As filed with the Securities and Exchange Commission on September 29, 2009

Registration No. 333-          

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

 

Form S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

 

 

ACCRETIVE HEALTH, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

 

401 North Michigan Avenue

Suite 2700

Chicago, Illinois 60611

(312) 324-7820

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

 

 

 

 

Mary A. Tolan

Founder, President and Chief Executive Officer

401 North Michigan Avenue

Suite 2700

Chicago, Illinois 60611

(312) 324-7820

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

 

 

Copies to:

 

 

Approximate date of commencement of proposed sale to the public:  As soon as practicable after this Registration Statement is declared effective.

 

 

 

 

If any of the securities being registered on this form are offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, as amended (the “Securities Act”) please check the following box. o

 

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o

 

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o

 

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b2 of the Exchange Act.

 

(Do not check if a smaller reporting company)

 

 

 

 

CALCULATION OF REGISTRATION FEE

 

 

 

 

 

 

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to Section 8(a), may determine.

 

 

Subject to Completion, dated September 29, 2009

 

           Shares

 

 

Common Stock

 

This is an initial public offering of shares of common stock of Accretive Health, Inc.

 

Accretive Health is offering           of the shares to be sold in the offering. The selling stockholders identified in this prospectus are offering           shares. Accretive Health will not receive any of the proceeds from the sale of the shares being sold by the selling stockholders.

 

Prior to this offering, there has been no public market for our common stock. It is currently estimated that the initial public offering price per share will be between $      and $     . We intend to apply to have our common stock listed on the New York Stock Exchange under the symbol “AH”.

 

See “Risk Factors” beginning on page 12 to read about factors you should consider before buying shares of our common stock.

 

 

 

 

Neither the Securities and Exchange Commission nor any other regulatory body has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.

 

 

 

 

 

To the extent that the underwriters sell more than           shares of common stock, the underwriters have the option to purchase up to an additional           shares from Accretive Health and the selling stockholders at the initial public offering price less the underwriting discount.

 

 

 

 

The underwriters expect to deliver the shares against payment in New York, New York on          , 2009.

 

 

 

 

 

 

Prospectus dated          , 2009.

TABLE OF CONTENTS

 

Prospectus

 

 

 

 

 

Through and including          , 2009 (the 25th day after the date of this prospectus), all dealers effecting transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to a dealer’s obligation to deliver a prospectus when acting as an underwriter and with respect to an unsold allotment or subscription.

 

 

 

 

No dealer, salesperson or other person is authorized to give any information or to represent anything not contained in this prospectus. You must not rely on any unauthorized information or representations. This prospectus is an offer to sell only the shares offered hereby, but only under circumstances and in jurisdictions where it is lawful to do so. The information contained in this prospectus is current only as of its date.

 

PROSPECTUS SUMMARY

	•	Complexity of Revenue Cycle Management.  At most hospitals, there is a lack of standardization across operating practices, payor and patient payment methodologies, data management processes and billing systems.
	•	Lack of Integrated Systems and Processes.  Although interrelated, the individual steps in the revenue cycle continuum are not operationally integrated across revenue cycle departments at many hospitals.

	•	Increasing Patient Financial Responsibility for Healthcare Services.  Hospitals are being forced to adapt to the need for direct-to-patient billing and collections capabilities as patients bear payment responsibility for an increasing portion of healthcare costs. Hospitals have traditionally focused on collecting payments from insurance companies and from state and federal payors, and typically are less familiar with the processes necessary to collect payments from patients at the point of service, including the use of alternative payment options.
	•	Outdated Systems and Insufficient Resources to Upgrade Them.  Many hospitals suffer from operating inefficiencies caused by outdated technology, increasingly complex billing requirements, a general lack of standardization of process and information flow, costly in-house services that could be more economically outsourced, and an increasingly stringent regulatory environment.

	•	Improving Net Revenue Yield.  We help our customers improve their net revenue yield. Through the use of our proprietary technologies and methodologies, we precisely calculate each customer’s improvement in net revenue yield.
	•	Increasing Charge Capture.  We help our customers increase their charge capture by implementing optimization techniques and related processes.

	•	Making Revenue Cycle Operations More Efficient.  We help our customers make their revenue cycle operations more efficient by implementing advanced technologies, streamlining operations, avoiding unnecessary re-work and improving quality.

	•	Gathering Complete Information.  We focus on gathering complete patient information and educating the patient as to his or her potential financial responsibilities before receiving care so the services can be recorded and billed to the appropriate parties. We believe that hospitals employing our services have increased the percentage of non-emergency in-patient admissions with complete information profiles to nearly 100%, enabling fewer billing delays, increased charge capture and reduced billing cycles.
	•	Improving Claims Filing and Third-Party Payor Collections.  We implement sophisticated analytics designed to improve claims filing and collection of claims from third-party insurance payors. By employing proprietary algorithms and modeling to determine how hospital revenue cycle staff should allocate time and resources across a pool of outstanding claims, we can increase the likelihood that patient services will be reimbursed.
	•	Identifying Alternative Payment Sources.  We use various methods to find payment sources for uninsured patients and reimbursement for services not covered by third-party insurance. After a typical implementation period, we have been able to help our customers find a third-party payment source for approximately 85% of all admitted patients who identified themselves as uninsured.
	•	Employing Proprietary Technology and Algorithms.  Our service offerings employ a variety of proprietary data analytics and predictive modeling algorithms. Our systems are designed to streamline work processes through the use of proprietary algorithms that focus revenue cycle staff effort on those accounts deemed to have the greatest potential for improving net revenue yield or charge capture.
	•	Using Analytical Capabilities and Operational Excellence.  We draw on the experience that we have gained from working with many of the best healthcare provider systems in the United States to train hospital staffs about new and innovative revenue cycle management practices.

	•	delivering tangible, long-term results for our customers by providing end-to-end services across the entire revenue cycle;
	•	continuing to develop innovative approaches to increase the yield on patient-owed obligations for medical services received;
	•	enhancing and developing proprietary algorithms to identify potential errors and to make process corrections in the collection of reimbursements from third-party payors;
	•	expanding our shared services program;
	•	hiring, training and retaining our personnel;
	•	continuing to diversify our customer base; and

	•	developing enhanced service offerings that offer us long-term opportunities.

	•	we may not be able to maintain or increase our profitability, and our recent growth rates may not be indicative of our future growth rates;
	•	hospitals affiliated with Ascension Health account for a majority of our net services revenue;
	•	we face competition from the internal revenue cycle management staff of hospitals as well as from a variety of external participants in the revenue cycle market;
	•	if we are unable to retain our existing customers, or if our customers fail to renew their managed service contracts with us upon expiration, our financial condition will suffer; and
	•	existing and prospective government regulation of the healthcare industry creates risks and challenges for our business.

Common stock offered by Accretive Health		shares
Common stock offered by the selling stockholders		shares
Common stock to be outstanding after this offering		shares
Use of proceeds		We intend to use approximately $      million of our net proceeds of this offering to pay the preferred stock liquidation preferences that will be paid in cash to the holders of our outstanding preferred stock concurrently with the conversion of such shares into shares of our common stock upon the closing of this offering. We intend to use the remainder of our net proceeds of this offering for general corporate purposes, which may include financing our growth, developing new services and funding capital expenditures, acquisitions and investments. We will not receive any proceeds from the shares sold by the selling stockholders. See “Use of Proceeds” for more information.
Risk Factors		You should read the “Risk Factors” section and other information included in this prospectus for a discussion of factors to consider carefully before deciding to invest in shares of our common stock.
Proposed New York Stock Exchange symbol		“AH”

	•	833,334 shares of common stock issuable upon the exercise of warrants outstanding and exercisable as of June 30, 2009 at a weighted-average exercise price of $1.12 per share, which will remain outstanding after this offering if not exercised prior to this offering;
	•	2,440,885 shares of common stock issuable upon the exercise of stock options outstanding and exercisable as of June 30, 2009 at a weighted-average exercise price of $21.59 per share, of which 1,054,930 shares with a weighted-average exercise price of $8.52 per share would be vested if purchased upon exercise of these options as of June 30, 2009;
	•	173,828 shares of common stock available for future issuance under our equity compensation plans as of June 30, 2009; and
	•	an additional           shares of our common stock that will be made available for future issuance under our equity compensation plans upon the closing of this offering.

	•	assumes no exercise by the underwriters of their option to purchase up to an additional           shares from us and the selling stockholders;
	•	assumes that the shares to be sold in this offering are sold at the initial public offering price of $      per share, the midpoint of the estimated price range shown on the cover of this prospectus;

	•	gives effect to a            -for-one split of our common stock to be effected prior to the closing of this offering;
	•	gives effect to the automatic conversion of all outstanding shares of non-voting common stock into shares of voting common stock on a share-for-share basis upon the closing of this offering;
	•	gives effect to the automatic conversion of all outstanding shares of convertible preferred stock into           shares of common stock upon the closing of this offering, assuming an initial public offering price of $      per share, the midpoint of the estimated price range shown on the cover of this prospectus;
	•	gives effect to our assumed issuance of           shares of common stock upon exercise of warrants that will be cancelled if not exercised prior to this offering, assuming an initial public offering price of $      per share, the midpoint of the estimated price range shown on the cover of this prospectus;
	•	gives effect to our issuance of           shares of common stock to Financial Technology Partners, LLC and/or FTP Securities, LLC, whom we collectively refer to as FT Partners, contemporaneously with the closing of this offering for financial advisory services in respect of this offering, assuming an initial public offering price of $      per share, the midpoint of the estimated price range shown on the cover of this prospectus; and
	•	gives effect to the restatement of our certificate of incorporation and amendment and restatement of our bylaws prior to the closing of this offering.

 

SUMMARY CONSOLIDATED FINANCIAL DATA

														Six Months Ended
		Fiscal Year Ended December 31,												June 30,
		2006				2007				2008				2008				2009
														(Unaudited)
		(In thousands, except share and per share data)
Statement of Operations Data:
Net services revenue		$	160,741			$	240,725			$	398,469			$	187,261			$	238,149
Costs of services			141,767				197,676				335,211				160,082				195,667
Operating margin			18,974				43,049				63,258				27,179				42,482
Operating expenses:
Infused management and technology			18,875				27,872				39,234				17,938				24,482
Selling, general and administrative			8,777				15,657				21,227				9,642				15,308
Total operating expenses			27,652				43,529				60,461				27,580				39,790
Income (loss) from operations			(8,678	)			(480	)			2,797				(401	)			2,692
Interest income			1,359				1,710				710				433				83
Income (loss) before provision for (benefit from) income taxes			(7,319	)			1,230				3,507				32				2,775

														Six Months Ended
		Fiscal Year Ended December 31,												June 30,
		2006				2007				2008				2008				2009
														(Unaudited)
		(In thousands, except share and per share data)
Provision for (benefit from) income taxes			—				456				2,264				626				(2,439	)
Net income (loss)		$	(7,319	)		$	774			$	1,243			$	(594	)		$	5,214
Net income (loss) per common share:
Basic:		$	(0.89	)		$	0.04			$	(0.70	)		$	(0.06	)		$	0.25
Diluted:			(1.02	)			0.03				(0.73	)			(0.06	)			0.21
Weighted-average shares used in computing net income (loss) per common share:
Basic:			6,611,975				8,410,226				9,214,916				9,160,187				9,337,812
Diluted:			6,611,975				10,296,011				9,214,916				9,160,187				11,492,646
Other Operating Data (unaudited):
Adjusted EBITDA(1)		$	(7,125	)		$	6,842			$	12,220			$	4,620			$	11,658
Net patient revenue under management (at period end) (in billions)		$	4.1			$	6.9			$	9.1			$	8.5			$	11.9

As of June 30, 2009

Pro Forma

Actual

Pro Forma

As Adjusted

(Unaudited)

(In thousands)

Balance Sheet Data:

Cash and cash equivalents

$

37,789

Working capital

4,114

Total assets

105,965

Total stockholders’ equity

$

20,537

(1)		We define adjusted EBITDA as net income (loss) before net interest income (expense), income tax expense (benefit), depreciation and amortization expense and share-based compensation expense. Adjusted EBITDA is a non-GAAP financial measure and should not be considered as an alternative to net income, operating income and any other measure of financial performance calculated and presented in accordance with GAAP.
		We believe adjusted EBITDA is useful to investors in evaluating our operating performance for the following reasons:

	•	adjusted EBITDA and similar non-GAAP measures are widely used by investors to measure a company’s operating performance without regard to items that can vary substantially from company to company depending upon financing and accounting methods, book values of assets, capital structures and the methods by which assets were acquired;
	•	securities analysts often use adjusted EBITDA and similar non-GAAP measures as supplemental measures to evaluate the overall operating performance of companies; and

	•	by comparing our adjusted EBITDA in different historical periods, our investors can evaluate our operating results without the additional variations of interest income (expense), income tax expense (benefit), depreciation and amortization expense and share-based compensation expense.

		Our management uses adjusted EBITDA:

	•	as a measure of operating performance, because it does not include the impact of items that we do not consider indicative of our core operating performance;
	•	for planning purposes, including the preparation of our annual operating budget;
	•	to allocate resources to enhance the financial performance of our business;
	•	to evaluate the effectiveness of our business strategies; and
	•	in communications with our board of directors and investors concerning our financial performance.

		We understand that, although measures similar to adjusted EBITDA are frequently used by investors and securities analysts in their evaluation of companies, adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results of operations as reported under GAAP. Some of these limitations are:

	•	adjusted EBITDA does not reflect our cash expenditures or future requirements for capital expenditures or other contractual commitments;
	•	adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs;
	•	adjusted EBITDA does not reflect share-based compensation expense;
	•	adjusted EBITDA does not reflect cash requirements for income taxes;
	•	adjusted EBITDA does not reflect net interest income (expense);
	•	although depreciation and amortization are non-cash charges, the assets being depreciated or amortized will often have to be replaced in the future, and adjusted EBITDA does not reflect any cash requirements for these replacements; and
	•	other companies in our industry may calculate adjusted EBITDA differently than we do, limiting its usefulness as a comparative measure.

		To properly and prudently evaluate our business, we encourage you to review the GAAP financial statements included elsewhere in this prospectus, and not to rely on any single financial measure to evaluate our business.

		The following table presents a reconciliation of adjusted EBITDA to net income (loss), the most comparable GAAP measure:

														Six Months Ended
		Fiscal Year Ended December 31,												June 30,
		2006				2007				2008				2008				2009
														(Unaudited)
		(In thousands)
Net income (loss)		$	(7,319	)		$	774			$	1,243			$	(594	)		$	5,214
Net interest income(a)			(1,359	)			(1,710	)			(710	)			(433	)			(83	)
Provision (benefit) for income taxes			—				456				2,264				626				(2,439	)
Depreciation and amortization expense			626				1,307				2,540				920				1,882
EBITDA		$	(8,052	)		$	827			$	5,337			$	519				4,574
Stock compensation expense(b)			844				934				3,551				1,021				2,977
Stock warrant expense(b)			83				5,081				3,332				3,080				4,107
Adjusted EBITDA		$	(7,125	)		$	6,842			$	12,220			$	4,620			$	11,658

 

An investment in our common stock involves a high degree of risk. In deciding whether to invest, you should carefully consider the following risk factors. Any of the following risks could have a material adverse effect on our business, financial condition, results of operations or prospects and cause the value of our common stock to decline, which could cause you to lose all or part of your investment. When deciding whether to invest in our common stock, you should also refer to the other information in this prospectus, including our consolidated financial statements and related notes and the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of this prospectus.

 

Risks Related to Our Business and Industry

 

We may not be able to maintain or increase our profitability, and our recent growth rates may not be indicative of our future growth rates.

 

We have been profitable on an annual basis only since the year ended December 31, 2007, and we incurred net losses in the quarters ended March 31, 2007, December 31, 2007, March 31, 2008, December 31, 2008 and March 31, 2009 and in the six months ended June 30, 2008. We may not succeed in maintaining our profitability on an annual basis and could incur quarterly or annual losses in future periods. We expect to incur additional operating expenses associated with being a public company and we intend to continue to increase our operating expenses as we grow our business. We also expect to continue to make investments in our proprietary technology applications, sales and marketing, infrastructure, facilities and other resources as we expand our operations, thus incurring additional costs. If our revenue does not increase to offset these increases in costs, our operating results would be negatively affected. You should not consider our historic revenue and net income growth rates as indicative of future growth rates. Accordingly, we cannot assure you that we will be able to maintain or increase our profitability in the future. Each of the risks described in this “Risk Factors” section, as well as other factors, may affect our future operating results and profitability. For example, factors that may affect our future operating results and profitability include:

 

 

 

Hospitals affiliated with Ascension Health currently account for a majority of our net services revenue, and we have several customers that have each accounted for 10% or more of our net services revenue in past fiscal periods. The termination of our master services agreement with Ascension Health, or any significant loss of business from our large customers, would have a material adverse effect on our business, results of operations and financial condition.

 

We are party to a master services agreement with Ascension Health pursuant to which we provide services to its affiliated hospitals that execute separate managed service contracts with us. Hospitals affiliated with Ascension Health have accounted for a majority of our net services revenue each year since our formation. In the years ended December 31, 2006, 2007 and 2008 and the six months ended June 30, 2008 and 2009, aggregate revenue from hospitals affiliated with Ascension Health were $142.6 million, $214.2 million, $281.7 million, $136.7 million and $151.6 million, respectively, representing 88.7%, 89.0%, 70.7%, 73.0% and 63.6% of our total net services revenue, which is the term we use for our net services revenue, in such periods. In some fiscal periods, individual hospitals affiliated with Ascension Health have each accounted for 10% or more of our total net services revenue. In addition, another customer, which is not affiliated with Ascension Health, accounted for 11.5% of our total net services revenue in the six months ended June 30, 2008 and 10.6% of our total net services revenue in the year ended December 31, 2008 but less than 10% of our total net services revenue in the six months ended June 30, 2009.

 

All of our managed service contracts with hospitals affiliated with Ascension Health will expire on December 13, 2012 unless renewed. Pursuant to the master services agreement and the managed service contracts with hospitals affiliated with Ascension Health, our fees are subject to adjustment in the event quarterly cash collections at these hospitals deteriorate materially after we take over revenue cycle management operations. While these adjustments have never been triggered, if they were, our future fees from hospitals affiliated with Ascension Health would be reduced. In addition, any of our other customers, including hospitals affiliated with Ascension Health, can elect not to renew their managed service contracts with us upon expiration. We intend to seek renewal of all managed service contracts with our customers, but cannot assure you that all of them will be renewed or that the terms upon which they may be renewed will be as favorable to us as the terms of the initial managed service contracts.

 

Our inability to renew the managed service contracts with hospitals affiliated with Ascension Health, the termination of our master services agreement with Ascension Health, the loss of any of our other large customers or their failure to renew their managed service contracts with us upon expiration, or a reduction in the fees for our services for these customers would have a material adverse effect on our business, results of operations and financial condition.

 

Our master services agreement with Ascension Health requires us to offer to Ascension Health’s affiliated hospitals service fees that are at least as low as the fees we charge any other similarly situated customer receiving comparable services at comparable volumes, and the master services agreement includes other provisions that could impede or delay our ability to enter into managed service contracts with new customers.

 

Our master services agreement with Ascension Health requires us to offer to Ascension Health’s affiliated hospitals fees for our services that are at least as low as the fees we charge any other similarly-situated customer receiving comparable services at comparable volumes. If we were to offer another similarly-situated customer receiving a comparable volume of comparable services fees that are lower than the fees paid by hospitals affiliated with Ascension Health, we would be obligated to offer such lower fees to hospitals affiliated with Ascension Health, which could have a material

adverse effect on our results of operations and financial condition. In addition, we are required to consult with Ascension Health’s affiliated hospitals before undertaking services for competitors identified by them in the managed service contracts they execute with us. In limited circumstances, we have also agreed not to enter into managed service contracts with an existing customer’s competitors without such customer’s consent. These obligations could impede or delay our ability to enter into managed service contracts with new customers.

 

The market for integrated, end-to-end revenue cycle solutions may develop more slowly than we expect, which could adversely affect our revenue and our ability to maintain or increase our profitability.

 

Our success depends, in part, on the willingness of hospitals, physicians and other healthcare providers to implement integrated, end-to-end revenue cycle solutions. Some hospitals may be reluctant or unwilling to implement our solution for a number of reasons, including failure to perceive the need for improved revenue cycle operations and lack of knowledge about the potential benefits our solution provides. Even if potential customers recognize the need for improved revenue cycle operations, they may not select an integrated, end-to-end revenue cycle solution such as ours because they previously have made investments in internally developed solutions and choose to continue to rely on their own internal revenue cycle management staff. As a result, the market for integrated, end-to-end revenue cycle solutions may develop more slowly than we expect, which could adversely affect our revenue and our ability to maintain or increase our profitability.

 

We operate in a highly competitive industry, and our current or future competitors may be able to compete more effectively than we do, which could have a material adverse effect on our business, revenue, growth rates and market share.

 

The market for revenue cycle management solutions is highly competitive and we expect competition to intensify in the future. We face competition from the internal revenue cycle management staff of hospitals, as described above. We also compete with external participants in the revenue cycle market, including software-as-a-service or other technology-supported revenue cycle management business process outsourcing companies; traditional consultants; and information technology outsourcers. Our competitors may be able to respond more quickly and effectively than we can to new or changing opportunities, technologies, standards, regulations or customer requirements. We may not be able to compete successfully with these companies, and these or other competitors may introduce technologies or services that render our technologies or services obsolete or less marketable. Even if our technologies and services are more effective than the offerings of our competitors, current or potential customers might prefer competitive technologies or services to our technologies and services. Increased competition is likely to result in pricing pressures, which could negatively impact our margins, growth rate or market share.

 

If we are unable to retain our existing customers, our financial condition will suffer.

 

Our success depends in part upon the retention of our customers, particularly Ascension Health and its affiliated hospitals. We derive our net services revenue primarily from managed service contracts pursuant to which we receive base fees and incentive payments. Customers can elect not to renew their managed service contracts with us upon expiration. If a managed service contract is not renewed or is terminated for any reason, we will not receive the payments we would have otherwise received over the life of contract. In addition, financial issues or other changes in customer circumstances, such as a customer change in control, may cause us or the customer to seek to modify or terminate a managed service contract, and either we or the customer may generally terminate a contract for material uncured breach by the other. If we breach a managed service contract or fail to perform in accordance with contractual service levels, we may also be liable to the customer for damages. Any of these events could adversely affect our business, financial condition, operating results and cash flows.

We face a variable selling cycle to secure new managed service contracts, making it difficult to predict the timing of specific new customer relationships.

 

We face a variable selling cycle, typically spanning six to twelve months, to secure a new managed service contract. Even if we succeed in developing a relationship with a potential new customer, we may not be successful in entering into a managed service contract with that customer. In addition, we cannot accurately predict the timing of entering into managed service contracts with new customers due to the complex procurement decision processes of most healthcare providers, which often involves high-level or committee approvals. Consequently, we have only a limited ability to predict the timing of specific new customer relationships.

 

Delayed or unsuccessful implementation of our technologies or services with our customers or implementation costs that exceed our expectations may harm our financial results.

 

To implement our solution, we utilize the customer’s existing revenue cycle management and staff and layer our proprietary technology tools on top of the customer’s existing patient accounting system. Each customer’s situation is different, and unanticipated difficulties and delays may arise. If the implementation process is not executed successfully or is delayed, our relationship with the customer may be adversely affected and our results of operations could suffer. Implementation of our solution also requires us to integrate our own employees into the customer’s operations. The customer’s circumstances may require us to devote a larger number of our employees than anticipated, which could increase our costs and harm our financial results.

 

Our quarterly results of operations may fluctuate as a result of factors that may impact our incentive and base fees, some of which may be outside of our control.

 

We recognize base fee revenue on a straight-line basis over the life of the managed service contract. Base fees for contracts which are received in advance of services delivered are classified as deferred revenue until services have been provided. Our managed service contracts generally allow for adjustments to the base fee. Adjustments typically occur at 90, 180 or 360 days after the contract commences, but can also occur at subsequent dates as a result of factors including changes to the scope of operations and internal and external audits. In addition, our fees from hospitals affiliated with Ascension Health are subject to adjustment in the event quarterly cash collections at these hospitals deteriorate materially after we take over revenue cycle management operations. While these adjustments have never been triggered, if they were, our future fees from hospitals affiliated with Ascension Health would be reduced. Further, estimates of the incentive payments we have earned from providing services to customers in prior periods could change because the laws, regulations, instructions, payor contracts and rule interpretations governing how our customers receive payments from payors are complex and change frequently. All adjustments, the timing of which are often dependent on factors outside of our control and which can increase or decrease our revenue and operating margin, are recorded in the period the changes are known and collectibility is reasonably assured. Any such adjustments may cause our quarter-to-quarter results of operations to fluctuate.

 

If we lose key personnel or if we are unable to attract, hire, integrate and retain key personnel and other necessary employees, our business would be harmed.

 

Our future success depends in part on our ability to attract, hire, integrate and retain key personnel. Our future success also depends on the continued contributions of our executive officers and other key personnel, each of whom may be difficult to replace. In particular, Mary A. Tolan, our president and chief executive officer, is critical to the management of our business and operations and the development of our strategic direction. The loss of services of Ms. Tolan or any of our other executive officers or key personnel or the inability to continue to attract qualified personnel could have a material adverse effect on our business. The replacement of any of these key personnel would involve significant time and expense and may significantly delay or prevent the achievement of our business objectives. Competition for the caliber and number of employees we require is intense. We

may face difficulty identifying and hiring qualified personnel at compensation levels consistent with our existing compensation and salary structure. In addition, we invest significant time and expense in training each of our employees, which increases their value to competitors who may seek to recruit them. If we fail to retain our employees, we could incur significant expenses in hiring, integrating and training their replacements and the quality of our services and our ability to serve our customers could diminish, resulting in a material adverse effect on our business.

 

If we fail to manage future growth effectively, our business would be harmed.

 

We have expanded our operations significantly since inception and anticipate expanding further. For example, our net services revenue increased from $16.2 million in 2004 to $398.5 million in 2008, and the number of our full-time employees increased from two at January 1, 2004 to 1,305 as of June 30, 2009. This growth has placed significant demands on our management, infrastructure and other resources. To manage future growth, we will need to hire, integrate and retain highly skilled and motivated employees. We will also need to continue to improve our financial and management controls, reporting systems and procedures. If we do not effectively manage our growth, we may not be able to execute on our business plan, respond to competitive pressures, take advantage of market opportunities, satisfy customer requirements or maintain high-quality service offerings.

 

Disruptions in service or damage to our data centers and shared services centers could adversely affect our business.

 

Our data centers and shared services centers are essential to our business. Our operations depend on our ability to operate our shared service centers, and to maintain and protect our applications, which are located in data centers that are operated for us by third parties. We cannot control or assure the continued or uninterrupted availability of these third party data centers. In addition, our information technologies and systems, as well as our data centers and shared services centers, are vulnerable to damage or interruption from various causes, including (i) acts of God and other natural disasters, war and acts of terrorism and (ii) power losses, computer systems failures, Internet and telecommunications or data network failures, operator error, losses of and corruption of data and similar events. We conduct business continuity planning and maintain insurance against fires, floods, other natural disasters and general business interruptions to mitigate the adverse effects of a disruption, relocation or change in operating environment at one of our data centers or shared services centers, but the situations we plan for and the amount of insurance coverage we maintain may not be adequate in any particular case. In addition, the occurrence of any of these events could result in interruptions, delays or cessations in service to our customers, or in interruptions, delays or cessations in the direct connections we establish between our customers and third-party payors. Any of these events could impair or prohibit our ability to provide our services, reduce the attractiveness of our services to current or potential customers and adversely impact our financial condition and results of operations.

 

In addition, despite the implementation of security measures, our infrastructure, data centers, shared services centers or systems that we interface with, including the Internet and related systems, may be vulnerable to physical break-ins, hackers, improper employee or contractor access, computer viruses, programming errors, denial-of-service attacks or other attacks by third parties seeking to disrupt operations or misappropriate information or similar physical or electronic breaches of security. Any of these can cause system failure, including network, software or hardware failure, which can result in service disruptions. As a result, we may be required to expend significant capital and other resources to protect against security breaches and hackers or to alleviate problems caused by such breaches.

If our security measures are breached or fail and unauthorized access is obtained to a customer’s data, our service may be perceived as not being secure, the attractiveness of our services to current or potential customers may be reduced, and we may incur significant liabilities.

 

Our services involve the storage and transmission of customers’ proprietary information and protected health, financial, payment and other personal information of patients. We rely on proprietary and commercially available systems, software, tools and monitoring, as well as other processes, to provide security for processing, transmission and storage of such information, and because of the sensitivity of this information, the effectiveness of such security efforts is very important. The systems currently used for transmission and approval of credit card transactions, and the technology utilized in credit cards themselves, all of which can put credit card data at risk, are determined and controlled by the payment card industry, not by us. If our security measures are breached or fail as a result of third-party action, employee error, malfeasance or otherwise, someone may be able to obtain unauthorized access to customer or patient data. Improper activities by third parties, advances in computer and software capabilities and encryption technology, new tools and discoveries and other events or developments may facilitate or result in a compromise or breach of our computer systems. Techniques used to obtain unauthorized access or to sabotage systems change frequently and generally are not recognized until launched against a target, and we may be unable to anticipate these techniques or to implement adequate preventive measures. Our security measures may not be effective in preventing these types of activities, and the security measures of our third-party data centers and service providers may not be adequate. If a breach of our security occurs, we could face damages for contract breach, penalties for violation of applicable laws or regulations, possible lawsuits by individuals affected by the breach and significant remediation costs and efforts to prevent future occurrences. In addition, whether there is an actual or a perceived breach of our security, the market perception of the effectiveness of our security measures could be harmed and we could lose current or potential customers.

 

We may be liable to our customers or third parties if we make errors in providing our services, and our anticipated net services revenue may be lower if we provide poor service.

 

The services we offer are complex, and we make errors from time to time. Errors can result from the interface of our proprietary technology tools and a customer’s existing patient accounting system, or we may make human errors in any aspect of our service offerings. The costs incurred in correcting any material errors may be substantial and could adversely affect our operating results. Our customers, or third parties such as our customers’ patients, may assert claims against us alleging that they suffered damages due to our errors, and such claims could subject us to significant legal defense costs and adverse publicity regardless of the merits or eventual outcome of such claims. In addition, if we provide poor service to a customer and the customer therefore realizes less improvement in revenue yield, the incentive fee payments to us from that customer will be lower than anticipated.

 

We offer our services in many jurisdictions and, therefore, may be subject to state and local taxes that could harm our business or that we may have inadvertently failed to pay.

 

We may lose sales or incur significant costs should various tax jurisdictions be successful in imposing taxes on a broader range of services. Imposition of such taxes on our services could result in substantial unplanned costs, would effectively increase the cost of such services to our customers and may adversely affect our ability to retain existing customers or to gain new customers in the areas in which such taxes are imposed. For example, in 2008 Michigan began to impose a tax based on gross receipts in addition to tax based on net income. For the year ended December 31, 2008, we recorded a tax provision of $2.3 million, of which $1.2 million was attributable to the Michigan gross receipts tax.

Our growing operations in India expose us to risks that could have an adverse effect on our costs of operations.

 

We employ a significant number of persons in India and expect to continue to add personnel in India. While there are cost advantages to operating in India, significant growth in the technology sector in India has increased competition to attract and retain skilled employees and has led to a commensurate increase in compensation costs. In the future, we may not be able to hire and retain such personnel at compensation levels consistent with our existing compensation and salary structure in India. In addition, our reliance on a workforce in India exposes us to disruptions in the business, political and economic environment in that region. Maintenance of a stable political environment is important to our operations, and terrorist attacks and acts of violence or war may directly affect our physical facilities and workforce or contribute to general instability. Our operations in India require us to comply with local laws and regulatory requirements, which are complex and of which we may not always be aware, and expose us to foreign currency exchange rate risk. Our Indian operations may also subject us to trade restrictions, reduced or inadequate protection for intellectual property rights, security breaches and other factors that may adversely affect our business. Negative developments in any of these areas could increase our costs of operations or otherwise harm our business.

 

Negative public perception in the United States regarding offshore outsourcing and proposed legislation may increase the cost of delivering our services.

 

Offshore outsourcing is a politically sensitive topic in the United States. For example, various organizations and public figures in the United States have expressed concern about a perceived association between offshore outsourcing providers and the loss of jobs in the United States. In addition, there has been recent publicity about the negative experience of certain companies that use offshore outsourcing, particularly in India. Current or prospective customers may elect to perform such services themselves or may be discouraged from transferring these services from onshore to offshore providers to avoid negative perceptions that may be associated with using an offshore provider. Any slowdown or reversal of existing industry trends towards offshore outsourcing would increase the cost of delivering our services if we had to relocate aspects of our services from India to the United States where operating costs are higher.

 

Legislation in the United States may be enacted that is intended to discourage or restrict offshore outsourcing. In the United States, federal and state legislation has been proposed, and enacted in several states, that could restrict or discourage U.S. companies from outsourcing their services to companies outside the United States. For example, legislation has been proposed that would require offshore providers to identify where they are located. In addition, legislation has been enacted in at least one state that requires that state contracts for services be performed within the United States, while several other states provide a preference to state contracts that are performed within the state. It is possible that legislation could be adopted that would restrict U.S. private sector companies that have federal or state government contracts, or that receive government funding or reimbursement, such as Medicare or Medicaid payments, from outsourcing their services to offshore service providers. Any changes to existing laws or the enactment of new legislation restricting offshore outsourcing in the United States may adversely affect our ability to do business, particularly if these changes are widespread, and could have a material adverse effect on our business, results of operations, financial condition and cash flows.

 

We may engage in future acquisitions that could disrupt our business, cause dilution to our stockholders and harm our business, operating results or financial condition.

 

Although we currently have no business acquisitions pending or planned, we may pursue acquisition opportunities in the future. We have limited experience consummating acquisitions, and therefore our ability as an organization to make acquisitions is unproven. We may not be able to find suitable acquisition candidates, and we may not be able to complete acquisitions on favorable terms. If we do complete acquisitions, we may not ultimately strengthen our competitive position or achieve

our goals, or such acquisitions may be viewed negatively by customers, financial markets or investors. In addition, any acquisitions that we make could lead to difficulties in integrating personnel and operations from the acquired businesses and in retaining and motivating key personnel from these businesses. Acquisitions may disrupt our ongoing operations, divert management from day-to-day responsibilities, increase our expenses or adversely affect our business, operating results and financial condition. Future acquisitions may reduce our cash available for operations and other uses and could result in an increase in amortization expense related to identifiable assets acquired, potentially dilutive issuances of equity securities or the incurrence of debt, which could harm our business, operating results and financial condition.

 

Regulatory Risks

 

The healthcare industry is heavily regulated. Our failure to comply with regulatory requirements could create liability for us, result in adverse publicity and negatively affect our business.

 

The healthcare industry is heavily regulated and is subject to changing political, legislative, regulatory and other influences. Many healthcare laws are complex, and their application to specific services and relationships may not be clear. In particular, many existing healthcare laws and regulations, when enacted, did not anticipate the services that we provide. We believe we have structured our operations to comply with all material legal requirements that are applicable to us, but there can be no assurance that our operations will not be challenged or adversely affected by enforcement initiatives. Our failure to accurately anticipate the application of these laws and regulations to our business, or any other failure to comply with regulatory requirements, could create liability for us, result in adverse publicity and negatively affect our business. Federal and state legislatures and agencies periodically consider proposals to revise aspects of the healthcare industry or to revise or create additional statutory and regulatory requirements. Such proposals, if implemented, could impact our operations, the use of our services and our ability to market new services, or could create unexpected liabilities for us. We are unable to predict what changes to laws or regulations might be made in the future or how those changes could affect our business or our operating costs.

 

Developments in the healthcare industry, including national healthcare reform, could adversely affect our business.

 

The healthcare industry has changed significantly in recent years and we expect that significant changes will continue to occur. The timing and impact of developments in the healthcare industry are difficult to predict. We cannot be sure that the markets for our services will continue to exist at current levels or that we will have adequate technical, financial and marketing resources to react to changes in those markets.

 

National healthcare reform is currently a major policy issue at the federal level. The Obama administration has made healthcare reform a priority, and legislative proposals are currently being debated by Congress. Some of the underlying themes of current reform proposals — quality and cost, uninsured coverage and healthcare information technology — are broadly targeted to drive greater efficiency in the U.S. healthcare system by, among other things, rewarding quality and coordination of care and promoting broader adoption of electronic medical records.

 

Although it is impossible to predict what healthcare reform legislation, if any, will be enacted, proposals currently being debated could have adverse consequences for the hospitals we serve and for us. Healthcare reform could, for example, result in additional or costly legal and regulatory requirements that are applicable to us and our customers, encourage more companies to enter our market, provide advantages to our competitors and result in the development of solutions that compete with ours. In addition, healthcare reform could result in an increase to the number or scope

of federal or state charity care programs or community benefits programs, which may adversely affect our claim collection and recovery efforts.

 

If a breach of our measures protecting personal data covered by the Health Insurance Portability and Accountability Act or Health Information Technology for Economic and Clinical Health Act occurs, we may incur significant liabilities.

 

The Health Insurance Portability and Accountability Act of 1996, as amended, and the regulations that have been issued under it, which we refer to collectively as HIPAA, contain substantial restrictions and requirements with respect to the use and disclosure of individuals’ protected health information. Under HIPAA, covered entities must establish administrative, physical and technical safeguards to protect the confidentiality, integrity and availability of electronic protected health information maintained or transmitted by them or by others on their behalf. In February 2009 HIPAA was amended by the Health Information Technology for Economic and Clinical Health, or HITECH, Act to add provisions that will, beginning in 2010, impose certain of the HIPAA privacy and security requirements directly upon business associates of covered entities. When new regulations take effect in late 2009, both covered entities and their business associates will be required to notify individuals and government authorities of data security breaches involving unsecured protected health information. We may be viewed as a business associate of a covered entity under HIPAA and the HITECH Act. We have implemented and maintain physical, technical and administrative safeguards intended to protect all personal data and have processes in place to assist us in complying with applicable laws and regulations regarding the protection of this data and properly responding to any security incidents. A knowing breach of the HITECH Act’s requirements could expose us to criminal liability. A breach of our safeguards and processes that is not due to reasonable cause or involves willful neglect could expose us to civil penalties and the possibility of civil litigation.

 

If we fail to comply with federal and state laws governing submission of false or fraudulent claims to government healthcare programs and financial relationships among healthcare providers, we may be subject to civil and criminal penalties or loss of eligibility to participate in government healthcare programs.

 

A number of federal and state laws, including anti-kickback restrictions and laws prohibiting the submission of false or fraudulent claims, apply to healthcare providers, physicians and others that make, offer, seek or receive referrals or payments for products or services that may be paid for through any federal or state healthcare program and, in some instances, any private program. These laws are complex and their application to our specific services and relationships may not be clear and may be applied to our business in ways that we do not anticipate. Federal and state regulatory and law enforcement authorities have recently increased enforcement activities with respect to Medicare and Medicaid fraud and abuse regulations and other healthcare reimbursement laws and rules. From time to time, participants in the healthcare industry receive inquiries or subpoenas to produce documents in connection with government investigations. We could be required to expend significant time and resources to comply with these requests, and the attention of our management team could be diverted by these efforts. Furthermore, if we are found to be in violation of any federal or state fraud and abuse laws, we could be subject to civil and criminal penalties, and we could be excluded from participating in federal and state healthcare programs such as Medicare and Medicaid. The occurrence of any of these events could give our customers the right to terminate our managed service contracts with them and result in significant harm to our business and financial condition.

 

The federal anti-kickback law prohibits any person or entity from offering, paying, soliciting or receiving anything of value, directly or indirectly, for the referral of patients covered by Medicare, Medicaid and other federal healthcare programs or the leasing, purchasing, ordering or arranging for or recommending the lease, purchase or order of any item, good, facility or service covered by these programs. Many states have adopted similar prohibitions against kickbacks and other practices that are intended to induce referrals, and some of these state laws are applicable to all patients regardless

of whether the patient is covered under a governmental health program or private health plan. We evaluate our business relationships and activities to comply with the federal anti-kickback statute and similar laws, and we seek to structure our financial arrangements in a manner that is consistent with the requirements of applicable safe harbors to these laws. We cannot assure you, however, that our arrangements will be protected by such safe harbors or that such increased enforcement activities will not directly or indirectly have an adverse effect on our business financial condition or results of operations. Any determination by a federal or state agency that any of our activities or those of our vendors or customers violate any of these laws could subject us to civil or criminal penalties, could require us to change or terminate some portions of our operations or business, could disqualify us from providing services to healthcare providers doing business with government programs, could give our customers the right to terminate our managed service contracts with them and, thus, could have a material adverse effect on our business and results of operations.

 

There are also numerous federal and state laws that forbid submission of false information or the failure to disclose information in connection with the submission and payment of physician claims for reimbursement. In particular, the federal False Claims Act, or the FCA, prohibits a person from knowingly presenting or causing to be presented a false or fraudulent claim for payment or approval by an officer, employee or agent of the United States. In addition, the FCA prohibits a person from knowingly making, using, or causing to be made or used a false record or statement material to such a claim. Violations of the FCA may result in treble damages, significant monetary penalties, and other collateral consequences including, potentially, exclusion from participation in federally funded health care programs. The scope and implications of the recent amendments pursuant to the Fraud Enforcement and Recovery Act of 2009, or FERA, have yet to be fully determined or adjudicated and as a result it is difficult to predict how future enforcement initiatives may impact our business.

 

These laws and regulations may change rapidly, and it is frequently unclear how they apply to our business. Errors created by our proprietary tools or services that relate to entry, formatting, preparation or transmission of claim or cost report information may be determined or alleged to be in violation of these laws and regulations. Any failure of our proprietary tools or services to comply with these laws and regulations could result in substantial civil or criminal liability and could, among other things, adversely affect demand for our services, invalidate all or portions of some of our managed service contracts with our customers, require us to change or terminate some portions of our business, require us to refund portions of our base fee revenues and incentive payment revenues, cause us to be disqualified from serving customers doing business with government payers, and give our customers the right to terminate our managed service contracts with them, any one of which could have an adverse effect on our business.

 

Our failure to comply with debt collection and consumer credit reporting regulations could subject us to fines and other liabilities, which could harm our reputation and business.

 

The U.S. Fair Debt Collection Practices Act, or FDCPA, regulates persons who regularly collect or attempt to collect, directly or indirectly, consumer debts owed or asserted to be owed to another person. Certain of our accounts receivable activities may be subject to the FDCPA. Many states impose additional requirements on debt collection communications, and some of those requirements may be more stringent than the comparable federal requirements. Moreover, regulations governing debt collection are subject to changing interpretations that may be inconsistent among different jurisdictions. We are also subject to the Fair Credit Reporting Act, or FCRA, which regulates consumer credit reporting and which may impose liability on us to the extent that the adverse credit information reported on a consumer to a credit bureau is false or inaccurate. We could incur costs or could be subject to fines or other penalties under the FCRA if the Federal Trade Commission determines that we have mishandled protected information. We or our customers could be required to report such breaches to affected consumers or regulatory authorities, leading to disclosures that could damage our reputation or harm our business, financial position and operating results.

Potential additional regulation of the disclosure of health information outside the United States may increase our costs.

 

Federal or state governmental authorities may impose additional data security standards or additional privacy or other restrictions on the collection, use, transmission and other disclosures of health information. Legislation has been proposed at various times at both the federal and the state levels that would limit, forbid or regulate the use or transmission of medical information pertaining to U.S. patients outside of the United States. Such legislation, if adopted, may render our operations in India impracticable or substantially more expensive. Moving such operations to the United States may involve substantial delay in implementation and increased costs.

 

Risks Related to Intellectual Property

 

We may be unable to adequately protect our intellectual property.

 

Our success depends, in part, upon our ability to establish, protect and enforce our intellectual property and other proprietary rights. If we fail to establish or protect our intellectual property rights, we may lose an important advantage in the market in which we compete. We rely upon a combination of trademark, copyright and trade secret law and contractual terms and conditions to protect our intellectual property rights, all of which provide only limited protection. We cannot assure you that our intellectual property rights are sufficient to protect our competitive advantages. Although we have filed four patent applications, we cannot assure you that any patents will issue from these applications in a manner that gives us the protection that we seek, or that any future patents issued to us will not be challenged, invalidated or circumvented. Legal standards relating to the validity, enforceability and scope of protection of patents are uncertain. Any patents that may issue in the future from pending or future patent applications may not provide sufficiently broad protection or they may not prove to be enforceable in actions against alleged infringers. Also, we cannot assure you that any trademark registrations will be issued for pending or future applications or that any of our trademarks will be enforceable or provide adequate protection of our proprietary rights.

 

We also rely in some circumstances on trade secrets to protect our technology. Trade secrets may lose their value if not properly protected. We endeavor to enter into non-disclosure agreements with our employees, customers, contractors and business partners to limit access to and disclosure of our proprietary information. The steps we have taken, however, may not prevent unauthorized use of our technology, and adequate remedies may not be available in the event of unauthorized use or disclosure of our trade secrets and proprietary technology. Moreover, others may reverse engineer or independently develop technologies that are competitive to ours or infringe our intellectual property.

 

Accordingly, despite our efforts, we may be unable to prevent third parties from infringing or misappropriating our intellectual property and using our technology for their competitive advantage. Any such infringement or misappropriation could have a material adverse effect on our business, results of operations and financial condition. Monitoring infringement of our intellectual property rights can be difficult and costly, and enforcement of our intellectual property rights may require us to bring legal actions against infringers. Infringement actions are inherently uncertain and therefore may not be successful, even when our rights have been infringed, and even if successful may require a substantial amount of resources and divert our management’s attention.

 

Claims by others that we infringe their intellectual property could force us to incur significant costs or revise the way we conduct our business.

 

Our competitors protect their intellectual property rights by means such as patents, trade secrets, copyrights and trademarks. We have not conducted an independent review of patents issued to third parties. Additionally, because patent applications in the United States and many other jurisdictions are kept confidential for 18 months before they are published, we may be unaware of pending patent applications that relate to our proprietary technology. Although we have not been involved in any litigation related to intellectual property rights of others, from time to time we receive

letters from other parties alleging, or inquiring about, possible breaches of their intellectual property rights. Any party asserting that we infringe its proprietary rights would force us to defend ourselves, and possibly our customers, against the alleged infringement. These claims and any resulting lawsuit, if successful, could subject us to significant liability for damages and invalidation of our proprietary rights or interruption or cessation of our operations. The software and technology industries are characterized by the existence of a large number of patents, copyrights, trademarks and trade secrets and by frequent litigation based on allegations of infringement or other violations of intellectual property rights. Moreover, the risk of such a lawsuit will likely increase as our size and scope of our services and technology platforms increase, as our geographic presence and market share expand and as the number of competitors in our market increases. Any such claims or litigation could:

 

 

Intellectual property litigation can be costly. Even if we prevail, the cost of such litigation could deplete our financial resources. Litigation is also time-consuming and could divert management’s attention and resources away from our business. Furthermore, during the course of litigation, confidential information may be disclosed in the form of documents or testimony in connection with discovery requests, depositions or trial testimony. Disclosure of our confidential information and our involvement in intellectual property litigation could materially adversely affect our business. Some of our competitors may be able to sustain the costs of complex intellectual property litigation more effectively than we can because they have substantially greater resources. In addition, any uncertainties resulting from the initiation and continuation of any litigation could significantly limit our ability to continue our operations and could harm our relationships with current and prospective customers. Any of the foregoing could disrupt our business and have a material adverse effect on our operating results and financial condition.

 

Risks Related to this Offering and Ownership of Shares of Our Common Stock

 

The trading price of our common stock is likely to be volatile, and you may not be able to sell your shares at or above the initial public offering price.

 

Our common stock has no prior trading history, and an active public market for these shares may not develop or be sustained after this offering. The initial public offering price for our common stock will be determined through negotiations with the representatives of the underwriters. This price will not necessarily reflect the price at which investors in the market will be willing to buy and sell our shares following this offering. In addition, the trading price of our common stock is likely to be highly volatile and could be subject to wide fluctuations in response to various factors. In addition to the risks

described in this section, factors that may cause the market price of our common stock to fluctuate include:

 

 

In addition, if the stock market in general experiences a loss of investor confidence, the trading price of our common stock could decline for reasons unrelated to our business, financial condition or results of operations.

 

Some companies that have had volatile market prices for their securities have had securities class actions filed against them. If a suit were filed against us, regardless of its merits or outcome, it would likely result in substantial costs and divert management’s attention and resources. This could have a material adverse effect on our business, operating results and financial condition.

 

Our securities have no prior market and our stock price may decline after the offering.

 

Prior to this offering, there has been no public market for shares of our common stock. Although we intend to apply to have our common stock listed on the New York Stock Exchange, an active public trading market for our common stock may not develop or, if it develops, may not be maintained after this offering. For example, the New York Stock Exchange imposes certain securities trading requirements, including minimum trading price, minimum number of stockholders and minimum market capitalization. Our company and the representatives of the underwriters will negotiate to determine the initial public offering price. The initial public offering price may be higher than the trading price of our common stock following this offering. As a result, you could lose all or part of your investment.

 

Future sales of shares by existing stockholders could cause our stock price to decline.

 

If our existing stockholders sell, or indicate an intention to sell, substantial amounts of our common stock in the public market after the contractual lock-up agreements described below expire and other restrictions on resale lapse, the trading price of our common stock could decline below the initial public offering price. Based on shares outstanding as of June 30, 2009, upon the closing of this offering, we will have outstanding           shares of common stock. Of these shares,           shares of common stock will be eligible for sale in the public market and           shares of common stock will be subject to a 180-day contractual lock-up with the underwriters. Goldman, Sachs & Co. and Credit Suisse Securities (USA) LLC, acting as representatives of the underwriters, may permit our officers, directors, employees and current stockholders who are subject to the contractual lock-up to sell shares prior to the expiration of the lock-up agreements. Upon expiration of the contractual lock-up agreements with the underwriters, and based on shares outstanding as of June 30, 2009, an additional           shares will be eligible for sale in the public market.

 

Some of our existing stockholders have demand and incidental registration rights to require us to register with the SEC up to           shares of our common stock. If we register these shares of common stock, the stockholders would be able to sell those shares freely in the public market.

 

See “Shares Eligible for Future Sale” for further details regarding the number of shares eligible for sale in the public market after this offering.

Insiders will continue to have substantial control over us after this offering and will be able to determine substantially all matters requiring stockholder approval.

 

Upon the closing of this offering, our directors and executive officers and their affiliates will beneficially own, in the aggregate, approximately     % of our outstanding common stock, assuming no exercise of the underwriters’ option to purchase additional shares. As a result, these stockholders will be able to determine substantially all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions, such as a merger or other sale of our company or its assets. This concentration of ownership could limit your ability to influence corporate matters and may have the effect of delaying or preventing a third-party from acquiring control over us. For information regarding the ownership of our outstanding stock by our executive officers and directors and their affiliates, see “Principal and Selling Stockholders”.

 

We will incur significant increased costs as a result of operating as a public company, and our management will be required to devote substantial time to public company compliance matters.

 

We have never operated as a public company. As a public company, we will incur significant legal, accounting and other expenses that we did not incur as a private company. In addition, the Sarbanes-Oxley Act of 2002, as well as rules subsequently implemented by the SEC and the New York Stock Exchange, have imposed various new requirements on public companies, including requiring changes in corporate governance practices. Our management and other personnel will need to devote a substantial amount of time to compliance with our public company obligations. Moreover, these rules and regulations will increase our legal and financial compliance costs and will make some activities more time-consuming and costly. For example, we expect these rules and regulations to make it more difficult and more expensive for us to obtain director and officer liability insurance.

 

The Sarbanes-Oxley Act requires, among other things, that we maintain effective internal control over financial reporting and disclosure controls and procedures. In particular, commencing with our fiscal year ending December 31, 2010, we must perform system and process evaluation and testing of our internal control over financial reporting to allow management and our independent registered public accounting firm to report on the effectiveness of our internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act. Our testing, or the subsequent testing by our independent registered public accounting firm, may reveal deficiencies in our internal control over financial reporting that are deemed to be material weaknesses. Our compliance with Section 404 will require that we incur substantial accounting expense and expend significant management time on compliance-related issues. Preparing for compliance with Section 404 will require us to strengthen our internal controls, improve our processes and systems for financial reporting and internal controls, and hire additional accounting and financial staff with appropriate public company experience and technical accounting knowledge. Moreover, if we are not able to comply with the requirements of Section 404 in a timely manner, or if we or our independent registered public accounting firm identifies deficiencies in our internal control over financial reporting that are deemed to be material weaknesses, the market price of our stock could decline, and we could be subject to sanctions or investigations by the New York Stock Exchange, the SEC or other regulatory authorities, which would require additional financial and management resources.

 

If securities or industry analysts do not publish research or publish inaccurate or unfavorable research about our business, our stock price and trading volume could decline.

 

The trading market for our common stock will depend in part on the research and reports that securities or industry analysts publish about us or our business. We do not currently have and may never obtain widespread research coverage by securities and industry analysts. In the event we obtain securities or industry analyst coverage, if one or more of the analysts who covers us downgrades our stock or publishes inaccurate or unfavorable research about our business, our stock price would likely decline. If one or more of these analysts ceases coverage of our company or fails to publish reports

on us regularly, demand for our stock could decrease, which could cause our stock price and trading volume to decline.

 

You will experience substantial dilution as a result of this offering and future equity issuances.

 

The initial public offering price per share is substantially higher than the pro forma net tangible book value per share of our common stock outstanding prior to this offering. As a result, investors purchasing common stock in this offering will experience immediate substantial dilution of $      per share. In addition, we have issued options to acquire common stock at prices significantly below the initial public offering price. To the extent outstanding options are ultimately exercised, there will be further dilution to investors in this offering. This dilution is due in large part to the fact that our earlier investors paid substantially less than the initial public offering price when they purchased their shares of common stock. In addition, if the underwriters exercise their option to purchase additional shares, if outstanding warrants to purchase our common stock are exercised, or if we issue additional equity securities, you will experience additional dilution.

 

Anti-takeover provisions in our charter documents and Delaware law could discourage, delay or prevent a change in control of our company and may affect the trading price of our common stock.

 

We are a Delaware corporation and the anti-takeover provisions of the Delaware General Corporation Law may discourage, delay or prevent a change in control by prohibiting us from engaging in a business combination with an interested stockholder for a period of three years after the person becomes an interested stockholder, even if a change in control would be beneficial to our existing stockholders. In addition, our restated certificate of incorporation and amended and restated bylaws may discourage, delay or prevent a change in our management or control over us that stockholders may consider favorable. Our restated certificate of incorporation and amended and restated bylaws, which will be in effect prior to the closing of this offering:

 

 

For additional information regarding these and other anti-takeover provisions, see “Description of Capital Stock — Anti-Takeover Effects of Our Charter and Bylaws and Delaware Law”.

Our management will have broad discretion over the use of the proceeds we receive in this offering and might not apply the proceeds in ways that increase the value of your investment.

 

Our management will have broad discretion to use the net proceeds from this offering, and you will be relying on the judgment of our management regarding the application of these proceeds. Our management might not apply the net proceeds of this offering in ways that increase the value of your investment. We expect to use the net proceeds from this offering for general corporate purposes, which may include financing our growth, developing new services and funding capital expenditures, acquisitions and investments. You will not have the opportunity to influence our decisions on how to use the net proceeds from this offering.

 

We do not anticipate paying any cash dividends on our capital stock in the foreseeable future following the closing of this offering.

 

Although we paid a cash dividend on our capital stock in July 2008 and declared another cash dividend on our capital stock in August 2009, we do not expect to pay cash dividends on our common stock in the foreseeable future following the closing of this offering. Any future dividend payments will be within the absolute discretion of our board of directors and will depend on, among other things, our financial condition, results of operations, capital requirements, capital expenditure requirements, contractual restrictions, provisions of applicable law and other factors that our board of directors may deem relevant. We may not generate sufficient cash from operations in the future to pay dividends on our common stock. See “Dividend Policy”.

 

This prospectus contains forward-looking statements that involve substantial risks and uncertainties. All statements, other than statements of historical facts, included in this prospectus regarding our strategy, future operations, future financial position, future revenue, projected costs, prospects, plans, objectives of management and expected market growth are forward-looking statements. The words “anticipate”, “believe”, “estimate”, “expect”, “intend”, “may”, “plan”, “predict”, “project”, “will”, “would” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. These forward-looking statements include, among other things, statements about:

 

 

We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements, and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements we make. We have included important factors in the cautionary statements included in this prospectus, particularly in the “Risk Factors” section, that could cause actual results or events to differ materially from the forward-looking statements that we make. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures or investments we may make.

 

You should read this prospectus and the documents that we have filed as exhibits to the registration statement, of which this prospectus is a part, completely and with the understanding that our actual future results may be materially different from what we expect. We do not assume any obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

 

We obtained the industry and market data in this prospectus from our own research as well as from industry and general publications, surveys and studies conducted by third parties. Industry and general publications, studies and surveys generally state that they have been obtained from sources believed to be reliable, although they do not guarantee the accuracy or completeness of such information. While we believe that these publications, studies and surveys are reliable, we have not independently verified the data contained in them. In addition, while we believe that the results and estimates from our internal research are reliable, such results and estimates have not been verified by any independent source.

 

We estimate that we will receive net proceeds from this offering of approximately $      million, or $      million if the underwriters exercise their option to purchase additional shares in full, based on an assumed initial public offering price of $      per share, the midpoint of the estimated price range shown on the cover of this prospectus, and after deducting the estimated underwriting discount and offering expenses payable by us. We will not receive any proceeds from the sale of shares of common stock by the selling stockholders.

 

A $1.00 increase (decrease) in the assumed initial public offering price of $      , the midpoint of the estimated price range shown on the cover of this prospectus, would increase (decrease) the net proceeds to us from this offering by $      million, assuming the number of shares offered by us, as set forth on the cover of this prospectus, remains the same and after deducting the estimated underwriting discount and offering expenses payable by us.

 

We intend to use approximately $      million of our net proceeds of this offering to pay the preferred stock liquidation preferences that will be paid in cash to the holders of our outstanding preferred stock concurrently with the conversion of such shares into shares of our common stock upon the closing of this offering. We intend to use the remainder of our net proceeds of this offering for general corporate purposes, which may include financing our growth, developing new services and funding capital expenditures, acquisitions and investments. In addition, the other principal purposes for this offering are to:

 

 

Except for the preferred stock liquidation preference payments described above, we have not yet determined with any certainty the manner in which we will allocate our net proceeds. Our management will retain broad discretion in the allocation and use of our net proceeds of this offering. The amounts and timing of these expenditures will vary depending on a number of factors, including the amount of cash generated by our operations, competitive and technological developments, and the rate of growth, if any, of our business. For example, if we were to expand our operations more rapidly than anticipated by our current plans, a greater portion of the proceeds would likely be used for the development or enhancement of our proprietary technologies. Alternatively, if we were to engage in an acquisition that required a significant cash outlay, some or all of the proceeds might be used for that purpose.

 

Although we may use a portion of the proceeds for the acquisition of, or investment in, companies, technologies or assets that complement our business, we have no present understandings, commitments or agreements to enter into any acquisitions or make any material investments. We cannot assure you that we will make any acquisitions or investments in the future.

 

Pending specific utilization of the net proceeds as described above, we intend to invest the net proceeds of the offering in short-term investment grade and U.S. government securities.

 

We paid a cash dividend in the aggregate amount of $15.0 million, or $0.7203 per common-equivalent share, to holders of record as of July 11, 2008 of our common stock and preferred stock. In August 2009, we declared an additional cash dividend in the aggregate amount of $15.0 million, or $0.72 per common-equivalent share, to holders of record as of September 1, 2009 of our common stock and preferred stock. Approximately $13 million of this dividend is being paid in September 2009 and the balance in October 2009.

 

We currently intend to retain earnings, if any, to finance the growth and development of our business, and we do not expect to pay any cash dividends on our common stock in the foreseeable future following the closing of this offering. Payment of future dividends, if any, will be at the discretion of our board of directors and will depend on our financial condition, results of operations, capital requirements, restrictions contained in current or future financing instruments, provisions of applicable law, and other factors the board deems relevant.

 

The following table sets forth our capitalization as of June 30, 2009:

 

 

You should read this table together with our financial statements and the related notes appearing at the end of this prospectus and the “Use of Proceeds” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections of this prospectus.

 

 

A $1.00 increase (decrease) in the assumed initial public offering price of $      , the midpoint of the estimated price range shown on the cover of this prospectus, would increase (decrease) each of additional paid-in capital and total stockholders’ equity in the pro forma as adjusted column by $      million, assuming the number of shares offered by us, as set forth on the cover of this prospectus, remains the same and after deducting the estimated underwriting discount and offering expenses payable by us.

 

The table above is based on the number of shares of common stock outstanding as of June 30, 2009, and excludes:

 

 

If you invest in our common stock, your interest will be diluted immediately to the extent of the difference between the initial public offering price per share you will pay in this offering and the pro forma as adjusted net tangible book value per share of our common stock after this offering. Our pro forma historical net tangible book value as of June 30, 2009 was $      million, or $      per share of common stock. Our pro forma net tangible book value per share set forth below represents our total tangible assets less total liabilities and convertible preferred stock, divided by the number of shares of our common stock outstanding on June 30, 2009, after giving effect to (1) the     -for-one split of our common stock to be effected prior to the closing of this offering, (2) the automatic conversion of all outstanding shares of non-voting common stock into shares of common stock upon the closing of this offering, (3) the automatic conversion of all outstanding shares of convertible preferred stock into shares of common stock immediately prior to the closing of this offering and (4) the assumed issuance of           shares of common stock upon exercise of warrants that will be cancelled if not exercised prior to this offering.

 

After giving effect to our issuance and sale of           shares of common stock in this offering at an assumed initial public offering price of $      per share, the midpoint of the estimated price range shown on the cover of this prospectus, after deducting the estimated underwriting discount and offering expenses payable by us, the pro forma as adjusted net tangible book value as of June 30, 2009 would have been $      million, or $      per share. This represents an immediate increase in net tangible book value to existing stockholders of $      per share. Accordingly, new investors who purchase shares of common stock in this offering will suffer an immediate dilution of their investment of $      per share. The following table illustrates this per share dilution to the new investors purchasing shares of common stock in this offering without giving effect to the option to purchase additional shares granted to the underwriters:

 

 

A $1.00 increase (decrease) in the assumed initial public offering price of $      per share, the midpoint of the estimated price range shown on the cover of this prospectus, would increase (decrease) the net tangible book value by $      million, the net tangible book value per share after this offering by $      per share and the dilution in net tangible book value per share to investors in this offering by $      per share, assuming that the number of shares offered by us, as set forth on the cover of this prospectus, remains the same and after deducting the estimated underwriting discount and offering expenses payable by us.

 

If the underwriters exercise their option to purchase additional shares in full, the pro forma as adjusted net tangible book value will increase to $      per share, representing an immediate increase to existing stockholders of $      per share and an immediate dilution of $      per share to new investors. If any shares are issued upon exercise of outstanding options or warrants, you will experience further dilution.

 

The following table summarizes, on a pro forma basis as of June 30, 2009, the differences between the number of shares of common stock purchased from us, the total consideration paid to us, and the average price per share paid by existing stockholders and by new investors purchasing shares of common stock in this offering. The calculation below is based on an assumed initial public offering price of $      per share, the midpoint of the estimated price range shown on the cover of this

prospectus, before the deduction of the estimated underwriting discount and offering expenses payable by us:

 

 

The foregoing tables and calculations are based on the number of shares of our common stock outstanding as of June 30, 2009 after giving effect to (1) the     -for-one split of our common stock to be effected prior to the closing of this offering, (2) the automatic conversion of all outstanding shares of non-voting common stock into shares of common stock upon the closing of this offering, (3) the automatic conversion of all outstanding shares of convertible preferred stock into shares of common stock and (4) the assumed issuance of          shares of common stock upon exercise of warrants that will be cancelled if not exercised prior to this offering, and excludes:

 

 

The sale of           shares of common stock to be sold by the selling stockholders in this offering will reduce the number of shares held by existing stockholders to          , or     % of the total shares outstanding, and will increase the number of shares held by new investors to          , or          % of the total shares outstanding. If the underwriters exercise their option to purchase additional shares in full, the shares held by existing stockholders will further decrease to          , or     % of the total shares outstanding, and the number of shares held by new investors will further increase to          , or     % of the total shares outstanding.

 

The following tables summarize our consolidated financial data for the periods presented. You should read the following selected consolidated financial data in conjunction with our financial statements and the related notes appearing at the end of this prospectus and the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of this prospectus.

 

We derived the statement of operations data for the years ended December 31, 2006, 2007 and 2008 and the balance sheet data as of December 31, 2007 and 2008 from our audited consolidated financial statements, which are included in this prospectus. We derived the statement of operations data for the years ended December 31, 2004 and 2005 and the balance sheet data as of December 31, 2004, 2005 and 2006 from our audited consolidated financial statements, which are not included in this prospectus. We derived the consolidated financial data for the six months ended June 30, 2008 and 2009 and as of June 30, 2009 from our unaudited consolidated financial statements, which are included in this prospectus. In the opinion of our management, the unaudited consolidated financial statements have been prepared on the same basis as our audited financial statements and include all adjustments, consisting of normal recurring adjustments and accruals, necessary for the fair statement of the financial information set forth in those statements. Our historical results for any prior period are not necessarily indicative of results to be expected for a full year or any future period.

 

 

 

 

We believe adjusted EBITDA is useful to investors in evaluating our operating performance for the following reasons:

 

 

Our management uses adjusted EBITDA:

 

 

We understand that, although measures similar to adjusted EBITDA are frequently used by investors and securities analysts in their evaluation of companies, adjusted EBITDA has limitations as an analytical tool, and you should not

consider it in isolation or as a substitute for analysis of our results of operations as reported under GAAP. Some of these limitations are:

 

 

To properly and prudently evaluate our business, we encourage you to review the GAAP financial statements included elsewhere in this prospectus, and not to rely on any single financial measure to evaluate our business.

The following table presents a reconciliation of adjusted EBITDA to net income (loss), the most comparable GAAP measure:

 

 

(a) Net interest income represents earnings from our cash and cash equivalents. No debt or other interest-bearing obligations were outstanding during any of the periods presented.

 

(b) Stock compensation expense and stock warrant expense collectively represent the share-based compensation expense reflected in our financial statements. Of the amounts presented above, $83, $928, $921, $696 and $1,334 was classified as a reduction in net services revenue for the years ended December 31, 2006, 2007 and 2008 and the six months ended June 30, 2008 and 2009, respectively.

 

You should read the following discussion and analysis of our financial condition and results of operations together with our financial statements and the related notes and other financial information included elsewhere in this prospectus. Some of the information contained in this discussion and analysis or set forth elsewhere in this prospectus, including information with respect to our plans and strategy for our business and related financing, includes forward-looking statements that involve risks and uncertainties. You should review the “Risk Factors” section of this prospectus for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.

 

Overview

 

Our Background

 

Accretive Health is a leading provider of healthcare revenue cycle management services. Our business purpose is to help U.S. hospitals, physicians and other healthcare providers manage their revenue cycle operations more efficiently. Our integrated, end-to-end technology and services offering, which we refer to as our solution, helps our customers realize sustainable improvements in their operating margins and improve the satisfaction of their patients, physicians and staff. We enable these improvements by helping our customers increase the portion of the maximum potential patient revenue they receive, while reducing total revenue cycle costs.

 

Our customers typically are multi-hospital systems, including faith-based or community healthcare systems, academic medical centers and independent ambulatory clinics, and their affiliated physician practice groups. To implement our solution, we assume full responsibility for the management and cost of a customer’s revenue cycle operations and supplement the customer’s existing revenue cycle staff with seasoned Accretive Health personnel. A customer’s net revenue improvements and cost savings generally increase over time as we deploy additional programs and as the programs we implement become more effective, which in turn provides visibility into our future revenue and profitability. In 2008, for example, approximately 80% of our net services revenue, and over 95% of our net income, was derived from customer contracts that were in place as of January 1, 2008.

 

Our customers have historically achieved significant net revenue yield improvements within 18 to 24 months of implementing our solution, with customers operating under mature managed service contracts realizing 400 to 600 basis points in yield improvements, typically in the third or fourth contract year. To date, we have experienced a contract renewal rate of 100% (excluding exploratory new services offerings, a consensual termination following a change of control and a customer reorganization). Coupled with the long-term nature of our managed service contracts and the fixed nature of the base fees under each contract, our historical renewal experience provides a core source of recurring revenue.

 

We believe that current macroeconomic conditions will continue to impose financial pressure on healthcare providers and will increase the importance of managing their revenue cycles effectively and efficiently. Additionally, the continued operating pressures facing U.S. hospitals coupled with some of the underlying themes of current healthcare reform proposals make the efficient management of the revenue cycle and collection of the full amount of payments due for patient services among the most critical challenges facing healthcare providers today.

 

Our corporate headquarters are located in Chicago, Illinois, and we operate shared services centers and offices in Michigan, Missouri, Florida and India. As of June 30, 2009, we had approximately 1,300 full-time employees and managed an additional 6,000 revenue cycle staff persons who are employed by our customers.

Net Services Revenue

 

We derive our net services revenue primarily from service contracts under which we manage our customers’ revenue cycle operations. Revenues from managed service contracts consist of base fees and incentive payments:

 

 

In addition, we earn revenue from other services, which primarily include our share of revenues associated with the collection of dormant patient accounts (more than 365 days old) under some of our service contracts. We also receive revenue from other services provided to customers that are not part of our integrated service offerings, such as reviewing a customer’s charge data master or consulting on the billing for individuals receiving emergency room treatment.

 

Some of our service contracts entitle customers to receive a share of the cost savings we achieve from operating their revenue cycle. This share is returned to customers as a reduction in subsequent base fees. Our services revenue is reported net of cost sharing, and we refer to this as our net services revenue.

 

Costs of Services

 

Costs of services consist primarily of the expenses necessary to conduct our customers’ revenue cycle operations. These costs include the salaries and benefits of the customers’ employees engaged in revenue cycle activities and managed on-site by us, the salaries and benefits of our employees engaged in revenue cycle activities, the costs associated with vendors that provide services integral to the customers’ revenue cycle and the costs associated with operating our shared services centers.

 

Operating Margin

 

Operating margin is equal to net services revenue less costs of services. Our operating model is designed to improve margin under each managed service contract as the contract matures, for several reasons:

 

 

Infused Management and Technology Expenses

 

We refer to the management and staff revenue cycle employees that we devote to customer operations as infused management. Infused management and technology expenses consist primarily of the wages, bonuses, benefits, share based compensation, travel and other costs associated with deploying our employees on customer sites to guide and manage our customers’ revenue cycle operations. The employees we deploy on customer sites typically have significant experience in revenue cycle operations, technology, quality control or other management disciplines. The other significant portion of these expenses is an allocation of the costs associated with maintaining,

improving and deploying our integrated proprietary technology suite and an allocation of the costs previously capitalized for developing our integrated proprietary technology suite.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses consist primarily of expenses for executive, sales, corporate information technology, legal, finance and human resources personnel, including wages, bonuses, benefits and share-based compensation; fees for professional services; share-based expense for stock warrants; insurance premiums; facility charges; and other corporate expenses. Professional services consist primarily of external legal, tax and audit services. We expect selling, general and administrative expenses to increase in absolute dollars as we continue to add information technology, human resources, finance, accounting and other administrative personnel as we expand our business.

 

We also expect to incur additional professional fees and other expenses resulting from future expansion and the compliance requirements of operating as a public company, including increased audit and legal expenses, investor relations expenses, increased insurance expenses, particularly for directors’ and officers’ liability insurance, and the costs of complying with Section 404 of the Sarbanes-Oxley Act. While these costs may initially increase as a percentage of our net services revenue, we expect that in the future these expenses will increase at a slower rate than our overall business volume, and that they will eventually represent a smaller percentage of our net services revenue.

 

Interest Income

 

Interest income is derived from the return achieved from our cash balances. We invest primarily in highly liquid, short-term investments, primarily those insured by the U.S. government. Our return on our cash investments declined in 2008 and the six months ended June 30, 2009 as a result of the general decrease in overall interest rates.

 

Income Taxes

 

Income tax expense consists of federal and state income taxes in the United States and India. Although we have net operating loss carryforwards, our effective tax rate in 2008 was approximately 65%. This is due principally to the fact that a large portion of our operations is conducted in Michigan, which in 2008 began to impose a tax based on gross receipts in addition to tax based on net income. We expect our overall effective tax rate to be lower in 2009 and thereafter as the impact of the Michigan gross receipts tax becomes less significant in relation to other income-based taxes. However, we expect our income tax expense to increase in absolute dollars as our income increases.

 

Application of Critical Accounting Policies and Use of Estimates

 

Our consolidated financial statements reflect the assets, liabilities and results of operations of Accretive Health, Inc. and our wholly-owned subsidiaries, SureDecisions, Inc., Accretive Health India Private Limited and Accretive Health India Services Private Limited. All intercompany transactions and balances have been eliminated in consolidation. Our consolidated financial statements have been prepared in accordance with GAAP.

 

The preparation of financial statements in conformity with GAAP requires us to make estimates and judgments that affect the amounts reported in our consolidated financial statements and the accompanying notes. We regularly evaluate the accounting policies and estimates we use. In general, we base estimates on historical experience and on assumptions that we believe to be reasonable given our operating environment. Estimates are based on our best knowledge of current events and the actions we may undertake in the future. Although we believe all adjustments considered necessary for fair presentation have been included, our actual results may differ materially from our estimates.

We believe that the accounting policies described below involve our more significant judgments, assumptions and estimates and, therefore, could have the greatest potential impact on our consolidated financial statements. In addition, we believe that a discussion of these policies is necessary to understand and evaluate the consolidated financial statements contained in this prospectus. For further information on our critical and other significant accounting policies, see note 2 to our consolidated financial statements contained elsewhere in this prospectus.

 

Revenue Recognition

 

Our managed service contracts generally have an initial term of four to five years and various start and end dates. After the initial terms, these contracts renew annually unless canceled by either party.

 

We record revenue in accordance with the provisions of Staff Accounting Bulletin 104. As a result, we only record revenue once there is persuasive evidence of an arrangement, services have been rendered, the amount of revenue has become fixed or determinable and collectibility is reasonably assured. We recognize base fee revenues on a straight-line basis over the life of the managed service contract. Base fees for contracts which are received in advance of services delivered are classified as deferred revenue until services have been provided.

 

Our managed service contracts generally allow for adjustments to the base fee. Adjustments typically occur at 90, 180 or 360 days after the contract commences, but can also occur at subsequent dates as a result of factors including changes to the scope of operations and internal and external audits. All adjustments, which can increase or decrease revenue and operating margin, are recorded in the period the changes are known and collectibility is reasonably assured. Any such adjustments may cause our quarter-to-quarter results of operations to fluctuate. Adjustments may vary in direction, frequency and magnitude and generally have not materially affected our annual revenue trends, margin trends, and visibility.

 

We record revenue for incentive payments once the calculation of the incentive payment earned is finalized and collectibility is reasonably assured. We use a proprietary technology and methodology to calculate the amount of benefit each customer receives as a result of our services. Our calculations are based in part on the amount of revenue each customer is entitled to receive from commercial and private insurance carriers, Medicare, Medicaid and patients. Because the laws, regulations, instructions, payor contracts and rule interpretations governing how our customers receive payments from these parties are complex and change frequently, estimates of the prior period net revenue yield calculations could change. All changes in estimates are recorded when new information is available and calculations are completed.

 

Incentive payments are based on the benefits a customer has received throughout the life of the managed service contract with us. Each quarter, we record the increase in the total benefits received to date. If a quarterly calculation indicates that the cumulative benefits to date have decreased, we record a reduction in revenue. If the decrease in revenue exceeds the amount previously paid by the customer, the excess is recorded as deferred revenue.

 

Our services also include collection of dormant patient accounts receivable that have aged 365 days or more directly from individual patients. We share all cash generated from these collections with our customers in accordance with specified arrangements. We record as revenue our portion of the cash received from these collections when each customer’s cash application is complete.

 

Accounts Receivable and Allowance for Uncollectible Accounts

 

Base fees are billed to customers quarterly. Base fees received prior to when services are delivered are classified as deferred revenue. Accordingly, the timing of customer payments can result in short-term fluctuations in cash, accounts receivable and deferred revenue.

 

We extend unsecured credit to our customers based on our assessment of each customer’s creditworthiness. We maintain an estimated allowance for doubtful accounts to reduce our gross

accounts receivable to the amount that we believe will be collected. This allowance is reviewed and based on our historical experience, our assessment of each customer’s ability to pay and the status of any ongoing operations with each applicable customer.

 

Software Development

 

We apply the provisions of the American Institute of Certified Public Accountants’ Statement of Position No. 98-1, or SOP 98-1, Accounting for Costs of Computer Software Developed or Obtained for Internal Use, which requires the capitalization of costs incurred in connection with developing or obtaining internal use software. In accordance with SOP 98-1, we capitalize the costs of internally-developed, internal use, software when an application is in the development stage. This generally occurs after the overall design and functionality of the application has been approved and our management has committed to the application’s development. Capitalized software development costs consist of payroll and payroll-related costs for employee time spent developing a specific internal use software application, and external costs incurred that are related directly to the development of a specific application.

 

Goodwill

 

Goodwill represents the excess purchase price over the net assets acquired for SureDecisions, which we acquired in May 2006. In accordance with Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, goodwill is not subject to amortization but is subject to impairment testing at least annually. Our annual impairment assessment date is the first day of our fourth quarter. We conduct our impairment testing on a company-wide basis because we have only one operating and reporting segment. Our impairment tests are based on our current business strategy in light of present industry and economic conditions and future expectations. As we apply our judgment to estimate future cash flows and an appropriate discount rate, the analysis reflects assumptions and uncertainties. Our estimates of future cash flows could differ from actual results. Our most recent impairment assessment did not result in goodwill impairment.

 

Impairments of Long-Lived Assets

 

We evaluate all of our long-lived assets, such as furniture, equipment, software and other intangibles, for impairment in accordance with Statement of Financial Accounting Standard No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, when events or changes in circumstances warrant such a review. If an evaluation is required, the estimated future undiscounted cash flows associated with the asset are compared to the asset’s carrying amount to determine if an adjustment to fair market value is required. This evaluation is significantly impacted by estimates and assumptions of future revenue, expenses and other factors, which are in turn affected by changes in the business climate, legal matters and competition. Our most recent assessment of intangible assets resulted in the impairment of customer relationships acquired as part of our SureDecisions acquisition in the amount of $0.1 million, which was recorded in 2008.

 

Income Taxes

 

We record deferred tax assets and liabilities for future income tax consequences that are attributable to differences between the carrying amount of assets and liabilities for financial statement purposes and the income tax bases of such assets and liabilities. We base the measurement of deferred tax assets and liabilities on enacted tax rates that we expect will apply to taxable income in the year we expect to settle or recover those temporary differences. We recognize the effect on deferred income tax assets and liabilities of any change in income tax rates in the period that includes the enactment date. We provide a valuation allowance for deferred tax assets if, based upon the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.

 

As of December 31, 2008 and in all prior periods, a valuation allowance was provided for all of our net deferred tax assets. As a result of our improved operations, in the second quarter of 2009 we

determined that it was no longer necessary to maintain a valuation allowance for all of our deferred tax assets.

 

The primary sources of our deferred taxes are:

 

 

Beginning January 1, 2008, with the adoption of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, or FIN 48, we recognize the financial statement effects of a tax position only when it is more likely than not that the position will be sustained upon examination. Tax positions taken or expected to be taken that are not recognized under the pronouncement are recorded as liabilities. For interest and penalties relating to income taxes, we recognize accrued interest in income tax expense and penalties in our income tax provision in the statements of consolidated operations.

 

Share-Based Compensation Expense

 

Our share-based compensation expense results from issuances of shares of restricted common stock and grants of stock options and warrants to employees, directors, outside consultants, customers, vendors and others. We recognize the costs associated with option and warrant grants using the fair value recognition provisions of Statement of Financial Accounting Standards No. 123(R), Share-Based Payment, which we refer to as SFAS 123(R). Generally, SFAS 123(R) requires the value of all share-based payments to be recognized in the statement of operations based on their estimated fair value at date of grant amortized over the grant’s vesting period.

 

Restricted Stock Plan.  Our restricted stock plan was adopted by our board of directors in March 2004 and amended in June 2004. As of June 30, 2009, there were 6,599,591 shares of common stock outstanding under our restricted stock plan, all of which were vested. We have made the following grants to employees, directors and consultants under the restricted stock plan:

 

 

Ascension Health Stock and Warrants.  In October 2004, Ascension Health became our founding customer. Since then, in exchange for its initial start-up assistance and subsequent sales and marketing assistance, we have issued common stock and granted warrants to Ascension Health, as described below:

 

 

In 2006, 2007 and 2008 and the six months ended June 30, 2008 and 2009, we granted Ascension Health the right to purchase 15,752, 58,175, 23,261, 19,358 and 25,837 shares of common stock for $0.01 per share, respectively, pursuant to the protection warrant agreement. We accounted for the costs associated with these purchase rights as a reduction in base fee revenues due to us from Ascension Health because Ascension Health was not required to provide us with any further services in connection with these grants. Accordingly, we reduced the amount of our base fee revenues from Ascension Health by $82,843, $928,108, $921,445, $696,385 and $1,334,131 in 2006, 2007 and 2008 and the six months ended June 30, 2008 and 2009, respectively. For additional information regarding our relationship with Ascension Health, see “Related Person Transactions — Transactions With Ascension Health”.

 

 

We recorded the costs associated with the purchase rights under the supplemental warrant agreement as marketing expense for the periods in which the purchase rights were earned. During December 2007, Ascension Health earned the right to purchase 223,095 shares of common stock for $17.36 per share, and we recorded $4,153,163 in selling, general and administrative expense. During March 2008, Ascension Health earned the right to purchase 111,548 shares of common stock for $40.17 per share, and we recorded $2,410,790 in marketing expense. During March 2009, Ascension Health earned the right to purchase 111,547 shares of common stock for $51.05 per share, and we recorded $2,772,953 in marketing expense.

 

Licensing and Consulting Warrant.  In conjunction with the start of our business, in February 2004, we executed a term sheet with a consulting firm and its principal contemplating that we would grant the consulting firm a warrant, with an exercise price equal to the fair market value of our common stock upon grant, to purchase shares of our common stock then representing 2.5% of our equity in exchange for exclusive rights to certain revenue cycle methodologies, tools, technology, benchmarking information and other intellectual property, plus up to another 2.5% of our equity at the time of grant if the consulting firm’s introduction of us to senior executives at prospective customers resulted in the execution of managed service contracts between us and such customers. In January 2005, we formalized the warrant grant contemplated by the term sheet and granted the consulting firm a warrant to purchase 833,334 shares of our common stock for $1.12 per share, representing 5% of

our equity at that time. In 2005, we recorded $483,334 in selling, general and administrative expense in conjunction with this warrant grant. The warrant expires on the earlier of January 15, 2015 or a change of control of our company.

 

We used the modified Black-Scholes option pricing model to determine the estimated fair value of the above purchase rights at the date earned. The following table sets forth the significant assumptions used in the model during 2006, 2007, 2008 and the six months ended June 30, 2009:

 

 

 

Stock Option Plan.  In December 2005, our board of directors approved a stock option plan, which provides for the grant of stock options to employees, directors and consultants. The plan was amended and restated in February 2006. As of June 30, 2009, the plan permitted the issuance of a maximum of 3,544,862 shares of common stock and 173,828 shares were available for grant. Under the terms of the plan, all options will expire if they are not exercised within ten years after the grant date. The majority of options granted vest over four years at a rate of 25% per year on each grant date anniversary. Options can be exercised immediately upon grant, but upon exercise the shares issued are subject to the same vesting and repurchase provisions that applied before exercise.

 

Prior to January 1, 2006, we accounted for share-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations, as permitted by Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, which we refer to as SFAS 123. Accordingly, compensation expense for stock options was measured as the excess, if any, of the fair market value of our common stock at the measurement date (the date of grant for stock options) over the exercise price. Since we only granted employee stock options with an exercise price equal to fair market value on the date of grant, we did not record any compensation expense for stock option grants prior to January 1, 2006.

 

Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS 123(R) using the modified prospective transition method. Under this method:

 

 

We use the modified Black-Scholes option pricing model to determine the estimated fair value of each option as of its grant date. These inputs are subjective and generally require significant analysis

and judgment to develop. The following table sets forth the significant assumptions used in the model during 2006, 2007, 2008 and the six months ended June 30, 2009:

 

 

Since our stock is not actively traded, we estimated its expected volatility by reviewing the historical volatility of the common stock of public companies that operate in similar industries or are similar in terms of stage of development or size and then projecting this information toward our future expected results. We used judgment in selecting these companies, as well as in evaluating the available historical and implied volatility for these companies.

 

We aggregate all employees into one pool for valuation purposes. The risk-free rate is based on the U.S. treasury yield curve in effect at the time of grant.

 

The plan has not been in existence a sufficient period for us to use our historical experience to estimate expected life. Furthermore, data from other companies is not readily available. Therefore, we have estimated our stock options’ expected life using a simplified method based on the average of each option’s vesting term and original contractual term. This methodology is set forth in Staff Accounting Bulletin No. 107 and its use is permitted by Staff Accounting Bulletin No. 110.

 

The estimated forfeiture rate is derived from our historical data and our estimates of the likely future actions of option holders.

 

We will continue to use judgment in evaluating the expected term, volatility and forfeiture rate related to our own share-based compensation on a prospective basis, and incorporating these factors into the Black-Scholes pricing model. Higher volatility and longer expected lives result in an increase to share based compensation expense determined at the date of grant. In addition, any changes in the estimated forfeiture rate can have a significant effect on reported share-based compensation expense, as the cumulative effect of adjusting the rate for all expense amortization is recognized in the period that the forfeiture estimate is changed. If a revised forfeiture rate is higher than the previously estimated forfeiture rate, an adjustment is made that will result in a decrease to the share-based compensation expense recognized in our consolidated financial statements. If a revised forfeiture rate is lower than the previously estimated forfeiture rate, an adjustment is made that will result in an increase to the share based compensation expense recognized in our consolidated financial statements. These adjustments will affect our infused management and technology expenses and selling, general and administrative expenses.

 

As of June 30, 2009, we had $18.1 million of total unrecognized share-based compensation cost related to employee stock options. We expect to recognize this cost over a weighted-average period of 3.1 years after July 1, 2009. The allocation of this cost between selling, general and administrative expenses and infused management and technology expenses will depend on the salaries and work assignments of the personnel holding these stock options.

 

Determination of Fair Value.  Valuing the share price of a privately-held company is complex. We believe that we have used reasonable methodologies, approaches and assumptions in assessing and determining the fair value of our common stock for financial reporting purposes.

 

We determine the fair value of our common stock through periodic internal valuations that are approved by our board of directors. The fair value approved by our board is used for all option grants until such time as a new determination of fair value is made. To date, and as permitted by our stock

option plan, our chief executive officer has selected option recipients and determined the number of shares covered by, and the timing of, option grants.

 

Our board considers the following factors when determining the fair value of our common stock:

 

 

From June 2005 to January 2008, we used the market approach to estimate our enterprise value. The market approach estimates the fair market value of a company by applying market multiples of publicly-traded firms in the same or similar lines of business to the results and projected results of the company being valued. When choosing companies for use in the market approach, we focused on businesses that provide outsourcing, consulting or technology services or that have high rates of growth. To obtain our preliminary enterprise value, we calculated the multiple of the market valuations of the comparable companies to their annual revenues and applied this multiple to our revenue run rate, defined as our total projected revenues for the next 12 months from existing customers. We then discounted the preliminary enterprise value by a percentage determined by our board to reflect our company’s relative immaturity in relation to the comparable companies. This discount changed over time as we matured. The resulting value was then divided by the number of shares of common stock outstanding on a fully-diluted basis to obtain the fair value per share of common stock. We performed a new valuation in this manner each time we signed a managed service contract with a new customer.

 

For all valuations since January 2008, we used both the market approach and the income approach to estimate our aggregate enterprise value at each valuation date. The change in valuation method was in recognition that in 2007 we had achieved some significant milestones, particularly positive net income and positive adjusted EBITDA for the year, and that an initial public offering or other type of liquidity event would eventually be considered. When choosing companies to be used for the market approach since January 2008, we focused on businesses with high rates of growth and relatively low profitability that provide services to hospitals or other medical providers, or that provide business outsourcing solutions. The comparable companies have remained largely unchanged since January 2008. The income approach involves applying an appropriate risk-adjusted discount rate to projected debt-free cash flows, based on forecasted revenue and costs. The financial forecasts were based on assumed revenue growth rates that took into account our past experience and future expectations. We assessed the risks associated with achieving these forecasts and applied an appropriate cost of capital rate based on our board’s view of our company’s stage of development and risks, the experience of our directors in managing companies backed by private equity investors, and our management’s review of academic research on this topic.

 

We averaged the two values derived under the market approach and the income approach and then added our current cash position and cash and tax benefits, assuming that all outstanding options and warrants were exercised, to create an enterprise value. Next, we allocated the enterprise value to our securities with rights and preferences that are superior to our common stock, using the option-pricing method set forth in the American Institute of Certified Public Accountants Practice Aid, Valuation of Privately-Held-Company Equity Securities Issued as Compensation. We then discounted

the remaining value by 10% to reflect the fact that our stockholders could not freely trade our common stock in the public markets. We based the 10% discount for lack of marketability primarily on the results of a study of this topic by Bajaj, Denis, Ferris and Sarin entitled “Firm Value and Marketability Discounts” (February 26, 2001). The resulting value was then divided by the number of shares of common stock outstanding on a fully-diluted basis to obtain the fair value per share of common stock.

 

Prior to this offering, stock options and certain warrants represented the right to purchase shares of our non-voting common stock. Upon the closing of this offering, all outstanding non-voting common stock will convert into voting common stock on a share-for-share basis, and thereafter stock options and warrants to purchase non-voting common stock will be stock options and warrants to purchase voting common stock, with no other changes in their terms. For all valuations prior to May 19, 2009, we determined the fair value of the voting common stock and applied it to the non-voting common stock without a discount.

 

Beginning on May 19, 2009, we refined our valuation methodology because of the increased potential for an initial public offering or company sale. We continued to use both the market approach and the income approach, but applied a discount to the fair value of the non-voting common stock and modified other variables as described below.

 

There is inherent uncertainty in these forecasts and projections. If we had made different assumptions and estimates than those described above, the amount of our share-based compensation expense, net income or loss and related per-share amounts could have been materially different.

 

Information regarding share-based compensation from January 1, 2008 through June 30, 2009 is summarized in the table below:

 

 

The analyses undertaken in determining the fair value of our common stock for all grants between January 1, 2008 and June 30, 2009 are summarized below. The methodology for the fair value determination made on September 4, 2007 is summarized above. All analyses since then used the market approach and the income approach summarized above, with the additional assumptions described below.

 

 

 

 

Legal Proceedings

 

In the normal course of business, we are involved in legal proceedings or regulatory investigations. We evaluate the need for loss accruals using the requirements of Statement of Financial Accounting Standards No. 5, Accounting for Contingencies. When conducting this evaluation we consider factors such as the probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. We record an estimated loss for any claim, lawsuit, investigation or proceeding when it is probable that a liability has been incurred and the amount of the loss can reasonably be estimated. If the reasonable estimate of a probable loss is a range, and no amount within the range is a better estimate, then we record the minimum amount in the range as our loss accrual. If a loss is not probable or a probable loss cannot be reasonably estimated, no liability is recorded.

 

Results of Operations

 

In evaluating our business performance, management monitors numerous quantitative and qualitative factors. The primary financial metrics we monitor are base fee revenues, incentive fee revenues, reductions in revenue cycle operating costs (both in absolute dollars and as a percentage of base fees), corporate level operating expenses, cash flow and adjusted EBITDA. We also monitor the

amount of net patient revenue under our management. The principal non-financial metrics we monitor are:

 

 

The following table sets forth consolidated operating results and other operating data for the periods indicated.