Preparing for Major Financing or Acquisition Transactions: Due Diligence Expectations and Advanced Problem Solving. June 9, 2014

Transcription

1 Preparing for Major Financing or Acquisition Transactions: Due Diligence Expectations and Advanced Problem Solving June 9, 2014 Presented by: Jeff Kerkay, The MetroHealth System Lori Kalic, McGladrey LLP Shannon Martin, Bricker & Eckler LLP Reminders These materials are for educational purposes only and are not intended to provide legal advice. The following report is proprietary information of the respective authors, The MetroHealth System, McGladrey and Bricker & Eckler, LLP (collectively, the Authors ). 1

2 Preparing for Major Financing or Acquisition Transactions: Due Diligence Expectations and Advanced Problem Solving Who We Are... Introductions Jeff Kerkay, Treasurer (joined July 2009) First Treasurer in the System s history Raised $75 million new money in the Build America Bonds market Refinanced the System s LOCs twice - replaced one of the LOCs and underlying VRDBs with a private placement Closed a tax-exempt loan to refinance a maturing synthetic lease on the System s primary parking facility Managed the System s S&P debt rating upgrade from BBB+ to A- Refinanced $67.5 million of tax-exempt debt via a private, taxable bond offering Had previously worked in corporate finance, leveraged finance, and investment banking in the Healthcare industry Experience in M&A, public and private debt, and public and private equity raising transactions for most sectors of the Healthcare industry 2

3 Introductions Lori Kalic, Director Lori is a Director in McGladrey s assurance practice. Lori has 20 years of experience serving as a business advisor to healthcare and not-for-profit entities and has significant experience leading audits of complex healthcare entities. Lori has assisted underwriters and her clients with significant debt issuance transactions requiring comfort letters. Shannon Martin, Partner Introductions Shannon is a partner in the firm s Health Care and Public Finance practice groups and participates in the firm s Real Estate Industry Group. Shannon serves as transaction counsel to hospitals and other health care providers in connection with a variety of transactions, including traditional and bond financing transactions, acquisitions/mergers, conversions, and real estate development and leasing. 3

4 Preparing for Major Financing or Acquisition Transactions The Transaction Landscape: Highways, Byways, Alleys and Cul-de-sacs Intersections and Junctions: Where Regulated Industries and Advisors Meet and Sometimes Collide On-Ramps to the Expressway The Transaction Landscape: Highways, Byways, Alleys and Cul-de-sac Healthcare Provider Trends Hospital M&A Trends Other Hospital Responses to the New Terrain Healthcare Capital Markets Trends 4

5 MetroHealth Introduction Safety Net Provider for Cuyahoga County in Northeast Ohio only Level I Trauma Center in the region Largest Medicaid provider in Ohio Major resource in the event of a local disaster Key operating statistics: Over 1 million patient visits in 2011 & inpatient acute beds Only Level 1 trauma service in region Conducts IP & OP burn treatment Utilizes a network of community-oriented primary care clinics Partners in Care" was launched in May 2009 to serve uninsured patients in a more clinically-effective and cost-effective way The MetroHealth System is an integrated healthcare system providing a broad range of services including inpatient and outpatient hospital care, long-term nursing care, rehabilitation, and primary care and specialty care services delivered through a network of ambulatory care centers Healthcare Provider Trends Negative Rating Agency Outlooks Slower revenue growth continued shift from I/P to O/P and lower commercial and governmental reimbursement Margins shrinking as hospitals adapt to changing reimbursement models and build the necessary provider networks and IT infrastructure Trend toward HDHP, both on the exchanges and off Today s high deductibles are tomorrow s bad debt 5

6 Healthcare Provider Trends (cont.) 2,500 2,000 1,500 1, Hospital Inpatient Admissions and Outpatient Visits Outpatient Visits/1,000 Persons Inpatient Admissions/1,000 Persons Data Source: American Hospital Association, 2012 TrendWatch Chartbook 60% 59% 58% 57% 56% 55% 54% 53% 52% 51% Healthcare increasingly delivered in ambulatory setting Patient preference Convenience Technology migration Payor preference Lower cost 54% MH Outpatient Revenue 55% 55% 57% 59% *2011 Hospital M&A Trends Need to be right-sized means getting bigger for most, to have access to capital for network and IT investments For MetroHealth, it means re-engineering for a more modern healthcare delivery system 6

7 MetroHealth System Redesign Reducing the hub and growing the spokes for a more modern healthcare delivery system and following the trend of the region s population The days of the old monolithic city hospital are over access and many procedures now delivered in an O/P setting, with the hospital more tertiary and the provider of trauma services Cleveland-proper population has shrunk, growth has been in the outer-ring suburbs Even with a limited ambulatory network, nearly all of the System s volume growth is O/P need significant new ambulatory assets, and a smaller more efficient main campus Significant funding likely to come from local government support, philanthropy (Foundation), free cash flow, and potentially the debt capital markets Importance in maintaining strong credit ratings: A-/A3/A- Healthcare Capital Markets Trends Taxable vs. Tax-Exempt As MMD/UST ratios have approached 100% (or higher!), taxable offerings have become attractive to issuers Taxable offerings require few documents (usually just a BPA and CCA), don t have the limitations and pension stipulations of tax-exempt offerings, and don t have the asset tracking / useful life requirements Private vs. Public Debt Private placements require fewer documents (no need for an OS or Appendix A), less due diligence and marketing, and simpler continuing disclosure Private placements run into maturity (~15 years) and structural limitations (inability to significantly back-end principal payments) 7

8 Healthcare Capital Markets Trends (cont.) Although off all-time lows, long-term interest rates and MMD have been on a long, downward trend Recent increases have been attributed to less accommodative Fed policies, and MMD has suffered due to large municipal bankruptcies/worries and limited tax-exempt demand Source: J.P. Morgan Securities LLC Healthcare Capital Markets Trends (cont.) Although well off the all-time lows before the financial crisis, healthcare credit spreads have been tightening since 2009 o AA offerings 1.1x DSC, no liquidity covenant, Revenue Pledge (not required for some larger systems) o A offerings 1.1x DSC, Days Cash, Revenue Pledge no DSRF o BBB offerings 1.25x DSC, Days Cash, Revenue Pledge, Mortgage, and DSRF Source: J.P. Morgan Securities LLC and Morgan Stanley 8

9 Intersections and Junctions: Where Regulated Industries and Advisors Meet Responsibilities of the Independent Auditor Responsibilities of Legal Counsel Regulatory Obligations of Lenders, Underwriters and Financial Advisors Other Transaction Drivers What is a Comfort Letter? A letter issued by a Auditor in accordance with AICPA AU-C Section 920, Letter for Underwriters and Certain Other Requesting Parties to requesting parties in connection with an entity s financial statements included in a securities offering. 9

10 What is a Comfort Letter? Underwriting Agreement (aka Bond Purchase Agreement or Stock Purchase Agreement) Underwriter agrees to buy, from the issuer, the securities that are being offered to the public, subject to certain conditions that must be met by issuer. A frequent condition of closing (the actual payment of funds to the issuer) is that the issuer will deliver to the underwriter at the time of closing, a letter from its Auditor that is: addressed to the underwriter; dated as of a determinable date prior to closing AND; Contains certain specified statements or assertions Why is the Comfort Letter Important? Delivery of the comfort letter that meets ALL of the requirements of the Underwriting Agreement is a condition of closing. Failure to deliver a letter or the delivery of a letter that fails to meet a requirement can be grounds for the underwriter to refuse to pay or call off the entire offering. 10

11 Why is the Comfort Letter Required? Developed following the Securities Act of Section 11 of the Act provides that Underwriters could be liable if any part of a registration statement contains material omissions or misstatements. The Act provides for an affirmative defense for the Underwriter if the Underwriter has reasonable grounds to believe that no material omissions or misstatements existed in a securities offering. Receipt of a comfort letter is one of a number of procedures that may be used to establish that an underwriter has conducted a reasonable investigation. Timeline and Schedule of Deliverables Preparation of the Preliminary Official Statement ( POS ). Deliverable 1: With issuance of POS, Auditor provides verbal or written consent for the audit opinion to be included with the audited financial statements in the POS. Deliverable 2: Auditor issues comfort letter related to financial information contained in POS. Oftentimes a draft letter will be requested prior to the issuance of a POS Issuance of Official Statement ( OS ). Deliverable 3: With issuance of OS, Auditor provides verbal or written consent for audited financial statements to be included in the OS. Deliverable 4: Auditor issues bring down letter. Can occur concurrently with issuance of OS. 11

12 Form and Content of the Comfort Letter Dated on or shortly after Underwriting Agreement is signed. Results of procedures performed as it relates to financial information (as instructed by the underwriter). Subjects Covered by Comfort Letter Independence of auditor Financial information Unaudited interim financial data Capsule information Pro forma financial information Financial forecasts Subsequent changes 12

13 Unaudited Interim Financial Information Auditor can provide negative assurance ONLY IF the Auditor has conducted a review in accordance with Generally Accepted Auditing Standards (GAAS). Negative assurance: a statement that, based on procedures performed, nothing has come to the auditor s attention that caused the auditor to believe that specified matters do not meet the specified criteria (for example, that nothing came to the auditor s attention that caused the auditor to believe that any material modifications should be made to the unaudited interim financial information for it to be in accordance with generally accepted accounting principles. Unaudited Interim Financial Information (cont d) If the Auditor states that they have performed a review of unaudited interim financial information, the review report must be attached to the letter. Unaudited financial information should be identified. Auditor should indicate that information was NOT audited and no opinion is expressed. 13

14 Capsule Information Defined as unaudited summarized interim financial information for periods subsequent to the periods covered by the audited financial statements or unaudited interim financial information included in the securities offering. Capsule information may be presented in narrative or tabular form and is often provided for the most recent interim period and for the corresponding period of the prior year. Capsule Information Auditor can not provide negative assurance regarding capsule information unless the Auditor has performed a review of the financial statements underlying the capsule information in accordance with GAAS applicable to reviews of interim financial information, AND the selected capsule information is in accordance with minimum disclosure requirements of the applicable financial reporting framework for interim financial information. If conditions not met, auditor is limited to reporting procedures performed and findings obtained. 14

15 Pro Forma Financial Information Auditor should not comment in a comfort letter on pro forma financial information unless the Auditor has an appropriate level of knowledge. Auditor may not be able to provide negative assurance unless the auditor has obtained the required knowledge and has performed: An audit of the annual financial statements, or A review of interim financial statements, in accordance with GAAS. Financial Forecasts When performing procedures, auditors should: Obtain an understanding of internal control over financial reporting for annual and interim periods; Perform procedures required by AT Section 301, Financial Forecasts and Projections, for reporting on a compilation of a forecast; Issue a report on the compilation of prospective financial information in accordance with AT Section 301; and Perform additional procedures as requested by requesting party and report the findings in the comfort letter. 15

16 Financial Forecasts (cont d) Auditor should not provide negative assurance on results of procedures performed on financial forecasts. Auditor should not provide negative assurance with respect to compliance of the financial forecast with Rule of Regulations S-X (unless appropriate examination procedures were performed). Auditor should not issue a comfort letter with respect to the financial forecast included in a securities offering unless the forecast is accompanied by an indication that the auditor has not examined the financial forecast and therefore, does not express an opinion on it. Subsequent Changes Auditor should base comments on specified financial statement items solely on the limited procedures performed Increase in long-term debt Decreases in specified f/s items (i.e. revenues/operating income etc.) Procedures may include: Reading minutes Making inquiries of entity officials 16

17 Subsequent Changes Auditor should provide negative assurance in the comfort letter regarding subsequent changes in specified financial statement items as of a date less than 135 days from the end of the most recent period for which the auditor has performed an audit or a review. Auditor should comment only on the occurrence of subsequent changes in specified financial statement items that are not disclosed in the securities offering. Tables, Statistics and Other Financial Information Auditor should not comment in a comfort letter unless the information Is expressed in dollars and has been obtained from accounting records that are subject to internal control over financial reporting, or Has been derived directly from such accounting records by analysis or computation. Auditor should not comment in a comfort letter on information related to an unaudited period unless auditor Has performed an audit of the financial statements for a period including, or immediately prior to, the unaudited period or completed an audit for a later period, or Otherwise obtained knowledge over an entity s internal control. 17

18 Best Practices Share a draft of the Underwriting Agreement with your Auditor as soon possible in order to determine exactly what is expected. The Auditor should provide a draft of the comfort letter to the Underwriter for their review and approval as soon as possible. Best Practices If CPA/Auditor is requested to participate in a due-diligence call also called a bring down call, provide the questions to the Auditor in advance of the call. 18

19 Responsibilities of Legal Counsel Hardhats and Helmets Defining Counsel s Role in the Transaction:» Borrower s Counsel» Bond Counsel» Seller s Counsel/Buyer s Counsel» Disclosure Counsel» Underwriter s Counsel» Issuer s Counsel Responsibilities of Legal Counsel Role in the Transaction: Driver Honk often to keep traffic moving Chauffeur Make the ride smoother for clients and other team members Mechanic Preventative and Corrective Traffic Cop Anticipate and direct the traffic 19

20 Responsibilities of Legal Counsel Issuance of Legal Opinions: To the best of our knowledge limitations Reliance/Back-up: Representations in the Documents Borrower Due Diligence Response Borrower s Certificate to Counsel Responsibilities of Legal Counsel Issuance of Legal Opinions: Due Authorization/Formation/Authority of Borrower Enforceability of Transaction Documents No conflict with Agreements, etc. Status as a tax-exempt entity 20

21 Responsibilities of Legal Counsel Co-Pilots with Borrower in: Disclosure Support Official Statements Appendix A Reps and Warranties Covenant Negotiation Financial Reporting Financial Covenants Completing Due Diligence Underwriters and Municipal Advisors The SEC has put a priority on increasing regulation of the municipal debt market Examples include MA regulations and continuing disclosure (including EMMA, MCDC Initiative, using underwriters to put pressure on issuers, etc.) We expect the regulations to continue to develop in reach and complexity Even the current MA rules raise lots of difficult questions with no clear answers Underwriters need to navigate engagements in light of additional regulations on MAs 21

22 Underwriters and Municipal Advisors The definition of municipal advisor in the Exchange Act essentially defines an MA as a person who provides advice to or on behalf of a municipal entity or obligated person with respect to municipal financial products or the issuance of municipal securities, including advice with respect to the structure, timing, terms, and other similar matters concerning such financial products or issues or who undertakes a solicitation of a municipal entity. Who Is a Municipal Advisor? Municipal entities (includes all political subdivisions and any other issuer of municipal securities ) and their employees are not included in the MA definition. The MA definition contains five statutory exclusions: 1) Brokers, dealers, and municipal securities dealers serving as an underwriter of a particular issue to the extent that they engage in activities that are within the scope of underwriting such issue (engagement letters are recommended to memorialize this relationship see question 5.1 in SEC s January 2014 FAQs); 2) Registered investment advisers and associated persons; 3) Registered commodity trading advisors and associated persons who are providing advice related to swaps ; 4) Attorneys offering legal advice or providing services that are of a traditional legal nature; 5) Engineers providing engineering advice. 22

23 Who is a Municipal Advisor? Note that even these statutory exclusions do not offer blanket status relief from the MA rules. You can fit within one of these categories and still be an MA if you offer MA services. Final rules added certain specific activities that are likewise excluded. Underwriter Exclusion Rule 15Ba1-1(d)(2)(i) The term municipal advisor does not include a broker, dealer, or municipal securities dealer serving as an underwriter of a particular issuance of municipal securities to the extent that the broker, dealer, or municipal securities dealer engages in activities that are within the scope of an underwriting of such issuance of municipal securities. SEC has avoided trying to create an exhaustive list of activities that are permissible within this exclusion, but permissible activities need to be integral to the purchase and distribution of a particular issuance or integral to fulfilling the role of an underwriter. 23

24 Other Transaction Drivers Title Insurer Third Party Reports ESA Survey Appraisal Insurance Inventory Permitting/Licensure Agencies/Authorities The On-Ramps to the Expressway Preparing for a Major Transaction Anticipating Common Due Diligence Problems 24

25 Preparing for a Major Transaction Advance Checklist Review Pre-transaction self-audit Organizational Housekeeping Contract Assembly and Review Mechanics Disclosure Team Logistics Preparing for a Major Transaction Compliance with Healthcare Regulations Do contracts and leases comply with Stark/Anti-kickback? Are the facilities licensed? Tax Exempt Status -- Any red-flags? Compensation Policies Governance Fundraising 25

26 Anticipating Common Due Diligence Problems Use of Proceeds Pre- and Post-Issuance Pot-holes Rev. Proc Compliance Compliance Concerns Disclosures of Self-Disclosures? Questions? Contact Jeff Kerkay, Treasurer Lori Kalic Shannon Martin, Esq