consolidated comprehensive income be adjusted to include the comprehensive income attributed to the noncontrolling interest. The accompanying consolidated financial statements reflect the required changes in presentation as described in the preceding sentence.
In September 2006, the FASB issued new guidance that defines fair value, establishes a framework for measuring fair value in accordance with GAAP and expands disclosures about fair value measurements. The new guidance is codified under ASC 820, Fair Value Measurements and Disclosures. The new guidance applies to other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, the new guidance does not require any new fair value measurements; however, for some entities, the application of the new guidance will change current practice. The new guidance was effective for the Company on July 1, 2008; however, in February 2008, the FASB issued additional guidance, codified under ASC 820-10, which delayed the effective date of the new guidance for non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
basis, for one year. The adoption of the new guidance on July 1, 2008 with respect to the Company’s financial assets and liabilities did not have a material impact on its consolidated financial statements. The adoption of the provisions of the new guidance with respect to its non-financial assets and non-financial liabilities on July 1, 2009 pursuant to the requirements of the additional guidance did not have a material impact on the Company’s consolidated financial statements and related disclosures.
(2) Fair Value Measurements
Fair value measurements are classified under the following hierarchy:
•
Level 1: Observable inputs such as quoted prices for identical assets or liabilities in active markets.
•
Level 2: Observable inputs other than quoted prices substantiated by market data and observable, either directly or indirectly for the asset or liability. This includes quoted prices for similar assets or liabilities in active markets.
•
Level 3: Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets and liabilities.
The following are the fair values as of June 30, 2010 of the Company’s assets recorded at fair value (in thousands):
(1) Cash and cash equivalents include bank deposits and money market accounts.
(2) At June 30, 2010, restricted cash consisted of certificates of deposit of various maturities. See Note 11 for details on restricted cash.
(3) The fair value of the interest rate cap at June 30, 2010 was based on quoted prices for similar instruments in active markets. See Note 10 for details on the interest rate cap.
The carrying values of accounts receivable, accounts payable, accrued liabilities and other liabilities approximate the related fair values due to the short-term maturities of these assets and liabilities.
The following is a comparison of the fair value and recorded value of the Company’s long-term debt (in thousands):
(1) The fair value of the Term Loan due December 2014 as of June 30, 2010 was based on the quoted ask price for the loan (Level 2).
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(2) The fair value of the Senior Discount Notes was determined using reported market transaction prices closest to June 30, 2010 and 2009 (Level 2).
(3) The fair value of the Term Loan B as of June 30, 2009 was based on the quoted ask price for the loan (Level 2).
(4) The fair value of the Senior Subordinated Notes was determined using reported market transaction prices closest to June 30, 2009 (Level 2).
(3) Sale of Accounts Receivable
The Company has entered into transactions to sell certain of its previously written-off self pay accounts receivables to an unrelated third party. The Company accounted for each transaction as a sale. The resulting gains were equal to proceeds received because the Company had previously removed the receivables from the balance sheet upon concluding they would not be collected.
The following table shows gains recognized on sale of accounts receivable (in thousands):
The gains associated with the Company’s continuing operations are included within gain on sale of assets and property insurance settlement in the Consolidated Statement of Operations. The gains associated with the Company’s discontinued operations are included within income (loss) from discontinued operations. The proceeds received in connection with these transactions are a component of cash provided by operating activities in the Consolidated Statements of Cash Flows.
(4) Property and Equipment
Property and equipment consists of the following (in thousands):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(5) Goodwill
The following table presents changes in the carrying amount of goodwill during fiscal 2010 and 2009 by segment (in thousands):
As described in Note 1, the Company performs an annual evaluation of goodwill for impairment in a two-step test. The results of the first step of the test performed for fiscal 2010 indicated that the goodwill associated with one of the nine reporting units was potentially impaired. The Company then performed the second step of the impairment test for this reporting unit. Goodwill related to this reporting unit prior to the impairment test totaled $2.2 million. The fair value of the reporting unit was estimated based on discounted cash flow methodologies, which showed that the carrying value of the net assets of the reporting unit exceeded the estimated fair value. The decline in the fair value of the reporting unit is primarily due to a trend in declining profitability and a planned future change in utilization of existing resources in this reporting unit. As a result, a goodwill impairment of $1.2 million was recorded. The Company will continue to monitor the performance of this reporting unit to determine if any interim review of the remaining goodwill is warranted. The results of the first step of the test did not indicate that any of the other reporting units were at risk of impairment.
(6) Other Assets
Other assets consist of the following (in thousands):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The changes in the net carrying amount of intangible assets are as follows (in thousands):
The carrying amounts of intangible assets as of June 30, 2010 and 2009 are as follows (in thousands):
In April 2010, the Company purchased the assets of a medical transportation services provider in Kentucky. The assets purchased included a certificate of need with a fair value of $0.4 million and service area contracts with a total fair value of $0.1 million. The certificate of need has been deemed an indefinite-lived intangible asset due to the automatic renewal process for it. The service area contracts are being amortized over the life of the agreements including assumed renewals.
During fiscal 2005, the Company capitalized $1.5 million related to a non-compete agreement with its former Chief Executive Officer (“CEO”) which is being amortized on a straight-line basis, adjusted for termination provisions, over the seven year term of the agreement which ends in fiscal 2011. The unamortized balance as of June 30, 2010 was $0.2 million.
During fiscal 2005, the Company entered into an employment agreement with its former CEO, under which the former CEO was paid a retention bonus which was subject to repayment through December 2010 should the Company terminate his employment with cause or should the former CEO terminate his employment without good reason. The former CEO terminated his employment without good reason in January 2010 and repaid $0.3 million of the retention bonus.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The following table shows the expected amortization of intangible assets for each of the fiscal years ending June 30 (in thousands):
(7) Accrued Liabilities
Accrued liabilities consist of the following (in thousands):
(8) Other Liabilities
Other liabilities consist of the following (in thousands):
(9) General/Auto Liability and Workers’ Compensation Insurance Programs
The Company carries a broad range of insurance policies, including general/auto liability, workers’ compensation, property, professional and other lines of coverage in order to minimize the risk of loss due to accident, injury, automobile and professional liability claims resulting from our operations, and to comply with certain legal and contractual requirements,.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The Company retains certain levels of exposure in its general/auto liability and workers’ compensation programs and purchases coverage from third-party insurers for exposures in excess of those levels. In addition to expensing premiums and other costs relating to excess coverage, the Company establishes reserves for claims, both reported and incurred but not reported, on a gross basis. A receivable is recognized for amounts expected to be recovered from insurers in excess of the retention limits. The Company regularly evaluates the financial capacity of its insurers to assess the recoverability of the receivable.
The Company engages third-party administrators (“TPAs”) to manage general/auto liability and workers’ compensation claims. The TPAs estimate a loss reserve at the time a claim is reported and then monitor the development of the claim over time to confirm that such estimates continue to be appropriate. Semi-annually, or in interim periods if events or changes in circumstances indicate additional evaluation is necessary, management engages independent actuaries to assist with estimating its claim reserves based on loss reserve estimates provided by the TPAs. The Company adjusts its claim reserves with an associated increase or decrease to expense as new information on the underlying claims is obtained.
Additionally, the Company’s general/auto liability and workers’ compensation insurers require the Company to post collateral to support future expected claim payments. The Company has provided letters of credit as collateral to support retention limits. These letters of credit, issued primarily under the Credit Facility and discussed in Note 11 to the Consolidated Financial Statements, totaled $44.7 million and $42.2 million as of June 30, 2010 and 2009, respectively.
General/Auto Liability
A summary of activity in the Company’s general/auto liability claim reserves and related receivable from insurers is as follows (in thousands):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The classification of general/auto liability related amounts in the consolidated balance sheets as of June 30, 2010 and 2009 is as follows (in thousands):
In 2004, an individual filed suit against the Company for injuries that were allegedly sustained as a result of negligence on the part of the Company. In 2007, a jury awarded the plaintiff compensatory damages of $12.1 million. The Company filed a motion to appeal. The Company is covered under an automobile liability insurance program and maintains excess insurance with coverage limits in excess of the award, for the related policy year. In December 2009, the appeal was denied and the claim was paid by the Company’s insurance carriers. The Company had recorded a liability and an offsetting receivable representing the amount due from the insurer of $13.1 million as of June 30, 2009. This amount represented the difference between the award plus accrued interest and the self-insured deductible. The liability was classified as a component of accrued liabilities and the receivable was classified as a component of prepaid expenses and other on the consolidated balance sheet as of June 30, 2009. The accrual, including accrued interest, was reversed in the second quarter of fiscal 2010 due to the settlement described above and therefore there are no amounts recorded as of June 30, 2010 related to this case. As of June 30, 2010 and 2009, respectively, we had liabilities and offsetting receivables of $8.0 million and $13.1 million, respectively, related to outstanding claims.
Workers’ Compensation
A summary of activity in the Company’s workers’ compensation claim related reserves, deposits and premium asset/liabilities is as follows (in thousands):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The classification of workers’ compensation related amounts in the consolidated balance sheets as of June 30, 2010 and 2009 is as follows (in thousands):
The Company has a per-occurrence self-insured retention for the policy periods which cover May 2005 through April 2011. The Company’s aggregate retention limit for those periods is unlimited. For policy years prior to May 2002, policies also included a per-occurrence retention with no annual aggregate limit. For the policy periods May 2002 through May 2005, the Company purchased a first dollar coverage program with a retrospectively rated endorsement whereby the related premiums are subject to adjustment at certain intervals based on subsequent review of actual losses incurred as well as payroll amounts.
The Company determined that the policies for the policy years ended April 30, 2003 and 2004 effectively transferred the risk of loss to the insurer. As a result, the cost applicable to those policy years consisted entirely of the related premium expense and no related claim reserves are recorded. However, the Company has recorded an estimated premium receivable/liability, based on estimates provided by an independent actuary, for subsequent premium adjustments. For these policy years as of June 30, 2010 and 2009, the Company had recorded premium liabilities of $0.5 million and $1.0 million, respectively.
For the policy year ended April 30, 2005, the Company determined that the risk of loss was not effectively transferred to the insurer. As a result, the Company recorded a deposit for amounts paid to the insurer during the policy period in excess of the identified premiums along with a corresponding insurance claim reserve. These amounts are periodically revalued as claims are paid under the policy. As of June 30, 2010 and 2009, the Company’s deposit balances for this policy year were $0.4 million and $1.1 million, respectively. As of June 30, 2010 and 2009, the claim reserves for this policy year were $1.5 million and $0.9 million, respectively.
The Company has issued a letter of credit, which totaled $2.2 million and $2.3 million as of June 30, 2010 and 2009, respectively, to cover any remaining claims on the policy periods 1992 to 2001.
Legion
During fiscal 2002, the Company purchased certain portions of its workers’ compensation coverage from Legion Insurance Company (“Legion”). Legion required assurances that the Company would fund its related retention obligations, which were estimated by Legion to approximate $6.2 million. The Company provided this assurance by purchasing a deductible reimbursement policy from Mutual Indemnity (Bermuda), Ltd. (“Mutual”), a Legion affiliate. That policy required the Company to deposit $6.2 million with Mutual and required Mutual to utilize such funds to satisfy the Company’s retention obligations under the Legion policy.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
On July 25, 2003, the Pennsylvania Insurance Department placed Legion into liquidation. In January 2003, the Commonwealth Court of Pennsylvania (the “Court”) ordered the Legion liquidator and Mutual to establish segregated trust accounts to be funded by cash deposits held by Mutual for the benefit of individual insureds, such as the Company. It is the Company’s understanding that the Legion liquidator and Mutual continue to negotiate the legal framework for the form and administration of these trust accounts and that no final agreement has yet been reached. Under Act 46, the Legion liquidator is required to first utilize the cash deposits available with Mutual before attempting to collect any amounts from the Company. Based on the information currently available, the Company believes that the amounts on deposit with Mutual are fully recoverable and will either be returned to the Company or used to pay claims on its behalf. In the event that the Company or the Legion liquidator are unable to access the funds on deposit with Mutual, the Company may be required to fund the related workers’ compensation claims for the applicable policy years, to the extent that such losses are not covered by the applicable state guaranty funds. In fiscal 2003 and 2004, the Legion liquidator ordered the Company’s TPA to forward all workers’ compensation claims related to fiscal 2002 to the state guaranty funds that will be administering these claims. Since these claims are not in the Company’s control, it may not be able to obtain current information as to the settlement of these claims and to the use of their deposits to satisfy these claims. The Company had a net receivable totaling $0.1 million and $0.5 million as of June 30, 2010 and 2009, respectively, related to this policy year.
(10) Derivative Instruments and Hedging Activities
To reduce its exposure to interest rate risk related to its variable-rate debt, the Company entered into a three-year interest rate cap contract during the third quarter of fiscal 2010. The interest rate cap covers a notional amount of $60.0 million of the 2009 Term Loan for three years (see Note 11). The interest rate cap qualifies for hedge accounting and has been formally designated as a cash flow hedging instrument. The fair value of the instrument is reported on the Company’s Consolidated Balance Sheet. The effective portion of the gain or loss on the instrument is reported as a component of other comprehensive income and reclassified into earnings as interest income/expense in the same periods during which the hedged forecasted transactions affect earnings.
The fair value of the instrument as of June 30, 2010 was $0.2 million (see Note 2) and is reported in other assets on the Consolidated Balance Sheet. The fair value of the components of the contract that mature within twelve months is reported as prepaid expenses and other and is not significant. For fiscal 2010, a decrease in the fair value of the instrument of $0.4 million, net of income tax benefit of $0.2 million, was recognized in other comprehensive income and no amounts of accumulated other comprehensive income were reclassified into earnings. The Company expects to reclassify $43,000 of existing losses reported in accumulated other comprehensive income to interest expense within the next twelve months. The balance of the comprehensive loss in accumulated other comprehensive income as of June 30, 2010 was $0.4 million, net of income tax benefit. There was no cash flow hedge ineffectiveness for fiscal 2010.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(11) Long-Term Debt
The following is a summary of the Company’s outstanding long-term debt (in thousands):
Debt Maturities
Aggregate annual maturities on long-term debt as of June 30, 2010 for each of the fiscal years ending June 30 are as follows (in thousands):
As of June 30, 2010, the Company had outstanding letters of credit which mature during the next twelve months totaling $44.6 million, of which $44.5 million support general/auto liability and workers’ compensation insurance programs. The Company anticipates renewing these letters of credit.
2009 Credit Facility
Effective December 9, 2009, the Company, through its wholly-owned subsidiary Rural/Metro Operating Company, LLC (“Rural/Metro LLC”) entered into a transaction whereby the 2005 Credit Facility was terminated. In connection with this transaction a tender offer was also made for the Senior Subordinated Notes. In order to terminate the existing debt Rural/Metro LLC entered into a new five-year $180.0 million term loan and a four-year $40.0 million revolving credit facility with a $25.0 million letter of credit sub-line (“2009 Credit Facility”). The Company and its domestic subsidiaries are guarantors of Rural/Metro LLC’s obligations under the 2009 Credit Facility. Additionally, the Company entered into a cash collateralized letter of credit facility agreement that provided $17.6 million in letters of credit secured by $17.8 million deposited in a restricted account. The Company elected to use the gross method to account for the debt refinancing. As a result of the refinancing, the Company recognized a $13.8 million loss on debt extinguishment in the Consolidated Statement of Operations. The loss on debt extinguishment was comprised of the write-off of unamortized debt issuance
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
costs related to the Company’s 2005 Credit Facility and the expensing of certain third-party and lender fees, offset by the capitalization of debt issuance costs on the 2009 Credit Facility. The Company called the remaining $4.0 million of Senior Subordinated Notes during the third quarter of fiscal 2010 and recognized additional loss on debt extinguishment of $0.3 million. See Senior Subordinated Notes below.
The loss on debt extinguishment and changes in unamortized debt issuance costs at the date of the transaction (in thousands) are summarized as follows:
Term Loan due December 2014
The 2009 Credit Facility includes a $180.0 million Term Loan due in December 2014 (“Term Loan due December 2014”). The Term Loan due December 2014 bears interest at the LIBOR plus an applicable margin of 5% subject to a LIBOR floor of 2%, or at Rural/Metro LLC’s option, the Alternate Base Rate (“ABR”) as defined in the credit agreement plus an applicable margin of 4% subject to an ABR floor of 3%. In the case of the LIBOR option, whereby the contract periods may be equal to one, two, three or six months from the date of initial borrowing, interest is payable on the last day of each contract period, subject to a maximum payment term of three months. Interest is payable at the end of each quarter in the case of the ABR option. The Term Loan due December 2014 requires quarterly principal payments totaling 1% of the original Term Loan principal balance in the first year, 5% of the original Term Loan principal balance in the second through fourth years and 10% of the original Term Loan principal balance in the fifth year of the agreement. Additionally, annual principal payments equal to 50% of fiscal year-end excess cash flow, as defined in the credit agreement, are required. The required excess cash flow payments may decrease to 25% or 0% based on the total leverage ratio, as defined in the credit agreement. The Term Loan due December 2014 may be prepaid without penalty (other than payment of certain losses and expenses incurred by the lender as a result of such prepayment) at any time at the option of Rural/Metro LLC. In addition to the scheduled principal payments, the Company is required to make an excess cash flow payment, as defined under its 2009 Credit Facility, of $1.9 million within 90 days of June 30, 2010. The excess cash flow payment will be applied to the principal balance of the Term Loan due 2014.
Based on the required principal payment terms and the excess cash flow payment, $6.4 million of the Term Loan due December 2014 has been classified as current on the Consolidated Balance Sheet as of June 30, 2010.
The Company purchased an interest rate cap as a hedge for $60.0 million of the Term Loan due December 2014 as discussed in Note 10 above.
The Company capitalized $2.8 million of debt issuance costs related to the Term Loan due December 2014 which includes the transfer of $1.4 million of unamortized debt issuance costs from the 2005 Credit Facility and
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
$1.4 million of fees incurred with third parties. The Company is amortizing those costs as interest expense over the term of the loan. Additionally, the Term Loan due December 2014 was issued at a discount of $1.8 million and $3.0 million of lender fees were also recorded as a discount, both of which are being accreted to interest expense over the term of the loan.
As of June 30, 2010, all of the outstanding Term Loan due December 2014 balance was accruing interest at 7.00% per annum under three-month LIBOR contracts.
2009 Revolving Credit Facility
The 2009 Credit Facility includes a $40.0 million revolving credit facility, which matures in December 2013 (“2009 Revolving Credit Facility”). The 2009 Revolving Credit Facility includes a letter of credit sub-line whereby $25.0 million of the facility can be utilized to issue letters of credit. Letters of credit issued under the facility reduce the borrowing capacity on the total facility. Borrowings on the Revolving Credit Facility bear interest at LIBOR plus an applicable margin of 5% subject to a LIBOR floor of 2% or, at Rural/Metro LLC’s option, the ABR as defined in the credit agreement plus an applicable margin of 4% subject to an ABR floor of 3%. In the case of the LIBOR option, whereby the contract periods may be equal to one, two, three or six months from the date of initial borrowing, interest is payable on the last day of each contract period, subject to a maximum payment term of three months. Interest is payable at the end of each quarter in the case of the ABR option. Additionally, Rural/Metro LLC will pay a commitment fee to the Revolving Credit Facility lenders equal to 0.75% on the undrawn revolving commitment, payable quarterly. An administrative fee of $125,000 per year is required to be paid in quarterly installments with the first installment due on the closing date.
Amounts related to outstanding letters of credit issued under the 2009 Revolving Credit Facility bear a participation fee of 5.0% and a fronting fee of 0.25%, payable quarterly.
The Company capitalized $1.5 million of debt issuance costs related to the 2009 Revolving Credit Facility which includes $0.8 million paid to the lenders in the facility and $0.7 million of fees incurred with third parties. The Company is amortizing those costs as interest expense over the term of the facility.
As of June 30, 2010, letters of credit totaling $24.6 million were outstanding under the 2009 Revolving Credit Facility. These letters of credit primarily support the Company’s insurance deductible programs. Aside from the letters of credit issued under the facility, no other amounts were outstanding under the 2009 Revolving Credit Facility as of June 30, 2010.
Cash Collateralized Letter of Credit Facility
In addition to the $25.0 million letter of credit sub-line available under the 2009 Revolving Credit Facility, the Company entered into an additional letter of credit agreement (“Cash Collateralized LC Facility”). The initial commitment under the Cash Collateralized LC Facility was $17.6 million and matures on December 9, 2011 (the “Maturity Date”). Letters of credit issued under the agreement expire on the earlier of one year after the date of issuance, renewal or extension up to one year after the Maturity Date (subject to renewal in certain cases). These letters of credit primarily support the Company’s insurance deductible programs.
The Company executed a collateral pledge agreement as a condition to the Cash Collateralized LC Facility. The collateral pledge agreement requires the Company to maintain on deposit an amount equal to the amount of the commitments under the Cash Collateralized LC Facility plus 1.375% for fees and cash reserves. The deposit is maintained in certificates of deposit and will be used as security in the event any of the lenders are required to make a letter of credit disbursement. As of June 30, 2010, the Company had $20.1 million in letters of credit
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
outstanding under the Cash Collateralized LC Facility and $20.4 million in restricted cash on deposit to guarantee those letters of credit. The restricted cash related to the Cash Collateralized LC Facility has been classified as a noncurrent asset on the Consolidated Balance Sheets due to the Company’s intent for the letters of credit to remain outstanding for a period greater than 12 months.
The Company must pay a participation fee of 1.25% of the face amount of the letters of credit, quarterly in arrears, to the administrative agent. The Company also must pay a 0.125% fronting fee to any new lenders if additional lenders enter the agreement.
The Company capitalized $28,000 of debt issuance costs related to the Cash Collateralized LC Facility. The Company is amortizing those costs as interest expense over the term of the facility.
2005 Credit Facility
The Company’s 2005 Credit Facility included a Term Loan B Facility maturing in 2011, a $45.0 million Letter of Credit Facility maturing in 2011 and a $20.0 million Revolving Credit Facility maturing in March 2010, each of which was terminated in conjunction with the Company entering into the 2009 Credit Facility, as discussed above. The Term Loan B Facility, the Letter of Credit Facility and the Revolving Credit Facility are described below.
Term Loan B Facility
During fiscal 2010, the Company made a $10.0 million principal repayment on its Term Loan B and repaid the balance of $56.0 million in connection with its December 2009 refinancing transaction. There were no prepayment penalties or fees associated with the principal repayments under the Term Loan B (other than our reimbursement of certain losses and expenses incurred by the lender as a result of such repayment). In connection with the $10.0 million principal repayment the Company wrote-off $0.1 million of debt issuance costs. In connection with its December 2009 refinancing transaction the Company incurred third-party fees and wrote off the remaining $0.5 million of unamortized debt issuance costs, a portion of which was transferred to the 2009 Term Loan and a portion of which was expensed as loss on debt extinguishment.
The Term Loan B bore interest at LIBOR plus 3.50% per annum, based on contractual periods from one to six months in length at the option of the Company. Through December 9, 2009, when the entire balance was repaid, all of the outstanding Term Loan B balance was under LIBOR option one-month contracts accruing interest at 3.74% per annum based on the interest rate contracts in effect at that time. As of June 30, 2009, all of the outstanding Term Loan B balance was under a LIBOR one-month contract accruing interest at 3.8175% per annum.
Letter of Credit Facility
In connection with its December 2009 refinancing transaction the Company terminated the Letter of Credit Facility. In connection with the termination of the facility, the Company incurred third-party fees and wrote-off the remaining $0.4 million of unamortized debt issuance costs, a portion of which was transferred to the 2009 Credit Facility and a portion of which was expensed as the loss on debt extinguishment. In connection with its December 2009 refinancing transaction the Company transferred its letters of credit under the 2005 Credit Facility to its letter of credit facility sub-line under its 2009 Revolving Credit Facility and its Cash Collateralized Letter of Credit Facility.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The Letter of Credit Facility was available primarily to support and/or replace existing and future insurance deductible arrangements of the Company, Rural/Metro LLC and the Guarantors as defined by the 2005 Credit Facility agreement. The Letter of Credit Facility required the Company to pay a participation fee of 3.50% plus an administrative fee of 0.15% for a total of 3.65% per annum on the total facility payable quarterly. In addition, Rural/Metro LLC was required to pay a fronting fee of 0.125% per annum on issued letters of credit payable quarterly.
Revolving Credit Facility
In connection with its December 2009 refinancing transaction the Company terminated its Revolving Credit Facility under the 2005 Credit Facility. In connection with the termination of the facility, the Company incurred third-party fees and wrote-off the remaining $51,000 of unamortized debt issuance costs, a portion of which was transferred to the 2009 Credit Facility and a portion of which was expensed as the loss on debt extinguishment. The Company’s $20.0 million Revolving Credit Facility included a letter of credit sub-line in the amount of $10.0 million and any letters of credit issued under the sub-line reduced the amount of drawings available under the Revolving Credit Facility by the amount of such letters of credit. A commitment fee of 0.50% was payable on the total undrawn revolving commitment, plus a fronting fee of 0.25% on any letter of credit issued under the sub-line, payable at the end of each quarter.
Senior Subordinated Notes
In the second quarter of fiscal 2010, the Company announced the launch of a tender offer and consent solicitation for its outstanding 9.875% Senior Subordinated Notes. The purchase price per $1,000 principal amount of Senior Subordinated Notes to be paid for each validly tendered Senior Subordinated Note was (1) the redemption price of the Senior Subordinated Notes plus scheduled interest to March 15, 2010, discounted based on a yield to March 15, 2010 that is equal to the sum of (i) the yield on the 4.00% US Treasury note due March 15, 2010, and (ii) a fixed spread of 50 basis points, less (2) an amount equal to the consent payment. Those Senior Subordinated Note holders who tendered on or before the consent date of November 20, 2009 were paid a consent fee of $20 per $1,000 of principal amount of Senior Subordinated Notes. This equated to a payment of $1,074.14 for each $1,000 of principal amount of Senior Subordinated Notes for those tendered on or before the consent date and $1,054.14 for each $1,000 of principal amount of Senior Subordinated Notes tendered subsequent to the consent date. A total of $121.0 million of principal amount of Senior Subordinated Notes were tendered on or before the consent date. None of the remaining Senior Subordinated Notes were tendered after the consent date but prior to the expiration date of December 8, 2009.
In connection with its December 2009 refinancing transaction the Company paid lenders $9.0 million of tender and consent fees, incurred third-party fees and wrote-off $2.8 million of unamortized debt issuance costs, a portion of which was transferred to the 2009 Credit Facility and a portion of which was expensed as debt extinguishment.
The Company used $4.2 million of restricted cash to call the remaining $4.0 million of Senior Subordinated Notes during the third quarter of fiscal 2010. The Company remitted to lenders the $4.0 million outstanding principal plus a call premium of $0.2 million which was equal to 4.938% of the principal balance as required by the terms of the agreement governing such Senior Subordinated Notes. The Company recognized a loss on debt extinguishment of $0.3 million which includes the call premium and the write-off of $0.1 million of unamortized debt issuance costs.
12.75% Senior Discount Notes
In March 2005, Rural/Metro Corporation completed a private placement of the Senior Discount Notes and received gross proceeds of $50.2 million. While interest was accrued prior to March 15, 2010, cash interest
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
payments will be due beginning September 15, 2010. The Senior Discount Notes had an initial accreted value of $536.99 per $1,000 principal amount at maturity. The accreted value increased from the date of issuance until March 15, 2010 at a rate of 12.75% per annum compounded semiannually such that the accreted value equaled the principal amount at maturity of each Senior Discount Note on that date. The accreted value of the Senior Discount Notes was $93.5 million at June 30, 2010 and $85.7 million at June 30, 2009. The Senior Discount Notes have been registered under the Securities Act of 1933, as amended.
The Senior Discount Notes are unsecured senior obligations of Rural/Metro Corporation and will rank equally in right of payment with all its existing and future unsecured senior obligations and senior to its subordinated indebtedness. The Senior Discount Notes will be subordinated to the Company’s existing and future secured indebtedness, including its guarantee of the 2009 Credit Facility, to the extent of the assets securing that indebtedness. The Senior Discount Notes are not guaranteed by any of Rural/Metro Corporation’s subsidiaries and are subordinated to all obligations of Rural/Metro Corporation’s subsidiaries.
Rural/Metro Corporation may redeem all or part of the Senior Discount Notes at various redemption prices given the date of redemption as set forth in the indenture governing the Senior Discount Notes. If Rural/Metro Corporation experiences a change of control, it may be required to offer to purchase the Senior Discount Notes at a purchase price equal to 101% of their accreted value, plus accrued and unpaid interest.
The Company capitalized costs totaling $2.2 million related to this issuance and is amortizing these costs to interest expense over the term of the Senior Discount Notes. Unamortized deferred financing costs related to the Senior Discount Notes were $1.1 million and $1.3 million at June 30, 2010 and 2009, respectively.
Debt Covenants
The 2009 Credit Facility and the Senior Discount Notes include various financial and non-financial covenants applicable to Rural/Metro LLC as well as quarterly and annual financial reporting obligations.
Specifically, the 2009 Credit Facility requires Rural/Metro LLC and its subsidiaries to meet certain financial tests, including an interest expense coverage ratio, a total leverage ratio, and a senior secured leverage ratio. The 2009 Credit Facility also contains covenants which, among other things, limit the incurrence of additional indebtedness, dividends, transactions with affiliates, asset sales, acquisitions, mergers, prepayments of other indebtedness, liens and encumbrances, capital expenditures, business activities by the Company as a holding company, and other matters customarily restricted in such agreements. The financial covenants related to the Senior Discount Notes are similar to or less restrictive than those under the 2009 Credit Facility. The Company was in compliance with all of the applicable covenants under the 2009 Credit Facility and under the Senior Discount Notes as of June 30, 2010.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(12) Income Taxes
The following table shows the components of the income tax (provision) benefit from total operations (in thousands):
The following table shows the components of the income tax (provision) benefit applicable to continuing operations (in thousands):
The income tax (provision) benefit differs from the amount computed by applying the statutory U.S. federal income tax rate of 35% to income (loss) from continuing operations before income taxes as follows (in thousands):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The following table summarizes the components of the Company’s deferred tax assets and liabilities (in thousands):
As of June 30, 2010, the Company had net operating loss (“NOL”) carryforwards for federal income tax purposes of approximately $65.8 million, which expire in 2021-2024, and state NOL carryforwards of approximately $211.7 million, which expire in 2010-2030. The Company had minimum tax credit carryforwards of $2.0 million for federal income tax purposes. These credits can be carried forward indefinitely, but may only be used to the extent that regular tax exceeds the alternative minimum tax in any given year. The Company also had Federal General Business Credit carryforwards of $0.5 million which expire in 2026-2029.
As required by GAAP, management assesses the recoverability of the Company’s deferred tax assets on a regular basis and records a valuation allowance for any such assets where recoverability is determined to be unlikely. The Company’s evaluation of its valuation allowance against certain state deferred tax assets resulted in a release of the valuation allowance for two states in fiscal 2009. The Company determined that realization of these deferred tax assets is more likely than not based on past results, projected future results, and the tax laws of these jurisdictions. The valuation allowance release resulted in a benefit of $0.4 million for fiscal 2009. The Company maintained a valuation allowance of $8.1 million as of June 30, 2010 for those net operating loss carryforwards that management currently expects will expire prior to utilization.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
A summary of activity in the Company’s valuation allowance for deferred tax assets during fiscal 2010, 2009 and 2008 is as follows (in thousands):
Pursuant to Internal Revenue Code Section 382, if the Company underwent an ownership change, the NOL carryforward limitations would impose an annual limit on the amount of the taxable income that may be offset by the Company’s NOL generated prior to the ownership change. If an ownership change were to occur, the Company may be unable to use a significant portion of its NOL to offset taxable income.
The income tax provision for fiscal 2009 reflects a $1.0 million benefit for wage tax credits related to the Company’s participation in Federal and state wage tax incentive programs in the state of New York from 2002 to 2008. The income tax provision for fiscal 2010 reflects a $0.1 million benefit for wage credits earned during the year.
The Company adopted new guidance related to uncertain tax positions as of July 1, 2007. The adoption of the guidance resulted in a $12.8 million cumulative effect adjustment to retained earnings. As of the date of adoption, the Company’s unrecognized tax benefits totaled approximately $34.1 million, $30.4 million of which would favorably impact the Company’s effective tax rate if subsequently recognized. As of June 30, 2010, the Company had unrecognized tax benefits totaling approximately $33.9 million, $30.4 million of which would favorably impact the Company’s effective tax rate if subsequently recognized.
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands):
The Company recognizes potential accrued interest and penalties related to unrecognized tax benefits as a component of income tax expense. Accrued interest and penalties as of June 30, 2010 and 2009 were approximately $0.4 million and $0.5 million, respectively. Approximately $0.1 million of interest and penalties were recorded for both fiscal 2010 and 2009. To the extent interest and penalties are not assessed with respect to uncertain tax positions, amounts accrued will be reduced and reflected as a reduction of the overall income tax provision.
The Company and its subsidiaries are subject to the following significant taxing jurisdictions: U.S. federal, Arizona, California, Florida, Indiana, New York, Ohio and Tennessee. The Company has had NOLs in various years for Federal purposes and for many states. The statute of limitations for a particular tax year for examination
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
by the Internal Revenue Service is generally three years subsequent to the filing of the associated tax return. However, the Internal Revenue Service can adjust NOL carryovers up to three years subsequent to the last year in which the loss carryover is finally used. Accordingly, there are multiple years open to examination. The statute of limitations is generally three to four years for many of the states where the Company operates. The State of New York is examining the Company’s New York franchise tax returns for the years ended June 30, 2005 through 2007. The Company does not expect the result of this audit to significantly change the Company’s total unrecognized tax benefits in the next twelve months, but the outcome of tax examinations is uncertain, and unforeseen results can occur. The Company is currently not under income tax examination in any other tax jurisdictions.
The Company anticipates a reduction of $0.1 million in the total amount of unrecognized tax benefits during the next twelve months as a result of the lapsing of the statute of limitations related to a state tax position.
(13) Preferred Stock
As of June 30, 2010 and 2009, there were 2,000,000 shares of preferred stock, par value $0.01 per share, authorized, none of which were issued and outstanding.
(14) Shareholder Rights Plan
On August 24, 2005, the Company entered into a shareholder rights plan to replace the previous plan that expired on August 23, 2005. The shareholder rights plan provides for one right to be attached to each share of common stock of the Company. Each right entitles the registered holder to purchase a unit consisting of one one-thousandth of a share (a “Unit”) of Series A Junior Participating Preferred Stock, par value $0.01 per share, at a purchase price of $45 per Unit, subject to adjustment. The rights will become exercisable following the tenth day (or such later date as may be determined by the Board of Directors) after a person or group (a) acquires beneficial ownership of 15% or more of the Company’s common stock, or (b) announces a tender or exchange offer, the consummation of which would result in ownership by a person or group of 15% or more of the Company’s common stock. On March 19, 2009, the Company amended the shareholder rights plan to change the beneficial ownership at which the shareholder rights plan is triggered to 10%. On December 22, 2009, the Company amended the shareholder rights plan to change the beneficial ownership at which the shareholder rights plan is triggered to 15%.
Upon exercise and subject to adjustment, each right will entitle the holder (other than the party seeking to acquire control of the Company) to acquire a number of shares of common stock of the Company or, in certain circumstances, such acquiring person having a value equal to two times the then applicable purchase price. The rights may be terminated by the Board of Directors at any time prior to the date they become exercisable at a price of $0.01 per right; thereafter, they may be redeemed for a specified period of time at $0.01 per right. The shareholder rights plan expires on August 24, 2015.
(15) Share-based Compensation
Incentive Stock Plan
In March 2008 the Company’s stockholders approved the 2008 Incentive Stock Plan (the “2008 Plan”) which provides for the award of up to 1.0 million shares of the Company’s common stock to employees, executive officers and non-employee directors. Awards may be made in different forms including options, restricted stock, restricted stock units (“RSUs”) and stock appreciation rights (“SARs”). Options and SARs are subject to a minimum vesting period of not less than one year from the grant date. Generally awards other than options and
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
SARs are subject to a minimum vesting period of not less than three years from the grant date. Through June 30, 2010, all awards granted under the 2008 Plan have been RSUs and SARs. As of June 30, 2010, there were 0.4 million shares available under the 2008 Plan.
RSUs
RSUs granted to employees and executive officers have a fair value per unit based on the closing price of the Company’s common stock on the grant date. Vesting of the RSUs is based on continued service, certain performance metrics and a time based vesting schedule. The awards consist of three tranches equal to approximately one-third of the award each. The grant date fair value of the RSUs is recognized as compensation expense over a graded schedule with the first tranche recognized over the period between the grant date and the expected date the performance condition will be satisfied, and the remaining tranches recognized over the period between the grant date and the vesting date for each tranche.
RSUs granted to the non-employee members of the Board of Directors of the Company have a grant date fair value per unit based on the closing price of the Company’s common stock on the grant date. Subject to continued service, the RSUs vest in three equal installments upon the date of the Company’s annual meeting of stockholders each fiscal year following the grant. The grant date fair value of the RSUs is recognized as compensation expense on a straight-line basis over the vesting period.
The following table summarizes the RSU activity in the 2008 Plan for fiscal 2010:
The table below summarizes information related to RSUs for fiscal 2010, 2009 and 2008 (in thousands, except shares and per RSU amounts):
The Company satisfies RSUs vested by authorizing its transfer agent to issue new shares after confirming that all requisite service periods and performance measures have been attained. As of June 30, 2010, there was approximately $0.5 million of total unrecognized compensation cost related to nonvested RSUs granted under the 2008 Plan which is expected to be recognized over a weighted-average period of 1.8 years.
RURAL/METRO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
SARs
SARs have an exercise price equal to the closing price of the Company’s common stock on the date of grant, and a weighted average fair value determined using the Black-Scholes option pricing model with the following assumptions:
(1) No SARs were granted under the 2008 Plan during fiscal 2008.
The weighted average expected term is based on the expected exercise behavior of the executive and non-executive groups of employees granted SARs. The weighted average risk free interest rate is based on the Daily Treasury Yield Curve Rates on the grant date for each expected term. Volatility was calculated based on an average of the Company’s actual volatility over the seven years prior to each grant date.
The SARs are subject to continued service, vest over three years and have contractual terms of seven years from the grant date. The grant date fair value of the SARs is recognized as compensation expense on a straight-line basis over the vesting period.
As of June 30, 2010, there was approximately $0.3 million of total unrecognized compensation cost related to nonvested SARs granted under the 2008 Plan, which is expected to be recognized over a weighted-average period of 2.0 years.
The following table summarizes the SAR activity in the 2008 Plan for fiscal 2010:
RURAL/METRO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The table below summarizes information related to SARs for fiscal 2010, 2009 and 2008 (in thousands, except shares):
The Company satisfies SAR exercises by authorizing its transfer agent to issue new shares after confirming that all requisite conditions have been satisfied.
The following table shows share-based compensation expense and income tax benefit recognized under the 2008 Plan (in thousands):
Non-employee director RSU expense is recognized in other operating expense and employee RSU and SAR expense are recognized in payroll and employee benefits in the Consolidated Statements of Operations.
The Company withholds shares to satisfy minimum statutory federal, state and local tax withholding obligations arising from the vesting of RSUs and the exercise of SARs.
2000 Non-Qualified Stock Option Plan
The Company’s 2000 Non-Qualified Stock Option Plan (the “2000 Plan”) was adopted in August 2000 and provides for the granting of options to acquire common stock of the Company. At the time of adoption, the maximum number of shares of common stock issuable under the 2000 Plan was 2.0 million. As of June 30, 2010, 1.4 million options had been exercised and 0.1 million options remain outstanding under the 2000 Plan. In November 2007, the 2000 Plan was modified to provide that no future option grants will be made pursuant to the 2000 Plan unless the Company’s stockholders approve an amendment to the 2000 Plan to permit future option grants.
1992 Stock Option Plan
The Company’s 1992 Stock Option Plan (the “1992 Plan”) was adopted in November 1992 and expired November 5, 2002. The 1992 Plan provided for the granting of up to 6.0 million options to acquire common stock of the Company as well as the granting of common stock, SARs or other cash awards. As of June 30, 2010, 3.1 million options had been exercised and 0.1 million options remain outstanding under the 1992 Plan. Options under the 1992 Plan were granted as incentive stock options or non-qualified stock options.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
All options granted under the 1992 Plan and the 2000 Plan through June 30, 2010 have exercise prices equal to the fair value of the Company’s stock on the date of grant. Options granted under both plans have a 10 year contractual term. Shares issued upon option exercise consist of authorized but unissued shares of the Company’s common stock.
The following table summarizes stock option activity in the 1992 Plan and the 2000 Plan for fiscal 2010:
The table below summarizes information related to stock option exercises for fiscal 2010, 2009 and 2008 (in thousands, except shares):
The Company satisfies stock option exercises by authorizing its transfer agent to issue new shares after confirming that all requisite consideration has been received from the option holder.
(16) Employee Benefit Plans
401(k) Plan
The Company has a defined contribution plan (“401(k) Plan”) covering eligible employees. The 401(k) Plan allows employees to contribute a portion of their compensation on a pre-tax basis in accordance with plan and statutory rules. The Company matches a percentage of the employee’s contributions according to the 401(k) Plan rules. Contributions for non-union employees are made at the Company’s discretion. The match may be made in the Company’s common stock at the Company’s discretion and subject to plan terms. The Company may also make discretionary profit sharing contributions subject to the 401(k) Plan terms. Matching contributions of $2.3 million, $2.1 million and $1.9 million were made for the 401(k) Plan during fiscal 2010, 2009 and 2008, respectively. The contributions expense was recorded as payroll and employee benefits expense in the Consolidated Statements of Operations. The Company’s matching contribution liability was $2.4 million and $2.7 million as of June 30, 2010 and 2009, respectively. The Company did not provide matching in its common stock or contribute discretionary profit sharing during fiscal 2010, 2009, or 2008.
RURAL/METRO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Defined Benefit Pension Plan
Effective July 1, 2004, the Company established a defined benefit pension plan (the “Pension Plan”) covering eligible employees of one of its subsidiaries, primarily those covered by collective bargaining arrangements. Eligibility is achieved upon the completion of one year of service. Participants become fully vested in their accrued benefit after the completion of five years of service. The amount of benefit is determined using a two-part formula, one of which is based upon compensation and the other which is based upon a flat dollar amount.
The Company’s general funding policy is to make annual contributions to the Pension Plan as required by the Employee Retirement Income Security Act (“ERISA”). Contributions by the Company during fiscal 2010 and 2009 totaled $2.0 million and $2.2 million, respectively.
The following table shows a reconciliation of changes in the Pension Plan’s benefit obligation and plan assets for fiscal 2010 and 2009 (in thousands):
Amounts recognized in the Consolidated Balance Sheets totaling $1.7 million and $0.7 million as of June 30, 2010 and 2009, respectively, were classified as noncurrent liabilities.
Amounts in accumulated other comprehensive income (loss) before income taxes that have not been recognized as net periodic benefit cost as of June 30, 2010 and 2009 consist of (in thousands):
RURAL/METRO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The accumulated benefit obligation for the Pension Plan was $9.6 million and $6.6 million as of June 30, 2010 and June 30, 2009, respectively.
The components of net periodic benefit cost and other amounts recognized as comprehensive (income) loss are as follows (in thousands):
(a) On July 1, 2008, the Company amended the Pension Plan to change the benefit formula for eligible participants. This change resulted in the recognition of $0.7 million of prior service costs, which are reported as an adjustment to other comprehensive (income) loss.
(b) In the Consolidated Statement of Stockholders’ Deficit and Comprehensive Income, the adjustments to accumulated other comprehensive income (loss) in fiscal 2010 were net of an income tax benefit of $0.5 million consisting of a $24,000 tax provision relating to the amortization of prior service cost, a $0.1 million tax provision related to the amortization of net loss and a $0.6 million tax benefit related to the net loss.
(c) In the Consolidated Statement of Stockholders’ Deficit and Comprehensive Income, the adjustments to accumulated other comprehensive income (loss) in fiscal 2009 were net of an income tax benefit of $1.3 million consisting of a $24,000 tax provision relating to the amortization of prior service cost and a $1.3 million tax benefit related to the net loss.
(d) In the Consolidated Statement of Stockholders’ Deficit and Comprehensive Income, the adjustments to accumulated other comprehensive income (loss) in fiscal 2008 were net of an income tax benefit of $0.5 million consisting of a $0.3 million tax benefit relating to the prior service cost and a $0.2 million tax benefit related to the net loss.
The prior service cost for the Pension Plan and the net loss that will be amortized from accumulated other comprehensive income (loss) into net periodic benefit cost in fiscal 2011 are $0.1 million and $0.3 million, respectively.
RURAL/METRO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The assumptions used to determine the Company’s benefit obligation as of June 30, 2010 and 2009 were:
The assumptions used to determine the Company’s net periodic benefit cost for fiscal 2010, 2009 and 2008 were:
Assumed discount rates were determined by applying the spot rates underlying the Citigroup Pension Discount Curve to the Pension Plan’s anticipated cash flows. A level rate was calculated that when compounded annually produced the same present value as the result of the spot rate calculation above, with an adjustment to reflect a provision for expenses. The resulting adjusted level rate is the discount rate.
In developing the expected long-term rate of return assumption, management evaluated the outputs of financial models designed to simulate results under multiple investment scenarios and to estimate long-term investment returns based on the Pension Plan’s asset allocation.
The Company’s Pension Plan assets as of June 30, 2010 and 2009 by asset category are shown below:
The Company invests in a diversified portfolio to ensure that adverse or unexpected results from a security class will not have a detrimental impact on the entire portfolio. The portfolio is diversified by asset type, performance and risk characteristics and number of investments. Asset classes and ranges considered appropriate for investment of the Pension Plan’s assets are determined by the Pension Plan’s investment committee. The asset classes include domestic and foreign equities, emerging market equities, domestic and foreign investment grade and high-yield bonds and domestic real estate.
RURAL/METRO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The fair values of the Pension Plan assets as of June 30, 2010 by asset class are as follows (in thousands):
The following table presents the changes in Level 3 Pension Plan assets for fiscal 2010 (in thousands):
(a) Unrealized loss on Level 3 Pension Plan assets was $11,000 for the period ended June 30, 2010.
The Company expects to contribute approximately $2.1 million to the plan during fiscal 2011.
Future benefit payments expected to be made from plan assets are summarized below by fiscal year (in thousands):
(17) Earnings per Share
Income from continuing operations per share assuming no dilution is computed by dividing income from continuing operations by the weighted-average number of shares outstanding. Income from continuing operations per share assuming dilution is computed based on the weighted-average number of shares outstanding after consideration of the dilutive effect of stock options and RSUs.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
A reconciliation of the weighted-average number of shares outstanding utilized in the basic and diluted income from continuing operations per share computations is as follows (in thousands, except per share amounts):
For fiscal 2009 and 2008, 0.1 million and 0.4 million shares of common stock underlying stock options and SARs, respectively, were excluded from consideration for the earnings per share computation because such options had exercise prices in excess of the average market price of the Company’s common stock during the respective period and, therefore would have had an antidilutive effect. For fiscal 2010, no such options or SARs were excluded.
(18) Commitments and Contingencies
Performance Bonds
Certain counties, municipalities, and fire districts require the Company to provide a performance bond or other assurance of financial or performance responsibility. The Company may also be required by law to post a performance bond as a prerequisite to obtaining and maintaining a license to operate. As a result, the Company has performance bonds that are renewable annually. The Company had $8.6 million of performance bonds outstanding as of June 30, 2010.
Operating Leases
The Company leases various facilities and equipment under operating lease agreements. Rental expense charged to continuing operations under these leases (including leases with terms of less than one year) was $15.3 million, $15.5 million and $13.9 million in fiscal 2010, 2009 and 2008, respectively.
Minimum rental commitments under non-cancelable operating leases for each of the fiscal years ending June 30 are as follows (in thousands):
RURAL/METRO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Indemnifications
The Company is a party to a variety of agreements entered into in the ordinary course of business pursuant to which it may be obligated to indemnify other parties for certain liabilities that arise out of or relate to the subject matter of the agreements. Some of the agreements entered into by the Company require it to indemnify other parties against losses due to property damage including environmental contamination, personal injury, failure to comply with applicable laws, the Company’s negligence or willful misconduct, or breach of representations and warranties and covenants.
Additionally, some of the Company’s customer agreements require the Company to provide certain assurances related to the performance of its services. Such assurances, from time to time, obligate the Company to (i) pay penalties for failure to meet response times or other requirements, (ii) lease, sell or assign equipment or facilities (either temporarily or permanently) in the event of uncured material defaults or other certain circumstances, or (iii) provide performance bonds or letters of credit issued in favor of the customer to cover costs resulting, under certain circumstances, from an uncured material default. With respect to such performance bonds, the Company is also required to indemnify the surety company for losses paid as a result of any claims made against such bonds.
The Company and its subsidiaries provide for indemnification of directors, officers and other persons in accordance with limited liability agreements, certificates of incorporation, by-laws, articles of association or similar organizational documents, as the case may be. In addition, the Company has entered into indemnification agreements with its directors and certain officers of the Company. The Company maintains directors’ and officers’ insurance, which should enable it to recover a portion of any future amounts paid.
In addition to the above, from time to time the Company provides standard representations and warranties to counterparties in contracts in connection with sales of its securities and the engagement of financial advisors, and also provides indemnities that protect the counterparties to these contracts in the event they suffer damages as a result of a breach of such representations and warranties, or in certain other circumstances relating to the sale of securities or their engagement by the Company.
While the Company’s future obligations under certain agreements may contain limitations on liability for indemnification, other agreements do not contain such limitations, and under such agreements it is not possible to predict the maximum potential amount of future payments due to the conditional nature of the Company’s obligations and the unique facts and circumstances involved in each particular agreement. Historically, payments made by the Company under any of these indemnities have not had a material effect on the Company’s business, financial condition, results of operations or cash flows. Additionally, the Company does not believe that any amounts that it may be required to pay under these indemnities in the future will be material to the Company’s business, financial condition, results of operations or cash flows.
Legal Proceedings
From time to time, the Company is a party to, or otherwise involved in, lawsuits, claims, proceedings, investigations and other legal matters that have arisen in the ordinary course of conducting its business. The Company cannot predict with certainty the ultimate outcome of any of these lawsuits, claims, proceedings, investigations and other legal matters which it is a party to, or otherwise involved in, due to, among other things, the inherent uncertainties of litigation, government investigations and proceedings and legal matters in general. The Company is also subject to requests and subpoenas for information in independent investigations. An unfavorable outcome in any of the lawsuits pending against the Company or in a government investigation or proceeding could result in substantial potential liabilities and have a material adverse effect on the Company’s business, financial condition, results of operations and cash flows. Further, these proceedings and investigations,
RURAL/METRO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
and the Company’s actions in response to them, could result in substantial potential liabilities, additional defense and other costs, increase the Company’s indemnification obligations, divert management’s attention, and/or adversely affect the Company’s ability to execute its business and financial strategies.
Regulatory Compliance
The Company is subject to numerous laws and regulations of federal, state and local governments. These laws and regulations include, but are not limited to, matters such as licensure, accreditation, government healthcare program participation requirements, reimbursement for patient services and Medicare and Medicaid fraud and abuse. Within the healthcare industry, government investigations and allegations concerning possible violations of fraud and abuse statutes and regulations by healthcare providers is ongoing. From time to time, the Company is subject to investigations relating to Medicare and Medicaid laws pertaining to its industry. The Company cooperates fully with the government agencies that conduct these investigations. Violations of these laws and regulations could result in exclusion from government healthcare programs together with the imposition of significant fines and penalties, as well as significant repayments for patient services previously billed. Under the Company’s existing compliance program, the Company initiates its own investigations and conducts audits to examine compliance with various policies and regulations, including periodic reviews of the levels of service and corresponding rates the Company bills to various payers. Internal investigations or audits may result in significant repayment obligations for patient services previously billed or the modification of estimates relating to reimbursements. For example, in the quarter ended March 31, 2010, following a review of certain claims in the Company’s Mid-Atlantic segment, a reserve was established in the amount of $1.5 million for a change in estimate relating to levels of service on claims for which the Company was previously reimbursed. The Company believes that it is substantially in compliance with fraud and abuse statutes and their applicable governmental interpretation.
Ohio Medicare
The Company is cooperating with an investigation by the U.S. government regarding the Company’s operations in the State of Ohio in connection with allegations of certain billing inaccuracies. Specifically, the government alleges that certain services performed between 1997 and 2001 did not meet Medicare medical necessity and reimbursement requirements. The government has examined sample records for each of the years stated above. The Company disagrees with the allegations and believes that there are errors in the sampling methodology performed by the government. Although the Company continues to disagree with the government’s allegations, the Company is engaged in settlement negotiations with the government and has made a counteroffer of $2.4 million in exchange for a full release relating to the government’s allegations. During fiscal 2009, the Company recorded charges of $0.8 million to continuing operations and $0.4 million to discontinued operations, as a portion of this matter relates to the Company’s discontinued operation in Marion, Ohio. In fiscal 2010, no additional charges were recorded. As of June 30, 2010, $2.4 million remained accrued for this matter. Although there can be no assurances that a settlement agreement will be reached, any such settlement agreement would likely require the Company to make a substantial payment to the government and may require the Company to enter into a Corporate Integrity Agreement (“CIA”) or similar arrangement. If a settlement is not reached, the government has indicated that it will pursue further civil action. At this time it is not possible to predict the ultimate conclusion of this investigation.
Texas Anti-Kickback Statute
In fiscal 2007, the Company negotiated a settlement in connection with the U.S. government investigation into alleged discounts made in violation of the federal Anti-Kickback Statute related to the Company’s discontinued operations in the State of Texas. Specifically, that certain of the Company’s contracts with medical facilities in effect in Texas prior to 2002 contained discounts in violation of the federal Anti-Kickback Statute. In connection with the settlement of the matter, the Company entered into a CIA, which is effective for a period of five years, beginning April 18, 2007. Pursuant to the CIA, the Company is required to maintain a compliance program that
RURAL/METRO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
includes, among other things, the appointment of a compliance officer and committee; the training of employees nationwide; enhancing procedures relating to certain of our contracting processes, including tracking contractual arrangements; review by an independent review organization; and reporting of certain reportable events.
These requirements are currently a part of the Company’s ongoing compliance program. Although this matter has been settled, there can be no assurances that other investigations or legal action related to these or similar matters will not be pursued against the Company in other jurisdictions or for different time frames.
During fiscal 2008, the Company made full payment on the remaining $1.4 million Texas obligation.
Tennessee Medicare
The Company appealed a determination made by a Medicare intermediary that certain claims for services provided in the Company’s Tennessee market were not reimbursable. Following an appeal and subsequent recalculation by the Medicare intermediary during fiscal 2008, the Company repaid $1.7 million to the Medicare intermediary in order to satisfy these overpayments.
The Company believes that reserves established for specific contingencies of $3.9 million and $2.4 million as of June 30, 2010 and 2009, respectively, are adequate based on information currently available. The specific contingencies at June 30, 2010 primarily include the Ohio matter and service level matter discussed above.
(19) Segment Reporting
The Company has four regional reporting segments that correspond with the manner in which the associated operations are managed and evaluated by its chief operating decision maker. Although some of the Company’s operations do not align with the segments’ geographic designation, all operations have been structured to capitalize on management’s strengths. These segments comprise operations within the following areas:
Segment
States
Mid-Atlantic
New York, Northern Ohio
South
Alabama, Florida (fire), Georgia, Indiana, Kentucky, Louisiana, Mississippi, Missouri,
New Jersey, North Dakota, Oregon (fire), Southern Ohio, Tennessee
Southwest
Arizona
West
California, Central Florida (ambulance), Colorado, Nebraska, Oregon (ambulance),
South Dakota, Washington
Each reporting segment provides ambulance services while the Company’s fire and other services are in the South and Southwest segments.
Effective July 1, 2010, the Company realigned its reporting segments to align with their geographic designation. Beginning in the first quarter of fiscal 2011, we will recast prior period information to reflect the changes in reporting segments.
The accounting policies used in the preparation of the Company’s consolidated financial statements have also been followed in the preparation of the accompanying financial information for each reporting segment. For management purposes, the Company’s measure of segment profitability is defined as income from continuing operations before depreciation and amortization, interest, income taxes and loss on extinguishment of debt. Additionally, corporate overhead allocations have been included within segment profits. Segment results presented below reflect continuing operations only. Segment asset information is not used by the Company’s chief operating decision maker in assessing segment performance.
RURAL/METRO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The following table summarizes segment information for fiscal 2010, 2009 and 2008:
(1) Other services consists of revenue generated from fire protection services; including master fire contract and subscription fire services, airport fire and rescue, home health care services, dispatch contracts, billing contracts and other miscellaneous forms of revenue.
The following is a reconciliation of segment profit to income from continuing operations before income taxes (in thousands):
(20) Discontinued Operations
During fiscal 2010, the Company made the decision to exit fire protection contracts in Florida and Wisconsin and ambulance services contracts in Salt Lake City, Utah and Jefferson County, Georgia. Because the operations in these markets are considered separate components of the Company as defined by GAAP, their results of operations are reported as income from discontinued operations in the Consolidated Statements of Operations for fiscal 2010, 2009 and 2008. Although the decision to exit these markets occurred in fiscal 2010, the Consolidated Statements of Operations for fiscal 2009 and 2008 have been recast to reflect these operations as discontinued. There were no discontinued operations related to the noncontrolling interest for fiscal 2010, 2009 and 2008.
RURAL/METRO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Revenue and income (loss) from discontinued operations for fiscal 2010, 2009 and 2008 (in thousands) were as follows:
Income (loss) from discontinued operations is presented net of income tax provision/(benefit) of $(0.3) million, $(0.5) million and $0.2 million for fiscal 2010, 2009 and 2008, respectively.
In addition to the recurring revenues and expenses associated with operations classified as discontinued, the Company recognized certain non-recurring pre-tax gains and losses during fiscal 2010, 2009 and 2008 as described below.
•
As discussed in Note 2, during fiscal 2008, the Company recognized gains of $2.1 million on the sale of certain previously written-off self pay accounts receivables of which $0.4 million was included within income (loss) from discontinued operations for fiscal 2008. The gains associated with discontinued operations were allocated to the Company’s Mid-Atlantic, South, Southwest and West segments and were $14,000, $200,000, $36,000 and $101,000, respectively.
•
During fiscal 2008, the Company recorded an additional reserve in the amount of $0.7 million for a change in estimate relating to the U.S. government’s review of reimbursement levels for certain patients in the Company’s Washington, D.C. operations, which were discontinued during fiscal 2004. The impact of this additional reserve is included in the Mid-Atlantic segment’s loss from discontinued operations for fiscal 2008. The total reserve for this issue was $0.6 million at June 30, 2008.
•
During fiscal 2008, the Company recognized $0.6 million of revenue upon the termination of its contract in Queen Creek, Arizona, effective January 1, 2008. This revenue is recorded in the Southwest segment’s income from discontinued operations for fiscal 2008.
(21) Variable Interest Entities
GAAP may require a company to consolidate in its financial statements the assets, liabilities and activities of a VIE. GAAP provides guidance as to the definition of a VIE and requires that such VIEs be consolidated if the interest in the entity has certain characteristics including: voting rights not proportional to ownership and the
RURAL/METRO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
right to receive the majority of expected residual returns or the requirement to absorb a majority of the expected losses. Additionally, the party exposed to the majority of the risks and rewards is the entity’s primary beneficiary, and the primary beneficiary must consolidate the entity.
In 2003, the Company determined that its investment in San Diego Medical Services Enterprise, LLC (“SDMSE”), the entity formed with respect to our public/private alliance with the City of San Diego, meets the definition of a VIE and that the Company is the primary beneficiary. The determination was made because:
•
The Company is entitled to a 50% interest in the profits and losses of SDMSE based on ownership percentage, but is only entitled to a 40% interest in voting;
•
SDMSE operates as the emergency services provider to the City of San Diego and certain surrounding areas. The Company provides emergency services personnel as well as administrative functions such as billing, purchasing and accounting to SDMSE. Therefore substantially all of SDMSE’s activities involve the Company; and
•
If cumulative losses exceed a determined threshold, the Company must absorb 100% of losses above that threshold.
Accordingly, the Company’s investment in SDMSE must be consolidated under GAAP. The Company began consolidating SDMSE during the fiscal 2003 based on its analysis and restated prior periods as allowed under GAAP.
The Company believes, based on the historical financial performance of SDMSE, that the probability is remote that SDMSE’s losses will exceed the cumulative threshold and require the Company to absorb 100% of the additional losses.
The following is a summary of SDMSE’s assets and liabilities (in thousands):
The assets held by SDMSE are generally not available for use by the Company. SDMSE’s operations are financed from cash flows from operations.
Under GAAP, the Company must reassess the VIE status if there are changes in the entity’s capital structure and/or in its activities or assets. The Company has not changed its determination of SDMSE’s status as a VIE since its original analysis in fiscal 2003.
Quarterly Financial Data
Refer to Item 6. Selected Financial Data, for the unaudited quarterly financial data.
ITEM 9.
ITEM 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure
Not applicable.
ITEM 9A.
ITEM 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Management, under the supervision and with the participation of the Chief Executive Officer and Chief Financial Officer, evaluated its disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this Report (June 30, 2010). The Company’s disclosure controls were designed to provide a reasonable assurance that information required to be disclosed in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and that such information is accumulated and communicated to management, including the Chief Executive Officer and the Chief Financial Officer, to allow timely decisions regarding required disclosures. It should be noted that the design of any system of controls is based, in part, upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote. However, the controls have been designed to provide reasonable assurance of achieving the controls’ stated goals. Based upon this evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective to provide reasonable assurance as of June 30, 2010.
Management’s Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)). Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
The Company’s management assessed the effectiveness of its internal control over financial reporting as of June 30, 2010. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework (the “COSO”). Based on our assessment using those criteria, our management concluded that our internal control over financial reporting was effective as of June 30, 2010.
The effectiveness of the Company’s internal control over financial reporting as of June 30, 2010 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears in Part II, Item 8 of this Annual Report on Form 10-K.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting during the last fiscal quarter that materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
ITEM 9B.
ITEM 9B. Other Information
Not applicable.
PART III
ITEM 10.
ITEM 10. Directors, Executive Officers and Corporate Governance
The information required by Item 10 is incorporated herein by reference to the information responsive to this Item contained in the Company’s definitive proxy statement for its 2010 Annual Meeting of Stockholders.
Our website (www.shareholder.com/ruralmetro/downloads/Code_of_Business_Conduct.pdf) contains the Company’s Code of Ethics and Business Conduct (“Code of Ethics”), which is the Company’s code of business conduct and ethics for its directors and employees, including the Chief Executive Officer and Chief Financial Officer. Any amendment to the Code of Ethics will be posted on the Company’s website.
ITEM 11.
ITEM 11. Executive Compensation
The information required by Item 11 is incorporated herein by reference to the information responsive to this Item contained in the Company’s definitive proxy statement for its 2010 Annual Meeting of Stockholders.
ITEM 12.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by Item 12 is incorporated herein by reference to the information responsive to this Item contained in the Company’s definitive proxy statement for its 2010 Annual Meeting of Stockholders.
ITEM 13.
ITEM 13. Certain Relationships and Related Transactions, and Director Independence
The information required by Item 13 is incorporated herein by reference to the information responsive to this Item contained in the Company’s definitive proxy statement for its 2010 Annual Meeting of Stockholders.
ITEM 14.
ITEM 14. Principal Accounting Fees and Services
The information required by Item 14 is incorporated herein by reference to the information responsive to this Item appearing in the Company’s definitive proxy statement for its 2010 Annual Meeting of Stockholders.
PART IV
ITEM 15.
ITEM 15. Exhibits and Financial Statement Schedules
(a) List of documents filed as a part of this Form 10-K:
(1) See the Consolidated Financial Statements included in Item 8 hereof.
(b) Exhibits
* Filed herewith.
+ Furnished but not filed.
** Management contracts or compensatory plan or arrangement.
(1) Incorporated by reference to the Registration Statement on Form S-1 of the Registrant (Registration No. 33-63448) filed May 27, 1993 and declared effective July 15, 1993.
(2) Incorporated by reference to the Registrant’s Form 10-Q filed with the Commission on or about November 10, 1998.
(3) Incorporated by reference to the Registrant’s Form S-8 Registration Statement filed with the Commission on October 31, 2000.
(4) Incorporated by reference to the Registrant’s Form S-8 Registration Statement filed with the Commission on May 22, 2001.
(5) Incorporated by reference to the Registrant’s Form 8-A/A filed with the Commission on December 22, 2009.
(6) Incorporated by reference to the Registrant’s Form 8-K filed with the Commission on December 14, 2009.
(7) Incorporated by reference to the Registrant’s Form 8-K/A filed with the Commission on March 11, 2005.
(8) Incorporated by reference to the Registrant’s Form 8-A/A filed with the Commission on August 29, 2005.
(9) Incorporated by reference to the Registrant’s Form 10-K filed with the Commission on September 28, 2005.
(10) Incorporated by reference to the Registrant’s Form 8-K filed with the Commission on December 28, 2005.
(11) Incorporated by reference to the Registrant’s Form 10-Q filed with the Commission on May 10, 2006.
(12) Incorporated by reference to the Registrant’s Form 8-K filed with the Commission on May 26, 2010.
(13) Incorporated by reference to the Registrant’s Form 10-Q filed with the Commission on November 14, 2006.
(14) Incorporated by reference to the Registrant’s Form 8-K filed with the Commission on January 23, 2007.
(15) Incorporated by reference to the Registrant’s Form 8-K filed with the Commission on March 19, 2007.
(16) Incorporated by reference to the Registrant’s Form 10-Q filed with the Commission on March 23, 2007.
(17) Incorporated by reference to the Registrant’s Form 8-K filed with the Commission on October 17, 2007.
(18) Incorporated by reference to the Registrant’s Form 10-Q filed with the Commission on November 14, 2007.
(19) Incorporated by reference to the Registrant’s Form 10-Q filed with the Commission on February 11, 2008.
(20) [Reserved.]
(21) Incorporated by reference to the Registrant’s Form 8-K filed with the Commission on March 31, 2008.
(22) Incorporated by reference to the Registrant’s Form 8-K filed with the Commission on August 13, 2008.
(23) Incorporated by reference to the Registrant’s Form 8-K filed with the Commission on July 16, 2010.
(24) Incorporated by reference to the Registrant’s Form 8-A/A filed with the Commission on September 18, 2008.
(25) Incorporated by reference to the Registrant’s Form 8-A/A filed with the Commission of March 19, 2009.
(26) Incorporated by reference to the Registrant’s Form 10-Q filed with the Commission on February 9, 2008.
(27) Incorporated by reference to the Registrant’s Form 10-K filed with the Commission on September 15, 2008.
(28) Incorporated by reference to the Registrant’s Form 8-K filed with the Commission on June 9, 2010.
SIGNATURES
Pursuant to the requirement of Section 13 or 15(d) 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.
RURAL/METRO CORPORATION
By:
/s/ MICHAEL P. DIMINO
Michael P. DiMino
President and Chief Executive Officer
September 8, 2010
Pursuant to the requirements of the Securities Act of 1934, this Report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.
EXHIBIT INDEX
* Filed herewith.
+ Furnished but not filed.
** Management contracts or compensatory plan or arrangement.
(1) Incorporated by reference to the Registration Statement on Form S-1 of the Registrant (Registration No. 33-63448) filed May 27, 1993 and declared effective July 15, 1993.
(2) Incorporated by reference to the Registrant’s Form 10-Q filed with the Commission on or about November 10, 1998.
(3) Incorporated by reference to the Registrant’s Form S-8 Registration Statement filed with the Commission on October 31, 2000.
(4) Incorporated by reference to the Registrant’s Form S-8 Registration Statement filed with the Commission on May 22, 2001.
(5) Incorporated by reference to the Registrant’s Form 8-A/A filed with the Commission on December 22, 2009.
(6) Incorporated by reference to the Registrant’s Form 8-K filed with the Commission on December 14, 2009.
(7) Incorporated by reference to the Registrant’s Form 8-K/A filed with the Commission on March 11, 2005.
(8) Incorporated by reference to the Registrant’s Form 8-A/A filed with the Commission on August 29, 2005.
(9) Incorporated by reference to the Registrant’s Form 10-K filed with the Commission on September 28, 2005.
(10) Incorporated by reference to the Registrant’s Form 8-K filed with the Commission on December 28, 2005.
(11) Incorporated by reference to the Registrant’s Form 10-Q filed with the Commission on May 10, 2006.
(12) Incorporated by reference to the Registrant’s Form 8-K filed with the Commission on May 26, 2010.
(13) Incorporated by reference to the Registrant’s Form 10-Q filed with the Commission on November 14, 2006.
(14) Incorporated by reference to the Registrant’s Form 8-K filed with the Commission on January 23, 2007.
(15) Incorporated by reference to the Registrant’s Form 8-K filed with the Commission on March 19, 2007.
(16) Incorporated by reference to the Registrant’s Form 10-Q filed with the Commission on March 23, 2007.
(17) Incorporated by reference to the Registrant’s Form 8-K filed with the Commission on October 17, 2007.
(18) Incorporated by reference to the Registrant’s Form 10-Q filed with the Commission on November 14, 2007.
(19) Incorporated by reference to the Registrant’s Form 10-Q filed with the Commission on February 11, 2008.
(20) [Reserved.]
(21) Incorporated by reference to the Registrant’s Form 8-K filed with the Commission on March 31, 2008.
(22) Incorporated by reference to the Registrant’s Form 8-K filed with the Commission on August 13, 2008.
(23) Incorporated by reference to the Registrant’s Form 8-K filed with the Commission on July 16, 2010.
(24) Incorporated by reference to the Registrant’s Form 8-A/A filed with the Commission on September 18, 2008.
(25) Incorporated by reference to the Registrant’s Form 8-A/A filed with the Commission of March 19, 2009.
(26) Incorporated by reference to the Registrant’s Form 10-Q filed with the Commission on February 9, 2008.
(27) Incorporated by reference to the Registrant’s Form 10-K filed with the Commission on September 15, 2008.
(28) Incorporated by reference to the Registrant’s Form 8-K filed with the Commission on June 9, 2010.