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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

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

 

For the quarterly period ended September 30, 2014.

 

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

 

For the transition period from                          to                         .

 

Commission file number: 333-170812

 

 

21ST CENTURY ONCOLOGY HOLDINGS, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

(239) 931-7275

(Registrant’s Telephone Number, Including Area Code)

 

N/A

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. * oYes  xNo

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that registrant was required to submit and post such files.) Yes x  No o

 

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

 

 

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

 

* The registrant has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934, but is not required to file such reports under such Sections.

 

As of February 1, 2015, we had outstanding 1,028 shares of Common Stock, par value $0.01 per share, which are 100% owned by 21st Century Oncology Investments, LLC.

 

 

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21ST CENTURY ONCOLOGY HOLDINGS, INC.

 

Form 10-Q

 

INDEX

 

PART I.    FINANCIAL INFORMATION
Item 1.	Financial Statements (unaudited)
	Condensed Consolidated Balance Sheets — September 30, 2014 and December 31, 2013		3
	Condensed Consolidated Statements of Operations and Comprehensive Loss - Three and Nine Months Ended September 30, 2014 and 2013		4
	Condensed Consolidated Statements of Cash Flows — Nine Months Ended September 30, 2014 and 2013		5
	Notes to Interim Condensed Consolidated Financial Statements		7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		36
Item 3.	Quantitative and Qualitative Disclosures about Market Risk		63
Item 4	Controls and Procedures		63
PART II.    OTHER INFORMATION
Item 1.	Legal Proceedings		65
Item 1A.	Risk Factors		65
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		71
Item 3.	Defaults Upon Senior Securities		71
Item 4.	Mine Safety Disclosures		71
Item 5.	Other Information		71
Item 6.	Exhibits		72

 

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PART I
FINANCIAL INFORMATION

Item 1.    Financial Statements

 

21ST CENTURY ONCOLOGY HOLDINGS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

(unaudited)

 

		September 30,			December 31,
		2014			2013
ASSETS
Current assets:
Cash and cash equivalents ($6,715 and $4,414 related to VIEs)		$	160,721		$	17,462
Restricted cash		7,239			3,768
Accounts receivable, net ($17,770 and $14,527 related to VIEs)		139,316			117,044
Prepaid expenses ($591 and $628 related to VIEs)		8,516			7,577
Inventories ($396 and $609 related to VIEs)		4,596			4,393
Deferred income taxes ($6 and $6 related to VIEs)		108			375
Other ($689 and $47 related to VIEs)		8,337			12,534
Total current assets		328,833			163,153
Equity investments in joint ventures		1,596			2,555
Property and equipment, net ($19,965 and $17,786 related to VIEs)		274,655			240,371
Real estate subject to finance obligation		17,743			19,239
Goodwill ($47,372 and $23,970 related to VIEs)		442,293			578,013
Intangible assets, net ($11,781 and $3,319 related to VIEs)		83,727			85,025
Other assets ($6,188 and $6,035 related to VIEs)		35,468			39,835
Total assets		$	1,184,315		$	1,128,191
LIABILITIES AND EQUITY
Current liabilities:
Accounts payable ($3,247 and $1,469 related to VIEs)		$	86,133		$	57,613
Accrued expenses ($3,804 and $4,692 related to VIEs)		97,459			64,021
Income taxes payable ($0 and $90 related to VIEs)		730			2,372
Current portion of long-term debt ($14 and $13 related to VIEs)		25,950			17,536
Current portion of finance obligation		361			317
Other current liabilities		12,018			12,237
Total current liabilities		222,651			154,096
Long-term debt, less current portion ($5,015 and $25 related to VIEs)		942,963			974,130
Finance obligation, less current portion		18,468			20,333
Embedded derivative features of Series A convertible redeemable preferred stock		15,006			—
Other long-term liabilities ($2,341 and $1,918 related to VIEs)		45,505			38,453
Deferred income taxes		4,609			4,498
Total liabilities		1,249,202			1,191,510
Series A convertible redeemable preferred stock, $0.001 par value, $1,000 stated value, 3,500,000 and -0- authorized, 385,000 and -0- issued and outstanding at September 30, 2014 and December 31, 2013, respectively		304,271			—
Noncontrolling interests - redeemable		45,987			15,899
Commitments and contingencies
Equity:
Common stock, $0.01 par value, 1,000,000 and 1,028 shares authorized at September 30, 2014 and December 31, 2013, respectively, 1,028 issued and outstanding		—			—
Additional paid-in capital		649,993			650,879
Retained deficit		(1,043,319		)	(718,237		)
Accumulated other comprehensive loss, net of tax		(37,901		)	(26,393		)
Total 21st Century Oncology Holdings, Inc. shareholder’s deficit		(431,227		)	(93,751		)
Noncontrolling interests - nonredeemable		16,082			14,533
Total deficit		(415,145		)	(79,218		)
Total liabilities and equity		$	1,184,315		$	1,128,191

 

See accompanying notes.

 

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21ST CENTURY ONCOLOGY HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(unaudited)

 

		Three Months Ended September 30,						Nine Months Ended September 30,
(in thousands):		2014			2013			2014			2013
Revenues:
Net patient service revenue		$	238,403		$	178,655		$	698,261		$	526,475
Management fees		16,762			—			50,215			—
Other revenue		2,453			2,385			8,437			6,651
Total revenues		257,618			181,040			756,913			533,126
Expenses:
Salaries and benefits		134,599			98,032			396,311			293,972
Medical supplies		24,771			15,917			71,007			46,166
Facility rent expenses		14,867			11,427			47,529			32,285
Other operating expenses		15,558			11,882			46,035			33,155
General and administrative expenses		37,811			24,936			101,985			68,832
Depreciation and amortization		22,388			16,059			65,272			46,550
Provision for doubtful accounts		5,621			3,767			13,345			8,857
Interest expense, net		30,233			21,952			87,659			62,369
Impairment loss		47,526			—			229,526			—
Early extinguishment of debt		8,558			—			8,558			—
Equity initial public offering expenses		742			—			4,905			—
Loss on sale leaseback transaction		—			—			135			—
Fair value adjustment of earn-out liability		209			—			612			—
Gain on the sale of an interest in a joint venture		—			—			—			(1,460		)
Loss on foreign currency transactions		210			364			317			1,166
Loss (gain) on foreign currency derivative contracts		—			67			(4		)	309
Total expenses		343,093			204,403			1,073,192			592,201
Loss before income taxes		(85,475		)	(23,363		)	(316,279		)	(59,075		)
Income tax expense		1,173			1,699			4,213			4,849
Net loss		(86,648		)	(25,062		)	(320,492		)	(63,924		)
Net income attributable to noncontrolling interests — redeemable and non-redeemable		(729		)	(347		)	(4,590		)	(1,365		)
Net loss attributable to 21st Century Oncology Holdings, Inc. shareholder		(87,377		)	(25,409		)	(325,082		)	(65,289		)
Other comprehensive loss:
Unrealized loss on foreign currency translation		(1,990		)	(4,228		)	(12,596		)	(9,817		)
Other comprehensive loss		(1,990		)	(4,228		)	(12,596		)	(9,817		)
Comprehensive loss		(88,638		)	(29,290		)	(333,088		)	(73,741		)
Comprehensive income attributable to noncontrolling interests-redeemable and non-redeemable:		(512		)	(25		)	(3,502		)	(516		)
Comprehensive loss attributable to 21st Century Oncology Holdings, Inc. shareholder		$	(89,150	)	$	(29,315	)	$	(336,590	)	$	(74,257	)

 

See accompanying notes.

 

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21ST CENTURY ONCOLOGY HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

 

		Nine Months Ended September 30,
(in thousands):		2014			2013
Cash flows from operating activities
Net loss		$	(320,492	)	$	(63,924	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation		54,003			40,062
Amortization		11,269			6,488
Deferred rent expense		477			636
Deferred income taxes		638			(1,989		)
Stock-based compensation		99			481
Provision for doubtful accounts		13,345			8,857
Loss on the sale/disposal of property and equipment		256			212
Loss on sale leaseback transaction		135			—
Impairment loss		229,526			—
Early extinguishment of debt		8,558			—
Equity initial public offering expenses		4,905			—
Gain on the sale of an interest in a joint venture		—			(1,460		)
Loss on foreign currency transactions		105			137
(Gain) loss on foreign currency derivative contracts		(4		)	309
Fair value adjustment of earn-out liability		612			—
Amortization of debt discount		2,035			703
Amortization of loan costs		4,821			4,128
Equity interest in net loss of joint ventures		161			425
Distribution received from unconsolidated joint ventures		168			—
Changes in operating assets and liabilities:
Accounts receivable and other current assets		(31,317		)	(25,578		)
Income taxes payable		(933		)	343
Inventories		(195		)	(591		)
Prepaid expenses		2,747			194
Accounts payable and other current liabilities		12,320			12,591
Accrued deferred compensation		1,059			1,019
Accrued expenses / other current liabilities		17,392			19,519
Net cash provided by operating activities		11,690			2,562
Cash flows from investing activities
Purchase of property and equipment		(44,269		)	(25,109		)
Acquisition of medical practices		(50,121		)	(24,250		)
Restricted cash associated with medical practice acquisitions		(3,471		)	(5,002		)
Proceeds from the sale of equity interest in a joint venture		—			1,460
Proceeds from the sale of property and equipment		91			64
Loans to employees		(871		)	(559		)
Contribution of capital to joint venture entities		(620		)	(542		)
Purchase of noncontrolling interest - non-redeemable		—			(1,509		)
Proceeds (payment) of foreign currency derivative contracts		26			(171		)
Premiums on life insurance policies		(851		)	(901		)
Change in other assets and other liabilities		(256		)	(53		)
Net cash used in investing activities		(100,342		)	(56,572		)
Cash flows from financing activities
Proceeds from issuance of debt (net of original issue discount of $3.4 million and $2.3 million, respectively)		164,556			207,650
Principal repayments of debt		(250,208		)	(133,917		)
Repayments of finance obligation		(167		)	(142		)
Proceeds from issuance of Series A convertible redeemable preferred stock		325,000
Proceeds from issuance of noncontrolling interest		1,250			—
Proceeds from noncontrolling interest holders - redeemable and non-redeemable		229			765
Cash distributions to noncontrolling interest holders — redeemable and non-redeemable		(2,050		)	(1,896		)
Payments of costs for equity securities offering		(4,220		)	—
Payments of loan costs		(2,437		)	(1,359		)
Net cash provided by financing activities		231,953			71,101
Effect of exchange rate changes on cash and cash equivalents		(42		)	(32		)
Net increase in cash and cash equivalents		143,259			17,059
Cash and cash equivalents, beginning of period		17,462			15,410
Cash and cash equivalents, end of period		$	160,721		$	32,469

 

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continued

 

21ST CENTURY ONCOLOGY HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

(unaudited)

 

		Nine Months Ended September 30,
(in thousands):		2014			2013
Supplemental disclosure of non-cash transactions
Finance obligation related to real estate projects		$	2,465		$	5,337
Derecognition of finance obligation related to real estate projects		$	4,119		$	—
Capital lease obligations related to the purchase of equipment		$	7,069		$	79
Medical equipment and service contract component related to the acquisition of medical equipment through accounts payable		$	12,486		$	—
Issuance of notes payable relating to the acquisition of medical practices		$	2,000		$	2,097
Liability relating to the escrow debt and purchase price of medical practices		$	2,970		$	—
Capital lease obligations related to the acquisition of medical practices		$	47,796		$	8,748
Earn-out accrual related to the acquisition of medical practices		$	1,003		$	400
Amounts payable to sellers in the purchase of a medical practice		$	295		$	—
Incurred offering costs		$	685		$	—
Issuance costs related to the Series A convertible redeemable preferred stock		$	6,792		$	—
Noncash dividend declared to noncontrolling interest		$	246		$	140
Accrued dividends on Series A convertible redeemable preferred stock		$	982		$	—
Accretion of redemption value on Series A convertible redeemable preferred stock		$	87		$	—
Noncash deconsolidation of noncontrolling interest		$	—		$	9
Noncash contribution of capital by noncontrolling interest holders		$	—		$	4,235
Termination of prepaid services by noncontrolling interest holder		$	—		$	2,551
Issuance of notes payable relating to the earn-out liability in the acquisition of Medical Developers		$	—		$	2,679
Issuance of equity LLC units relating to the earn-out liability in the acquisition of Medical Developers		$	—		$	705

 

See accompanying notes.

 

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21ST CENTURY ONCOLOGY HOLDINGS, INC.

 

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

 

1.          Organization

 

21st Century Oncology Holdings, Inc. (formerly known as Radiation Therapy Services Holdings, Inc.) (“Parent”), through its wholly-owned subsidiaries (the “Subsidiaries” and, collectively with the Subsidiaries, the “Company”) is a leading global, physician-led provider of integrated cancer care (“ICC”) services. The Company’s physicians provide comprehensive, academic quality, cost-effective coordinated care for cancer patients in personal and convenient community settings (its “ICC model”). The Company provides academic center level care to cancer patients in a community setting and employs or affiliates with leading physicians and provides them with the advanced medical technology necessary to achieve optimal clinical outcomes across a full spectrum of oncologic disease in each local market. The Company’s provision of care includes a full spectrum of cancer care services by employing and affiliating with physicians in the related specialties of medical oncology, breast, gynecological and general surgery, urology and primary care. This innovative approach to cancer care through its ICC model enables the Company to collaborate across its physician base, integrate services and payments for related medical needs and disseminate best practices.

 

The Company operates the largest integrated network of cancer treatment centers and affiliated physicians in the world which, as of September 30, 2014, was comprised of approximately 794 community-based physicians in the fields of radiation oncology, medical oncology, breast, gynecological and general surgery, urology and primary care. The Company’s physicians provide medical services at approximately 391 locations, including our 178 radiation therapy centers, of which 48 operate in partnership with health systems. The Company’s cancer treatment centers in the United States are operated predominantly under the 21st Century Oncology brand and are strategically clustered in 31 local markets in 16 states. The Company’s 35 international treatment centers in six Latin American markets are operated under the 21st Century Oncology brand or a local brand and, in many cases, are operated with local minority partners, including hospitals.

 

The Company operates in 16 states, including Alabama, Arizona, California, Florida, Indiana, Kentucky, Maryland, Massachusetts, Michigan, Nevada, New Jersey, New York, North Carolina, Rhode Island, South Carolina and West Virginia, as well as countries in Latin America, Central America and the Caribbean. The international centers are located in Argentina, Mexico, Costa Rica, Dominican Republic, Guatemala, and El Salvador.

 

The Company is also engaged in providing capital equipment and business management services to oncology physician groups (“Groups”) that treat patients at cancer centers (“Centers”). The Company owns the Centers’ assets and provides services to the Groups through exclusive, long-term management services agreements. The Company provides the Groups with oncology business management expertise and new technologies including radiation oncology equipment and related treatment software. Business services that the Company provides to the Groups include non-physician clinical and administrative staff, operations management, purchasing, managed care contract negotiation assistance, reimbursement, billing and collecting, information technology, human resource and payroll, compliance, accounting, and treasury. Under the terms of the management service agreements, the Company is reimbursed for certain operating expenses of each Center and earns a monthly management fee from each Group.  The management fee is primarily based on a predetermined percentage of each Group’s earnings before interest, income taxes, depreciation, and amortization (“EBITDA”) associated with the provision of radiation therapy.  The Company manages the radiation oncology business operations of one Group in Florida, six Groups in California, and one Group in Indiana.  The Company’s management fees range from 40% to 60% of EBITDA, with one Group in California whose fee ranges from 20% to 30% of collections.

 

On December 9, 2013, Radiation Therapy Services, Inc., a wholly owned subsidiary of Parent, changed its name to 21st Century Oncology, Inc. (“21C”)

 

2.  Liquidity

 

The Company is highly leveraged. As of September 30, 2014, the Company had approximately $1.0 billion of long-term debt outstanding.  The Company has experienced and continues to experience losses from its operations. The Company reported a net loss of approximately $78.2 million, $151.1 million and $349.9 million for the years ended December 31, 2013, 2012 and 2011, respectively, and $320.5 million and $63.9 million for the nine month periods ended September 30, 2014 and 2013, respectively.

 

The Company’s high level of debt could have material adverse effects on its business and financial condition. Specifically, the Company’s high level of debt could have important consequences, including the following:

 

·    making it more difficult for the Company to satisfy its obligations with respect to debt;

 

·    limiting the Company’s ability to obtain additional financing to fund future working capital, capital expenditures, acquisitions or other general corporate requirements;

 

·    requiring a substantial portion of the Company’s cash flows to be dedicated to debt service payments instead of other purposes;

 

·    increasing the Company’s vulnerability to general adverse economic and industry conditions;

 

·    limiting the Company’s flexibility in planning for and reacting to changes in the industry in which the Company competes;

 

·    placing the Company at a disadvantage compared to other, less leveraged competitors; and

 

·    increasing the Company’s cost of borrowing.

 

The Company’s ability to make scheduled payments and to refinance its indebtedness depends on, and is subject to, its financial and operating performance, which in turn is affected by general and regional economic, financial, competitive, business and other factors beyond the Company’s control, including the availability of financing in the international banking and capital markets.

 

                                    As discussed in Note 15, the Company is involved in disputes, litigation, and regulatory matters incidental to its operations, including governmental investigations and other matters arising out of the normal conduct of business.  The resolution of these matters could have a material adverse effect on the Company’s business and financial position.

 

On July 29, 2014, the Company, and each of its direct and indirect wholly-owned subsidiaries entered into a Recapitalization Support Agreement (the “Recapitalization Support Agreement”). The Recapitalization Support Agreement set forth the terms through which the Company expected to either (a) obtain additional liquidity through an equity contribution or subordinated debt incurred in a minimum amount of $150 million on or before October 1, 2014 (the “Capital Contribution”) or (b) consummate a recapitalization (the “Recapitalization”) consistent with the material terms and conditions described in the term sheet (the “Recapitalization Term Sheet”) attached to the Recapitalization Support Agreement.

 

On September 26, 2014, the Company issued to Canada Pension Plan Investment Board (“CPPIB”), in a private placement, an aggregate of 385,000 newly issued shares of its Series A Convertible Redeemable Preferred Stock, par value $0.001 per share (the “Series A Preferred Stock”), for a purchase price of $325.0 million.

 

This equity investment provides the Company with substantial incremental liquidity, significantly reduces its debt, and provides the necessary long-term capital to continue to grow its business.  As further described in Note 14, a portion of the net proceeds from the Series A Preferred Stock was used to repay all outstanding borrowings under the Company’s revolving credit facility, repay all obligations under the South Florida Radiation Oncology Term A, Term A-1, and Term B loans, repay certain other debt and capital leases, as well as provide capital for near-term strategic initiatives and general corporate purposes.  As a result of this investment, the Recapitalization Support Agreement that the Company entered into in July was terminated in accordance with its terms, and the Company’s senior subordinated notes will remain outstanding and unmodified.

 

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3.   Basis of presentation

 

The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for annual financial statements.  All adjustments necessary for a fair presentation have been included. All such adjustments are considered to be of a normal and recurring nature. Interim results for the nine months ended September 30, 2014 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2014.

 

These unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated audited financial statements and the notes thereto included in the Company’s Form 10-K for the year ended December 31, 2013.

 

The Company’s results of operations historically have fluctuated on a quarterly basis and can be expected to continue to fluctuate. Many of the patients of the Company’s Florida treatment centers are part-time residents during the winter months. Hence, these treatment centers have historically experienced higher utilization rates during the winter months than during the remainder of the year. In addition, volume is typically lower in the summer months due to traditional vacation periods.

 

The accompanying interim condensed consolidated financial statements include the accounts of the Company and all subsidiaries and entities controlled by the Company through the Company’s direct or indirect ownership of a majority interest and/or exclusive rights granted to the Company as the management company of such entities or by contract. All significant intercompany accounts and transactions have been eliminated.

 

The Company has evaluated certain radiation oncology practices in order to determine if they are variable interest entities (“VIEs”). This evaluation resulted in the Company determining that certain of its radiation oncology practices were potential VIEs. For each of these practices, the Company has evaluated (1) the sufficiency of the fair value of the entity’s equity investments at risk to absorb losses, (2) that, as a group, the holders of the equity investments at risk have (a) the direct or indirect ability through voting rights to make decisions about the entity’s significant activities, (b) the obligation to absorb the expected losses of the entity and that their obligations are not protected directly or indirectly, and (c) the right to receive the expected residual return of the entity, and (3) substantially all of the entity’s activities do not involve or are not conducted on behalf of an investor that has disproportionately fewer voting rights in terms of its obligation to absorb the expected losses or its right to receive expected residual returns of the entity, or both. The Accounting Standards Codification (ASC), 810, Consolidation (ASC 810), requires a company to consolidate VIEs if the company is the primary beneficiary of the activities of those entities. Certain of the Company’s radiation oncology practices are VIEs and the Company has a variable interest in each of these practices through its administrative services agreements. Other of the Company’s radiation oncology practices (primarily consisting of partnerships) are VIEs and the Company has a variable interest in each of these practices because the total equity investment at risk is not sufficient to permit the legal entity to finance its activities without the additional subordinated financial support provided by its members.

 

In accordance with ASC 810, the Company consolidates certain radiation oncology practices where the Company provides administrative services pursuant to long-term management agreements. The noncontrolling interests in these entities represent the interests of the physician owners of the oncology practices in the equity and results of operations of these consolidated entities. The Company, through its variable interests in these practices, has the power to direct the activities of these practices that most significantly impact the entity’s economic performance and the Company would absorb a majority of the expected losses of these practices should they occur. Based on these determinations, the Company has consolidated these radiation oncology practices in its condensed consolidated financial statements for all periods presented.

 

The Company could be obligated, under the terms of the operating agreements governing certain of its joint ventures, upon the occurrence of various fundamental regulatory changes and or upon the occurrence of certain events outside of the Company’s control to purchase some or all of the noncontrolling interests related to the Company’s consolidated subsidiaries. These repurchase requirements would be triggered by, among other things, regulatory changes prohibiting the existing ownership structure. While the Company is not aware of events that would make the occurrence of such a change probable, regulatory changes are outside the control of the Company. Accordingly, the noncontrolling interests subject to these repurchase provisions have been classified outside of equity on the Company’s condensed consolidated balance sheets.

 

As of September 30, 2014 and December 31, 2013, the combined total assets included in the Company’s condensed consolidated balance sheet relating to the VIEs were approximately $111.5 million and $71.3 million, respectively.

 

As of September 30, 2014, the Company was the primary beneficiary of, and therefore consolidated, 27 VIEs, which operate 46 centers. Any significant amounts of assets and liabilities related to the consolidated VIEs are identified parenthetically on the accompanying condensed consolidated balance sheets. The assets are owned by, and the liabilities are obligations of the VIEs, not the Company. Only the VIE’s assets can be used to settle the liabilities of the VIE. The assets are used pursuant to operating agreements established by each VIE. The VIEs are not guarantors of the Company’s debts. In the states of California, Massachusetts, Michigan, Nevada, New York and North Carolina, the Company’s treatment centers are operated as physician office practices. The Company typically provides technical services to these treatment centers in addition to administrative services. For the nine months ended September 30, 2014 and 2013 approximately 15.0% and 18.6% of the Company’s net patient service revenue, respectively, was generated by professional corporations for which it has administrative management agreements.

 

As of September 30, 2014, the Company also held equity interests in six VIEs for which the Company is not the primary beneficiary. Those VIEs consist of partnerships that primarily provide radiation oncology services.  The Company is not the primary beneficiary of these VIEs as it does not retain the power and rights in the operations of the entities. The Company’s investments in the unconsolidated VIEs are approximately $1.6 million and $2.6 million at September 30, 2014 and December 31, 2013, respectively, with ownership interests ranging between 33.3% and 50.1% general partner or equivalent interest. Accordingly, substantially all of these equity investment balances are attributed to the Company’s noncontrolling interests in the unconsolidated partnerships. The Company’s maximum risk of loss related to the investments in these VIEs is limited to the equity interest.

 

The cost of revenues for the three months ended September 30, 2014 and 2013 are approximately $185.1 million and $130.3 million, respectively. The cost of revenues for the nine months ended September 30, 2014 and 2013 are approximately $544.9 million and $381.7

 

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million, respectively. The cost of revenues includes costs related to expenses incurred for the delivery of patient care.  These costs include salaries and benefits of physician, physicists, dosimetrists radiation technicians etc., medical supplies, facility rent expenses, other operating expenses, depreciation and amortization.

 

Foreign currency translation

 

The Argentine government has implemented certain measures that control and restrict the ability of companies and individuals to exchange Argentine pesos for foreign currencies. Those measures include, among other things, the requirement to obtain the prior approval from the Argentine Tax Authority of the foreign currency transaction (for example and without limitation, for the payment of non-Argentine goods and services, payment of principal and interest on non-Argentine debt and also payment of dividends to parties outside of the country), which approval process could delay, and eventually restrict, the ability to exchange Argentine pesos for other currencies, such as U.S. dollars. Those approvals are administered by the Argentine Central Bank through the Local Exchange Market (“Mercado Unico Libre de Cambios”, or “MULC”), which is the only market where exchange transactions may be lawfully made.

 

During January 2014, the Argentinean peso exchange rate against the U.S. Dollar increased by approximately 23%, from 6.52 Argentinean Pesos per U.S. Dollar as of December 31, 2013 to approximately 8.0 Argentinean Pesos per U.S. Dollar. As of September 30, 2014, the Argentinean Peso exchange rate was 8.48 Argentine Pesos per U.S. Dollar.

 

New Pronouncements

 

In July 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2013-11, Income Taxes (Topic 740):Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (ASU 2013-11), which amends ASC 740 to clarify balance sheet presentation requirements of unrecognized tax benefits. ASU 2013-11 was effective for the Company on January 1, 2014. The Company adopted ASC 740 and reclassified approximately $1.2 million of unrecognized tax benefits from income taxes payable to other long term liabilities.

 

In April 2014, the FASB issued ASU No. 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. ASU 2014-08 changes the requirements for reporting discontinued operations in FASB Accounting Standards Codification Subtopic 205-20, such that a disposal of a component of an entity or a group of components of an entity is required to be reported in discontinued operations if the disposal represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results. ASU 2014-08 requires an entity to present, for each comparative period, the assets and liabilities of a disposal group that includes a discontinued operation separately in the asset and liability sections, respectively, of the statement of financial position, as well as additional disclosures about discontinued operations. Additionally, ASU 2014-08 requires disclosures about a disposal of an individually significant component of an entity that does not qualify for discontinued operations presentation in the financial statements and expands the disclosures about an entity’s significant continuing involvement with a discontinued operation. The accounting update is effective for annual periods beginning on or after December 15, 2014. Early adoption is permitted but only for disposals that have not been reported in financial statements previously issued. The Company is currently evaluating the potential impact of this guidance.

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards. The core principle of the guidance in ASU 2014-09 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The Company is currently evaluating the potential impact of this guidance, which will be effective beginning January 1, 2017.

 

In August 2014, the Financial Accounting Standards Board issued Accounting Standards Update 2014-15, “Presentation of Financial Statements - Going Concern (Subtopic 205-40).” The new guidance addresses management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. Management’s evaluation should be based on relevant conditions and events that are known and reasonably knowable at the date that the financial statements are issued. The standard will be effective for the first interim period within annual reporting periods beginning after December 15, 2016. Early adoption is permitted. The Company does not expect to early adopt this guidance and does not believe the adoption of this guidance will have a material impact on its consolidated financial statements.

 

4.  Stock-based compensation

 

2012 Equity-based incentive plans

 

Effective as of June 11, 2012, 21st Century Oncology Investments, LLC, the Company’s direct parent (“21CI”), entered into a Third Amended and Restated LLC Agreement (the “Amended LLC Agreement”). The Amended LLC Agreement established new classes of equity units (such new units, the “2012 Plan”) in 21CI in the form of Class MEP Units, Class EMEP Units, Class L Units and Class G Units for issuance to employees, officers, directors and other service providers, establishes new distribution entitlements related thereto, and modifies the distribution entitlements for holders of Preferred units and Class A Units of 21CI. In addition to the Preferred Units and Class A Units of 21CI, the Amended LLC Agreement authorized for issuance under the 2012 Plan 1,100,200 units of limited liability company interests consisting of 1,000,000 Class MEP Units, 100,000 Class EMEP Units, 100 Class L Units, and 100 Class G Units.

 

Generally, for Class MEP units awarded, 66.6% vest upon issuance, while the remaining 33.4% vest on the 18 month anniversary of the issuance date. There are no performance conditions for the MEP units to vest. For newly hired individuals after January 1, 2012, vesting occurs at 33.3% in years one and two, and 33.4% in year three of the individual’s hire date. In the event of a sale or public offering of the Company prior to termination of employment, all unvested Class MEP units would vest upon consummation of the transaction. The MEP units are eligible to receive distributions only upon a return of all capital invested in 21CI, plus the amounts to which the Class EMEP Units, are entitled to receive under the Amended LLC Agreements; which effectively creates a market condition that is reflected in the value of the Class MEP units.

 

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Vesting of the Class EMEP units is dependent upon achievement of an implied equity value target. The right to receive proceeds from vested units is dependent upon the occurrence of a qualified sale or liquidation event. Specifically, the percentage of EMEP units that vest is based on the implied value of the Company’s equity, to be measured quarterly beginning December 31, 2012. 25% of the awards will be eligible for vesting if the “implied equity value” exceeds a predetermined threshold, with 50% incremental vesting eligibility if the implied value exceeds several higher thresholds for at least two consecutive quarters. The implied equity value per the Amended LLC Agreement is a multiple of EBITDA (earnings before interest, taxes, depreciation and amortization) as defined in the Amended LLC Agreement. As with the MEP units, the values of the EMEP units are subject to a market condition in the form of the return on investment target for Vestar’s interest. The Class EMEP Units were eliminated under the Fourth Amended and Restated Limited Liability Company Agreement (the “Fourth Amended LLC Agreement”) in December 2013.

 

For purposes of determining the compensation expense associated with the 2012 equity-based incentive plan grants, management valued the business enterprise using a variety of widely accepted valuation techniques, which considered a number of factors such as the financial performance of the Company, the values of comparable companies and the lack of marketability of the Company’s equity. The Company then used the probability-weighted expected return method (“PWERM”) to determine the fair value of these units at the time of grant. Under the PWERM, the value of the units is estimated based upon an analysis of future values for the enterprise assuming various future outcomes (exits) as well as the rights of each unit class. In developing assumptions for the various exit scenarios, management considered the Company’s ability to achieve certain growth and profitability milestone in order to maximize shareholder value at the time of potential exit. Management considers an initial public offering of the Company’s stock to be one of the exit scenarios for the current shareholders, although sale or merger/acquisition are possible future exit options as well. For the scenarios the enterprise value at exit was estimated based on a multiple of the Company’s earnings before interest, taxes, depreciation and amortization EBITDA for the fiscal year preceding the exit date. The enterprise value for the Staying Private Scenario was estimated based on a discounted cash flow analysis as well as guideline company market approach. The guideline companies were publicly-traded companies that were deemed comparable to the Company. The discount rate analysis also leveraged market data of the same guideline companies.

 

For each PWERM scenario, management estimated probability factors based on the outlook of the Company and the industry as well as prospects for potential exit at the exit date based on information known or knowable as of the grant date. The probability-weighted unit values calculated at each potential exit date was present-valued to the grant date to estimate the per-unit value. The discount rate utilized in the present value calculation was the cost of equity calculated using the Capital Asset Pricing Model (“CAPM”) and based on the market data of the guideline companies as well as historical data published by Morningstar, Inc. For each PWERM scenario, the per unit values were adjusted for lack of marketability discount to conclude on unit value on a minority, non-marketable basis.

 

The estimated fair value of the units, less an assumed forfeiture rate of 3.9%, is recognized in expense in the Company’s condensed consolidated financial statements over the requisite service period and in accordance with the vesting conditions of the awards for Class MEP Units. For Class MEP Units, the requisite service period is approximately 18 months, and for Class EMEP Units, the requisite service period is 36 months only if met or probable of being met. The assumed forfeiture rate is based on an average historical forfeiture rate.

 

Grants under 2013 Plan

 

On December 9, 2013, 21CI entered into the Fourth Amended LLC Agreement which replaced the Amended LLC Agreement in its entirety. The Fourth Amended LLC Agreement established new classes of incentive equity units (such new units, together with Class MEP Units, as modified under the Fourth Amended LLC Agreement, (the “2013 Plan”) in 21CI in the form of Class M Units, Class N Units and Class O Units for issuance to employees, officers, directors and other service providers, eliminated 21CI’s Class L Units and Class EMEP Units, and modified the distribution entitlements for holders of each existing class of equity units of 21CI.

 

The Company recorded approximately $28,000 and $136,000 of stock-based compensation for the three months ended September 30, 2014 and 2013, respectively, and $99,000 and $481,000 for the nine months ended September 30, 2014 and 2013, respectively, which is included in salaries and benefits in the condensed consolidated statements of operations and comprehensive loss.

 

The summary of activity under the 2012 and 2013 Plans is presented below:

 

2012 and 2013 Plans		Class MEP  Units  Outstanding		Weighted- Average  Grant Date  Fair Value			Class M Units  Outstanding		Weighted- Average  Grant Date  Fair Value			Class O Units  Outstanding		Weighted- Average  Grant Date  Fair Value
Nonvested balance at end of period December 31, 2013		73,624		$	2.24		100,000		$	58.37		100,000		$	0.47
Units granted		—		—			—		—			—		—
Units forfeited		—		—			(15,000	)	58.37			(14,000	)	0.47
Units vested		(29,698	)	2.68			—		—			—		—
Nonvested balance at end of period September 30, 2014		43,926		$	1.94		85,000		$	58.37		86,000		$	0.47

 

As of September 30, 2014, there was approximately $0.2 million of total unrecognized compensation expense related to the MEP Units. These costs are expected to be recognized over a weighted-average period of 1.27 years for MEP Units.

 

As of September 30, 2014, there was approximately $3.8 million, and $39,000 of total unrecognized compensation expense related to the M Units, and O Units, respectively. The Class M Units and O Units compensation will be recognized upon the sale of the Company or an initial public offering. Under the terms of the incentive unit grant agreements governing the grants of the Class M Units and Class O Units, in the

 

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event of an initial public offering of the Company’s common stock, holders have certain rights to receive shares of restricted common stock of the Company in exchange for their Class M Units and Class O Units.

 

Executive Bonus Plan

 

On December 9, 2013, the Company adopted the Executive Bonus Plan to provide certain senior level employees of the Company with an opportunity to receive additional compensation based on the Equity Value, as defined in the plan and described in general terms as noted below, of 21CI. Upon the occurrence of the first company sale or initial public offering to occur following the effective date of the plan, a bonus pool was established equal in value of 5% of the Equity Value of 21CI, subject to a maximum bonus pool of $12.7 million. Each participant in the plan will participate in the bonus pool based on the participant’s award percentage.

 

Payments of awards under the plan generally will be made as follows:

 

If the applicable liquidity event is a company sale, payment of the awards under the plan will be made within 30 days following consummation of the company sale in the same form as the proceeds received by 21CI. If the applicable liquidity event is an initial public offering, one-third of the award will be paid within 45 days following the effective date of the initial public offering, and the remaining two-thirds of the award will be payable in two equal annual installments on each of the first and second anniversaries of the effective date of the initial public offering. Payment of the award may be made in cash or stock or a combination thereof.

 

For purposes of the plan, the term “Equity Value” generally refers to: (i) if the applicable liquidity event is a company sale, the aggregate fair market value of the cash and non-cash proceeds received by 21CI and its equity holders in connection with the sale of equity interests in the Company; or (ii) if the applicable liquidity event is an initial public offering, the aggregate fair market value of 100% of the common stock of the Company on the effective date of its initial public offering.

 

As of September 30, 2014, there was approximately $8.9 million total unrecognized compensation expense related to the Executive Bonus Plan. The Executive Bonus Plan compensation will be recognized upon the sale of the Company or an initial public offering.

 

Grant of Class N Units

 

In December, 2013, 10 class N units were granted to an employee.  50% of the Class N Units vest upon the sale of the Company or an initial public offering. The remaining 50% is amortized over five years subsequent to an initial public offering. As of September 30, 2014, there was approximately $6,000 total unrecognized compensation expense related to the Class N Units.

 

Grant of Class G Units

 

In May, 2014, 10 class G units were granted to an employee.  100% of the Class G Units vest upon the sale of the Company or an initial public offering. As of September 30, 2014, there was approximately $1.5 million total unrecognized compensation expense related to the Class G Units.

 

5.  Comprehensive loss

 

Comprehensive loss consists of two components, net loss and other comprehensive loss. Other comprehensive loss refers to revenue, expenses, gains, and losses that under accounting principles generally accepted in the United States are recorded as an element of equity but are excluded from net loss. The Company’s other comprehensive loss is composed of the Company’s foreign currency translation of its operations in Latin America, Central America and the Caribbean. The impact of the unrealized loss increased accumulated other comprehensive loss on a consolidated basis by approximately $11.5 million and $9.0 million for the nine months ended September 30, 2014 and 2013, respectively. There were no reclassifications from other comprehensive income into earnings for the periods presented.

 

The components of accumulated other comprehensive loss were as follows (in thousands):

 

		Accumulated Other Comprehensive Loss
Quarter to date (in thousands):		21st Century Oncology  Holdings, Inc. Shareholder			Noncontrolling Interests			Other  Comprehensive Loss
As of June 30, 2014		$	(36,128	)	$	(3,511	)	$	(10,606	)
Foreign Currency Translation Adjustments		(1,773		)	(217		)	(1,990		)
As of September 30, 2014		$	(37,901	)	$	(3,728	)	$	(12,596	)

 

		Accumulated Other Comprehensive Loss
Year to date (in thousands):		21st Century Oncology  Holdings, Inc. Shareholder			Noncontrolling Interests			Other  Comprehensive Loss
As of December 31, 2013		$	(26,393	)	$	(2,640	)
Foreign Currency Translation Adjustments		(11,508		)	(1,088		)	$	(12,596	)
As of September 30, 2014		$	(37,901	)	$	(3,728	)	$	(12,596	)

 

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6.   Redeemable preferred stock

 

On September 26, 2014, the Company entered into a Subscription Agreement (the “Subscription Agreement”) with CPPIB. Pursuant to the Subscription Agreement, the Company issued to CPPIB an aggregate of 385,000 newly issued shares of its Series A Preferred Stock, par value $0.001 per share, stated value $1,000 per share, for a purchase price of $325.0 million.

 

As set forth in the Certificate of Designations of Series A Convertible Preferred Stock (the “Certificate of Designations”), holders of Series A Preferred Stock are entitled to receive, as and if declared by the board of directors of the Company, dividends at an applicable rate per annum, payable quarterly in arrears on January 1, April 1, July 1 and October 1 of each year.  During the first three years after issuance, any dividends when and if declared, shall be paid by the Company in the form of additional shares of Series A Preferred Stock.  During the first twelve months after issuance, the applicable dividend rate on the Series A Preferred Stock shall be 9.875%, thereafter increasing on a periodic basis, as set forth in the Certificate of Designations.  Such dividends accrue daily, whether or not declared by the board of directors of the Company.  After the third anniversary of issuance and only if the Company’s outstanding 97/8% senior subordinated notes due 2017 are repaid in full, or upon certain other events of default, dividends shall be paid in cash upon the election of a majority of the holders of Series A Preferred Stock (the “Majority Preferred Holders”).

 

The Series A Preferred Stock is mandatorily convertible into common stock, par value $0.01 per share (the “Common Stock”) of the Company upon the occurrence of a qualifying initial public offering of the Company or a qualifying merger.  In the case of a qualifying initial public offer, the conversion price is the initial public offering price of the qualifying initial public offer.  In the case of a qualifying merger, the conversion price is the price per share of Common Stock pursuant to the qualifying merger. The Series A Preferred Stock also becomes convertible on the tenth anniversary of issuance at the option of either the Company or CPPIB. Absent a qualifying initial public offering or qualifying merger, the conversion price shall be determined upon appraisal. If upon conversion, the Series A Preferred Stock converted to Common Stock represents greater than 29% of the Company’s outstanding Common Stock (“Excess Common Stock”), CPPIB has the option to convert amounts in excess of 29% to newly issued preferred stock (the “Excess Preferred Stock”). Holders of the Excess Preferred Stock are entitled to receive dividends, payable in additional shares of Excess Preferred Stock at 12% per annum. The Excess Preferred Stock becomes mandatorily convertible upon the 15th anniversary of issuance and may be redeemed by the Company at any time at 100% of its stated value. If CPPIB does not elect to receive Excess Preferred Stock, the Company is required to issue a new Class B common stock that will be exchanged for the Excess Common Stock. As long as CPPIB holds the Class B common stock, CPPIB is not entitled to voting rights with respect to the election or removal of directors.

 

Holders of Series A Preferred Stock also have, among other rights, the right to require the Company to repurchase their shares upon the occurrence of certain events of default and certain change of control transactions, at the prices set forth in the Certificate of Designations.  In addition, the Certificate of Designations also provides for certain consent rights of the Majority Preferred Holders in connection with specified corporate events of 21CI or its subsidiaries, including, among other things, with respect to certain equity issuances and certain acquisitions, financing transactions and asset sale transactions.  Upon certain events of default and the obtaining of applicable anti-trust regulatory approvals, holders of Series A Preferred Stock are also entitled to vote together with holders of Common Stock, on an as-converted basis. In addition, the Series A Preferred Stock is senior in preference to the Company’s Common Stock with respect to dividend rights, rights upon liquidation, winding up or dissolution.

 

Pursuant to the terms of the Subscription Agreement, immediately following the occurrence of a qualifying initial public offering of the Company or a qualifying merger, the Company will execute and deliver to CPPIB a Warrant Agreement (the “Warrant Agreement”) and issue to CPPIB warrants to purchase shares of Common Stock having a then-current value of $30 million, at a purchase price of $0.01 per share.  The warrants expire on the tenth anniversary of the date of issuance. The Company evaluated the contingent events that could trigger the conversion of the Series A Preferred Stock to Common Stock and issuance of warrants and determined those contingent conversion features to qualify as an embedded derivative, requiring bifurcation and classification as a liability, measured at fair value. The estimated fair value measurement was developed using significant unobservable inputs (Level 3). The primary valuation technique used was comparing the difference between the present value of discounted cash flows, assuming no triggering events occur and the present value of discounted cash flows assuming a triggering event does occur. The assumptions incorporated management’s estimates of timing and probability of each triggering event, with those cash flows discounted using rates commensurate with the risks of those cash flows. The Company determined the fair value of the embedded derivative to be, and recorded approximately $15.0 million as of September 30, 2014.

 

The Company is accreting changes to the Series A Preferred Stock redemption value through the tenth anniversary of issuance utilizing the interest method. If the Series A Preferred Stock were redeemable as of the balance sheet date, the Series A Preferred Stock would be redeemable at its stated value plus accrued dividends.

 

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Changes to the Series A Preferred Stock are as follows:

 

Quarter to date (in thousands):
As of June 30, 2014		$	—
Issuance of Series A preferred stock, net of discount and issuance costs		318,208
Embedded derivative		(15,006		)
Accretion of Series A preferred stock to redemption value		87
Accrued Series A preferred stock dividends		982
As of September 30, 2014		$	304,271

 

Year to date (in thousands):
As of December 31, 2013		$	—
Issuance of Series A preferred stock, net of discount and issuance costs		318,208
Embedded derivative		(15,006		)
Accretion of Series A preferred stock to redemption value		87
Accrued Series A preferred stock dividends		982
As of September 30, 2014		$	304,271

 

7. Reconciliation of total equity

 

The condensed consolidated financial statements include the accounts of the Company and its majority owned subsidiaries in which it has a controlling financial interest.  Noncontrolling interests-nonredeemable principally represent minority shareholders’ proportionate share of the equity of certain consolidated majority owned entities of the Company. The Company has certain arrangements whereby the noncontrolling interest may be redeemed upon the occurrence of certain events outside of the Company’s control. These noncontrolling interests have been classified outside of permanent equity on the Company’s condensed consolidated balance sheets. The noncontrolling interests are not redeemable at September 30, 2014 and December 31, 2013 and the contingent events upon which the noncontrolling interest may be redeemed are not probable of occurring at September 30, 2014. Accordingly, the noncontrolling interests are measured at their carrying value at September 30, 2014 and December 31, 2013.

 

The following table presents changes in total equity for the respective periods:

 

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(in thousands):		21st Century  Oncology  Holdings, Inc.  Shareholder’s  Equity			Noncontrolling  interests -  nonredeemable			Total Equity			Noncontrolling  interests -  redeemable
Balance, December 31, 2013		$	(93,751	)	$	14,533		$	(79,218	)	$	15,899
Net (loss) income		(325,082		)	1,658			(323,424		)	2,932
Other comprehensive loss from foreign currency translation		(11,508		)	(1,079		)	(12,587		)	(9		)
Accretion of Series A convertible redeemable preferred stock to redemption value		(87		)	—			(87		)	—
Accrued Series A convertible redeemable preferred stock dividends		(982		)	—			(982		)	—
Purchase price fair value of noncontrolling interest - nonredeemable		—			616			616			—
Purchase price fair value of noncontrolling interest - redeemable		—			—			—			28,420
Proceeds from issuance of noncontrolling interest - nonredeemable		84			1,166			1,250			—
Proceeds from noncontrolling interest holders - nonredeemable		—			229			229			—
Stock-based compensation		99			—			99			—
Distributions		—			(1,041		)	(1,041		)	(1,255		)
Balance, September 30, 2014		$	(431,227	)	$	16,082		$	(415,145	)	$	45,987
Balance, December 31, 2012		$	2,420		$	16,047		$	18,467		$	11,368
Net (loss) income		(65,289		)	1,681			(63,608		)	(316		)
Other comprehensive loss from foreign currency translation		(8,968		)	(827		)	(9,795		)	(22		)
Proceeds from noncontrolling interest holders		—			—			—			765
Deconsolidation of noncontrolling interest		(9		)	9			—			—
Stock based compensation		481			—			481			—
Noncash contribution of capital by noncontrolling interest holders		—			—			—			4,235
Issuance of equity LLC units relating to earn-out liability		705			—			705			—
Purchase on noncontrolling interest - non-redeemable		(2,404		)	895			(1,509		)	—
Termination of prepaid services by noncontrolling interest holder		—			(2,551		)	(2,551		)	—
Distributions		—			(1,939		)	(1,939		)	(97		)
Balance, September 30, 2013		$	(73,064	)	$	13,315		$	(59,749	)	$	15,933

 

Redeemable equity securities with redemption features that are not solely within the Company’s control are classified outside of permanent equity. Those securities are initially recorded at their estimated fair value on the date of issuance. Securities that are currently redeemable or redeemable after the passage of time are adjusted to their redemption value as changes occur. In the unlikely event that a redeemable equity security will require redemption, any subsequent adjustments to the initially recorded amount will be recognized in the period that a redemption becomes probable. Contingent redemption events vary by joint venture and generally include either the holder’s discretion or circumstances jeopardizing: the joint ventures’ ability to provide services, the joint ventures’ participation in Medicare, Medicaid, or other third party reimbursement programs, the tax-exempt status of minority shareholders, and violation of federal statutes, regulations, ordinances, or guidelines. Amounts required to redeem noncontrolling interests are based on either fair value or a multiple of trailing financial performance. These amounts are not limited.

 

8. Derivative Agreements

 

The Company recognizes all derivatives in the condensed consolidated balance sheets at fair value. The accounting for changes in the fair value (i.e., gains or losses) of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship based on its effectiveness in hedging against the exposure. Derivatives that do not meet hedge accounting requirements must be adjusted to fair value through operating results. If the derivative meets hedge accounting requirements, depending on the nature of the hedge, changes in the fair value of derivatives are either offset against the change in fair value of assets, liabilities, or firm commitments through operating results or recognized in other comprehensive loss until the hedged item is recognized in operating results. The ineffective portion of a derivative’s change in fair value is immediately recognized in earnings.

 

Foreign currency derivative contracts

 

Foreign currency risk is the risk that fluctuations in foreign exchange rates could impact the Company’s results from operations.  The Company is exposed to a significant amount of foreign exchange risk, primarily between the U.S. dollar and the Argentine Peso.  This exposure relates to the provision of radiation oncology services to patients at the Company’s Latin American operations and purchases of goods and services in foreign currencies. The Company enters into foreign exchange option contracts to convert a significant portion of the Company’s forecasted foreign currency denominated net income into U.S. dollars to limit the adverse impact of a potential weakening Argentine Peso against the U.S. dollar. Because the Company’s Argentine forecasted foreign currency denominated net income is expected to increase commensurate with inflationary expectations, any adverse impact on net income from a weakening Argentine Peso against the U.S. dollar is limited to the cost of the option contracts. Under the Company’s foreign currency management program, the Company expects to monitor foreign exchange rates and periodically enter into forward contracts and other derivative instruments. The Company does not use derivative financial instruments for speculative purposes.

 

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These programs reduce, but do not entirely eliminate, the impact of currency exchange movements.  The Company’s current practice is to use currency derivatives without hedge accounting designation. The maturity of these instruments generally occurs within twelve months. Gains or losses resulting from the fair valuing of these instruments are reported in loss (gain) on foreign currency derivative contracts on the condensed consolidated statements of operations and comprehensive loss.  For the nine months ended September 30, 2014 and 2013, the Company recognized a gain of approximately $4,000 and a loss of approximately $0.3 million, respectively relating to the change in fair market value of its foreign currency derivatives.  The fair value of the foreign currency derivative is recorded in other current assets in the accompanying condensed consolidated balance sheet.  At December 31, 2013, the fair value of the foreign currency derivative was approximately $22,000. No foreign currency derivative contract was outstanding at September 30, 2014.

 

Series A Preferred Stock embedded derivative

 

The Company’s Series A Preferred Stock contains provisions for contingent events that could trigger the conversion of the Series A Preferred Stock to Common Stock and issuance of warrants to CPPIB. The Company determined those contingent conversion features to qualify as an embedded derivative, requiring bifurcation and classification as a liability, measured at fair value. The Company evaluates the fair value of those embedded derivatives and adjusts changes in fair value through operating results.

 

9. Fair value of financial instruments

 

ASC 820 requires disclosure about how fair value is determined for assets and liabilities and establishes a hierarchy for which these assets and liabilities must be grouped, based on significant levels of inputs. The three-tier fair value hierarchy, which prioritizes the inputs used in the valuation methodologies, is as follows:

 

Level 1 — Quoted prices for identical assets and liabilities in active markets.

 

Level 2 — Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.

 

Level 3 — Unobservable inputs for the asset or liability.

 

In accordance with ASC 820, the fair value of the Term Loan portion of the senior secured credit facility (“Term Facility”), the 97/8% Senior Subordinated Notes due 2017, 87/8% Senior Secured Second Lien Notes due 2017, and the 113/4% Senior Secured Notes due 2017 was based on prices quoted from third-party financial institutions (Level 2). At September 30, 2014, the fair values are as follows (in thousands):

 

		Fair Value			Carrying Value
$90.0 million senior secured credit facility - (Term Facility)		$	88,650		$	88,526
$380.1 million Senior Subordinated Notes due April 15, 2017		$	368,649		$	378,224
$350.0 million Senior Secured Second Lien Notes due January 15, 2017		$	357,875		$	349,188
$75.0 million Senior Secured Notes due January 15, 2017		$	75,000		$	75,000

 

At December 31, 2013, the fair values are as follows (in thousands):

 

		Fair Value			Carrying Value
$90.0 million senior secured credit facility - (Term Facility)		$	88,650		$	87,989
$380.1 million Senior Subordinated Notes due April 15, 2017		$	328,743		$	377,667
$350.0 million Senior Secured Second Lien Notes due January 15, 2017		$	355,250		$	348,926
$75.0 million Senior Secured Notes due January 15, 2017		$	78,750		$	75,000

 

As of September 30, 2014 and December 31, 2013, the Company held certain items that are required to be measured at fair value on a recurring basis including foreign currency derivative contracts. Cash and cash equivalents are reflected in the financial statements at their carrying value, which approximate their fair value due to their short maturity.  The carrying values of the Company’s long-term debt other than the Term Loan portion of the senior secured credit facility, Senior Subordinated Notes, Senior Secured Second Lien Notes and Senior Secured Notes approximates fair value due to the length of time to maturity and/or the existence of interest rates that approximate prevailing market rates.  There have been no transfers between levels of valuation hierarchies for the nine months ended September 30, 2014 and 2013.

 

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The following items are measured at fair value on a recurring basis subject to the disclosure requirements of ASC 820, as of December 31, 2013:

 

					Fair Value Measurements at Reporting Date Using
(in thousands):		December 31, 2013			Quoted Prices in Active Markets for Identical  Assets (Level 1)			Significant Other  Observable Inputs (Level  2)			Significant Unobservable Inputs (Level 3)
Other current assets
Foreign currency derivative contracts		$	22		$	—		$	22		$	—

 

No foreign currency derivative contract was outstanding at September 30, 2014.

 

The estimated fair value of the Company’s foreign currency derivative agreements considered various inputs and assumptions, including the applicable spot rate, forward rates, maturity, implied volatility and other relevant economic measures, all of which are observable market inputs that are classified under Level 2 of the fair value hierarchy.  The valuation technique used is an income approach with the best market estimate of what will be realized on a discounted cash flow basis.

 

10.  Income tax accounting

 

The Company provides for federal, state and non-US income taxes currently payable, as well as for those deferred due to timing differences between reporting income and expenses for financial statement purposes versus tax purposes. Deferred tax assets and liabilities are recognized for the 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 and liabilities are measured using enacted income 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 change in income tax rates is recognized as income or expense in the period that includes the enactment date.

 

ASC 740, Income Taxes, clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements and prescribes a threshold for the recognition and measurement of a tax position taken or expected to be taken on a tax return. Under ASC 740 the impact of an uncertain tax position on the income tax return must be recognized at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. Additionally, ASC 740 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition.

 

The Company is subject to taxation in the United States, approximately 25 state jurisdictions, the Netherlands, and throughout Latin America, namely, Argentina, Bolivia, Brazil, Costa Rica, Dominican Republic, El Salvador, Guatemala and Mexico. However, the principal jurisdictions for which the Company is subject to tax are the United States, Florida and Argentina.

 

The Company’s effective rate was (1.3)% and (8.2)% for the nine months ended September 30, 2014 and 2013, respectively. The change in the effective rate for the third quarter of 2014 compared to the same period of the year prior is primarily the result of the recording of an impairment against goodwill of the domestic operations during the second and third quarters of 2014, the release of previously recorded reserves related to US federal and state tax issues, the relative mix of earnings and tax rates across jurisdictions, and the application of ASC 740-270 to exclude certain jurisdictions for which the Company is unable to benefit from losses. These items also caused the effective tax rate to differ from the U.S. statutory rate of 35%.  The Company’s tax expense in the third quarter of fiscal 2014 is primarily due to the non-US tax expense associated with foreign subsidiaries.

 

The Company’s future effective tax rates could be affected by changes in the relative mix of taxable income and taxable loss jurisdictions, changes in the valuation of deferred tax assets or liabilities, or changes in tax laws or interpretations thereof.  The Company monitors the assumptions used in estimating the annual effective tax rate and makes adjustments, if required, throughout the year.  If actual results differ from the assumptions used in estimating the Company’s annual effective tax rates, future income tax expense (benefit) could be materially affected.

 

The Company has not provided U.S. federal and state deferred taxes on the cumulative earnings of non-U.S. affiliates and associated companies that have been reinvested indefinitely. The aggregate undistributed earnings of the Company’s foreign subsidiaries for which no deferred tax liability has been recorded is approximately $8.6 million as of December 31, 2013 (including positive accumulated earnings of approximately $19 million in foreign jurisdictions that impose withholding taxes of up to 10%). It is not practicable to determine the U.S. income tax liability that would be payable if such earnings were not reinvested indefinitely.

 

The Company is routinely under audit by federal, state, or local authorities in the areas of income taxes and other taxes. These audits may include questioning the timing and amount of deductions and compliance with federal, state, and local tax laws. The Company regularly assesses the likelihood of adverse outcomes from these audits to determine the adequacy of the Company’s provision for income taxes.  To the extent the Company prevails in matters for which accruals have been established or is required to pay amounts in excess of such accruals, the effective tax rate could be materially affected.  In accordance with the statute of limitations for federal tax returns, the Company’s federal tax returns for the years 2011 through 2013 are subject to examination. During the second and third quarters of 2014, the Company reached a favorable settlement

 

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with the US Internal Revenue Service related to tax years 2007 and 2008 and various state and local jurisdictions related to tax years 2005 through 2012.  As a result, the Company released approximately $2.1 million of previously recorded reserves. During the third quarter of 2013, the Company closed the federal income tax audit related to calendar year 2009 with no material adjustments. The Company closed the New York State audit for tax years 2006 through 2008 with a favorable result during the first quarter of 2013.

 

11.  Acquisitions and other arrangements

 

On February 6, 2012, the Company acquired the assets of a radiation oncology practice and a medical oncology group located in Asheville, North Carolina for approximately $0.9 million.  The acquisition of the radiation oncology practice and the medical oncology group, further expands the Company’s presence in the Western North Carolina market and builds on the Company’s ICC model. The allocation of the purchase price is to tangible assets of $0.8 million, and goodwill of $0.1 million, which is all deductible for tax purposes.

 

In September 2011, the Company entered into a professional services agreement with the North Broward Hospital District in Broward County, Florida to provide professional services at the two radiation oncology departments at Broward General Medical Center and North Broward Medical Center.  In March 2012, the Company amended the license agreement to license the space and equipment and assume responsibility for the operation of those radiation therapy departments, as part of the Company’s value added services offering.  The license agreement runs for an initial term of ten years, with three separate five year renewal options.  The Company recorded approximately $4.3 million of tangible assets relating to the use of medical equipment pursuant to the license agreement.

 

On March 30, 2012, the Company acquired the assets of a radiation oncology practice for $26.0 million and two urology groups located in Sarasota/Manatee counties in Southwest Florida for approximately $1.6 million, for a total purchase price of approximately $27.6 million, comprised of $21.9 million in cash and assumed capital lease obligation of approximately $5.7 million. The allocation of the purchase price is to tangible assets of $7.8 million, intangible assets including non-compete agreements of $6.1 million amortized over 5 years, goodwill of $13.7 million, which is all deductible for tax purposes, and assumed capital lease obligations of approximately $5.7 million.

 

On December 28, 2012, the Company purchased the remaining 50% interest it did not already own in an unconsolidated joint venture which operates a freestanding radiation treatment center in West Palm Beach, Florida for approximately $1.1 million. The allocation of the purchase price is to tangible assets of $0.3 million, intangible assets including non-compete agreements of $0.2 million amortized over 2 years, goodwill of $0.8 million and current liabilities of approximately $0.2 million.

 

During 2012, the Company acquired the assets of several physician practices in Arizona, California and Florida for approximately $1.7 million. The physician practices provide synergistic clinical services and an ICC service to its patients in the respective markets in which the Company provides radiation therapy treatment services.  The allocation of the purchase price to tangible assets is $1.7 million.

 

On May 25, 2013, the Company acquired the assets of five radiation oncology practices and a urology group located in Lee/Collier counties in Southwest Florida for approximately $28.5 million, comprised of $17.7 million in cash, seller financing note of approximately $2.1 million and assumed capital lease obligations of approximately $8.7 million. The acquisition of the five radiation treatment centers and the urology group further expands the Company’s presence into the Southwest Florida market and builds on its ICC model. The allocation of the purchase price is to tangible assets of $10.4 million, intangible assets including non-compete agreements of $1.9 million amortized over five years, current liabilities of $0.2 million, and goodwill of $16.4 million, which is all deductible for tax purposes. During the quarter ended June 30, 2014, the Company finalized its valuation of assets acquired, primarily working capital. The final valuation resulted in an increase to goodwill of $0.1 million and an increase in current liabilities of $0.1 million. Pro forma results and other expanded disclosures prescribed by ASC 805, Business Combinations, have not been presented as this acquisition is not deemed material.

 

In June 2013, the Company sold its 45% interest in an unconsolidated joint venture which operated a radiation treatment center in Providence, Rhode Island in partnership with a hospital to provide stereotactic radio-surgery through the use of a cyberknife for approximately $1.5 million.

 

In June 2013, the Company contributed its Casa Grande, Arizona radiation physician practice, ICC practice and approximately $5.2 million to purchase a 55.0% interest in a joint venture which included an additional radiation physician practice and an expansion of an ICC model that includes medical oncology, urology and dermatology. The allocation of the purchase price is to tangible assets of $2.2 million, intangible assets including a tradename of approximately $1.8 million, non-compete agreements of $0.4 million amortized over 7 years, goodwill of $5.1 million, current liabilities of $0.1 million and noncontrolling interest-redeemable of approximately $4.2 million. For purposes of valuing the noncontrolling interest-redeemable, the Company considered a number of factors such as the joint venture’s performance projections, cost of capital, and consideration ascribed to applicable discounts for lack of control and marketability. During the quarter ended June 30, 2014, the Company finalized its valuation of assets acquired, primarily working capital. The final valuation resulted in an increase to goodwill of $0.1 million and an increase in current liabilities of $0.1 million.

 

In July 2013, the Company purchased a legal entity, which operates a radiation treatment center in Tijuana Mexico for approximately $1.6 million. The acquisition of this operating treatment center expands the Company’s presence in the international markets.

 

In July 2013, the Company purchased the remaining 38.0% interest in a joint venture radiation facility, located in Woonsocket, Rhode Island from a hospital partner for approximately $1.5 million.

 

In June 2013, the Company entered into a “stalking horse” investment agreement to acquire OnCure Holdings, Inc. (together with its subsidiaries, “OnCure”) upon effectiveness of its plan of reorganization under Chapter 11 of the U.S. Bankruptcy Code for approximately $125.0 million, (excluding capital leases, working capital and other adjustments). The purchase price included $42.5 million in cash and up to $82.5 million in assumed debt ($7.5 million of assumed debt will be released assuming certain OnCure centers achieve a minimum level of EBITDA).  The Company funded an initial deposit of approximately $5.0 million into an escrow account subject to the working capital adjustments. During the quarter ended June 30, 2014, the Company received approximately $3.3 million of the escrow account pursuant to a negotiated working capital settlement.

 

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On October 25, 2013, the Company completed the acquisition of OnCure. The transaction was funded through a combination of cash on hand, borrowings from the Company’s senior secured credit facility and the issuance of $82.5 million in senior secured notes of OnCure, which accrue interest at a rate of 11.75% per annum and mature January 15, 2017, of which $7.5 million included in other long-term liabilities in the condensed consolidated balance sheets, is subject to escrow arrangements and will be released to holders upon satisfaction of certain conditions.

 

OnCure operates radiation oncology treatment centers for cancer patients. It contracts with radiation oncology physician groups and their radiation oncologists through long-term management services agreements to offer cancer patients a comprehensive range of radiation oncology treatment options, including most traditional and next generation services. OnCure provides services to a network of 11 physician groups that treat cancer patients at its 33 radiation oncology treatment centers, making it one of the largest strategically located networks of radiation oncology service providers. OnCure has treatment centers located in California, Florida and Indiana, where it provides the physician groups with the use of the facilities and with certain clinical services of treatment center staff, and administers the non-medical business functions of the treatment centers, such as technical staff recruiting, marketing, managed care contracting, receivables management and compliance, purchasing, information systems, accounting, human resource management and physician succession planning.

 

The allocation of the purchase price was as follows (in thousands):

 

Preliminary Estimated Acquisition Consideration
Cash		$	42,250
11.75% senior secured notes due January 2017		75,000
Assumed capital lease obligations & other notes		2,090
Fair value of contingent earn-out, represented by 11.75% senior secured notes due January 2017 issued into escrow		7,550
Total preliminary estimated acquisition consideration		$	126,890

 

The following table summarizes the allocation of the aggregate purchase price of OnCure, including assumed liabilities (in thousands):

 

Preliminary Estimated Acquisition Consideration Allocation
Cash and cash equivalents		$	307
Accounts receivable		11,011
Inventories		199
Deferred income taxes—asset		4,875
Other currents assets		1,798
Accounts payable		(4,674		)
Accrued expenses		(3,540		)
Other current liabilities		—
Equity investments in joint ventures		1,625
Property and equipment		22,397
Intangible assets—management services agreements		57,739
Other noncurrent assets		265
Other long—term liabilities		(5,828		)
Deferred income taxes—liability		(31,669		)
Noncontrolling interest—nonredeemable		(1,299		)
Goodwill		73,684
Preliminary estimated acquisition consideration		$	126,890

 

Net identifiable assets include the following intangible assets (in thousands):

 

Management service agreements

$

57,739

 

The Company valued the management services agreements based on the income approach utilizing the excess earnings method. The Company considered a number of factors to value the management services agreements, including OnCure’s performance projections, discount rates, strength of competition, and income tax rates. The management services agreements will be amortized on a straight-line basis over the terms of the respective agreements.

 

The weighted-average amortization period for the acquired amortizable intangible assets at the time of the acquisition was approximately 11.6 years. Total amortization expense recognized for these acquired amortizable intangible assets totaled approximately $0.9 million for the year ended December 31, 2013.

 

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