Financing Equipment – Pitfalls to Avoid Jennifer Conner VP, Division Controller USPI

Business & Financial Considerations Evaluation of Equipment Case Analysis Return on Investment Payback period Example Various Strategies to Consider Leases Loans Upfront Cash Expenditure Illustration Other Financial Considerations & Pitfalls Q&A Agenda

1. Need Bring new cases (recruiting) Prevent the loss of existing cases (defensive) 2. Cost New Refurbished Finance vs buy 3. Case Analysis Volume Case Cost vs Reimbursement Staffing Levels Managed Care Contracts Scheduling 4. Return on Investment How much will the capital expenditure contribute to the bottom line on an annual basis (relative to investment)? 5. Payback Period How long will it take to recoup investment (# months)? Evaluation of Equipment

Example: You are recruiting Dr. Ow (pain management) but you need equipment in order for him to perform the new cases. Need: C-Arm, Imaging table, etc. Cost: $150k Case Analysis: 50 cases/month (600 annually) New Line of Business

1. Volume 2. Payer Mix 3. Revenue Analysis 4. Personnel Cost Analysis 5. Drugs & Medical Supplies 6. Other Operating Expenses 7. Contribution 50 cases/month (600 cases annually) 1. Net Revenue (based on payer mix) = $1,000 per case 2. Personnel Cost = $200/case (additional staff) 3. Drugs & Medical Supplies = $60/case 4. Other Operating Expenses = $40/case Contribution = $700/case Case Analysis

1. What is your current ROI? Annual Cash Distributions / Valuation (at 100%) 2. Calculate ROI of new investment Annual Contribution $ / Investment $ Return on Investment (ROI)

Return on Annual Investment: Year 1 = 280% ($420,000 contribution over $150,000 investment)

Payback Period Payback Period: = 4.3 months ($150,000 investment over $35,000 per month contribution)

Capital Lease Operating Lease Loan Financing Cash Expenditure Strategies to Consider

A capital lease is one in which the rights and risks of ownership of the asset have been transferred to the lessee. Requirement to Qualify (only one needed) Title transfers at end of lease term Bargain purchase option (Example: $1 buyout) Lease term is at least 75% of economic life of asset NPV (net present value) of lease payments is at least 90% of fair market value of asset Accounting for a Capital Lease Asset capitalized on balance sheet Treated as debt on balance sheet Interest expense recorded as part of debt in non-operating expenses Depreciation recorded on income statement in non-operating expenses Capital Lease

Advantageous for long lived assets or if seeking ownership at end of term Potential Pitfalls: Implicit Interest rates Usually non-cancelable Increases debt shown on balance sheet Cash Flow Considerations Lease payments will impact future cash outlays (for distribution purposes) Capital Lease

If a lease does not qualify for a capital lease, then it is classified as operating Accounting for an Operating Lease Lease Payments expensed as part of operating expenses Deductible for tax purposes Not shown as debt on balance sheet (off- balance sheet financing) Lease Payments will impact future cash flow (for distribution purposes) Operating Lease

Advantageous for shorter lived assets (avoid risk of asset becoming obsolete) Payments are usually lower than capital lease or traditional financing, but you don’t own equipment at the end of the lease term Potential Pitfalls: Implicit interest rate Upgrade in middle of contract (fees) End of term purchase (FMV option) What is residual value? Only buy if market value is reasonable and asset has economic life remaining Try to negotiate end of term purchase cost up-front Usually better to turn equipment in and negotiate new lease contract Operating Lease

Cash Flow Considerations Loan payments will impact future cash outlays (for distribution purposes) What is interest rate charged by financing company? Compare net present value of loan payments compared to fair market value of asset Accounting for a Loan Asset capitalized on balance sheet Treated as debt on balance sheet Interest expense recorded as part of debt in non-operating expenses Depreciation of asset recorded on income statement in non- operating expenses Potential Pitfalls: Pre-payment penalty Read the fine print Financial & Compliance Requirements Financing/Loan

Upfront cash expenditure to purchase asset will impact current distribution (one-time occurrence) Overall cheaper than financing, but consider cash flow impact Asset capitalized on balance sheet Depreciation of asset recorded on income statement in non-operating expenses Upfront Cash Expenditure

Financial Comparison of Various Strategies $150K investment, 60 month term, 8% interest

Other Financing Considerations & Pitfalls Renting month to month for trial period Bundling supplies with lease payment Mark-up of supplies not as visible Guarantees Financial Covenants Mandatory Depository Relationships Health System Partner Capital Limits