ITEM 1. BUSINESS
Company Overview
We are University General Health System, Inc. Unless the context indicates otherwise, all references to “UGHS,” “we,” “our,” “ours,” “us” and the “Company” refer to University General Health Systems, Inc. and our consolidated subsidiaries. We are a diversified, integrated multi-specialty healthcare provider that delivers the highest quality physician-and patient-oriented services by providing timely, innovative health solutions that are uniquely competitive, efficient and adaptive in today’s healthcare delivery environment. We currently operate two general acute care hospitals, a 69-bed facility in Houston and a 111-bed facility in Dallas, ambulatory surgical centers (“ASC“s), hyperbaric wound care centers, diagnostic imaging centers, physical therapy centers, a sports and rehabilitation center, sleep centers, six senior living facilities, three of which are owned and all of which are managed by the majority-owned management company. We also offer billing, coding and other revenue cycle management services as well as food, hospitality, and other services to both our facilities and outside clients. We plan to complete additional complementary acquisitions in 2014 and future years in Texas and other markets.
Our business was founded in 2005 to establish University General Hospital in Houston, Texas (“UGH”), a 69-bed physician-owned general acute care hospital. The Company has expanded rapidly and is well-positioned to continue its aggressive growth strategy, partially leveraging the proceeds from financing in order to do so. The Company anticipates the continued acquisition of acute care host hospitals and the development and operation of regional health networks that support general acute care hospital services. For example, as host hospitals acquire physician-owned free-standing ancillary service providers (such as diagnostic imaging centers, ambulatory surgery centers, physical therapy and sleep centers), the former physician owners of these centers not only integrate into hospital operations and governance, but strengthen the physician network surrounding the acquiring hospital. As a result, the acquiring hospital experiences higher and more stable occupancy levels. Moreover, the hospital also gains an integrated group of supporting physicians who share the hospital’s interest in delivering better patient outcomes at a lower cost.
Merger Transaction
On March 28, 2011, pursuant to an Agreement and Plan of Reorganization (“Reorganization Agreement”) executed on March 10, 2011, UGH GP and UGH LP (collectively “UGH Partnerships”) were acquired by SeaBridge Freight Corp. (“SeaBridge”), a public reporting Nevada corporation, in a “reverse” merger (“Merger”) in exchange for the issuance of 232,416,956 shares of common stock, a majority of the common stock, to the former partners of the UGH Partnerships. Approximately 90 Houston area physicians are former owners of UGH and are now our shareholders. At the same time, SeaBridge changed its name to University General Health System, Inc.
In connection with and immediately following the Merger, we divested of our wholly-owned subsidiary, SeaBridge. The divested subsidiary was in the business of providing container-on-barge, break-bulk and out-of-gauge freight transport service between Port Manatee of Tampa Bay, FL and Port Brownsville, Texas. In consideration of the divestiture, we received and cancelled 135,000,000 outstanding shares of our common stock from existing shareholders. We are no longer in the freight transport business.
After completing the Merger management embarked on an aggressive acquisition campaign designed to create a regional healthcare delivery network around UGH near Texas Medical Center. The acquisition strategic plan expects to continue as we intend to expand our health delivery network, which could include ambulatory surgical centers, diagnostic imaging centers, physician practices, physical therapy and rehabilitation centers, sleep centers, senior living communities, home healthcare, post-acute skilled nursing facilities (SNF’s) and other facilities that complement our general acute care hospital model.
Through acquisitions and organic growth, we have established an integrated health delivery system that is based on a general acute care hospital model that is physician-centric with the inherent incentives associated with ownership driving a higher standard of care with better patient outcomes at a lower cost. Our model supports our host general acute care hospitals, generating industry-leading occupancy rates and operating margins. In addition to leveraging its proven experience in developing integrated networks of care to expand in the regional Texas markets, we intend to seek additional acquisition opportunities with physician-owned hospitals across the country once we achieve the scale to do so.
Business Strategy
Our operational strategy for our hospital segment is to providing the highest quality and cost effective healthcare services to the communities we serve. Our goal is to create a healing environment through excellence in patient care, positive attitudes and the energetic spirit of every one of our employees. We endeavor to be the premier provider of acute care services while utilizing the latest technological and medical advances within an environment that is both physically superior and emotionally healing.
Our operational strategy for our senior living segment is dedicated to providing the highest residential and assisted living care and our commitment and ability to address all of our residents’ needs, ranging from their physical health to their social well-being, has helped drive operating improvements in our business.
Our operational strategy for our support services segment is focused on providing the highest quality and most effective revenue cycle management, facility and hospitality services for our hospitals and other clients. The goal of these subsidiaries is to save time and money in managing account receivables and revenue cycle management for our hospitals and our clients. We are committed to providing a complete solution during the most critical point in recovery cycle while maintaining a positive relationship with patients. In addition, our goal is to identify and develop an effective recovery solution that will lead to fast and efficient results. We offer healthcare organizations to our clients as a single source provider for managed service solutions, including patient food and nutrition services, retail food services, clinical equipment maintenance, environmental services, laundry and linen distribution, plant operations, energy management, strategic and technical services, supply chain management and central transportation.
We are a physician-centric model of care, whereby we believe that the active engagement of physicians will allow us to provide a higher quality of care and better outcomes for the patient. We believe that our ongoing focus on patient and customer satisfaction, rates and occupancy will generate the incremental growth in margins we are striving to achieve. We are focused on expanding services and implementing and maintaining effective controls. We believe that our foundation-built on patient-centered healthcare and clinical quality and efficiency in our existing markets-will give us a competitive advantage in expanding our services in these and other markets through acquisitions or partnerships. We continue to monitor opportunities to acquire hospitals systems or ancillary service providers that strategically fit our vision and long-term strategies.
Acquisitions
We completed several acquisitions that enhance our general acute care hospital capabilities in existing markets and in new markets.
2012 Acquisitions
Baytown Endoscopy Center. On April 13, 2012, we completed the asset acquisition of Baytown Endoscopy Center, LLC (the “Baytown Center”). The Baytown Center is a three-bed ambulatory surgery center which operates as a hospital outpatient department (HOPD) of UGH under the name “UGH Baytown Endoscopy Center”. Primary procedures at the Baytown Center currently include gastroenterology and pain management. The Baytown Center is co-managed with Jacinto Medical Group, P.A., which is a multi-specialty group of physicians practicing in Baytown.
Diagnostic Imaging and Physical Therapy . On June 1, 2012, we acquired a Diagnostic Imaging and Physical Therapy Centers (the “1960 Centers”) from 1960 Family Practice, PA., a multi-specialty group of physicians practicing in northern areas of Houston. We operate these centers as HOPDs of UGH under the names “UGH Diagnostic Imaging” and “UGH Physical Therapy.”
Kingwood Diagnostic and Rehabilitation Center. On July 30, 2012, we acquired diagnostic imaging, physical therapy and sleep centers (the “Kingwood Centers”) from Management Affiliates of Northeast Houston, LLC, a Kingwood, Texas-based health service operations company. We operate the Kingwood Centers as HOPDs of the hospital segment under the name “UGH Kingwood Diagnostic and Rehabilitation Center.”
Robert Horry Center for Sports and Physical Rehabilitation. On August 24, 2012, we executed asset acquisition agreements with Robert Horry Center for Sports and Physical Rehabilitation (“UGH Robert Horry Center”), pursuant to which we acquired the business assets and properties of UGH Robert Horry Center, which we operate as HOPDs of UGH.
Baytown Diagnostic Imaging and Sleep Evaluation Centers. On November 27, 2012, we acquired a Diagnostic Imaging and a Sleep Evaluation Center from Jacinto Medical Group, PA. We operate these centers as HOPDs of UGH under the names “UGH Baytown Imaging” and “UGH Baytown Sleep.” The Baytown Centers also complement UGH Baytown Endoscopy Center that was acquired in April 2012.
South Hampton Community Hospital. On December 14, 2012, we acquired South Hampton Community Hospital Complex (the “South Hampton Community Hospital”) from Dufek Massif Hospital Corporation, the owner of South Hampton Community Hospital and a medical office building on the medical complex. We acquired 100% of the capital stock of Dufek Massif Hospital Corporation. The hospital is a 111-bed general acute care hospital that provides health services across multiple specialties. We operate the South Hampton Community Hospital Complex under the name “University General Hospital Dallas.” This acquisition is our first acute care hospital in Dallas.
2013 Acquisitions
Woodlands Physical Therapy. On February 15, 2013, we acquired a physical therapy center (the “Woodlands Center”) from The Houston Spine and Rehabilitation Center, a health service operations company near The Woodlands, Texas. We operate the Woodlands Center as an HOPD of UGH under the name “UGH Woodlands Physical Therapy.”
Physical Therapy of Ennis. On March 25, 2013, we acquired a physical therapy center in Ennis, Texas, approximately 32 miles from University General Hospital Dallas. We operate the center as an HOPD of University General Hospital Dallas under the name “UGHD Physical Therapy of Ennis.”
Living Well Diagnostic Imaging Center. On May 10, 2013, we acquired Living Well Diagnostic Imaging center in Waxahachie, Texas, approximately 22 miles south of University General Hospital Dallas. Living Well Diagnostic Imaging center is a free-standing diagnostic imaging facility. We operate the center as an HOPD of University General Hospital Dallas under the name “UGHD Living Well Diagnostic Imaging Center.”
Texas Anesthesia and Pain Management Institute. On June 1, 2013, we acquired Texas Anesthesia and Pain Management Institute in Waxahachie, Texas. We operate under the name “UGHS Physician Services.”
Waxahachie Diagnostic Center. On July 1, 2013, we acquired an ambulatory surgery center in Waxahachie, Texas. We operate the center as an HOPD of University General Hospital Dallas under the name “UGHD Waxahachie Diagnostic Center”.
Clint Foster and Associates. On October 1, 2013, we acquired four free-standing physical therapy and rehabilitation facilities (the “Clint Foster Centers”) from C.W. Foster Enterprises, Inc. We operate the Clint Forster Centers as HOPDs of UGH under the name “UGH C. Foster and Associates”.
Texas Rehabilitation Institute. On October 8, 2013, we acquired a physical therapy rehabilitation center (the “Physical Therapy Rehabilitation Center”) from Texas Spine Institute, LLP. We operate the Physical Therapy Rehabilitation Center as HOPD under the name “UGHD Physical Therapy Rehabilitation Center”.
The Houston Spine and Rehabilitation Centers. On November 26, 2013, we acquired a physical health services (the “Houston Spine and Rehabilitation Centers” from The Houston Spine and Rehabilitation Centers, P.A. We operate the Houston Spine and Rehabilitation Center as HOPD under the name “UGH Houston Spine and Rehabilitation Centers”.
During 2013, the Company also completed other smaller acquisitions of physician services located in Houston Texas. The Company, in the aggregate, paid $250,000 in total consideration for these physician services centers.
The purpose of our acquisitions was to expand our regional network into the Dallas areas, areas of metropolitan Houston and increase market share.
Plan of Operation
Our business model anticipates the acquisition of general acute care “host” hospitals and the development and operation of regional health networks within a defined radius of each host hospital that can provide services under separate departments under the hospitals’ acute care licenses. Such regional health networks and ancillary services will reflect a vertically integrated, diversified system, which will include provider-based HOPDs of the host hospitals and may consist of Free-Standing Ambulatory Surgical Centers, Free-Standing Emergency Rooms, Free-Standing Procedure Facilities, Diagnostic Imaging Treatment Facilities, Hyperbaric Oxygen Therapy/Wound Care Centers, and/or other ancillary service providers. In 2013, we completed acquisitions of complementary businesses that expand our service offerings within the healthcare industry.
We consummated acquisitions of complementary businesses, further discussed below, and as of December 31, 2013, we owned or operated the following centers:
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University General Hospital (“UGH”), which is a 69-bed general acute care hospital near Texas Medical Center in Houston, Texas, and also consists of Mainland Surgery Center, a free-standing ambulatory surgery center in Dickinson, Texas, and the following HOPDs:
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University General Hospital -Hyperbaric Wound Care Center
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UGH Baytown Endoscopy, which is a 3-bed ambulatory surgery center
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UGH Diagnostic Imaging and UGH Physical Therapy
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UGH KW Imaging and UGH KW Sleep Center
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UGH Robert Horry Center for Sports and Physical Rehabilitation
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UGH Baytown Imaging and UGH Sleep Evaluation
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UGH Woodlands Physical Therapy
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UGH Clint Foster Centers
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Houston Spine and Rehabilitation Center
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University General Hospital Dallas (formerly known as South Hampton Community Hospital) which is a 111-bed general acute care hospital near downtown Dallas, Texas, and also consists of the following HOPDs:
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UGHD Physical Therapy of Ennis
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UGHD Living Well Diagnostic Imaging Center
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UGHD Waxahachie Diagnostic Center
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UGHD Texas Anesthesia and Pain Management
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UGHD Physical Therapy Rehabilitation Center
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Senior Living which consists of
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Trinity Oaks senior living community in Pearland, Texas, which is an 80 unit senior living community providing independent living and assisted living services since 2001.
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Trinity Shores senior living community in Port Lavaca, Texas, which is a 63 unit senior living community providing independent living, assisted living and memory care services since 2007.
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Trinity Hills senior living community in Knoxville, Tennessee, which is an 87 unit senior living community providing independent living, assisted living and memory care services since 2007.
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Support Services which consists of
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UGHS Autimis Companies, which are a revenue cycle management company and a specialized health care coding company that serve hospitals, ambulatory surgery centers, outpatient laboratories and free-standing outpatient emergency rooms.
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Sybaris Group, Inc., which is a luxury hospitality service provider and facilities management company.
We plan to capitalize on opportunities created by the current regulatory and reimbursement environment through acquisitions and expansions or services to create an integrated health care delivery system.
Business Segments
As of December 31, 2013, we operate in three lines of business: (i) as a hospital, (ii) as a senior living care community, and (iii) as a support services company. These segments were determined based on the way that our chief operating decision makers organize our business activities for making operating decisions and assessing performance.
(i) Hospitals. We currently own, manage or operate two general acute care hospitals, which offer a variety of medical and surgical services with a total of 180 beds. We provide inpatient, outpatient and ancillary services including inpatient surgery, outpatient surgery, heart catheterization procedures, physical therapy, diagnostic imaging and respiratory therapy, sleep lab, speech therapy, bariatrics, orthopedics, lab, and wound care. Our hospitals provide 24-7 emergency services and comprehensive inpatient services including critical care and cardiovascular services. This business segment also includes the ownership of free-standing ambulatory surgery centers in markets that we target for expansion.
(ii) Senior Living. Senior living communities offer housing and 24-hour assistance with activities of daily life to mid-acuity, frail and elderly residents. We also operate memory care services specially designed for residents with Alzheimer’s disease and progressive dementia.
(iii) Support Services. We provide billing, coding and other revenue cycling management services to University General Hospital and University General Hospital Dallas, as well as other clients not affiliated with our company. Our food and support services group provides a number of interrelated services including food, hospitality and facility services for businesses and healthcare facilities.
Sources of Revenue
Hospital revenues
Hospital revenues consist primarily of net revenues derived from patient care services and other non-patient care services. The net patient revenues are based on the facilities’ established billing rates less allowances and discounts. Charges and reimbursement rates for patient care vary significantly depending on the type of service and payer. We receive payments for patient care from commercial and managed care providers, government-related programs and self-pay patients. Commercial and managed care providers consist of various payors including private insurance carriers, health maintenance organizations (“HMO”) and preferred provider organizations (“PPO”). Government-related programs consist of Medicare and Medicaid programs. The approximate percentages of our net patient revenues before provision of doubtful accounts from such sources were as follows:
Hospital revenues depend upon inpatient occupancy levels, the extent to which ancillary services and therapy programs are ordered by physicians and provided to patients, and the volume of outpatient procedures. Reimbursement rates for routine inpatient services vary significantly depending on the type of service and payer. Inpatient occupancy levels fluctuate for various reasons, many of which are beyond our control.
Patients generally are not responsible for any difference between established hospital charges and amounts reimbursed for such service under Medicare, Medicaid and some private insurer plans, HMO and PPO plans. However, patients are responsible to the extent of any exclusions, deductibles or co-insurance features of their coverage. The amount of such exclusions, deductibles and co-insurance has been increasing in recent years. Collection of amounts due from individuals typically is more difficult than from governmental or third-party payors.
Medicare is a federally funded and administered health insurance program, primarily for individuals entitled to social security benefits who are 65 or older or who are disabled. Medicaid is a health insurance program jointly funded by state and federal governments that provides medical assistance to qualifying low income persons. The various state Medicaid programs also pay us a fixed payment for our services, which amount varies from state to state. Our hospital is certified to participate in the Medicare and Medicaid programs. Amounts received from Medicare and Medicaid programs are generally significantly less than established hospital gross charges for the services provided.
We have agreements with third-party payors that provide for payments to us at amounts different from our established rates. Payment arrangements include prospectively-determined rates per discharge, reimbursed costs, discounted charges and per diem payments. Net patient service revenue is reported at the estimated net realizable amount from patients, third-party payors, and others for services rendered, including estimated contractual adjustments under reimbursement agreements with third party payors. Allowances and discounts are accrued on an estimated basis in the period the related services are rendered and adjusted in future periods as final settlements are determined. These allowances and discounts are related to the Medicare and Medicaid programs and commercial and managed care contracts.
Senior Living revenues
Revenues related to the senior living segment consist primarily of resident fees, entrance fees, community fees and management fees. Resident fee revenues consists of fees for basic housing, support services and fees associated with additional services such as personalized assisted living care. Residency agreements are generally non-binding, for a term of one year, with resident fees billed monthly in advance.
TrinityCare Management provides management services to the TrinityCare Facilities, as well as an assisted living community and two memory care greenhouses in Georgia. Management fee revenue is determined by an agreed upon percentage of gross revenues and recorded as services are provided, consistent within industry.
We rely primarily on our residents’ ability to pay our charges for services from their own or family resources and expect that we will continue to do so for the foreseeable future. As third-party reimbursement programs and other forms of payment continue to grow, we will evaluate and selectively participate in these alternative forms of payment depending on the level of reimbursement provided in relation to the level of care provided. We also believe that private long-term care insurance will increasingly become a revenue source in the future, although it is currently insignificant.
Support Services revenues
Billing and coding revenues are generated from revenue cycle management services provided by Autimis to our Hospital segment and other third-party clients. Fees charged for these services are defined in service agreements and based upon a stated percentage of cash collections. Food and support services revenues are generated from environmental, food and nutrition, and facilities management services by Sybaris to our Hospital segment and other third-party clients. Billing, coding and food and support services revenue received from the Hospital operating segment has been eliminated in consolidation.
Competition
Hospital
We have established a strong presence in the greater Houston market and with the acquisition of the South Hampton Hospital in Dallas are now actively replicating its model in a second major market. The state of Texas is highly attractive as it has a consistently growing demand for healthcare services, yet remains below the national average in terms of hospital beds per inhabitant, with 1.8 beds per 1,000 inhabitants compared to the roughly 2.6 per 1,000 inhabitants national average (source Kaiser Family Foundation). Our primary Houston facility, University General Hospital, competes with at least fifty-four other general hospitals operating in Harris County, Texas. The greater Houston-Baytown-Sugar Land metropolitan area has over 100 hospitals, according to U.S. News and World Report, including the Texas Medical Center (TMC), the largest medical center in the world. Founded in 1945, TMC is comprised of 54 member institutions, including four nursing schools and three medical schools (dentistry, public health and pharmacy), all of which are not-for-profit, which representing nearly 46 million square feet and 290 buildings. Among the various institutions with which UGH competes, six Houston-based facilities (including the University of Texas M.D., the Methodist Hospital and St. Luke’s Episcopal Hospital) were ranked in U.S. News & World Report’s 2012-2013 Best Hospitals list. Also, five of the top 10 employers in Houston are healthcare organizations. The Dallas market is relatively under-penetrated, with 75 hospitals serving a population of 6.4 million people, or approximately 85,000 per hospital compared to the national average of 54,000 per hospital.
Regulatory and other changes affecting the healthcare industry expose our business and other industry participants to the risk that they will lose competitive advantages. Many of our existing and potential competitors have significantly greater financial and other resources than our business. Some of the facilities that compete with our business are owned by governmental agencies or not-for-profit corporations supported by endowments, charitable contributions and/or tax revenues and can finance capital expenditures and operations on a tax-exempt basis.
Our licensed hospitals beds are concentrated in certain market areas within Texas, which makes us sensitive to economic, regulatory, environmental and other conditions in those areas. Our licensed beds are currently located exclusively in market areas within Texas. This concentration in Texas increases the risk that, should any adverse economic, regulatory, environmental or other condition occur in these areas, our overall business, financial condition, results of operations or cash flows could be materially adversely affected.
Our strategies are designed to ensure our hospitals are competitive. We believe our hospitals compete within local communities on the basis of many factors, including the quality of care, ability to attract and retain quality physicians, skilled clinical personnel and other health care professionals, location, breadth of services, technology offered and prices charged. In addition, a significant factor in our future success will be the ability of our hospitals to attract and establish strong relationships with physicians, as it is physicians who decide whether a patient is admitted to the hospital and the procedures to be performed. Although physicians may terminate their relationships with our hospitals at any time, we seek to retain contractual arrangements with physicians. We have increased our focus on operating outpatient services with improved accessibility and more convenient service for patients, and increased predictability and efficiency for physicians.
Another major factor in the competitive position of a hospital is the ability of its management to obtain contracts with managed care plans and other group payers. The importance of obtaining managed care contracts has increased in the recent years due primarily to consolidations of health plans. The revenues and operating results of our hospitals are significantly affected by our hospitals’ ability to negotiate favorable contracts with managed care plans. Health maintenance organizations and preferred provider organizations use managed care contracts to encourage patients to use certain hospitals in exchange for discounts from the hospitals’ established charges. Other healthcare providers may impact our ability to enter into managed care contracts or negotiate increases in our reimbursement and other favorable terms and conditions. In addition, as various provisions of the Health Reform Law are implemented, including the establishment of exchanges and limitations on rescissions of coverage and pre-existing condition exclusions, non-government payers may increasingly demand reduced fees or be unwilling to negotiate reimbursement increases. Traditional health insurers and large employers also are interested in containing costs through similar contracts with hospitals.
We face the challenge of continuing to provide quality patient care while dealing with rising costs and strong competition for patients. Changes in medical technology, existing and future legislation, regulations and interpretations and managed care contracting for provider services by private and government payers remain ongoing challenges.
Furthermore, a natural disaster or other catastrophic event (such as a hurricane) could affect us more significantly than other companies with less geographic concentration, and the property insurance we obtain may not be adequate to cover our losses. In the past, hurricanes have had a disruptive effect on the operations of our business in Texas and the patient populations in those states.
Senior Living
TrinityCare has no direct for-profit national competitors who develop, manage and own faith-based senior living facilities. While there are a number of competitors who own and operate independent living, assisted living, memory care and skilled nursing facilities, a limited number with churches and fewer develop these in an “aging in place” setting.
We expect to face increased competition in the long term from new market entrants as the demand for senior living grows, although short-term data indicates limited new supply coming into the markets we serve. Providers of senior living residences compete for residents primarily on the basis of quality of care, price, reputation, physical appearance of the residences, services offered, family preferences, physician referrals, and location. Our competition comes from local, regional, and national senior living companies that operate, manage, and develop residences within the geographic areas in which we operate, as well as retirement housing communities, home healthcare agencies, not-for-profit or charitable operators and, to a lesser extent, skilled nursing facilities and convalescent centers. In addition, we compete with home-based residential care, either provided by family members or other third parties. As the general economy declines and unemployment increases, families are less able to afford our residences or are more willing or available to care for family members at home.
We believe that quality of service, reputation, community location, physical appearance and price will continue to be significant competitive factors. We also believe that each local market is different, and our responses to the specific competitive environment in any market will vary. However, if a competitor were to attempt to enter one of the markets in which we operate, we may be required to reduce our rates, provide additional services or expand our facilities to meet perceived additional demand. We may not be able to compete effectively in markets that become overbuilt. In general, regulatory and other barriers to competitive entry in the senior living industry are not substantial. Some of our present and potential competitors have, or may obtain, greater financial resources than we have and may have a lower cost of capital. Consequently, we may encounter competition that could limit our ability to attract residents or expand our business, which could have a material adverse effect on our financial position, results of operations or cash flows.
Support Services
The accounts receivable management industry is highly competitive, but our revenue cycle management service group operates across multiple healthcare segments; as a result we generally face less competition. Our competition is generally from local and national companies. We believe that we have a competitive advantage over our competitors due to our (i) Autimis Revenaid Practice Management system, which we believe increases efficiency and collections and (ii) experienced and detail oriented personnel who focus on all aspects of the reimbursement process and who have including having extensive knowledge of payor responsibilities and managed care contracts.
There is significant competition in the food and support services business from local companies, as well as from businesses and healthcare institutions. Institutions may decide to operate their own services following the expiration or termination of contracts with us or with our competitors. Currently, we do not directly compete with international companies such as Sodexho, Inc. and Aramark Corporation. However, we face competition from many local and national service providers. We believe that we have a competitive advantage over local service providers due to our (i) quality and breadth of services and management talent, (ii) service innovation, (iii) reputation within the industry and (iv) pricing.
Environmental Matters
We are subject to various federal, state and local statutes and ordinances regulating the discharge of materials into the environment. We believe we are in substantial compliance with applicable federal, state, and local environmental regulations. We anticipate that the regulation of our business operations under federal, state and local environmental regulations in the United States and abroad will increase and become more stringent over time. We cannot estimate the impact of increased and more stringent regulation on our operations, future capital expenditure requirements or the cost of compliance.
United States Regulation. In response to growing public concerns over the presence of contaminants affecting health, safety, and the quality of the environment, federal, state, and local governments have enacted numerous laws designed to clean up existing environmental problems and to implement practices intended to minimize future environmental problems. The principal federal statutes enacted in this regard are the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (“CERCLA”) and the Resource Conservation Recovery Act of 1976 (“RCRA”). CERCLA addresses the practices involved in handling, utilizing, and disposing of hazardous substances, and imposes liability for cleaning up contamination in soil and groundwater. Under CERCLA, the parties who may be liable for the costs of cleaning up environmental contamination include the current owner of the contaminated property, the owner of the property at the time of contamination, the person who arranged for the transportation of the hazardous substances, and the person who transported the hazardous substances. RCRA provides for a “cradle to grave” regulatory program to control and manage hazardous wastes, and is administered by the United States Environmental Protection Agency (“EPA”). RCRA sets treatment and storage requirements for hazardous wastes, and requires that persons who generate, transport, treat, store, or dispose of hazardous wastes meet EPA permit requirements and follow EPA guidelines. We may, in certain aspects of our business, be subject to CERCLA and RCRA. Specifically, by owning our primary hospital, we could become liable under CERCLA for the costs of cleaning up any contamination on the site of our hospital.
There are a variety of regulations at various governmental levels relating to the handling, preparation and serving of food, including in some cases requirements relating to the temperature of food, the cleanliness of the kitchen, and the hygiene of personnel, which are enforced primarily at the local public health department level. While we attempt to comply with all applicable laws and regulations, we cannot assure you that we are in full compliance at all times with all of the applicable laws and regulations referenced above. Furthermore, additional or amended regulations in this area may significantly increase the cost of compliance.
In addition, various federal and state and provincial agencies impose nutritional guidelines and other requirements on us at certain facilities we serve. There can be no assurance that federal or state legislation, or changes in regulatory implementation or interpretation of government regulations, would not limit our activities in the future or significantly increase the cost of regulatory compliance.
Regulatory Matters
The healthcare industry in general is subject to significant federal, state, and local regulation that affects our business activities by controlling the reimbursement we receive for services provided, requiring licensure or certification of our hospitals, regulating our relationships with physicians and other referral sources, regulating the use of our properties and controlling our growth. Our facilities provide the medical, nursing, therapy and ancillary services required to comply with local, state, and federal regulations, as well as, for most facilities, accreditation standards of the Joint Commission (formerly known as the Joint Commission on Accreditation of Healthcare Organizations).
Licensure and Certification
Healthcare facility operations are subject to numerous federal, state, and local regulations relating to, among other things, the adequacy of medical care, equipment, personnel, operating policies and procedures, acquisition and dispensing of pharmaceuticals and controlled substances, infection control, maintenance of adequate records and patient privacy, fire prevention, and compliance with building codes and environmental protection laws. Our hospital is subject to periodic inspection and other reviews by governmental and non-governmental certification authorities to ensure continued compliance with the various standards necessary for facility licensure, and our hospital is currently required to be licensed.
In addition, hospitals must be certified by the Centers for Medicare and Medicaid Services (“CMS”) to participate in the Medicare program and generally must be certified by Medicaid state agencies to participate in Medicaid programs. Once certified by Medicare, a hospital undergoes periodic on-site surveys in order to maintain their certification. Our hospital participates in the Medicare program.
Failure to comply with applicable certification requirements may make our hospital ineligible for Medicare or Medicaid reimbursement. In addition, Medicare or Medicaid may seek retroactive reimbursement from noncompliant facilities or otherwise impose sanctions on noncompliant facilities. Non-governmental payors often have the right to terminate provider contracts if a facility loses its Medicare or Medicaid certification.
The Healthcare Reform Laws added new screening requirements and associated fees for all Medicare providers. The screening must include a licensure check and may include other procedures such as fingerprinting, criminal background checks, unscheduled and unannounced site visits, database checks and other screening procedures prescribed by CMS.
We have developed operational systems to oversee compliance with the various standards and requirements of the Medicare program and have established ongoing quality assurance activities; however, given the complex nature of governmental healthcare regulations, there can be no assurance that Medicare, Medicaid, or other regulatory authorities will not allege instances of noncompliance. A determination by a regulatory authority that a facility is not in compliance with applicable requirements could also lead to the assessment of fines or other penalties, loss of licensure, and the imposition of requirements that an offending facility takes corrective action.
False Claims
The federal False Claims Act prohibits the knowing presentation of a false claim to the United States government and provides for penalties equal to three times the actual amount of any overpayments plus up to $11,000 per claim. For hospitals, a “false claim” can also include a false certification of compliance with federal health care laws on a cost report submitted to CMS. In this context, hospitals that have been found in violation of the federal Physician Self-Referral Law (a/k/a the “Stark” law) or the federal Anti-Kickback Law, both of which are discussed below, may also be liable under the False Claims Act. In addition, the False Claims Act allows private persons, known as “relators,” to file complaints under seal and provides a period of time for the government to investigate such complaints and determine whether to intervene in them and take over the handling of all or part of such complaints. Relators are entitled to a percentage of the government’s recovery as well as reimbursement of their attorney’s fees, so there is significant financial incentive for private citizens to enforce the False Claims Act. Because we perform thousands of similar procedures a year for which we are reimbursed by Medicare and other federal payors and there is a relatively long statute of limitations, a billing error or cost reporting error could result in significant civil or criminal penalties under the False Claims Act.
The Fraud Enforcement and Recovery Act of 2009 (“FERA”) and the 2010 Healthcare Reform Laws amended the federal False Claims Act to expand the definition of false claims, to make it easier for the government to initiate and conduct investigations, to enhance the monetary reward to relators where prosecutions are ultimately successful, and to extend the statute of limitation on claims by the government. One of these areas of expansion relates to the retention of overpayments from the Medicare and Medicaid programs. The FERA amended the False Claims Act to include improper retention of an overpayment as a basis for liability. The 2010 Healthcare Reform Laws added that the failure to disclose and repay an overpayment within sixty (60) days of when it was discovered or from the date any corresponding cost report is due equates to retention of an overpayment for purposes of the False Claims Act.
Relationships with Physicians and Other Providers
Anti-Kickback Law. Various federal laws regulate relationships between providers of healthcare services, including management or service contracts and investment relationships. Among the most important of these restrictions is a federal law prohibiting the offer, payment, solicitation, or receipt of remuneration by individuals or entities when done knowingly and willfully to induce referrals of patients for services reimbursed under the Medicare, Medicaid or any other federal health care program (the “Anti-Kickback Law”). The 2010 Healthcare Reform Laws amended the federal Anti-Kickback Law to provide that proving violations of this law does not require proving actual knowledge or specific intent to commit a violation. Another amendment made it clear that Anti-Kickback Law violations can be the basis for claims under the False Claims Act.
These changes and those described above related to the False Claims Act, when combined with other recent federal initiatives, are likely to increase investigation and enforcement efforts in the healthcare industry generally.
In addition to standard federal criminal and civil sanctions, including civil monetary penalties of up to $50,000 for each violation plus tripled damages for improper claims, violators of the Anti-Kickback Law may be subject to criminal fines of up to $25,000 and imprisonment, as well as exclusion from the Medicare and/or Medicaid programs. In 1991, the Office of Inspector General of the United States Department of Health and Human Services (the “HHS-OIG”) issued regulations describing compensation arrangements that are not viewed as illegal remuneration under the Anti-Kickback Law.
Those regulations provide for certain safe harbors for identified types of compensation arrangements that, if fully complied with, assure participants in the particular arrangement that the HHS-OIG will not treat that participation as a criminal offense under the Anti-Kickback Law or as the basis for an exclusion from the Medicare and Medicaid programs or the imposition of civil sanctions. Failure to fall within a safe harbor does not constitute a violation of the Anti-Kickback Law, but the HHS-OIG has indicated failure to fall within a safe harbor may subject an arrangement to increased scrutiny.
A violation or even the assertion of, a violation of the Anti-Kickback Law by us or one or more of our companies could have a material adverse effect upon our business, financial position, results of operations, or cash flows.
We have a number of relationships with physicians and other healthcare providers who refer Medicare patients to our hospitals, including management or service contracts. The federal authorities responsible for enforcing the Anti-Kickback Law have held that such contracts may violate the law if even one purpose of the remuneration was to obtain money for the referral of services or to induce further referrals. Even though some of these contractual relationships may not meet all of the regulatory requirements to fall within the protection offered by a relevant safe harbor, we do not believe we engage in activities that violate the Anti-Kickback Law. However, there can be no assurance such violations may not be asserted in the future, nor can there be any assurance that our defense against any such assertion would be successful.
For example, we have entered into agreements to manage our hospitals and surgery centers with management companies that are owned by physicians. Most of these agreements incorporate a management fee that pays for the services provided by the management companies. Although there is a safe harbor for personal services and management contracts, this safe harbor requires, among other things, the aggregate compensation paid to the manager over the term of the agreement be set in advance, not take into account the volume or value of referrals and represent the fair market value of the services rendered by the management company. Our management fees are generally fixed fees (rather than a percentage of revenues) and do not take into account the volume or value of referrals. However, while all parties to these agreements believe that the management fees under such arrangements do not exceed the fair market value, the fees are generally not determined by independent valuation appraisals prior to entering these agreements. The agreements generally provide for fee adjustments (not less than annually) in the event either party believes the services rendered do not reflect fair market value; but as fair market value is often difficult to predict, the fee arrangements may not meet these requirements of the safe harbor. However, we believe our management arrangements satisfy the other requirements of the safe harbor for personal services and management contracts and do not violate the Anti-Kickback Law.
Physician Self-Referral Law. The federal law commonly known as the “Stark law” and CMS regulations promulgated under the Stark law prohibit physicians from making referrals for “designated health services” including inpatient and outpatient hospital services, physical therapy, occupational therapy, and radiology services, to an entity with respect to which the physician (or an immediate family member) has an ownership or investment interest or compensation arrangement, subject to certain exceptions. The Stark law is considered a “strict liability” statute because it does not require a violation to be knowing or willful in order to impose liability.
The Stark law also prohibits those entities from filing claims or billing for those referred services. Violators of the Stark statute and regulations may be subject to recoupments, civil monetary sanctions (up to $15,000 for each violation and assessments up to three times the amount claimed for each prohibited service) and exclusion from any federal, state, or other governmental healthcare programs. The statute also provides a penalty of up to $100,000 for a circumvention scheme, which is an arrangement (such as a cross-referral arrangement) that the physician or entity knows or should know has a principal purpose of assuring referrals by the physician to a particular entity which, if the physician directly made referrals to such entity, would violate the Stark Law. As with the Anti-Kickback Law, violation of the Stark law by a hospital can also result in liability under the False Claims Act.
There are statutory exceptions to the Stark law for many of the customary financial arrangements between physicians and providers, including personal services contracts and leases. However, in order to be afforded protection by a Stark law exception, the financial arrangement must comply with every requirement of the applicable exception.
Historically, the Stark law provided certain exceptions for ownership and investments in specific providers, such as hospitals (the “Whole Hospital Exception”), which allowed a physician to refer patients to a hospital where the referring physician is a member of the hospital’s medical staff and has an ownership interest in the hospital as a whole, as opposed to a distinct part or department of the hospital.
The Healthcare Reform Laws eliminated the application of the Whole Hospital Exception to physician-owned hospitals that did not have physician ownership as of March 23, 2010 and their Medicare provider agreements in place by December 31, 2010. However, hospitals that had physician ownership as of March 23, 2010 and their Medicare provider number as of December 31st were grandfathered and allowed to keep their physician ownership. These grandfathered hospitals may not expand the number of operating rooms, procedure rooms or beds for which the hospital was licensed as of March 23, 2010 (the date of enactment of the Healthcare Reform Laws), unless an exception is met. In addition, the total amount of physician ownership or investment interests held in the hospital, or in an entity whose assets include the hospital, must not exceed such percentage as of March 23, 2010. The legislation also subjects grandfathered hospitals to reporting requirements and extensive disclosure requirements on the hospital’s website and in any public advertisements.
Another exception relevant to our business under the Stark law protects personal service arrangements with physicians where certain specified requirements are met, including the requirement that (i) each arrangement be set out in writing; (ii) the arrangement covers all of the services furnished by the physician; (iii) the aggregate services contracted for do not exceed those that are reasonable and necessary for the legitimate business purpose of the arrangement; (iv) the term of each arrangement is at least one year; (v) the compensation to be paid over the term is set in advance, does not exceed fair market value and is not determined in a manner that takes into account the volume or value of referrals or other business generated between the parties; and (vi) the services furnished under each arrangement do not involve the counseling or promotion of a business arrangement that violates any federal or state law (the “Personal Service Arrangements Exception”). We have structured these arrangements between our companies and the applicable physicians to meet the requirements of the Personal Service Arrangements Exception under the Stark Law.
CMS has issued several phases of final regulations implementing the Stark law. While these regulations help clarify the requirements of the exceptions to the Stark law, it is unclear how the government will interpret many of these exceptions for enforcement purposes. Recent changes to the regulations implementing the Stark law further restrict the types of arrangements into which facilities and physicians may enter, including additional restrictions on certain leases, percentage compensation arrangements, and agreements under which a hospital purchases services “under arrangements.” As many of these laws and their implementing regulations are relatively new, we do not always have the benefit of significant regulatory or judicial interpretation of these laws and regulations. We attempt to structure our relationships to meet an exception to the Stark law, but the regulations implementing the exceptions are detailed and complex. Accordingly, we cannot assure that every relationship complies fully with the Stark law.
Additionally, no assurances can be given that any agency charged with enforcement of the Stark law and regulations might not assert a violation under the Stark law, nor can there be any assurance that our defense against any such assertion would be successful or that new federal or state laws governing physician relationships, or new interpretations of existing laws governing such relationships, might not adversely affect relationships we have established with physicians or result in the imposition of penalties on us. Even the assertion of a violation could have a material adverse effect upon our business, financial position, results of operations or cash flows.
Emergency Medical Treatment and Active Labor Act
We are subject to the Emergency Medical Treatment and Active Labor Act (“EMTALA”). This federal law requires any hospital that participates in the Medicare program to conduct an appropriate medical screening examination of every person who presents himself to the hospital’s emergency department for treatment and, if the patient is suffering from an emergency medical condition, to either stabilize that condition or make an appropriate transfer of the patient to a facility that can handle the condition. The obligation to screen and stabilize emergency medical conditions exists regardless of a patient’s ability to pay for treatment. There are severe penalties under EMTALA if a hospital fails to screen or appropriately stabilize or transfer a patient or if the hospital delays appropriate treatment in order to first inquire about the patient’s ability to pay. Penalties for violations of EMTALA include civil monetary penalties and exclusion from participation in the Medicare program. In addition, an injured patient, the patient’s family or a medical facility that suffers a financial loss as a direct result of another hospital’s violation of the law can bring a civil suit against the hospital. In a final rule, effective November 10, 2003, CMS clarified when a patient is considered to be on a hospital’s property for purposes of treating the person pursuant to EMTALA. CMS stated that off-campus facilities such as specialty clinics, surgery centers and other facilities that lack emergency departments should not be subject to EMTALA, but that these locations must have a plan explaining how the location should proceed in an emergency situation such as transferring the patient to the closest hospital with an emergency department. CMS further clarified that hospital-owned ambulances could transport a patient to the closest emergency department instead of to the hospital that owns the ambulance.
Health Insurance Portability and Accountability Act
The Health Insurance Portability and Accountability Act of 1996, commonly known as “HIPAA,” broadened the scope of certain fraud and abuse laws by adding several criminal provisions for healthcare fraud offenses that apply to all health benefit programs. HIPAA also added a prohibition against incentives intended to influence decisions by Medicare beneficiaries as to the provider from which they will receive services. In addition, HIPAA created new enforcement mechanisms to combat fraud and abuse, including the Medicare Integrity Program, and an incentive program under which individuals can receive up to $1,000 for providing information on Medicare fraud and abuse that leads to the recovery of at least $100 of Medicare funds. Penalties for violations of HIPAA include civil and criminal monetary penalties.
HIPAA also contains certain administrative simplification provisions that require the use of uniform electronic data transmission standards for certain healthcare claims and payment transactions submitted or received electronically. In support of the statute, the Department of Health and Human Services (“HHS”) promulgated extensive regulations governing the use and disclosure of individually identifiable health-related information, whether communicated electronically, on paper, or orally, also known as Protected Health Information (“PHI”). These regulations are grouped into distinct rules - the Privacy Rule, the Security Rule and the Enforcement Rule. The regulations provide patients with significant rights related to understanding and controlling how their health information is used or disclosed, but do not provide a private right of action for an individual to sue a covered entity. The regulations also require covered entities, including a hospital, to implement administrative, physical, and technical practices to protect the security of individually identifiable health information that is maintained or transmitted electronically.
In addition, the regulations govern covered entities’ relationships with business associates - vendors, including other covered entities, who receive, create, maintain or disclose PHI - by requiring covered entities to enter business associate agreements that contain certain provisions mandated by the regulations. Our hospitals can be either a covered entity or a business associate depending on the nature of the services being provided.
With the enactment of the Health Information Technology for Economic and Clinical Health (“HITECH”) Act as part of the American Recovery and Reinvestment Act of 2009 (“ARRA”), the privacy and security requirements of HIPAA have been modified and expanded. The HITECH Act applies certain of the HIPAA privacy and security requirements directly to business associates of covered entities.
The modifications to existing HIPAA requirements include: expanded accounting requirements for electronic health records, tighter restrictions on marketing and fundraising, heightened penalties, expansion of criminal liability and increased enforcement associated with noncompliance. Significantly, the HITECH Act also establishes new mandatory federal requirements for notification of breaches of security involving protected health information, the Breach Notification Rule. HHS is responsible for enforcing the requirement that covered entities notify individuals whose protected health information has been improperly disclosed. In certain cases, notice of a breach is required to be made to HHS and media outlets.
The heightened penalties for noncompliance range from $100 to $50,000 for single incidents and from $25,000 to $1,500,000 for multiple identical violations. In the event of violations due to willful neglect that are not corrected within 30 days, penalties are not subject to a statutory maximum. HIPAA enforcement actions and civil monetary penalties have significantly increased in the wake of HITECH.
In addition, there are numerous legislative and regulatory initiatives at the federal and state levels addressing patient privacy concerns. Facilities will continue to remain subject to any federal and state privacy-related laws that are more restrictive than the privacy regulations issued under HIPAA. These laws vary and could impose additional penalties.
On January 28, 2013, HHS issued final rules implementing HITECH. Among other things, these final rules increase the scope of the Breach Notification Rule, make covered entities vicariously liable for the conduct of their business associates under the federal common law of agency, and require business associates to enter business associate agreements with their subcontractors.
In light of increased federal enforcement of HIPAA, our hospitals are subject to increased administrative burdens for regulatory compliance, regulatory scrutiny, and potential regulatory liability. We believe our current practices comply with the up to date regulations under HIPAA and HITECH, but cannot guarantee that the new regulations will not have an adverse impact on our business. Any actual or perceived violation of these privacy-related laws, including HIPAA could have a material adverse effect on our business, financial position, results of operations and cash flows.
Health Care Industry Investigations
Significant media and public attention has focused in recent years on the hospital industry. This media and public attention, changes in government personnel and other factors have led to increased scrutiny of the health care industry. Except as may be disclosed in our SEC filings, we are not aware of any material investigations of the Company under federal or state health care laws or regulations. It is possible that governmental entities could initiate investigations or litigation in the future at facilities we operate and that such matters could result in penalties, as well as adverse publicity. It is also possible that our executives and managers could be included in governmental investigations or litigation or named as defendants in private litigation.
In public statements surrounding current investigations, governmental authorities have taken positions on a number of issues, including some for which little official interpretation previously has been available, that appear to be inconsistent with practices that have been common within the industry and that previously have not been challenged in this manner. In some instances, government investigations that have in the past been conducted under the civil provisions of federal law may now be conducted as criminal investigations.
Both federal and state government agencies have increased their focus on and coordination of civil and criminal enforcement efforts in the health care area. The OIG and the Department of Justice (“DOJ”) have, from time to time, established national enforcement initiatives, targeting all hospital providers that focus on specific billing practices or other suspected areas of abuse. The Health Reform Law includes additional federal funding of $350 million over 10 years to fight health care fraud, waste and abuse, including $40 million in federal fiscal year 2014. In addition, governmental agencies and their agents, such as MACs, fiscal intermediaries and carriers, may conduct audits of our health care operations. Private payers may conduct similar post-payment audits, and we also perform internal audits and monitoring.
In addition to national enforcement initiatives, federal and state investigations have addressed a wide variety of routine health care operations such as: cost reporting and billing practices, including for Medicare outliers; financial arrangements with referral sources; physician recruitment activities; physician joint ventures; and hospital charges and collection practices for self-pay patients. We engage in many of these routine health care operations and other activities that could be the subject of governmental investigations or inquiries. For example, we have significant Medicare and Medicaid billings, numerous financial arrangements with physicians who are referral sources to our hospitals, and joint venture arrangements involving physician investors. Certain of our individual facilities have received, and other facilities may receive, government inquiries from, and may be subject to investigation by, federal and state agencies. Any additional investigations of the Company, our executives or managers could result in liabilities or penalties to us, as well as adverse publicity.
Health Reform Legislation
The Health Reform Law changes how health care services are covered, delivered and reimbursed through expanded coverage of uninsured individuals, reduced growth in Medicare program spending, reductions in Medicare and Medicaid DSH payments, and the establishment of programs that tie reimbursement to quality and integration. In addition, the law reforms certain aspects of health insurance, expands existing efforts to tie Medicare and Medicaid payments to performance and quality, and contains provisions intended to strengthen fraud and abuse enforcement. Most of the provisions of the Health Reform Law that seek to decrease the number of uninsured became effective January 1, 2014.
Expanded Coverage
Based on the CBO’s February 2014 projection, by 2022, the Health Reform Law will expand coverage to 25 million additional individuals. This increased coverage will occur through a combination of public program expansion and private sector health insurance and other reforms.
Medicaid Expansion
The primary public program coverage expansion is occurring through changes in Medicaid, and to a lesser extent, expansion of the Children’s Health Insurance Program (“CHIP”). The most significant changes expand the categories of individuals eligible for Medicaid coverage and permit individuals with relatively higher incomes to qualify. Although the Health Reform Law requires, as of January 1, 2014, all state Medicaid programs to provide, and the federal government to subsidize, Medicaid coverage to virtually all adults under 65 years old with incomes at or under 133% of the federal poverty level (“FPL”), states may opt out of the expansion without losing existing federal Medicaid funding. For states that expand Medicaid coverage, the Health Reform Law also requires those states to apply a “5% income disregard” to the Medicaid eligibility standard, so that Medicaid eligibility will effectively be extended to those with incomes up to 138% of the FPL. States that choose not to implement the Medicaid expansion will forego funding established by the Health Reform Law to cover most of the expansion costs. A number of states, including Texas and Florida, have chosen not to participate in the expanded Medicaid program, but these states could choose to implement the expansion at a later date. For states that do not participate, the maximum income level required for individuals and families to qualify for Medicaid varies widely from state to state. According to the CBO’s February 2014 projection, the new eligibility requirements will expand Medicaid and CHIP coverage by an estimated 13 million persons nationwide by 2022.
As Medicaid is a joint federal and state program, the federal government provides states with “matching funds” in a defined percentage, known as the federal medical assistance percentage (“FMAP”). Beginning in 2014, states will receive an enhanced FMAP for the individuals enrolled in Medicaid pursuant to the Health Reform Law. The FMAP percentage is as follows: 100% for calendar years 2014 through 2016; 95% for 2017; 94% in 2018; 93% in 2019; and 90% in 2020 and thereafter. CMS has indicated that states that only partially expand their Medicaid programs will not receive an enhanced FMAP.
The Health Reform Law also provides that the federal government will subsidize states that create non-Medicaid plans for residents whose incomes are greater than 133% of the FPL but do not exceed 200% of the FPL. Approved state plans will be eligible to receive federal funding. The amount of that funding per individual will be equal to 95% of subsidies that would have been provided for that individual had he or she enrolled in a health plan offered through one of the Exchanges, as discussed below.
Historically, states often have attempted to reduce Medicaid spending by limiting benefits and tightening Medicaid eligibility requirements. However, the Health Reform Law requires states to at least maintain Medicaid eligibility standards established prior to the enactment of the law for children until October 1, 2019.
Private Sector Expansion
The expansion of health coverage through the private sector as a result of the Health Reform Law occurs through new requirements applicable to health insurers, employers and individuals. Health insurers must keep their annual nonmedical costs lower than 15% of premium revenue for the group market and lower than 20% in the small group and individual markets or rebate to enrollees the amount spent in excess of the percentage. In addition, health insurers are not permitted to deny coverage to children based upon a pre-existing condition and must allow dependent care coverage for children up to 26 years old. As of January 1, 2014, health insurers are prohibited from imposing annual coverage limits, dropping coverage, excluding persons based upon pre-existing conditions or denying coverage for any individual who is willing to pay the premiums for such coverage.
Larger employers will be subject to new requirements and incentives to provide health insurance benefits to their full time employees. Employers with 50 or more employees that do not offer health insurance will be held subject to a penalty if an employee obtains government-subsidized coverage through an Exchange. The employer penalties will range from $2,000 to $3,000 per employee, subject to certain thresholds and conditions. This requirement was originally effective January 1, 2014, but has been delayed until January 1, 2015. For employers with 50 to 99 employees, this requirement has been further delayed until January 1, 2016.
The Health Reform Law uses various means to induce individuals who do not have health insurance to obtain coverage. Effective January 1, 2014, individuals are required to maintain health insurance for a minimum defined set of benefits or pay a tax penalty. The penalty in most cases is the greater of $95 or 1% of income in 2014, $325 or 2% of income in 2015, $695 or 2.5% of income in 2016, and indexed to a cost of living adjustment in subsequent years. The Internal Revenue Service (“IRS”), in consultation with HHS, is responsible for enforcing the tax penalty, although the Health Reform Law limits the availability of certain IRS enforcement mechanisms. In addition, for individuals and families below 400% of the FPL, the cost of obtaining health insurance through the Exchanges will be subsidized by the federal government. Those with lower incomes will be eligible to receive greater subsidies. It is anticipated that those at the lowest income levels will have the majority of their premiums subsidized by the federal government, in some cases in excess of 95% of the premium amount.
To facilitate the purchase of health insurance by individuals and small employers, the Health Reform Law mandated that each state establish or participate in an Exchange or default to a federally-operated Exchange by January 1, 2014. Based on CBO estimates issued in May 2013, approximately 24 million individuals will obtain their health insurance coverage through an Exchange by 2022. This amount will include individuals who were previously uninsured and individuals who have switched from their prior insurance coverage to a plan obtained through an Exchange. The Health Reform Law requires that the Exchanges be designed to make the process of evaluating, comparing and acquiring coverage simple for consumers. For example, each state’s Exchange must maintain an internet website through which consumers may access health plan ratings that are assigned by the state based on quality and price, view governmental health program eligibility requirements and calculate the actual cost of health coverage. Health insurers participating in an Exchange must offer a set of minimum benefits, as defined by HHS, and may offer more benefits. Health insurers must offer at least two, and up to five, levels of plans that vary by the percentage of medical expenses that must be paid by the enrollee. These levels are referred to as platinum, gold, silver, bronze and catastrophic plans, with gold and silver being the two mandatory levels of plans. Each level of plan must require the enrollee to share the following percentages of medical expenses up to the deductible/copayment limit: platinum, 10%; gold, 20%; silver, 30%; bronze, 40%; and catastrophic, 100%. Health insurers may establish varying deductible/copayment levels, up to the statutory maximum ($6,250 for 2013 and $6,350 in 2014 for an individual, subject to increases in future years). The health insurers must cover 100% of the amount of medical expenses in excess of the deductible/copayment limit. For example, an individual making 100% to 200% of the FPL will have copayments and deductibles reduced to about one-third of the amount payable by those with the same plan with incomes at or above 400% of the FPL.
Public Program Spending
The Health Reform Law provides for Medicare, Medicaid and other federal health care program spending reductions between 2010 and 2019. In March 2010, CMS estimated Medicare fee-for-service reductions from 2010 to 2019 would be $233 billion and the Medicare and Medicaid DSH reductions would be an additional $64 billion. In July 2012, the CBO estimated that from 2013 to 2022, the Health Reform Law reductions would include $415 billion in Medicare fee-for-service market basket and productivity reimbursement reductions, the majority of which will come from hospitals. The CBO estimate included an additional $56 billion in reductions in Medicare and Medicaid DSH funding.
Inpatient Market Basket and Productivity Adjustment. Under the Medicare program, hospitals receive reimbursement under a PPS for general, acute care hospital inpatient services. CMS establishes fixed PPS payment amounts per inpatient discharge based on the patient’s assigned MS-DRG. These MS-DRG rates are updated each federal fiscal year, which begins October 1, using a market basket index that takes into account inflation experienced by hospitals and other entities outside the health care industry in purchasing goods and services.
The Health Reform Law provides for three types of annual reductions in the market basket. The first is a general reduction of a specified percentage each federal fiscal year that began in 2010 and extends through 2019. The remaining reductions are as follows: 2014 (0.3%); 2015 (0.2%); 2016 (0.2%); 2017 (0.75%); 2018 (0.75%); and 2019 (0.75%).
The second type of reduction to the market basket is a “productivity adjustment” that was implemented by HHS beginning in federal fiscal year 2012. The amount of that reduction is the projected nationwide productivity gains over the preceding 10 years. To determine the projection, HHS uses the BLS 10-year moving average of changes in specified economy-wide productivity. For federal fiscal year 2014, CMS has announced a negative 0.5% productivity adjustment to the market basket. In 2010, CMS estimated that the combined market basket and productivity adjustments would reduce Medicare payments under the inpatient PPS by $112.6 billion from 2010 to 2019.
The third type of reduction is in connection with the value-based purchasing program discussed in more detail below. For each federal fiscal year, CMS will reduce the inpatient PPS payment amount for all discharges by the following: 1.25% for 2014; 1.5% for 2015; 1.75% for 2016; and 2% for 2017 and subsequent years. For each federal fiscal year, the total amount collected from these reductions will be pooled and used to fund payments to hospitals that satisfy certain quality metrics. While some or all of these reductions may be recovered if a hospital satisfies these quality metrics, the recovery amounts may be delayed.
If the aggregate of the three market basket reductions described above is more than the annual market basket adjustments made to account for inflation, there will be a reduction in the MS-DRG rates paid to hospitals.
Quality-Based Payment Adjustments and Reductions for Inpatient Services. The Health Reform Law establishes or expands three provisions to promote value-based purchasing and to link payments to quality and efficiency. First, in federal fiscal year 2013, HHS was directed to implement a value-based purchasing program for inpatient hospital services. This program rewards hospitals that meet certain quality performance standards established by HHS. The Health Reform Law provides HHS considerable discretion over the value-based purchasing program. Under the value-based purchasing program for hospital inpatient services, CMS will distribute an estimated $1.1 billion in federal fiscal year 2014 to hospitals based on their overall performance on a set of quality measures that have been linked to improved clinical processes of care and patient satisfaction. Hospitals are scored based on a weighted average of patient experience scores using the Hospital Consumer Assessment of Healthcare Providers and Systems survey and certain clinical measures. In federal fiscal year 2014, there are 17 measures by which hospitals will be scored. CMS scores each hospital based on achievement (relative to other hospitals) and improvement ranges (relative to the hospital’s own past performance) for each applicable measure. Because the Health Reform Law provides that the pool will be fully distributed, hospitals that meet or exceed the quality performance standards set by HHS will receive greater reimbursement under the value-based purchasing program than they would have otherwise. Hospitals that do not achieve the necessary quality performance will receive reduced Medicare inpatient hospital payments. CMS published the value-based incentive payment adjustment factor for each hospital for federal fiscal year 2014 discharges on November 14, 2013.
Second, beginning in federal fiscal year 2013 and continuing in each federal fiscal year, inpatient payments are reduced if a hospital experiences “excess readmissions” within the 30-day period from the date of discharge for heart attack, heart failure, pneumonia or other conditions that may be designated by CMS. Hospitals with what CMS defines as “excess readmissions” for these conditions will receive reduced payments for all inpatient discharges, not just discharges relating to the conditions subject to the excess readmission standard. The amount by which payments will be reduced if a hospital experiences excess readmissions is determined by comparison of the hospital’s readmission performance to a risk-adjusted national average and is subject to a cap established by CMS. Each hospital’s performance is publicly reported by CMS. Third, reimbursement will be reduced based on a facility’s HAC rates. A HAC is a condition that is acquired by a patient while admitted as an inpatient in a hospital, such as a surgical site infection. Beginning in federal fiscal year 2015, the 25% of hospitals with the worst national risk-adjusted HAC rates in the previous year will receive a 1% reduction in their total inpatient operating Medicare payments. In addition, the Health Reform Law prohibits the use of federal funds under the Medicaid program to reimburse providers for medical services provided to treat HACs. CMS implemented this prohibition for services with dates beginning July 1, 2012. States may add additional provider-preventable conditions to the list of HACs for which Medicaid reimbursement will not be allowed.
Outpatient Market Basket and Productivity Adjustment. Hospital outpatient services paid under PPS are classified into APCs. The APC payment rates are updated each calendar year based on the market basket. The first two market basket changes outlined above - the general reduction and the productivity adjustment - apply to outpatient services as well as inpatient services, although these are applied on a calendar year basis. The percentage changes specified in the Health Reform Law summarized above as the general reduction for inpatients - e.g., 0.2% in 2015 - are the same for outpatients.
Medicare and Medicaid DSH Payments. The Medicare DSH program provides for additional payments to hospitals that treat a disproportionate share of low-income patients. Under the Health Reform Law, beginning in federal fiscal year 2014, Medicare DSH payments are reduced to 25% of the amount they otherwise would have been absent the law. The remaining 75% of the amount that would otherwise be paid under Medicare DSH is effectively pooled, and this pool will be reduced further each year by a formula that reflects reductions in the national level of uninsured who are under 65 years of age. In other words, the greater the level of coverage for the uninsured nationally, the more the Medicare DSH payment pool will be reduced. Each hospital is then paid, out of the reduced DSH payment pool, an amount allocated based upon its level of uncompensated care, which was not the basis for DSH payments prior to implementation of the Health Reform Law. In 2013, CMS issued final rules to implement these reductions.
Hospitals that provide care to a disproportionately high number of low-income patients may receive Medicaid DSH payments. The federal government distributes federal Medicaid DSH funds to each state based on a statutory formula. The states then distribute the DSH funding among qualifying hospitals. Although federal Medicaid law defines some level of hospitals that must receive Medicaid DSH funding, states have broad discretion to define additional hospitals that also may qualify for Medicaid DSH payments and the amount of such payments. The Health Reform Law, as modified by the Bipartisan Budget Act of 2013, provides for reductions to the Medicaid DSH hospital program in federal fiscal years 2016 through 2020 by the following amounts: 2016 ($1.2 billion); 2017 ($1.8 billion); 2018 ($5 billion); 2019 ($5.6 billion); and 2020 ($4 billion). The Jobs Creation Act and the American Taxpayer Relief Act of 2012 and the Bipartisan Budget Act of 2013 provide for additional Medicaid DSH reductions in federal fiscal years 2021, 2022 and 2023 estimated at $4.1 billion, $4.2 billion and $4.3 billion, respectively. CMS has issued a final rule establishing the methodology for allocating the cuts among the states based on the volume of Medicaid inpatients and levels of uncompensated care in each state. States largely retain the ability to manage the reduced allotments and to allocate these cuts among providers within the state.
ACOs. Pursuant to the Health Reform Law, HHS established the MSSP, which seeks to promote accountability and coordination of care through the creation of ACOs. The MSSP allows certain providers and suppliers (including hospitals, physicians and other designated professionals) to voluntarily form ACOs and work together along with other ACO participants to invest in infrastructure and redesign delivery processes to achieve high quality and efficient delivery of services. The program is intended to produce savings as a result of improved quality and operational efficiency. ACOs that achieve quality performance standards established by HHS will be eligible to share in a portion of the amounts saved by the Medicare program. Participants may choose between two different ACO tracks, the first of which allows ACOs to share only in the savings under the MSSP. The second track requires ACOs to share in any savings and losses under the MSSP but offers ACOs a greater share of any savings realized under the MSSP. As authorized by the Health Reform Law, certain waivers are available from fraud and abuse laws for ACOs. CMS has approved over 300 ACOs to participate in the MSSP.
Bundled Payment Pilot Programs. The Health Reform Law created the Center for Medicare & Medicaid Innovation with responsibility for establishing demonstration projects and other initiatives in order to identify, develop, test and encourage the adoption of new methods of delivering and paying for health care that create savings under the Medicare and Medicaid programs while improving quality of care. One initiative announced by the Center for Medicare & Medicaid Innovation is a voluntary bundled payment initiative involving over 400 participants that will link payments to participating providers for services provided during an episode of care. In addition, as required by the Health Reform Law, HHS established a five-year, voluntary, national pilot program on payment bundling for Medicare services. Under the program, organizations may enter into payment arrangements that include financial and performance accountability for episodes of care, and these models are intended to lead to higher quality, more coordinated care at a lower cost to the Medicare program. Participating providers agree to receive one payment for services provided to Medicare patients for certain medical conditions or episodes of care. HHS has discretion to determine how the program will function, including what medical conditions will be included in the program and the amount of the payment for each condition. The Health Reform Law also provides for a five-year bundled payment pilot program for Medicaid services, but CMS has not yet implemented this program. HHS may select up to eight states to participate based on the potential to lower costs under the Medicaid program while improving care. State programs may target particular categories of beneficiaries, selected diagnoses or geographic regions of the state. The selected state programs will provide one payment for both hospital and physician services provided to Medicaid patients for certain episodes of inpatient care. For both pilot programs, HHS will determine the relationship between the programs and restrictions in certain existing laws, including the Civil Monetary Penalty Law, the Anti-kickback Statute, the Stark Law and the HIPAA privacy, security and transaction standard requirements. However, the Health Reform Law does not authorize HHS to waive other laws that may impact the ability of hospitals and other eligible participants to participate in the pilot programs, such as antitrust laws.
Ambulatory Surgery Centers. The Health Reform Law reduces reimbursement for ASCs through a productivity adjustment to the market basket similar to the productivity adjustment for inpatient and outpatient hospital services. In addition, CMS has established a quality reporting program for ASCs under which ASCs that fail to report on required quality measures will receive a 2% reduction in reimbursement beginning with the calendar year 2014 payment determination.
Medicare Managed Care (Medicare Advantage or “MA”). Under the MA program, the federal government contracts with private health plans to provide inpatient and outpatient benefits to beneficiaries who enroll in such plans. In 2013, approximately 14.4 million Medicare beneficiaries elected to enroll in MA plans. Effective in 2014, the Health Reform Law requires MA plans to keep annual administrative costs lower than 15% of annual premium revenue. The Health Reform Law reduces, over a three year period starting in 2012, premium payments to the MA plans such that CMS’ managed care per capita premium payments are, on average, equal to traditional Medicare. In addition, the Health Reform Law implements fee payment adjustments based on service benchmarks and quality ratings. As a result of these changes, payments to MA plans are estimated to be reduced by $138 to $145 billion between 2010 and 2019. These reductions to MA plan premium payments paid by the federal government may cause some plans to raise beneficiary premiums or limit benefits, which in turn might cause some Medicare beneficiaries to terminate their MA coverage and enroll in traditional Medicare.
Physician-Owned Hospital Limitations
Over the last decade, we have faced competition from hospitals that have physician ownership. The Health Reform Law prohibits newly created physician-owned hospitals from billing for Medicare patients referred by their physician owners. As a result, the law effectively prevents the formation of new physician-owned hospitals that participate in Medicare and Medicaid after December 31, 2010. While the law grandfathers existing physician-owned hospitals, it does not allow these hospitals to increase the percentage of physician ownership and significantly restricts their ability to expand services.
Program Integrity and Fraud and Abuse
The Health Reform Law makes several significant changes to health care fraud and abuse laws, provides additional enforcement tools to the government, increases cooperation between agencies by establishing mechanisms for the sharing of information and enhances criminal and administrative penalties for non-compliance. For example, the Health Reform Law: (1) provides $350 million in increased federal funding over 10 years to fight health care fraud, waste and abuse; (2) expands the scope of the RAC program to include MA plans and Medicaid; (3) authorizes HHS, in consultation with the OIG, to suspend Medicare and Medicaid payments to a provider of services or a supplier “pending an investigation of a credible allegation of fraud;” (4) provides Medicare contractors with additional flexibility to conduct random prepayment reviews; and (5) tightens up the rules for returning overpayments made by governmental health programs and expands FCA liability to include failure to timely repay identified overpayments.
Impact of Health Reform Law on the Company
The expansion of health insurance coverage under the Health Reform Law may result in an increase in the number of patients using our facilities who have either private or public program coverage. In addition, the Health Reform Law provides for initiatives that create possible sources of additional revenue, such as ACOs. However, any positive effects of the Health Reform Law could be offset, and the Company could be significantly impacted, by reductions to the Medicare and Medicaid programs. Substantial uncertainty remains regarding the net effect of the Health Reform Law on the Company because the resolution of a number of material factors remains unclear, including the following:
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the potential for and impact of further delays in or complications related to implementation of the Health Reform Law (for example, there were significant problems during the initial implementation of the Exchanges that negatively impacted the ability of individuals to enroll in Medicaid and to purchase health insurance);
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the possibility of enactment of additional federal or state health care reforms and possible changes to the Health Reform Law;
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our ability to participate in health insurance plans offered through the Exchanges and the terms of our participation as well as treatment of out of network claims;
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how many previously uninsured individuals will obtain coverage as a result of the Health Reform Law (based on the CBO’s February 2014 estimates, by 2022, the Health Reform Law will expand coverage to 25 million additional individuals);
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what percentage of the newly insured patients will be covered under the Medicaid program and what percentage will be covered by private health insurers;
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the extent to which states will enroll new Medicaid participants in managed care programs;
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the pace at which insurance coverage expands, including the pace of different types of coverage expansion;
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the change, if any, in the volume of inpatient and outpatient hospital services that are sought by and provided to previously uninsured individuals;
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the rate paid to hospitals by private payers for newly covered individuals and individuals with existing coverage, including those covered through the Exchanges and those who might be covered under the Medicaid program;
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the rate paid by state governments under the Medicaid program for newly covered individuals;
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the effect of the value-based purchasing provisions of the Health Reform Law on our hospitals’ revenues and the effects of other quality programs;
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the percentage of individuals in the Exchanges who select the high deductible plans, since health insurers offering those kinds of products have traditionally sought to pay lower rates to hospitals;
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the amount of overall revenues the Company will generate from Medicare and Medicaid business when the reductions are implemented (26.9% of our revenues in 2013 were from Medicare and Medicaid);
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the size of the Health Reform Law’s annual productivity adjustment to the market basket;
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the amount of the Medicare DSH reductions and the allocation of the Medicaid DSH reductions to our hospitals;
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how successful ACOs will be at coordinating care and reducing costs or whether they will decrease reimbursement;
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the scope and nature of potential changes to Medicare reimbursement methods, such as an emphasis on bundling payments or coordination of care programs;
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whether the Company’s revenues from Medicaid supplemental programs developed through a federally approved waiver program (“Waiver Program”), will be adversely affected because there may be reductions in available state and local government funding for the programs; and
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the impact of efforts to repeal or revise the Health Reform Law and remaining or new federal lawsuits challenging its constitutionality.
General Economic and Demographic Factors
The health care industry is impacted by the overall United States economy. Budget deficits at federal, state and local government entities have had a negative impact on spending for many health and human service programs, including Medicare, Medicaid and similar programs, which represent significant payer sources for our hospitals. The federal deficit, the growing magnitude of Medicare expenditures and the aging of the United States population will continue to place pressure on federal health care programs. Other risks we face during periods of economic weakness and high unemployment include potential declines in the population covered under managed care agreements, increased patient decisions to postpone or cancel elective and nonemergency health care procedures, increases in the uninsured and underinsured populations, increased adoption of health plan structures that shift financial responsibility to patients and further difficulties in our collecting patient receivables for copayment and deductible amounts. The Health Reform Law seeks to decrease over time the number of uninsured individuals, but it is difficult to predict the full impact of the Health Reform Law.
Compliance Program
We maintain a comprehensive ethics and compliance program that is designed to meet or exceed applicable federal guidelines and industry standards. The program is intended to monitor and raise awareness of various regulatory issues among employees and to emphasize the importance of complying with governmental laws and regulations. As part of the ethics and compliance program, we provide annual ethics and compliance training to our employees and encourage all employees to report any violations to their supervisor, an ethics and compliance officer or a toll-free telephone ethics line. The Health Reform Law requires providers to implement core elements of compliance program criteria to be established by HHS, on a timeline to be established by HHS, as a condition of enrollment in the Medicare or Medicaid programs, and we may have to modify our compliance programs to comply with these new criteria.
Antitrust Laws
The federal government and most states have enacted antitrust laws that prohibit certain types of conduct deemed to be anti-competitive. These laws prohibit price fixing, market allocation, bid-rigging, concerted refusal to deal, market monopolization, price discrimination, tying arrangements, acquisitions of competitors and other practices that have, or may have, an adverse effect on competition. Violations of federal or state antitrust laws can result in various sanctions, including criminal and civil penalties. Antitrust enforcement in the health care industry is currently a priority of the Federal Trade Commission and the DOJ. We believe we are in compliance with such federal and state laws, but courts or regulatory authorities may reach a determination in the future that could adversely affect our operations.
Medicare Inpatient Reimbursement
The Medicare program pays hospitals under the provisions of a prospective payment system (“PPS”) for inpatient services. Under the inpatient prospective payment system, a hospital receives a fixed amount for inpatient hospital services based on the established fixed payment amount per discharge for categories of hospital treatment, known as Medicare severity diagnosis related group (“MS-DRG”). Each patient admitted for care is assigned to a MS-DRG based upon his or her primary admitting diagnosis. Every MS-DRG is assigned a payment rate by the government based upon the estimated intensity of hospital resources necessary to treat the average patient with that particular diagnosis. MS-DRG payments do not consider a specific hospital’s costs, but are national rates adjusted for area wage differentials and case-mix indices.
MS-DRG rates are usually adjusted by an update factor each Federal Fiscal Year (“FFY”). The percentage increases to MS-DRG payment rates for the last several years have been lower than the percentage increases in the related cost of goods and services provided by general hospitals. The index used to adjust the MS-DRG payment rates is based on a price statistic, known as the CMS Market Basket Index, reduced by congressionally mandated reduction factors.
MS-DRG rates are updated, and MS-DRG weights are recalibrated, using cost-relative weights each federal fiscal year (which begins October 1). The index used to update the MS-DRG rates (the “market basket”) gives consideration to the inflation experienced by hospitals and entities outside the health care industry in purchasing goods and services. The Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010 (collectively, the “Health Reform Law”), provides for annual decreases to the market basket, including the following reductions for each of the following federal fiscal years: 0.3% in 2014; 0.2% in 2015 and 2016 and 0.75% in 2017, 2018 and 2019. For each federal fiscal year, the Health Reform Law provides for the annual market basket update to be further reduced by a productivity adjustment based on the Bureau of Labor Statistics (“BLS”) 10-year moving average of changes in specified economy-wide productivity. At the time of enactment, the Centers for Medicare & Medicaid Services (“CMS”) estimated that the combined market basket and productivity adjustments would reduce Medicare payments under the inpatient PPS by $112.6 billion from 2010 to 2019. The American Taxpayer Relief Act of 2012 requires a negative documentation and coding adjustment for four years beginning in federal fiscal year 2014. It is estimated that this documentation and coding adjustment will reduce Medicare inpatient PPS payments by $10.5 billion. A decrease in payment rates or an increase in rates that is below the increase in our costs may adversely affect our results of operations.
For federal fiscal year 2013, CMS increased the MS-DRG rate by 2.8%. This increase reflected a 2.6% market basket increase, the 0.1% reduction required by the Health Reform Law, a negative 0.7% productivity adjustment, a negative 1.9% prospective documentation and coding adjustment and a positive 2.9% retrospective documentation and coding adjustment. For federal fiscal year 2014, CMS issued a final rule that resulted in a net increase of 0.7%. This increase reflects a 2.5% market basket increase, the 0.3% reduction required by the Health Reform Law, a negative 0.5% productivity adjustment, a negative 0.8% prospective documentation and coding adjustment and a negative 0.2% adjustment to offset projected spending increases associated with new admission and medical review criteria for inpatient services commonly known as the “two midnight rule.” Under the rule, Medicare beneficiaries are only to be admitted as inpatients when there is a reasonable expectation that the hospital care is medically necessary and will be required across two midnights, absent unusual circumstances. Compliance with the two midnight rule was required beginning October 1, 2013 and will become subject to Recovery Audit Contractor (“RAC”) audits beginning October 1, 2014.
Medicare Outpatient Reimbursement
CMS reimburses hospital outpatient services (and certain Medicare Part B services furnished to hospital inpatients who have no Part A coverage) on a PPS basis. CMS uses fee schedules to pay for physical, occupational and speech therapies, durable medical equipment, clinical diagnostic laboratory services, nonimplantable orthotics and prosthetics, freestanding surgery center services and services provided by independent diagnostic testing facilities.
Hospital outpatient services paid under PPS are classified into groups called ambulatory payment classifications (“APCs”). Services for each APC are similar clinically and in terms of the resources they require. A payment rate is established for each APC. Depending on the services provided, a hospital may be paid for more than one APC for a patient visit. The APC payment rates are updated for each calendar year. The Health Reform Law provides for reductions to the market basket update, including the following reductions for each of the following calendar years: 0.3% in 2014; 0.2% in 2015 and 2016 and 0.75% in 2017, 2018 and 2019. For each calendar year, the Health Reform Law provides for the annual market basket update to be further reduced by a productivity adjustment based on the BLS 10-year moving average of changes in specified economy-wide productivity. At the time of enactment, CMS estimated that the combined market basket and productivity adjustments would reduce Medicare payments under the outpatient PPS by $26.3 billion from 2010 to 2019. For calendar year 2013, CMS increased APC payment rates by 1.8%, which represented the full market basket update of 2.6%, a negative 0.7% productivity adjustment and the negative 0.1% adjustment required by the Health Reform Law. For calendar year 2014, CMS has issued a final rule that increases the APC payment rate by 1.7%, which includes the full market basket update of 2.5%, a negative 0.5% productivity adjustment and the negative 0.3% adjustment required by the Health Reform Law. CMS requires hospitals to submit quality data relating to outpatient care to avoid receiving a 2% reduction to the market basket update under the outpatient PPS.
Medicare Disproportionate Share Payments
In addition to making payments for services provided directly to beneficiaries, Medicare makes additional payments to hospitals that treat a disproportionately large number of low-income patients (Medicaid and Medicare patients eligible to receive Supplemental Security Income). DSH payments are determined annually based on certain statistical information required by HHS and are calculated as a percentage addition to MS-DRG payments.
Under the Health Reform Law, beginning in federal fiscal year 2014, Medicare DSH payments are reduced to 25% of the amount they otherwise would have been absent the law. The remaining 75% of the amount that would otherwise be paid under Medicare DSH is effectively pooled, and this pool will be reduced further each year by a formula that reflects reductions in the national level of uninsured who are under 65 years of age. Thus, the greater the level of coverage for the uninsured nationally, the more the Medicare DSH payment pool will be reduced. Each DSH hospital is then to be paid, out of the reduced DSH payment pool, an amount allocated based upon its estimated cost of providing uncompensated care. In 2013, CMS issued final rules to implement these reductions.
Hospitals that provide care to a disproportionately high number of low-income patients may receive Medicaid DSH payments. The federal government distributes federal Medicaid DSH funds to each state based on a statutory formula. The states then distribute the DSH funding among qualifying hospitals. States have broad discretion to define which hospitals qualify for Medicaid DSH payments and the amount of such payments. The Health Reform Law, as modified by the Bipartisan Budget Act of 2013, provides for reductions to the Medicaid DSH hospital program in federal fiscal years 2016 through 2020 by the following amounts: 2016 ($1.2 billion); 2017 ($1.8 billion); 2018 ($5 billion); 2019 ($5.6 billion); and 2020 ($4 billion). The Jobs Creation Act, the American Taxpayer Relief Act of 2012 and the Bipartisan Budget Act of 2013 provide for additional Medicaid DSH reductions in federal fiscal years 2021, 2022 and 2023 estimated at $4.1 billion, $4.2 billion and $4.3 billion, respectively. CMS has issued a final rule establishing the methodology for allocating the cuts among the states based on the volume of Medicaid inpatients and levels of uncompensated care in each state. States largely retain the ability to manage the reduced allotments and to allocate these cuts among providers within the state.
Medicaid Inpatient and Outpatient Reimbursement
Each state operates a Medicaid program funded jointly by the state and the Federal government. Federal law governs the general management of the Medicaid program, but there is wide latitude for states to customize Medicaid programs to fit local needs and resources. As a result, each state Medicaid plan has its own payment formula and recipient eligibility criteria. On February 17, 2009, President Obama signed into law the ARRA. This law provides a temporary increase in the State Federal Medical Assistance Percentage (“FMAP”) during a 9-calendar quarter recession adjustment period beginning October 1, 2008 and ending December 31, 2010.
As discussed above, the 2010 Healthcare Reform Laws proposed an expansion of the Medicaid program. The United States Supreme Court ruled that such expansion was unconstitutional as written, but that ruling will not prohibit States from expanding Medicaid if they choose to do so. To date, the State of Texas has declared that it will not participate in Medicaid expansion under the 2010 Healthcare Reform Laws. We cannot predict what the State of Texas will ultimately do or how its decision will affect our business, but if Medicaid expansion does not occur, it could adversely impact our ability to collect for healthcare services in the future.
Electronic Health Record Incentives
The American Recovery and Reinvestment Act of 2009 (“ARRA”) provides for Medicare and Medicaid incentive payments for eligible hospitals and for eligible professionals that adopt and meaningfully use certified electronic health record (“EHR”) technology and provides for penalties for eligible hospitals and eligible professionals that do not adopt and meaningfully use EHR technology. Through December 2013, approximately $19 billion in incentive payments have been made through the Medicare and Medicaid EHR incentive programs to eligible hospitals and eligible professionals.
Under the Medicare incentive program, eligible hospitals that demonstrate meaningful use will receive incentive payments for up to four fiscal years. The Medicare incentive payment amount is the product of three factors: (1) an initial amount comprised of a base amount of $2,000,000, plus $200 for each acute care inpatient discharge, beginning with a hospital’s 1,150th discharge of the applicable year and ending with a hospital’s 23,000th discharge of the applicable year; (2) the “Medicare share,” which is the sum of Medicare Part A and Part C acute care inpatient-bed-days divided by the product of the total acute care inpatient-bed-days and a charity care factor; and (3) a transition factor applicable to the payment year. In order to maximize their incentive payments, acute care hospitals must have begun participating in the incentive program by federal fiscal year 2013. Beginning in federal fiscal year 2015, acute care hospitals that have failed to demonstrate meaningful use of certified EHR technology in an applicable prior reporting period will receive reduced market basket updates under inpatient PPS.
Eligible professionals who demonstrate meaningful use are entitled to incentive payments for up to five payment years in an amount equal to 75% of their estimated Medicare allowed charges for covered professional services furnished during the relevant calendar year, subject to an annual limit. Eligible professionals must have begun participating in the incentive payment program by calendar year 2012 in order to maximize their incentive payments and must participate by calendar year 2014 in order to receive any incentive payments. Beginning in calendar year 2015, eligible professionals who have failed to demonstrate meaningful use of certified EHR technology in an applicable prior reporting period will face Medicare payment reductions.
The Medicaid EHR incentive program is voluntary for states to implement. For participating states, the Medicaid EHR incentive program provides incentive payments for acute care hospitals and eligible professionals that meet certain volume percentages of Medicaid patients, as well as children’s hospitals. Providers may only participate in a single state’s Medicaid EHR incentive program. Eligible professionals can only participate in either the Medicaid incentive program or the Medicare incentive program and can change this election only one time. Eligible hospitals may participate in both the Medicare and Medicaid incentive programs.
To qualify for incentive payments under the Medicaid program, providers must either adopt, implement, upgrade or demonstrate meaningful use of certified EHR technology during their first participation year or successfully demonstrate meaningful use of certified EHR technology in subsequent participation years. Payments may be received for up to six participation years. For hospitals, the aggregate Medicaid EHR incentive amount is the product of two factors: (1) the overall EHR amount, which is comprised of a base amount of $2,000,000 plus a discharge-related amount, multiplied by the Medicare share (which is set at one by statute) multiplied by a transition factor, and (2) the “Medicaid share,” which is the estimated Medicaid inpatient-bed days plus estimated Medicaid managed care inpatient bed-days, divided by the product of the estimated total inpatient bed-days and a charity care factor. Under the Medicaid incentive program, eligible professionals may
Government Reimbursement Program Administration and Adjustments
The Medicare, Medicaid and TriCare programs are subject to additional statutory and regulatory changes, administrative rulings, interpretations and determinations, requirements for utilization review and new governmental funding restrictions, all of which may materially increase or decrease program payments as well as affect the cost of providing services and the timing of payments to facilities.
All hospitals participating in the Medicare and Medicaid programs, whether paid on a reasonable cost basis or under a prospective payment system, are required to meet certain financial reporting requirements. Federal and, where applicable, state regulations require the submission of annual cost reports covering the revenue, costs and expenses associated with the services provided by each hospital to Medicare beneficiaries and Medicaid recipients.
Annual cost reports required under the Medicare and Medicaid programs are subject to routine audits which may result in adjustments to the amounts ultimately determined to be due to a hospital under these reimbursement programs. These audits often require several years to reach the final determination of amounts due. Providers have rights of appeal and it is common to contest issues raised in audits of prior years’ cost reports. Although the final outcome of these audits and the nature and amounts of any adjustments are difficult to predict, we believe that we have made adequate provisions in our financial statements for adjustments that may result from these audits and that final resolution of any contested issues should not have a material adverse effect upon our consolidated results of operations or financial position. Until final adjustment, however, significant issues may remain unresolved and previously determined allowances could become either inadequate or greater than ultimately required.
In 2005, CMS began using recovery audit contractors (“RACs”) to detect Medicare overpayments not identified through existing claims review mechanisms. The RAC program relies on private auditing firms to examine Medicare claims filed by healthcare providers. The RAC program began as a demonstration project in three states (New York, California and Florida), but was made permanent by the Tax Relief and Health Care Act of 2006. CMS has expanded the RAC program, which now includes in Texas.
RACs perform post-discharge audits of medical records to identify Medicare overpayments resulting from incorrect payment amounts, non-covered services, incorrectly coded services, and duplicate services. CMS has given RACs the authority to look back at claims up to three years old, provided that the claim was paid on or after October 1, 2007. Claims identified as overpayments will be subject to the Medicare appeals process.
The ACA expanded the RAC program to include Medicaid claims beginning on or after June 1, 2010.
RACs are paid a contingency fee based on the overpayments they identify and collect. We expect that the RACs will look closely at claims submitted by our facilities in an attempt to identify possible overpayments. Although we believe the claims for reimbursement submitted to the Medicare program are accurate, we cannot predict the results of the RAC audits.
If our hospitals were found to be in violation of Federal or state laws relating to Medicare, Medicaid or similar programs, UGHS could be subject to substantial monetary fines, civil penalties and exclusion from future participation in the Medicare and Medicaid programs. Any such sanctions could have a material adverse effect on our financial position and results of operations.
Medicare and Medicaid Participation
Medicare is a federally funded and administered health insurance program, primarily for individuals entitled to social security benefits who are 65 or older or who are disabled. Medicaid is a health insurance program jointly funded by state and federal governments that provides medical assistance to qualifying low income persons. Each state Medicaid program has the option to determine coverage for ambulatory surgery center services and to determine payment rates for those services.
Medicare prospectively determines fixed payment amounts for procedures performed at short stay surgical facilities. These amounts are adjusted for regional wage variations. The various state Medicaid programs also pay us a fixed payment for our services, which amount varies from state to state. A portion of our revenues are attributable to payments received from the Medicare and Medicaid programs. For the years ended December 31, 2013 and 2012, 26.9% and 30.0% of our patient service revenues were contributed by Medicare and Medicaid, respectively.
In order to participate in the Medicare program, our hospital must satisfy regulations known as conditions of participation (COPs) for hospitals and conditions for coverage (CFCs) for ambulatory surgery centers. Each facility can meet this requirement through accreditation with the Joint Commission on Accreditation of Healthcare Organizations or other CMS-approved accreditation organizations, or through direct surveys at the direction of CMS. Our hospitals and facilities are certified to participate in the Medicare program. We have established ongoing quality assurance activities to monitor and ensure our facilities’ compliance with these COPs or CFCs. Any failure by a facility to maintain compliance with these COPs or CFCs as determined by a survey could result in the loss of the facility’s provider agreement with CMS, which would prohibit reimbursement for services rendered to Medicare or Medicaid beneficiaries until such time as the facility is found to be back in compliance with the COPs or CFCs. This could have a material adverse effect on our facilities billing and collections.
As with most government programs, the Medicare and Medicaid programs are subject to statutory and regulatory changes, possible retroactive and prospective rate adjustments, administrative rulings, freezes and funding reductions, all of which may adversely affect the level of payments to our short stay surgical facilities. Beginning in 2008, CMS began transitioning Medicare payments to ambulatory surgery centers to a system based upon the hospital outpatient prospective payment system. That transition is now complete and payments to ambulatory surgery centers will be solely based on the outpatient prospective payment system (OPPS) relative weights. CMS has cautioned that the final OPPS relative weights may result in payment rates for the year being less than the payment rates for the preceding year. On November 2, 2010, CMS issued a final rule to update the Medicare program’s payment policies and rates for ambulatory surgery centers (“ASC”) for 2011. The final rule applied a 0.2% increase to the ASC payment rate. The final rule also added six procedures to the list of procedures for which Medicare will reimburse when performed in an ASC. In 2011, HHS disclosed its value-based purchasing program for ambulatory surgery centers. Significant aspects of the program include: recognition of the ASC quality measures for quality reporting and the inclusion of a shared savings plan among the possible quality bonus funding options. Such a program may further impact Medicare reimbursement of ASC or increase our operating costs in order to satisfy the value-based standards. For federal fiscal year 2011 and each subsequent FFY, the ACA provide for the annual market basket update to be reduced by a productivity adjustment. The amount of that reduction will be the projected nationwide productivity gains over the preceding 10 years. To determine the projection, the Department of Health and Human Services will use the Bureau of Labor Statistics 10-year moving average of changes in specified economy-wide productivity. The ultimate impact of the changes in Medicare reimbursement will depend on a number of factors, including the procedure mix at the centers and our ability to realize an increased procedure volume.
Texas Statutory and Regulatory Risks
Illegal Remuneration Law. The Texas Illegal Remuneration Statute (Chapter 102 of the Texas Occupations Code) (the “Texas Remuneration Statute”) mirrors the federal Anti-Kickback Law, except that it applies to all healthcare services, regardless of the source of payment. The Texas Remuneration Statute makes it illegal to solicit or receive any remuneration, directly or indirectly, overtly or covertly, in cash or in kind, in return for referring an individual to or from a person licensed, certified or registered by a state health care regulatory agency. The penalty for violating this prohibition ranges from a Class A misdemeanor to a third degree felony. The Texas Remuneration Statute does, however, permit any payment, business arrangement, or payment practice permitted under the Anti-Kickback Law or any regulation adopted thereunder, provided the relationship is appropriately disclosed. There is no express provision that such practices will protect arrangements relating to services reimbursed by commercial insurance, however. We intend for all business activities and operations of our company and our hospitals to conform in all respects with the Texas Remuneration Statute, but no assurances can be given that our activities will not be reviewed and challenged under this statute.
Medicaid Fraud. There are both federal and state laws that impose penalties for improper billing practices. Texas has several laws, including the Medicaid Fraud Prevention Act, which provides civil and criminal penalties for improper billing. Our hospitals attempt to comply with all reimbursement and billing requirements. However, no assurances can be given that our hospitals activities will not be reviewed and challenged under these Texas laws.
Other Texas Statutes. Texas has laws which prohibit various business practices including the corporate practice of medicine, fee splitting, and commercial bribery. In essence, the corporate practice of medicine prohibition, as established by case law and interpretive opinions of the Texas Attorney General, provides that an individual or entity that is not licensed to practice medicine may not employ a physician and receive the fees for the physician’s professional services. Further, Texas case law has established that other arrangements, besides employment of the physician by the non-licensed individual or entity, may result in the application of the corporate practice of medicine prohibition. Arrangements that are viewed as “fee splitting” or “fee sharing” arrangements between the non-licensed person or entity and the licensed physician could also be problematic from a state law perspective. There have been numerous bills filed in the Texas legislature to remove or modify the Texas corporate practice of medicine doctrine, but no such legislation has passed to date in connection with private hospitals.
There has been very little interpretation of some of these laws and a government agency charged with enforcement of these laws might assert that our, or any of our affiliates’, arrangements with physicians do not comply with some of these prohibitions. If this occurs or if new applicable laws are enacted, this may have a material adverse effect on our hospitals, operations and prospects.
Employees
At December 31, 2013, we had a total of 1,113 employees, including approximately 96 part-time, 364 full-time and 653 full-time equivalent employees. Approximately 653 full-time equivalent employees including nurses, therapists, lab and radiology technicians, facility maintenance workers and the administrative staff of the hospital represent the majority of our employees. There are no collective bargaining agreements in effect with respect to any of our employees. We believe that we maintain a good relationship with our employees.
Available Information
Our executive offices are located at 7501 Fannin Street, Houston, Texas 77054. Our telephone number is 713-375-7100. We make available, free of charge, through our website, among other things, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports as soon as reasonably practicable after they have been electronically filed with the Securities and Exchange Commission (“SEC”). They can be obtained by accessing our website at www.ughs.net and clicking on “Investor Relations.” To access SEC filings, click “SEC Filings,” then the report to be obtained. Information contained on our website is not part of this Annual Report on Form 10-K. Our common stock trades under the symbol “UGHS.PK”.
ITEM 1A.
ITEM 1A. RISK FACTORS
Forward Looking Statements
This annual report on Form 10-K contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements other than statements of historical facts included in this annual report including, without limitation, statements in the Management’s Discussion and Analysis of Financial Condition and Results of Operations included in this annual report on Form 10-K, regarding our financial condition, estimated working capital, business strategy, the plans and objectives of our management for future operations and those statements preceded by, followed by or that otherwise include the words “expects” or “does not expect”, “is expected”, “anticipates” or “does not anticipate”, “plans”, “estimates”, “approximately”, “believes”, “continue”, “forecast”, “ongoing”, “pending”, “potential”, “seeks”, “views”, or “intends”, or stating that certain actions, events or results “may”, “must”, “could”, “would”, “might”, “should” or “will” be taken, occur or be achieved are not statements of historical fact and may be forward-looking statements. Forward-looking statements are subject to a variety of known and unknown risks, uncertainties and other factors which could cause actual events or results to differ from those expressed or implied by the forward-looking statements, including, without limitation:
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risks related to health care laws and regulations and environmental risks;
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risks related to changes in and the competitive nature of the healthcare industry;
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risks related to stock price and volume volatility;
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risks related to our ability to access capital markets;
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risks related to our ability to successfully implement our business and acquisition strategies; and
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risks related to our issuance of additional shares of common stock.
This list is not exhaustive of the factors that may affect our forward-looking statements. Some of the important risks and uncertainties that could affect forward-looking statements are described further in this Item 1A of this annual report. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, believed, estimated or expected. We caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. We disclaim any obligation subsequently to revise any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events, except as required by applicable law.
OUR FUTURE PERFORMANCE IS SUBJECT TO A VARIETY OF RISKS, INCLUDING THOSE KNOWN MATERIAL RISKS DESCRIBED BELOW. WE HAVE DISCLOSED IF ANY OF THE FOLLOWING RISKS ACTUALLY OCCUR, OUR BUSINESS COULD BE HARMED AND THE TRADING PRICE OF OUR COMMON STOCK COULD DECLINE. YOU SHOULD ALSO REFER TO THE OTHER INFORMATION CONTAINED IN THIS REPORT.
Risks related to our business and industry
Our significant leverage could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industry, expose us to interest rate risk and prevent us from meeting our obligations.
We have a high ratio of debt to assets and require substantial cash flow to meet our debt service requirements. The degree of our leverage has several important effects on our operations, including:
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a substantial amount of our cash flow from operations must be dedicated to the payment of debt and lease payments as well as interest on our indebtedness, and will not be available for other purposes;
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covenants contained in our debt agreements require us to meet certain financial tests and retain minimum cash balances, in addition to certain other restrictions that will limit our ability to borrow additional funds, acquire additional assets, or dispose of our assets, and may affect our flexibility in growing, planning for, and reacting to, changes in our business;
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our ability to obtain permanent and additional financing for working capital, capital expenditures, acquisitions, or general corporate purposes may be impaired;
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our vulnerability to downturns or adverse changes in general economic, industry or competitive conditions and adverse changes in government regulations is increased;
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our risk of exposure to interest rate fluctuations is increased;
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our ability to make strategic acquisitions may be limited; and
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our ability to adjust to changing market conditions may be constrained.
We may not be able to generate sufficient cash to service all of our indebtedness and may not be able to refinance our indebtedness on favorable terms. If we are unable to do so, we may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful.
Our ability to make scheduled payments on or to refinance our debt obligations depends on our financial condition and operating performance, which are subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control. We cannot provide assurance that we will maintain a level of cash flows from operating activities sufficient to permit us to pay the principal, premium, if any, and interest on our indebtedness.
In addition, we conduct our operations through our subsidiaries. Accordingly, repayment of our indebtedness is dependent on the generation of cash flow by our subsidiaries and their ability to make such cash available to us by dividend, debt repayment or otherwise. Our subsidiaries may not be able to, or may not be permitted to, make distributions to enable us to make payments in respect of our indebtedness. Each subsidiary is a distinct legal entity, and, under certain circumstances, legal and contractual restrictions may limit our ability to obtain cash from our subsidiaries.
We may find it necessary or prudent to refinance our outstanding indebtedness with longer-maturity debt at a higher interest rate. In addition, our ability to incur secured indebtedness (which would generally enable us to achieve better pricing than the incurrence of unsecured indebtedness) depends in part on the value of our assets, which depends, in turn, on the strength of our cash flows and results of operations, and on economic and market conditions and other factors.
If our cash flows and capital resources are insufficient to fund our debt service obligations or we are unable to refinance our indebtedness, we may be forced to reduce or delay investments and capital expenditures, or to sell assets, seek additional capital or restructure our indebtedness. These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations. If our operating results and available cash are insufficient to meet our debt service obligations, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet our debt service and other obligations. We may not be able to consummate those dispositions, or the proceeds from the dispositions may not be adequate to meet any debt service obligations then due.
Due to our lack of capital, we have outstanding obligations due the Internal Revenue Service (the “IRS”) and our vendors who could file liens and other claims against us, which could force us to cease operations.
A claim could be made by the IRS or any vendor at any time where payment is significantly past due. If the amount past due is sent to a collection agency or attorney by the IRS or a vendor, and we do not have the capital to satisfy the obligation, a lien or other claim may be filed against us which could force us to cease operations. As of December 31, 2013, we owe approximately $5.9 million in payroll taxes and related interest and penalties and a total of approximately $21.7 million in trade payables. However, we have arranged in the past and plan to arrange in the future, arrange payment plans with the IRS and our vendors with past due balances.
We may not be able to obtain additional capital, when desired, on favorable terms, without dilution to our shareholders or at all.
We operate in a market that makes our prospects difficult to evaluate to remain competitive. We will be required to make continued investments in capital equipment, facilities and technological improvements. We expect that substantial capital will be required to expand our operations and fund working capital for anticipated growth. If we do not generate sufficient cash flow from operations or otherwise have the capital resources to meet our future capital needs, we may need additional financing to implement our business strategy.
If we raise additional funds through the issuance of our common stock or convertible securities, our shareholders could be significantly diluted. These newly issued securities may have rights, preferences or privileges senior to those of existing shareholders. Additional financing may not, however, be available on terms favorable to us, or at all, if and when needed, and our ability to fund our operations, take advantage of unanticipated opportunities, develop or enhance our infrastructure or respond to competitive pressures could be significantly limited.
Our expansion strategy involves risks.
We may seek to acquire companies or interests in companies or enter into joint ventures that complement our business, and our inability to complete acquisitions, integrate acquired companies successfully or enter into joint ventures may render us less competitive. We may be evaluating acquisitions or engaging in acquisition negotiations at any given time. We cannot be sure that we will be able to continue to identify acquisition candidates or joint venture partners on commercially reasonable terms or at all. If we make additional acquisitions, we also cannot be sure that any benefits anticipated from the acquisitions will actually be realized. Likewise, we cannot be sure that we will be able to obtain necessary financing for acquisitions. Such financing could be restricted by the terms of our debt agreements or it could be more expensive than our current debt. The amount of such debt financing for acquisitions could be significant and the terms of such debt instruments could be more restrictive than our current covenants. In addition, our ability to control the planning and operations of our joint ventures and other less than majority owned affiliates may be subject to numerous restrictions imposed by the joint venture agreements and majority shareholders. Our joint venture partners may also have interests which differ from ours. The process of integrating acquired operations into our existing operations may result in operating, contract and supply chain difficulties, such as the failure to retain clients or management personnel and problems coordinating technology and supply chain arrangements. Also, in connection with any acquisition, we could fail to discover liabilities of the acquired company for which we may be responsible as a successor owner or operator in spite of any investigation we make prior to the acquisition. The diversion of management attention, particularly in a difficult operating environment, may affect our revenues. Similarly, our business depends on effective information technology systems such as revenue cycle systems, and implementation delays or poor execution of the integration of different information technology systems could disrupt our operations, delay our collection processes, and increase costs. Possible future acquisitions could result in the incurrence of additional debt and related interest expense or contingent liabilities and amortization expenses related to intangible assets, which could have a material adverse effect on our financial condition, operating results and/or cash flow. In addition, goodwill resulting from business combinations represents a significant portion of our assets. If the goodwill were deemed to be impaired, we would need to take a charge to earnings (if any) to write down the goodwill to its fair value.
If we are unable to enter into and retain managed care contractual arrangements on acceptable terms, if we experience material reductions in the contracted rates we receive from managed care payors or if we have difficulty collecting from health maintenance organizations, preferred provider organizations, and other third party payors, our results of operations could be adversely affected.
We have experienced (and will likely continue to experience) difficulty in establishing and maintaining relationships with certain health maintenance organizations, preferred provider organizations, and other third party payors. Health maintenance organizations and other third-party payors have also undertaken cost-containment efforts during the past several years, including revising payment methods and monitoring healthcare expenditures more closely. In addition, some payors have been reluctant to enter into agreements with us, citing a lack of need for our hospitals in their networks.
Our future success depends, in part, on our ability to retain and renew our managed care contracts and enter into new managed care contracts with health maintenance organizations, preferred provider organizations, and other third party payors on terms favorable to us. Other health maintenance organizations, preferred provider organizations and other third party payors may impact our ability to enter into acceptable managed care contractual arrangements or negotiate increases in our reimbursement and other favorable terms and conditions. Any inability to negotiate and maintain agreements on favorable terms with health maintenance organizations, preferred provider organizations and other third party payors could reduce our revenues and adversely affect our business.
In some cases, health maintenance organizations, preferred provider organizations and other third party payors rely on all or portions of Medicare’s severity-adjusted diagnosis-related group system to determine payment rates, which could result in decreased reimbursement from some of these payors if levels of payments to health care providers or payment methodologies under the Medicare program are changed.
Other changes to government health care programs may negatively impact payments from health maintenance organizations, preferred provider organizations and other third party payors and our ability to negotiate reimbursement increases. Any material reductions in the contracted rates we receive for our services, along with any difficulties in collecting receivables from health maintenance organizations, preferred provider organizations and other third party payors, could have a material adverse effect on our financial condition, results of operations or cash flows.
We cannot predict with certainty the effect that the Affordable Care Act may have on our business, financial condition, results of operations or cash flows.
As enacted, the Patient Protection and Affordable Care Act (the “PPACA”) will change how health care services are covered, delivered and reimbursed. The expansion of health insurance coverage under the law may result in a material increase in the number of patients using our facilities who have either private or public program coverage. In addition, a disproportionately large percentage of the new Medicaid coverage is likely to be in states that currently have relatively low income eligibility requirements (for example, Texas, where all of our licensed beds are currently located). On the other hand, the PPACA provides for significant reductions in the growth of Medicare spending and reductions in Medicare and Medicaid disproportionate share hospital payments. A significant portion of both our patient volumes and, as result, our revenues is derived from government health care programs, principally Medicare and Medicaid. Reductions to our reimbursement under the Medicare and Medicaid programs by the PPACA could adversely affect our business and results of operations to the extent such reductions are not offset by increased revenues from providing care to previously uninsured individuals.
We are unable to predict with certainty the full impact of the PPACA on our future revenues and operations at this time due to the law’s complexity and the limited amount of implementing regulations and interpretive guidance, as well as our inability to foresee how individuals and businesses will respond to the choices available to them under the law. Furthermore, many of the provisions of the PPACA that expand insurance coverage will not become effective until 2014 or later. In addition, the PPACA will result in increased state legislative and regulatory changes in order for states to comply with new federal mandates, such as the requirement to establish health insurance exchanges and to participate in grants and other incentive opportunities, and we are unable to predict the timing and impact of such changes at this time. It is also possible that implementation of the PPACA could be delayed or even blocked due to court challenges and efforts to repeal or amend the law .
Our business and financial results could be harmed by violations of existing regulations or compliance with new or changed regulations.
Our business is subject to extensive federal, state and local regulation relating to, among other things, licensure, conduct of operations, ownership of facilities, physician relationships, addition of facilities and services, and reimbursement rates for services. The laws, rules and regulations governing the health care industry are extremely complex and, in certain areas, the industry has little or no regulatory or judicial interpretation for guidance. If a determination is made that we were in material violation of such laws, rules or regulations, we could be subject to penalties or liabilities or required to make significant changes to our operations. Even the public announcement that we are being investigated for possible violations of these laws could have a material adverse effect on our business, financial condition or results of operations, and our business reputation could suffer. Furthermore, health care, as one of the largest industries in the United States, continues to attract much legislative interest and public attention.
We are unable to predict the future course of federal, state and local regulation or legislation, including Medicare and Medicaid statutes and regulations. Further changes in the regulatory framework affecting health care providers could have a material adverse effect on our business, financial condition, results of operations or cash flows.
Among these laws are the federal Anti-kickback Statute, the federal physician self-referral law (commonly called the “Stark Law”), the federal False Claims Act (“FCA”) and similar state laws. We have a variety of financial relationships with physicians and others who either refer or influence the referral of patients to our facilities and other health care facilities, and these laws govern those relationships. The Office of Inspector General of the Department of Health and Human Services (“OIG”) has enacted safe harbor regulations that outline practices deemed protected from prosecution under the Anti-kickback Statute although as discussed below, our arrangements may not fall within the applicable safe harbor regulations.
While we endeavor to comply with the applicable safe harbors, certain of our current arrangements, including joint ventures and financial relationships with physicians and other referral sources and persons and entities to which we refer patients, do not qualify for safe harbor protection.
Failure to qualify for a safe harbor does not mean the arrangement necessarily violates the Anti-kickback Statute but may subject the arrangement to greater scrutiny. However, we cannot offer assurance that practices outside of a safe harbor will not be found to violate the Anti-kickback Statute. Allegations of violations of the Anti-kickback Statute may be brought under the federal Civil Monetary Penalty Law, which requires a lower burden of proof than other fraud and abuse laws, including the Anti-kickback Statute.
Our financial relationships with referring physicians and their immediate family members must comply with the Stark Law by meeting an exception. We attempt to structure our relationships to meet an exception to the Stark Law, but the regulations implementing the exceptions are detailed and complex, and we cannot provide assurance that every relationship complies fully with the Stark Law. Unlike the Anti-kickback Statute, failure to meet an exception under the Stark Law results in a violation of the Stark Law, even if such violation is technical in nature.
Additionally, if we violate the Anti-kickback Statute or the Stark Law, or if we improperly bill for our services, we may be found in violation of the FCA, either under a suit brought by the government or by a private person under a qui tam, or “whistleblower,” suit.
If we fail to comply with the Anti-kickback Statute, the Stark Law, the FCA or other applicable laws and regulations, we could be subjected to liabilities, including civil penalties (including the loss of our licenses to operate one or more facilities), exclusion of one or more facilities from participation in the Medicare, Medicaid and other federal and state health care programs and, for violations of certain laws and regulations, criminal penalties.
We do not always have the benefit of significant regulatory or judicial interpretation of these laws and regulations. In the future, different interpretations or enforcement of, or amendment to, these laws and regulations could subject our current or past practices to allegations of impropriety or illegality or could require us to make changes in our facilities, equipment, personnel, services, capital expenditure programs and operating expenses. A determination that we have violated these laws, or the public announcement that we are being investigated for possible violations of these laws, could have a material, adverse effect on our business, financial condition, results of operations or prospects, and our business reputation could suffer significantly. In addition, other legislation or regulations at the federal or state level may be adopted that adversely affect our business.
We are also required to comply with various federal and state labor laws, rules and regulations governing a variety of workplace wage and hour issues. From time to time, we have been and expect to continue to be subject to regulatory proceedings and private litigation concerning our application of such laws, rules and regulations.
If we fail to implement and maintain effective internal controls over financial reporting, the price of our common stock may be adversely affected.
We are required to establish and maintain appropriate internal controls over financial reporting. Failure to establish those controls or the failure of controls that have been established could adversely impact our public disclosures regarding our business, financial condition or results of operations. Management’s assessment of internal controls over financial reporting may identify weaknesses and conditions that need to be addressed in our internal controls over financial reporting or other matters that may raise concerns for investors. Any actual or perceived weaknesses and conditions that need to be addressed in our internal control over financial reporting, disclosure of management’s assessment of those internal controls or our independent registered public accounting firm’s report on our internal controls may have an adverse effect on the price of our common stock and may require significant management time and resources to remedy.
Future acquisitions may adversely affect our financial condition and results of operations.
As part of our business strategy, we intend to pursue acquisitions of hospitals, surgery centers, diagnostic and imaging centers, and other similar facilities that we believe could enhance or complement our current business operations or diversify our revenue base or expand our physician networks. Acquisitions involve numerous risks, any of which could harm our business, including:
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difficulties integrating the acquired business;
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unanticipated costs, capital expenditures or liabilities;
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diversion of financial and management resources from our existing business;
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difficulties integrating acquired business relationships with our existing business relationships;
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risks associated with entering markets in which we have little or no prior experience; and
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potential loss of key employees, particularly those of the acquired organizations.
Acquisitions may also result in the recording of goodwill and other intangible assets subject to potential impairment in the future, adversely affecting our operating results. We may not achieve the anticipated benefits of an acquisition if we fail to evaluate it properly, and we may incur costs in excess of what we anticipate. A failure to evaluate and execute an acquisition appropriately or otherwise adequately address these risks may adversely affect our financial condition and results of operations.
Our acquisition of the Dallas-based South Hampton Community Hospital represents our first expansion outside of the Houston market and involves these risks. We cannot provide assurance that all of the risks associated with our Dallas operations will be adequately addressed or that these operations will not adversely impact our business.
The profitability of our business may be affected by the highly competitive healthcare industry.
The healthcare industry, in general and the market for hospital services in particular, is highly competitive. In the course of developing and operating a hospital and establishing relationships with local physicians (including surgeons), our business expects to encounter competition from hospitals located in the Houston and Dallas, Texas areas. In addition, the number of freestanding hospitals, surgery centers and diagnostic and imaging centers in the geographic areas in which we operate has increased significantly. For example, there are at least fifty-four (54) existing general hospitals already located in Harris County, Texas with which our business may compete. These hospitals probably offer some or all of the services offered by our business. As a result, our business operates in a highly competitive environment.
Regulatory and other changes affecting the healthcare industry expose our business and other industry participants to the risk that they will lose competitive advantages. Many of our existing and potential competitors have significantly greater financial and other resources than our business and there can be no assurance that our business will be able to compete successfully against them. Some of the facilities that compete with our business are owned by governmental agencies or not-for-profit corporations supported by endowments, charitable contributions and/or tax revenues and can finance capital expenditures and operations on a tax-exempt basis.
Our licensed hospital beds are currently concentrated in certain market areas within Texas, which makes us sensitive to economic, regulatory, environmental and other conditions in those areas.
Our licensed beds are currently located exclusively in market areas within Texas. This concentration in Texas increases the risk that, should any adverse economic, regulatory, environmental or other conditions occur in these areas, our overall business, financial condition, results of operations or cash flows could be materially adversely affected.
Furthermore, a natural disaster or other catastrophic event (such as a hurricane) could affect us more significantly than other companies with less geographic concentration, and the property insurance we obtain may not be adequate to cover our losses. In the past, hurricanes have had a disruptive effect on the operations of our business in Houston, Texas and the patient and physician populations in that area.
Certain events may adversely affect the ability of seniors to afford our monthly resident fees or entrance fees (including downturns in the economy, housing market, and unemployment among resident family members), which could cause our occupancy rates, revenues and results of operations of our Senior Living segment to decline.
Costs to seniors associated with independent and assisted living services are not generally reimbursable under government reimbursement programs such as Medicare and Medicaid. Only seniors with income or assets meeting or exceeding the comparable median in the regions where our communities are located typically can afford to pay our monthly resident fees. Certain economic events such as economic downturns, softness in the housing market, and higher levels of unemployment among resident family members, could adversely affect the ability of seniors to afford our entrance fees and resident fees. If we are unable to retain and attract seniors with sufficient income and assets required to pay the fees associated with independent and assisted living services and other service offerings in our senior living communities, our occupancy rates, revenues and results of operations could decline.
The inability of seniors to sell real estate may delay their moving into our senior living care communities, which could negatively impact our occupancy rates, revenues, cash flows and results of operations.
Recent housing price declines and reduced home mortgage availability have negatively affected the U.S. housing market. Downturns in the housing markets could adversely affect the ability of seniors to afford our entrance fees and resident fees as our customers frequently use the proceeds from the sale of their homes to cover the cost of our fees. Specifically, if seniors have a difficult time selling their homes, these difficulties could impact their ability to relocate into our communities or finance their stays at our communities with private resources. If the recent volatility in the housing market continues for an extended period, our occupancy rates, revenues, cash flows and results of operations could be negatively impacted.
Our liability insurance may not be sufficient to cover all potential liabilities.
We may be liable for damages to persons or property, which occur at our business. Although we maintain general and professional liability insurance, we may not be able to obtain coverage in amounts sufficient to cover all potential liabilities, including errors and omissions liabilities to third party customers of our support services segment. Since most insurance policies contain insurable limits and various exclusions, we will not be insured against all possible occurrences.
As is typical in the healthcare industry, our business is subject to claims and legal actions by patients in the ordinary course of business. To cover these claims, we procure and maintain professional malpractice liability insurance and general liability insurance in amounts that we believe to be sufficient for our operations, although some claims may exceed the scope of the coverage in effect. We also maintain umbrella coverage for our operations. Losses up to our self-insured retentions and any losses incurred in excess of amounts maintained under such insurance are funded from working capital.
The cost of malpractice and other liability insurance, and the premiums and self-retention limits of such insurance, have risen significantly in recent years. We cannot assure you that any insurance we obtain will continue to be available at reasonable prices that will allow us to maintain adequate levels of coverage for our business. We also cannot assure you that our cash flow will be adequate to provide for professional and general liability claims in the future.
We depend on key individuals and access to highly skilled employees to maintain and manage our business in a rapidly changing market.
The continued services of our executive officers and other key individuals are essential to our success. Any of our key employees and individuals, including our Chairman, Hassan Chahadeh, M.D. and President Donald W. Sapaugh, may resign at any time. These individuals are in charge of the strategic planning and operations of our business and the loss of the services of one or more of these individuals could disrupt our operations and damage our ability to grow our business. We do not currently have key person life insurance policies covering any of our employees.
To implement our business plan, we intend to hire additional employees, particularly in the areas of healthcare services. Our ability to continue to attract and retain highly skilled employees is a critical factor in our success. Competition for highly skilled personnel is intense. We may not be successful in attracting, assimilating or retaining qualified personnel to satisfy our current or future needs. Our ability to develop our business would be adversely affected if we are unable to retain existing personnel or hire additional qualified personnel.
We depend on relationships with the physicians who use our hospitals.
Our success depends upon the efforts and success of physicians and physician groups who will provide healthcare services at our hospitals and particularly on the strength of our relationship with those groups comprised of surgeons and other physicians in the Houston and Dallas, Texas.
There can be no assurance that we will be successful in identifying and establishing relationships with surgeons or other physicians. In particular, there can be no assurance that we will be successful in integrating those physicians into a delivery system that will improve operating efficiencies and reduce costs while providing quality patient care. The physicians who will use our hospitals will not be employees of our business, and many, if not all, of them will serve on the medical staffs of hospitals other than our hospitals.
Our business could be adversely affected if a significant number of key physicians or a group of physicians providing services at our hospitals:
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terminates their relationship with, or reduces their use of our hospitals;
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fails to maintain the quality of care provided or to otherwise adhere to professional standards at our hospitals or suffers any damage to their reputation;
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exits the Texas market entirely;
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experiences major changes in the composition or leadership of the physician group; or
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elects to join a competing hospital system as an employee.
Insufficient business is likely to make it impossible for us to repay our indebtedness to our third party lenders. There is no assurance that we will be able to enter into managed care or similar contracts that would provide patients to our hospitals. In addition, there can be no assurance that our business will be able to maintain its utilization at satisfactory levels.
A nationwide shortage of qualified nurses could affect our ability to grow and deliver quality, cost-effective services.
Our business depends on qualified nurses to provide quality service to our patients. There is currently a nationwide shortage of qualified nurses. This shortage and the more stressful working conditions it creates for those remaining in the profession are increasingly viewed as a threat to patient safety and may trigger the adoption of state and federal laws and regulations intended to reduce that risk. For example, some states are reported to be considering legislation that would prohibit forced overtime for nurses. Growing numbers of nurses are also joining unions that threaten and sometimes call work stoppages.
In response to this shortage of qualified nurses, our business is likely to have to increase wages and benefits from time to time to recruit and retain nurses or to engage expensive contract nurses until hiring permanent staff nurses. Our business may not be able to increase the rates it charges to offset these increased costs. Also, the shortage of qualified nurses may in the future delay our ability to achieve the operational goals of our business on schedule by limiting the number of patient beds available during start-up phases.
We do not own the land on which our primary hospital is located and, as such, are subject to a Lease Agreement with Cambridge Properties and various risks related to such lease arrangement.
Cambridge Properties owns the land and building on which UGH is located. UGH has leased the hospital space from Cambridge Properties pursuant to a lease agreement (the “Lease Agreement”). The Lease Agreement is a “triple net” lease with an initial term of ten (10) years beginning October 1, 2006, plus tenant’s option to renew the term for two additional ten (10) year periods. In previous years, we have been in litigation with Cambridge Properties concerning the rights and obligations under the Lease Agreement, including expenses chargeable to us as additional rent. In addition, we have responded to notices of past due rent by making periodic payments of rent as permitted by our current cash flow requirements. If we fail to make rent payments in the future or are otherwise in default of the Lease Agreement, the Lease Agreement may be terminated and we would have no further right to occupy and operate UGH. There can also be no assurance that our efforts in any future litigation with Cambridge Properties will be successful. Adverse outcomes in any such proceedings will result in substantial harm to our business operations.
We are subject to various licensure requirements.
We require licensing, permits, certification, and accreditation from various federal and Texas agencies as well as from accrediting agencies or organizations for our business. If the State of Texas determines that there is a failure to comply with licensure requirements, it has the authority to deny, suspend or revoke our license.
We also hold a number of other licenses and permits for our various departments. Numerous requirements must be met to renew and maintain all required licenses, permits and accreditations, and no assurance can be given that all such required licenses, permits and accreditations will be renewed or maintained.
We are subject to various environmental regulations.
In response to growing public concerns over the presence of contaminants affecting health, safety, and the quality of the environment, federal, state, and local governments have enacted numerous laws designed to clean up existing environmental problems and to implement practices intended to minimize future environmental problems. The principal federal statutes enacted in this regard are the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (“CERCLA”) and the Resource Conservation Recovery Act of 1976 (“RCRA”). CERCLA addresses the practices involved in handling, utilizing, and disposing of hazardous substances, and imposes liability for cleaning up contamination in soil and groundwater. Under CERCLA, the parties who may be liable for the costs of cleaning up environmental contamination include the current owner of the contaminated property, the owner of the property at the time of contamination, the person who arranged for the transportation of the hazardous substances, and the person who transported the hazardous substances. RCRA provides for a “cradle to grave” regulatory program to control and manage hazardous wastes, and is administered by the United States Environmental Protection Agency (“EPA”). RCRA sets treatment and storage requirements for hazardous wastes, and requires that persons who generate, transport, treat, store, or dispose of hazardous wastes meet EPA permit requirements and follow EPA guidelines. We may, in certain aspects of our business, be subject to CERCLA and RCRA. Specifically, by owning our primary hospitals, we could become liable under CERCLA for the costs of cleaning up any contamination on the site of our hospitals.
Competition in our Support Services industry could adversely affect our results of operations.
There is significant competition in the food and support services business from local, regional, national and international companies, of varying sizes, many of which have substantial financial resources. Our ability to successfully compete depends on our ability to provide quality services at a reasonable price and to provide value to our customers. A certain number of our competitors have been and may in the future be willing to underbid us or accept a lower profit margin or expend more capital in order to obtain or retain business. Also, certain regional and local service providers may be better established than we are within a specific geographic region. In addition, existing or potential clients may elect to self-operate their food service and other support services, eliminating the opportunity for us to serve them or compete for the account.
The pricing and cancellation terms of our food and support services contracts may constrain our ability to recover costs and to make a profit on our contracts.
The amount of risk that we bear and our profit potential vary depending on the type of contract under which we provide food and support services. We may be unable to fully recover costs on contracts that limit our ability to increase prices. In addition, we provide many of our services under contracts of indefinite term, which are subject to termination on short notice by either party without cause. Generally, our contracts limit our ability to raise prices on the food, beverages and merchandise we sell within a particular facility without the client’s consent. In addition, some of our contracts exclude certain events or products from the scope of the contract, or give the client the right to modify the terms under which we may operate at certain events. The imposition by clients of limits on prices which are not economically feasible for us or decisions by clients to curtail their use of the services we provide could adversely affect our sales and results of operations.
Governmental regulations relating to food and support services may subject us to significant liability.
The regulations relating to our food and support services group are numerous and complex. A variety of regulations at various governmental levels relating to the handling, preparation and serving of food (including in some cases requirements relating to the temperature of food), and the cleanliness of food production facilities and the hygiene of food-handling personnel are enforced primarily at the local public health department level. We cannot assure you that we are in full compliance with all applicable laws and regulations at all times or that we will be able to comply with any future laws or and regulations. Furthermore, legislative and regulatory attention to food safety is very high. Additional or amended regulations in this area may significantly increase the cost of compliance.
Risks Related to Our Common Stock
An active, liquid trading market for our common stock may not develop.
We cannot predict the extent to which investor interest in our Company will lead to the development of an active and liquid trading market. If an active and liquid trading market does not develop, you may have difficulty selling any of our common stock that is purchased. The market price of our common stock may decline, and you may not be able to sell your shares of our common stock at or above the price you paid, or at all.
Our stock price may be volatile.
The market price of our common stock could be subject to wide fluctuations in response to, among other things, the risk factors described in this section, and other factors beyond our control, such as fluctuations in the valuation of companies perceived by investors to be comparable to us.
Furthermore, the stock markets have experienced price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many companies. These fluctuations often have been unrelated or disproportionate to the operating performance of those companies. These broad market and industry fluctuations, as well as general economic, political and market conditions, such as recessions, interest rate changes or international currency fluctuations, may negatively affect the market price of our common stock.
In the past, many companies that have experienced volatility in the market price of their stock have been subject to securities class action litigation. We may become the target of this type of litigation in the future. Securities litigation against us could result in substantial costs and divert our management’s attention from other business concerns, which could seriously harm our business.
Our principal shareholders, executive officers and directors own a significant percentage of our common stock and will continue to have significant control of our management and affairs, and they may take actions contrary to your interests.
Our executive officers, current directors and holders of five percent or more of our common stock beneficially own an aggregate of approximately 28.8% of our outstanding common stock as of June 23, 2014. This significant concentration of share ownership may adversely affect the trading price for our common stock because investors often perceive disadvantages in owning stock in companies with controlling shareholders. Also, as a result, these shareholders, acting together, may be able to control our management and affairs and matters requiring shareholder approval, including the election of directors and approval of significant corporate transactions, such as mergers, consolidations or the sale of substantially all of our assets. Consequently, this concentration of ownership may have the effect of delaying or preventing a change in control, including a merger, consolidation or other business combination involving us, or discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control, even if such a change in control would benefit our other shareholders.
Further, Hassan Chahadeh, M.D. holds 3,000 shares of Series B Preferred Stock, which, except as otherwise required by law, has the number of votes equal to the number of votes of all outstanding shares of capital stock plus one additional vote so that such shareholder shall always constitute a majority of our voting rights. Therefore, Hassan Chahadeh, M.D. retains the voting power to approve all matters requiring shareholder approval and has significant influence over our operations. The interests of Dr. Chahadeh may be different than the interests of other shareholders on these matters. This concentration of ownership could also have the effect of delaying or preventing a change in our control or otherwise discouraging a potential acquirer from attempting to obtain control of us, which in turn could reduce the price of our common stock. This preferred issuance has no dividend, liquidation or other rights.
Provisions of our articles of incorporation could make an acquisition of our business, which may be beneficial to our shareholders, more difficult and may prevent attempts by our shareholders to replace or remove the current members of our board and management.
Certain provisions of our articles of incorporation could discourage, delay or prevent a merger, acquisition or other change of control that shareholders may consider favorable, including transactions in which you might otherwise receive a premium for your shares. Furthermore, these provisions could prevent or frustrate attempts by our shareholders to replace or remove members of our board of directors. These provisions also could limit the price that investors might be willing to pay in the future for our common stock, thereby depressing the market price of our common stock. Shareholders who wish to participate in these transactions may not have the opportunity to do so. These provisions:
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allow the authorized number of directors to be changed only by resolution of our board of directors;
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establish a classified board of directors, such that not all members of the board of directors may be elected at one time;
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operate as a “poison pill” to dilute the voting power of a potential hostile acquirer to prevent an acquisition that is not approved by our board of directors;
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authorize our board of directors to issue without shareholder approval preferred stock, the rights of which will be determined at the discretion of the board of directors;
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limit who may call shareholder meetings; and
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establish our Series B Preferred Stock.
Our stock price could decline due to the large number of outstanding shares of our common stock eligible for future sale.
Sales of substantial amounts of our common stock in the public market, or the perception that these sales could occur, could cause the market price of our common stock to decline. These sales could also make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate.
Additionally, pursuant to certain registration rights agreements executed in connection with the Merger, we have granted shareholders holding a significant number of shares of our common stock the right to include up to 20% of their shares (subject to customary restrictions) for resale in the event we conduct an underwritten public offering of common stock pursuant to a registration statement under the Securities Act. Our shares of common stock may also be sold under Rule 144 under the Securities Act, depending on their holding period and subject to restrictions in the case of shares held by persons deemed to be our affiliates. As restrictions on resale end or upon registration of any of these shares for resale, the market price of our common stock could drop significantly if the holders of these shares sell them or are perceived by the market as intending to sell them.
Furthermore, because our common stock is traded on the Over-The-Counter Bulletin Board, our stock price may be impacted by factors that are unrelated or disproportionate to our operating performance. These market fluctuations, as well as general economic, political and market conditions, such as recessions, interest rates or international currency fluctuations may adversely affect the market price of our common stock. Additionally, at present, we have a limited number of shares in our public float, and as a result, there could be extreme fluctuations in the price of our common stock. Further, due to the limited volume of our shares which trade and our limited public float, we believe that our stock prices (bid, ask and closing prices are entirely arbitrary) are not related to the actual value of the Company, and do not reflect the actual value of our common stock (and in fact reflect a value that is much higher than the actual value of our common stock). Shareholders and potential investors in our common stock should exercise caution before making an investment in our company, and should not rely on the publicly quoted or traded stock prices in determining our common stock value, but should instead determine the value of our common stock based on the information contained in our public reports, industry information, and those business valuation methods commonly used to value private companies
Investors may face significant restrictions on the resale of our common stock due to federal regulations of penny stocks.
Our common stock will be subject to the requirements of Rule 15(g)9, promulgated under the Securities Exchange Act as long as the price of our common stock is below $5.0 per share. Under such rule, broker-dealers who recommend low-priced securities to persons other than established customers and accredited investors must satisfy special sales practice requirements, including a requirement that they make an individualized written suitability determination for the purchaser and receive the purchaser’s consent prior to the transaction. The Securities Enforcement Remedies and Penny Stock Reform Act of 1990, also requires additional disclosure in connection with any trades involving a stock defined as a penny stock.
Generally, the SEC defines a penny stock as any equity security not traded on an exchange or quoted on NASDAQ that has a market price of less than $5.0 per share. The required penny stock disclosures include the delivery, prior to any transaction, of a disclosure schedule explaining the penny stock market and the risks associated with it. Such requirements could severely limit the market liquidity of the securities and the ability of purchasers to sell their securities in the secondary market.
In addition, various state securities laws impose restrictions on transferring “penny stocks” and as a result, the ability of investors in the common stock to sell their shares may be significantly restricted.
We currently do not intend to pay dividends on our common stock and, consequently, your only opportunity to achieve a return on your investment is if the price of our common stock appreciates and you are able to sell your investment.
We currently do not plan to declare dividends on shares of our common stock in the foreseeable future. Consequently, your only opportunity to achieve a return on your investment in our company will be if the market price of our common stock appreciates and you sell your shares at a profit. There is no guarantee that the price of our common stock will ever exceed the price that you paid.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2.
ITEM 2. PROPERTIES
We own or lease the following properties as of December 31, 2013:
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Information with respect to this item may be found in Note 11 to the Consolidated Financial Statements in “Index to Consolidated Financial Statements of University General Health System, Inc.” included on page for information required under this Item 8, which is incorporated herein by reference.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
Our common stock is traded on the Over-The-Counter Bulletin Board under the designation UGHS.PK. The following table sets forth the high and low bid quotations for our common stock for each quarter during the last two fiscal years, so far as information is reported, as quoted on the Over-the-Counter Bulletin Board. These quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transactions.
Holders
As of June 23, 2014, there were approximately 316 holders of record of our common stock.
Dividends
We have never declared or paid cash dividends on our common stock. We intend to retain future earnings to finance the growth and development of our business and, accordingly, do not currently intend to declare or pay any cash dividends on our common stock. Our Board of Directors will evaluate our future earnings, results of operations, financial condition and capital requirements in determining whether to declare or pay cash dividends. In addition, our Credit Agreement and certain other indebtedness of the Company impose restrictions on our ability to pay dividends on our common stock.
Securities Authorized for Issuance under Equity Compensation Plans
As of the date of this report, we do not have any securities authorized for issuance under any equity compensation plans and we do not have any equity compensation plans.
Performance graph
Not applicable.
Penny Stock Regulations
Our common stock will be subject to the requirements of Rule 15(g)9, promulgated under the Securities Exchange Act (the “SEC”) as long as the price of our common stock is below $5.00 per share. Under such rule, broker-dealers who recommend low-priced securities to persons other than established customers and accredited investors must satisfy special sales practice requirements, including a requirement that they make an individualized written suitability determination for the purchaser and receive the purchaser’s consent prior to the transaction. The Securities Enforcement Remedies and Penny Stock Reform Act of 1990, also requires additional disclosure in connection with any trades involving a stock defined as a penny stock.
Generally, the SEC defines a penny stock as any equity security not traded on an exchange or quoted on NASDAQ that has a market price of less than $5.00 per share. The required penny stock disclosures include the delivery, prior to any transaction, of a disclosure schedule explaining the penny stock market and the risks associated with it. Such requirements could severely limit the market liquidity of the securities and the ability of purchasers to sell their securities in the secondary market.
In addition, various state securities laws impose restrictions on transferring “penny stocks” and as a result, the ability of investors in the common stock to sell their shares may be restricted.
Recent Sales of Unregistered Securities
On November 5, 2013, the Company issued an aggregate of 375,000 shares of its common stock, valued at $195,000, to certain persons as compensation for services rendered by such persons related to the development of the Company’s health delivery network in the Dallas, Texas market.
On December 26, 2013, the Company issued an aggregate of 2,500,000 shares of its common stock, valued at $850,000, to certain shareholders of Series C Preferred Stock in consideration for their agreements to consent to certain agreements to the Certification of Designation applicable to the Series C Stock.
The shares were issued without registration in reliance on the exemption in Section 4(2) of the Securities Act of 1933 and Rule 506 of Regulation D thereunder. The Company believes the exemption is available because the offering was made solely and only to the parties to the transactions described above without any public offering or solicitation. Except for the matters described above or as previously disclosed in Current Reports on Form 8-K that we have filed, we have not sold any of our equity securities during the period covered by this Report that were not registered under the Securities Act.
Repurchase of Equity Securities
None.
Item 6.
Item 6. Selected Financial Data
Not applicable.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Our Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) begins with an executive overview which provides a general description of our company today, 2013 in review, the plans and objectives of our management for future operations and our outlook for 2014. Next, we analyze the results of our operations for the last two years, including the trends in our business. Then we review our cash flows and liquidity and capital resources. We conclude with an overview of our critical accounting judgments and estimates and a summary of recently issued accounting pronouncements.
The following discussion should be read in conjunction with our Consolidated Financial Statements and Notes thereto included in “Item 8. Financial Statements and Supplementary Data.” Our discussion includes various forward-looking statements about our industry, environmental laws, regulations, risks and our future results. These statements are based on certain assumptions we consider reasonable. For information about these assumptions, you should refer to the section entitled “Item 1A. Risk Factors - Forward-Looking Statements.”
2013 Executive Overview
In 2013, we completed several acquisitions that enhance our capabilities in existing markets and in new markets. We acquired South Hampton Community Hospital in Dallas, Texas in December 2012, which we believe provides us a growth opportunity in a new market, where we can leverage the established market presence of South Hampton Community Hospital and our expertise to expand services and pursue other initiatives that we believe will result in attractive growth. Additionally, in 2013, we acquired eleven hospital outpatient departments (HOPDs) and 3 physician services locations in Houston and Dallas.
Our strategy for 2013 was to build on our 2012 achievements and to pursue revenues and earnings growth as the economy stabilized. Reflecting the successful implementation of our business acquisition strategies, total revenues for the year increased 44.8%. The revenues increase was driven by the increases in admissions, surgeries and adjusted patient days of 52.9%, 48.2% and 36.0%, respectively. The significant increase in net patient service revenues was primarily the result of recent HOPDs acquisitions and Dallas hospital acquisition. Dallas hospital and the recent HOPDs acquisitions contributed to additional revenue of approximately $22.0 million and $16.9 million of net patient revenues for the year ended December 31, 2013.
The senior living properties reported an overall occupancy of 92.9%. This is a favorable comparison to the national average as reported by the National Investment Center (NIC) for Senior Housing which reports similar facilities with an overall average occupancy rate of less than 89.7%.
Outlook and Trends
Our strategy in 2014 will be focused on building on our 2013 achievements and pursuing additional acquisitions and earnings growth. We plan to capitalize on opportunities created by the current regulatory and reimbursement environment through acquisitions and expansions to create an integrated, physician-centric, health care delivery system. Further, we will continue our commitment to providing superior patient care with greater efficiency and lower operating cost. We also continue to focus our business strategy on retention of our employees, efforts to improve physician and employee satisfaction and targeted investments in new technologies, new service lines and capital improvements at our facilities. In addition, we are committed to improve in costs of revenues and operating expenses. Our objective for 2014 is to focus on expanding into the Dallas market through University General Hospital Dallas, further expanding our presence in the Houston market, operating high-quality senior living and memory care communities, increasing occupancy and improving the operating efficiency of our senior care communities, restructuring certain mortgages and lender relationships to further stabilize our revenue stream and cash flow, seeking strategic investments in attractive real estate opportunities, improving the operating efficiency of our corporate operations, and reducing our operational financial risk. We expect these efforts, among other factors, will result in improved financial performance and gains in 2014.
Results of Operations
Key Performance Indicators
We manage our business by monitoring certain key performance indicators. We believe our most important key performance indicators are:
Census
Census is defined as the number of units of patient rooms occupied or rented at a given time.
Average Daily Census
For our Hospital Segment, the average daily census, or ADC, is the sum of the patient rooms occupied at midnight, divided by the number of days in that period. For our Senior Living Segment, the ADC is the sum of rented units for each day over a period of time, divided by the number of days in that period.
Occupancy
Occupancy is measured as the percentage of average daily census relative to the total number of patient rooms or units available for occupancy in the period.
Adjusted patient days
Adjusted patient days have been calculated based on a revenue-based formula of multiplying actual patient days by the sum of gross inpatient revenues and gross outpatient revenues and dividing the result by gross inpatient revenues for each hospital. Adjusted patient days is a statistic (which is used generally in the industry) designed to communicate an approximate volume of service provided to inpatients and outpatients by converting total patient revenues to a number representing adjusted patient days.
The following table contains our consolidated and segments results of operations for 2013 and 2012:
(1) Percentages may not foot due to rounding.
Discussion of Consolidated Results of Operations
Our revenues for 2013 increased $50.8 million, or 44.8%, to $164.0 million as compared to $113.2 million for the year ended December 31, 2012. The revenues increase was primarily attributable to 52.9% increase in our average daily census. The average daily census for the year ended December 31, 2013 was 59 as compared to 39 for the year ended December 31, 2012. In addition, the patient days increased by 7,388 days to 20,539 from 13,151, or 56.2% increase, compared to the prior year. The adjusted patient days increased by 9,380 days to 35,435 from 26,055, or 36.0% increase, compared to the prior year. The significant increase in net patient service revenues was also the results of Dallas hospital and the hospital outpatient departments (HOPDs) acquisitions during 2013, which contributed to additional revenues of $22.0 million from Dallas hospital and $16.9 million from HOPDs for the year ended December 31, 2013.
The American Recovery and Reinvestment Act of 2009 provides for Medicare and Medicaid incentive payments, beginning in 2011, for eligible hospitals and professionals that adopt and meaningfully use certified electronic health record (“EHR”) technology. We recognize income related to Medicare and Medicaid incentive payments using a gain contingency model that is based upon when our eligible hospitals have demonstrated meaningful use of certified EHR technology for the applicable period and the cost report information for the full cost report year that will determine the final calculation of the incentive payment is available. We recognized $0.2 million of EHR incentive income related to Medicaid and $1.0 million of EHR incentive income related to Medicare in 2013. The recognized amount has been included in the “Other income” in the consolidated statement of operations in the current year.
Salaries, wages and benefits for the year ended December 31, 2013 increased approximately $37.9 million, or 95.9%, to $77.6 million from $39.6 million for the year ended December 31, 2012. As of December 31, 2013, we had approximately 1,113 full-time and part-time employees compared to approximately 782 as of December 31, 2012. The number of full-time and part-time employees increased approximately 42.3% as compared to the prior year, which was due primarily to increase HOPDs acquisitions during 2013. As a percentage of revenues, salaries, wages and benefits increased to 47.3% in 2013 from 35.0% in 2012. We have implemented a reduction in our management salaries effective June 15, 2014 as part of our overall cost reduction plan. We intend to implement and complete a restructuring plan in the second half of 2014 . In addition, we issued a total of 10,100,000 common shares to members of our senior management as discretionary bonus compensation for their performance for prior years; as a result, we recorded approximately $4.0 million as compensation expense. However, effective December 31, 2013, our board of directors and senior management rescinded 9.6 million of these shares. We reversed approximately $3.8 million compensation expense on December 31, 2013.
Medical supplies expense in 2013 increased approximately $12.5 million, or 77.2%, to $28.7 million from $16.2 million 2012. As a percentage of revenues, our medical supplies expense increased to 17.5% in 2013 as compared to 14.3% in 2012. The increase in medical supplies expense rate in 2013 over 2012 was primary due to increase in higher revenues which was due to more acquisitions in 2013. On an APD basis, medical expenses in 2013 increased approximately 32.2% or $809 per APD from $612 per APD in 2012. In addition, surgeries for the year ended December 31, 2013 were 11,139 compared to 7,518 for the prior year.
General and administrative (“G&A”) expenses in 2013 increased approximately $30.6 million, or 93.3%, to $63.4 million from $32.8 million 2012. As a percentage of revenues, G&A expenses increased to 38.6% in 2013 from 28.9% in 2012. The increase in G&A expenses was due to the acquisitions of HOPDs and UGH Dallas hospital. In addition, the increase was due to increases in marketing and advertising and management fees. Marketing and advertising expenses were up as part of the Company’s initiatives and strategies to increase revenues.
We settled certain accounts payable with vendors and reduced the accounts payable owed to those vendors and lenders. In 2012, we recognized a gain on extinguishment of liabilities of $3.6 million, of which $2.9 million representing the portion of the principal balance, accrued interest, taxes and penalties due on a master equipment lease agreement and two promissory notes that have been extinguished in accordance with the statute of limitations.
Depreciation and amortization expense in 2013 increased approximately $2.3 million, or 25.0%, to $11.5 million as compared to $9.2 million in 2012. The increase in depreciation and amortization expense primarily resulted from the amortization expense of debt issuance costs, customer relationship, tradename, software and non-compete intangibles, offset by some assets being fully depreciated in the current year as compared to prior year.
Net interest expense was $7.1 million in 2013 as compared to $6.1 million in 2012. Interest expense is primarily comprised of interest on borrowings under the Revolving Credit Facility, interest on financing lease obligations, related party notes and debt obligations. In addition, the increase in interest expense in the current year, as compared to the prior year, was attributable to an increase in our outstanding debt balance and debt assumed from the acquisitions.
We are subject to a tax mandated by the State of Texas based on a defined calculation of gross margin (the “margin tax”). The margin tax is calculated by applying a tax rate to a base that considers both revenue and expenses and therefore has the characteristics of an income tax. As a result, we recorded $0.7 million and $0.4 million in state income tax expense for the years ended December 31, 2013 and 2012, respectively.
Our provision for income taxes was approximately $4.6 million in 2013, which resulted in an effective tax rate of negative 15.5%. Our provision for income taxes was impacted by non-deductible interest and penalties of $4.2 million, valuation allowances $8.3 million, and change in derivative accruals of $2.4 million. We are required to file separate tax returns for 2011 and 2012 because a valid election was not made to file a consolidated return on a timely filed tax return; therefore, we were subject to interest and penalties. As a result, we recorded a total of $3.7 million interest and penalties related to 2011 and 2012 tax returns.
As fully described in Notes 12 and 14 to the Consolidated Financial Statements, the Company issued preferred stock and the related common stock warrant in May 2012, which do not have readily determinable fair values and therefore require significant management judgment and estimation. The Company uses the Binomial pricing model to estimate the fair value of warrant and preferred stock conversion features at the end of each applicable reporting period. Changes in the fair value of these derivatives during each reporting period are included in the statement of income. As a result, the total direct investor expense and change in fair market value of derivatives were approximately $4.9 million and $2.0 million in 2013 and $6.9 million and $4.9 million in 2012, which directly reduced the net income attributable to the Company. The change in the direct investor expense and change in fair market value of derivatives were primarily due to the amendments to C Series Preferred and warrants. In December 2012, certain warrants shareholders agreed to waive all full ratchet price protection and in March 2013, all C Series Preferred shareholders agreed to waive all full ratchet price protection. As of the date of the amendments, the Company reclassified the fair market value of derivatives to additional paid in capital as the derivative ceased to exist.
As a result of the foregoing, our net loss attributable to the Company was $34.5 million for 2013 as compared to a net loss of $3.4 million for 2012.
Discussion of Segment Results of Operations
Hospital
Our revenues in 2013 increased $45.5 million, or 44.3%, to $148.3 million as compared to $102.8 million in 2012. The revenues increase was primarily attributable 52.9% increase in our average daily census. The average daily census for the year ended December 31, 2013 was 59 as compared to 39 for the year ended December 31, 2012. In addition, the patient days increased by 7,388 days to 20,539 from 13,151, or 56.2% increase, compared to the prior year. The adjusted patient days increased by 9,380 days to 35,435 from 26,055, or 36.0% increase, compared to the prior year. These increases were primarily driven by the acquisition of Dallas hospital, which contributed $22.0 million revenues. The significant increase in net patient service revenues was also the result of the hospital outpatient departments (HOPDs) acquisitions during 2013, which contributed to additional revenues of $16.9 million for the year ended December 31, 2013.
Our provision for doubtful accounts in 2013 increased $16.0 million to 16.1% of net revenue before the provision for doubtful accounts as compared to 8.1% of net revenue before the provision for doubtful accounts in 2012. As percentage of gross revenue, the provision for doubtful accounts was 3% in 2013 as compared to 2% in 2012. This change was primarily due an increase in self-pay patients gross revenue from Dallas hospital of $9.4 million and coupled with a significant increase in revenues.
We adopted the provisions of Accounting Standards Update No. 2011-07, Presentation and Disclosure of Patient Service Revenue, Provision for Bad Debts, and the Allowance for Doubtful Accounts for Certain Health Care Entities (“ASU 2011-07”), during the period ended March 31, 2012. ASU 2011-07 requires health care entities to change the presentation of the statement of income by reclassifying the provision for doubtful accounts from an operating expense to a deduction from patient service revenues. All periods presented have been reclassified in accordance with ASU 2011-07.
Our days revenues outstanding were 56 days at December 31, 2013 as compared to 73 days at December 31, 2012. To calculate our day’s revenues outstanding, we divide our average accounts receivable net of allowance for doubtful accounts by our net revenues per day. Our net revenues per day is calculated by dividing our revenues for the periods by the number of calendar days in the periods. The decrease in days revenues outstanding due to a significant increase in revenues during current year as a result of the acquisitions in 2013.
Salaries, wages and benefits in 2013 increased approximately $30.9 million, or 104.1%, to $60.5 million from $29.6 million in 2012. This was primarily due to acquisitions. As of December 31, 2013, we had approximately 653 full-time equivalent employees compared to approximately 443 full-time equivalent employees as of December 31, 2012. As a percentage of revenues, salaries, wages and benefits decreased to 40.8% in 2013 from 28.8% in 2012. The increase in the salaries, wages and benefits rate in 2013 over 2012 was primarily due to acquisitions in 2013.
Medical supplies expense in 2013 increased approximately $12.5 million, or 77.2%, to $28.7 million from $16.2 million 2012. As a percentage of revenues, our medical supplies expense increased to 19.3% in 2013 as compared to 15.8% in 2012. The increase in medical supplies expense rate in 2013 over 2012 was primary due to increases in higher revenues and acquisitions. On an APD basis, medical expenses in 2013 increased approximately 32.2% or $809 per APD from $612 per APD in 2012. In addition, surgeries for the year ended December 31, 2013 were 11,139 compared to 7,518 for the prior year.
General and administrative expenses in 2013 increased approximately $26.0 million, or 94.5%, to $53.5 million from $27.5 million in 2012. As a percentage of revenues, G&A expenses increased to 36.1% in 2013 from 26.7% in 2012. The increase in amount of G&A expenses was primarily comprised of legal fees, contract services, professional fees, repairs and maintenance, penalties fees and marketing fees, coupled with acquisitions in 2013.
Depreciation and amortization expense in 2013 increased approximately $2.0 million, or 32.2%, to $8.1 million as compared to $6.1 million in 2012. The increase in depreciation and amortization expense resulted from acquisitions.
Net interest expense was $5.9 million in 2013 as compared to $4.9 million in 2012. Interest expense is primarily comprised of interest on borrowings under the Revolving Credit Facility, amortization of debt issue costs, interest on financing lease obligations, related party notes and debt obligations. The increase in interest expense was due to a higher average outstanding amount on notes. For a further discussion of our debt and corresponding interest rate, see “Liquidity and Capital Resources.”
Operating loss of the hospital segment was approximately $14.3 million for the current year as compared to the operating income of $19.6 million for the prior year. The operating loss was due to increase in acquisitions and operating expenses, which included salaries, benefits and other employee costs, G&A expenses and medical supplies as compared to the prior year. In addition, marketing and advertising expenses increased as part of the Company’s initiatives and strategies to increase revenues.
Senior Living
Senior living net revenues in 2013 increased $0.2 million, or 2.8%, to approximately $8.1 million as compared to $7.9 million in 2012. This reflects average revenue per unit occupied of $3,169 in 2013 as compared to the average revenue per unit occupied of $3,096 in 2012. These are blended rates of assisted living dominant facilities which include independent living and memory care units. The senior living properties reported continued stable occupancy, with an overall average occupancy in excess of 92.9% in 2013 and 93.1% in 2012. Overall occupancy and revenues were not negatively impacted by the significant downturn in the macroeconomic environment, including the high unemployment levels and poor housing markets which affect private pay occupancy.
Salaries and benefit expense in 2013 was approximately $3.3 million, G&A expense was $3.2 million, depreciation and amortization was $2.8 million and interest expenses was $1.4 million. Net operating income before depreciation and amortization and interest expense was approximately $2.0 million.
Salaries and benefit expense in 2012 was approximately $3.0 million, G&A expense was $2.8 million, depreciation and amortization was $2.6 million and interest expenses was $1.3 million. Net operating income before depreciation and amortization and interest expense was approximately $2.1 million.
Support Services
Revenues, net of the intercompany revenues, in 2013 were approximately $7.5 million as compared to $2.5 million in 2012. The net operating loss was approximately $1.6 million in 2013 as compared to $0.1 million net operating loss in 2012. The net operating expense was $9.1 million in 2013 as compared to $2.6 million in 2012. The increase in revenues was due to increase in new number of clients, coupled with the new acquisitions in 2013.
The Company performs an impairment test for goodwill annually each June, or more frequently if indicators of potential impairment exist. The Company’s goodwill impairment test involves a comparison of the fair value of each of its reporting units with its carrying amount. Fair value is estimated using discounted cash flows and a discount rate based on the weighted average cost of capital of the reporting unit.
The fair value of the Autimis reporting unit did not substantially exceed its carrying value as of its June 2013 annual impairment test.
Liquidity and Capital Resources
Our primary cash requirements are paying our operating expenses, servicing our debt, capital expenditures on our existing properties, acquisitions and distributions to non-controlling interests. Our primary cash sources are cash flows from operating activities, issuances of debt and equity securities.
Operating Activities
The cash provided by operating activities was $9.1 million for the year ended December 31, 2013. Net income, adjusted for non-cash expenses and income, provided cash of approximately $14.7 million. Net changes in operating assets and liabilities used net cash of approximately $5.2 million, which primarily included a $28.6 million increase in accounts receivable and a $1.4 million increase in prepaid expenses and other assets, inventories and others, partially offset by a $24.8 million increase in accounts payable.
The cash provided by operating activities was $8.2 million for the year ended December 31, 2012. Net income, adjusted for non-cash expenses and income, provided cash of approximately $21.9 million. Net changes in operating assets and liabilities used net cash of approximately $13.7 million, which primarily included a $18.9 million increase in accounts receivable and a $2.1 million increase in prepaid expenses and other assets, partially offset by a net $7.3 million increase in accounts payable, accrued expenses, tax payable, inventories, related party payables and deferred revenues.
Investing Activities
The cash used in investing activities was approximately $9.4 million for the year ended December 31, 2013, compared to $8.3 million for the year ended December 31, 2012. The increase in cash used in investing activities was primarily attributable to higher purchases of property and equipment of $7.3 million as compared to the prior year of $5.9 million. In addition, the cash used in business acquisitions was $2.0 million during 2013 as compared to the prior year of $2.2 million during 2012.
Financing Activities
The cash provided in financing activities was approximately $0.8 million for the year ended December 31, 2013, compared to cash provided of $0.7 million for the year ended December 31, 2012.
As of December 31, 2013, we had a negative working capital of approximately $57.8 million compared to negative of approximately $41.8 million as of December 31, 2012. The negative working capital and relative low levels of cash and cash equivalents amounts, significant increase in operating expenses, and required past due payroll taxes and its related penalties and interest and income tax payments raise substantial doubt concerning the Company’s ability to continue as a going concern for a reasonable period of time. If we ultimately are unable to pay the outstanding taxes, penalties and interest to the Internal Revenue Service (IRS), then the IRS may force us to cease our operations.
On September 28, 2012, the Company entered into a Credit and Security Agreement for a $15.0 million secured revolving credit facility (the “Revolving Credit Facility”) that matures on September 28, 2015. The Revolving Credit Facility includes an additional amount of revolving loan commitment feature to increase the size of the facility to $25.0 million. In June 2013, the secured revolving credit facility increased to $22.5 million. Borrowings under the Revolving Credit Facility are limited to the availability under a borrowing base that is determined principally on eligible account receivable as defined by the Revolving Credit Facility agreement. The daily interest rates under the Revolving Credit Facility are determined by a LIBOR rate plus an applicable margin, as set forth in the Revolving Credit Facility agreement. All of the Company’s assets are pledged as collateral under the Revolving Credit Facility. The Revolving Credit Facility is used by the Company to provide financing for working capital, capital expenditures and other general corporate purposes, as well as to support its outstanding indebtedness requirements. The Revolving Credit Facility contains certain affirmative covenants, negative covenants and financial covenants including restrictions on the payment of dividends, as set forth in the Revolving Credit Facility Agreement. The Revolving Credit Facility agreement included unused line fee of 0.5% per annum. Excess borrowing availability under the Revolving Credit Facility at December 31, 2013 was $2,427,074. At December 31, 2013, the Company was in compliance with all of the financials debt covenants of the Revolving Credit Facility and expects to remain in compliance during the year 2014. The interest rate on outstanding borrowings and average daily borrowings under the Revolving Credit Facility were 4.5% and $346,777, respectively. The Company had an outstanding balance on its Revolving Credit Facility as of December 31, 2013 of $20,072,926.
Inflation
The healthcare industry is labor-intensive. Wages and other expenses increase during periods of inflation and when labor shortages in marketplaces occur. Various federal, state and local laws have been enacted that, in certain cases, limit our ability to increase prices. Revenues for acute hospital services rendered to Medicare patients are established under the federal government’s prospective payment system. We believe that hospital industry operating margins have been, and may continue to be, under significant pressure because of changes in payer mix and growth in operating expenses in excess of the increase in prospective payments under the Medicare program. In addition, as a result of increasing regulatory and competitive pressures, our ability to maintain operating margins through price increases to non-Medicare patients is limited. Accordingly, inflationary pressures could have a material adverse effect on our results of operations.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to select appropriate accounting policies and to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. In preparing our consolidated financial statements, we make estimates and assumptions that affect the accounting for and recognition and disclosure of assets, liabilities, equity, revenues and expenses. We must make these estimates and assumptions because certain information that we use is dependent on future events, cannot be calculated with a high degree of precision from data available or simply cannot be readily calculated based on generally accepted methods. In some cases, these estimates are particularly difficult to determine and we must exercise significant judgment. We periodically evaluate our estimates and judgments that are most critical in nature. We believe that the following discussion of critical accounting policies address all important accounting areas where the nature of accounting estimates or assumptions is material due to the levels of subjectivity and judgment. Actual results could differ materially from the estimates and assumptions that we use in the preparation of our financial statements.
Business Combinations
We account for our business acquisitions under the acquisition method of accounting as indicated in Accounting Standards Codification (“ASC”) No. 805, Business Combinations, which requires the acquiring entity in a business combination to recognize the fair value of all assets acquired, liabilities assumed, and any non-controlling interest in the acquiree; and establishes the acquisition date as the fair value measurement point. Accordingly, we recognize assets acquired and liabilities assumed in business combinations, including contingent assets and liabilities and non-controlling interest in the acquiree, based on fair value estimates as of the date of acquisition. In accordance with ASC 805, we recognize and measure goodwill as of the acquisition date, as the excess of the fair value of the consideration paid over the fair value of the identified net assets acquired.
All acquisition-related transaction costs have been expensed as incurred rather than capitalized as a part of the cost of the acquisition.
Acquired Assets and Assumed Liabilities
Pursuant to ASC 805-10-25, if the initial accounting for a business combination is incomplete by the end of the reporting period in which the combination occurs, but during the allowed measurement period not to exceed one year from the acquisition date, we retrospectively adjust the provisional amounts recognized at the acquisition date, by means of adjusting the amount recognized for goodwill.
Revenue Recognition
We recognize revenues in the period in which services are performed. We derive a significant portion of our revenues from the hospital segment. Accordingly, the revenues reported in our Consolidated Statements of Operations are recorded at the net amount expected to be received.
We recognize net patient service revenues in the reporting period in which we perform the service based on our current billing rates (i.e., gross charges), less adjustments and estimated discounts for contractual allowances (principally for patients covered by Medicare, Medicaid, and managed care and other health plans). We record gross service charges in our accounting records on an accrual basis using its established rates for the type of service provided to the patient. We recognize an estimated contractual allowance to reduce gross patient charges to the amount it estimates it will actually realize for the service rendered based upon previously agreed to rates with a payor. Such estimated contractual allowances are based primarily upon historical collection rates for various payers, and assumes consistency with regard to patients discharged in similar time periods for the same payor classes. Payors include federal and state agencies, including Medicare and Medicaid, managed care health plans, commercial insurance companies and patients.
The process of estimating contractual allowances requires us to estimate the amount expected to be received based on payor contract provisions. The key assumption in this process is the estimated contractual reimbursement percentage, which is based on payor classification and historical paid claims data. Due to the complexities involved in these estimates, actual payments we receive could be different from the amounts estimate and recorded. If the actual contractual reimbursement percentage under government programs and managed care contracts differed by 1.0% at December 31, 2013 from its estimated reimbursement percentage, net revenues for the year ended December 31, 2013 and 2012 would have changed by approximately $3.6 million and $4.5 million, and net accounts receivable at December 31, 2013 and 2012 would have changed by approximately $0.5 million and $0.9 million, respectively. Final settlements under some of these programs are subject to adjustment based on administrative review and audit by third parties. We account for adjustments to previous program reimbursement estimates as contractual allowance adjustments, and we report them in the periods that such adjustments become known.
Revenues related to our hospital segment consist primarily of net patient service revenues, which are based on the facilities’ established billing rates less adjustments and discounts. Summary information for revenues for the years ended December 31, 2013 and 2012 is as follows:
The hospital has agreements with third-party payors that provide for payments to the hospital at amounts different from its established rates. Payment arrangements include prospectively-determined rates per discharge, reimbursed costs, discounted charges, and per diem payments. Net patient service revenue is reported at the estimated net realizable amount from patients, third-party payors, and others for services rendered, including estimated contractual adjustments under reimbursement agreements with third party payors. Allowances and discounts are accrued on an estimated basis in the period the related services are rendered and adjusted in future periods as final settlements are determined. These allowance and discounts are related to the Medicare and Medicaid programs and managed care contracts.
The following table sets forth the revenues (after contractual adjustments and discounts) and percentages from major payor sources for the Company’s hospital segment during the periods indicated:
Allowance for Doubtful Accounts and Provision for Doubtful Accounts
Substantially all of our accounts receivable are related to providing healthcare services to patients. Collection of these accounts receivable is our primary source of cash and is critical to our operating performance. Our primary collection risks relate to non-governmental payors who insure these patients, and deductibles, co-payments and self-insured amounts owed by the patient. At December 31, 2013 and 2012, deductibles, co-payments and self-insured amounts owed by the patient accounted for approximately 1.4% and 1.9% of our accounts receivable balance before doubtful accounts. Our general policy is to verify insurance coverage prior to the date of admission for a patient admitted to our hospitals and to verify insurance coverage prior to a patient’s first outpatient visit. Our estimate for the allowance for doubtful accounts is calculated by providing a reserve allowance based upon the age of an account balance. Generally we apply the collection rates to the gross accounts receivable amounts for the first 120 days for both inpatient and outpatient to determine the contractual adjustment, the remaining amount is assessed for collectability. As such, we then apply a graduated reserve to uncollectible accounts for greater than 121 days. This method is monitored based on our historical cash collections experience and other factors, including management’s plans related to collections. Collections are impacted by the effectiveness of our collection efforts with non-governmental payors and regulatory or administrative disruptions with the fiscal intermediaries that pay our governmental receivables. The allowance for doubtful accounts was $36,802,691 and $21,422,475 as of December 31, 2013 and 2012, respectively.
We do not have any significant amounts subject to pre-approval from third party payors because our business office obtains approvals prior to admission based on information provided by our patients.
We estimate bad debts for total accounts receivable, and we believe our policies have resulted in reasonable estimates determined on a consistent basis. We believe that we collect substantially all of our third-party insured receivables (net of contractual allowances) which include receivables from governmental agencies. To date, we believe there has not been a material difference between our bad debt allowances and the ultimate historical collection rates on accounts receivable. We review our overall reserve adequacy by monitoring historical cash collections as a percentage of net revenue less the provision for bad debts. We attempt to collect deductibles, co-payments and self-pay accounts prior to or at the time of service for non-emergency care. If we do not collect these patient responsibility accounts prior to the delivery of care, the accounts are handled through our billing and collections processes.
Accounts receivable are stated at estimated net realizable value. The breakdown of accounts receivable by payer classification as of December 31, 2013 and 2012 consists of the following:
We verify each patient’s insurance coverage as early as possible before a scheduled admission or procedure with respect to eligibility, benefits, and authorization/pre-certification requirements in order to notify patients of the amounts for which they will be responsible. We attempt to verify insurance coverage within a reasonable amount of time for all emergency room visits and urgent admissions in compliance with the Emergency Medical Treatment and Active Labor Act. We do not pursue collection of amounts related to patients who meet our guidelines to qualify as charity care.
In general, we perform the following steps in collecting our accounts receivable: We collect deductibles, co-payments and self-pay accounts prior to or at time of service if possible; we bill and follow-up with third party-payors as soon as possible following discharge; we make collection calls on a regular basis; we utilize the services of outside collection agencies; we write-off of accounts manually if collection efforts are unsuccessful.
The amount of the provision for bad debts accounts is based upon management’s assessment of historical write-offs and expected net collections, business and economic conditions, trends in federal, state, and private employer health care coverage and other collection indicators. Management relies on the results of detailed reviews of historical write-offs and recoveries as a primary source of information in estimating the collectability of our accounts receivable.
Long-lived Assets
Long-lived assets, which include property, plant and equipment, are reviewed to determine whether any events or changes in circumstances indicate that the carrying amount of an asset, or related groups of assets, may not be fully recoverable from estimated future cash flows.
We evaluate our long-lived assets for possible impairment annually or whenever events or changes in circumstances indicate that the carrying amount of the asset, or related group of assets, may not be recoverable from estimated future undiscounted cash flows. If the estimated future undiscounted cash flows are less than the carrying value of the assets, we calculate the amount of an impairment if the carrying value of the long-lived assets exceeds the fair value of the assets. The fair value of the assets is estimated based on appraisals, established market values of comparable assets or internal estimates of future net cash flows expected to result from the use and ultimate disposition of the asset. The estimates of these future cash flows are based on assumptions and projections it believes to be reasonable and supportable. The estimates require our subjective judgments and take into account assumptions about revenue and expense growth rates. These assumptions may vary by type of facility and presume stable, improving or, in some cases, declining results at its hospitals, depending on the circumstances.
Income Taxes
We provide for income taxes using the asset and liability method. Under the asset and liability method, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. In addition, deferred tax assets are also recorded with respect to net operating losses and other tax attribute carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. A valuation allowance is established when realization of the benefit of deferred tax assets is not deemed to be more likely than not. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
The application of income tax law is inherently complex. Laws and regulations in this area are voluminous and are often ambiguous. As such, we are required to make many subjective assumptions and judgments regarding our income tax exposures. Interpretations of and guidance surrounding income tax laws and regulations change over time, such as changes in our subjective assumptions and judgments can materially affect amounts recognized in our consolidated financial statements.
A high degree of judgment is required to determine the extent a valuation allowance should be provided against deferred tax assets. On a quarterly basis, we assess the likelihood of realization of our deferred tax assets considering all available evidence, both positive and negative. Our operating performance in recent years, the scheduled reversal of temporary differences, our forecast of taxable income in future periods, our ability to sustain a core level of earnings, and the availability of prudent tax planning strategies are important considerations in our assessment. Based on the weight of available evidence, we determine whether it is not more likely than not our deferred tax assets will be realized in the near term future. Based on this determination, we have provided a significant valuation allowance on net deferred tax assets as of December 31, 2013 and 2012. If circumstances change and we determine in the future that it is more likely than not that our deferred tax assets will be realized in the near term future, a reversal of a portion or all of the valuation allowance will be required, which could result in a significant reduction in future income tax expense.
Uncertain Tax Positions
We record and review our uncertain tax positions on a quarterly basis. Reserves for uncertain tax positions are established for exposure items related to various federal and state tax matters. Income tax reserves are recorded when an exposure is identified and when, in the opinion of management, it is more likely than not that a tax position will not be sustained and the amount of the liability can be estimated. While we believe that our reserves for uncertain tax positions are adequate, the settlement of any such exposures at amounts that differ from current reserves may require us to materially increase or decrease our reserves for uncertain tax positions.
Assessment of Loss Contingencies
Certain conditions may exist as of the date the financial statements are issued, which may result in a loss, but which will only be resolved when one or more future events occur or fail to occur. Our management and its legal counsel assess such contingent liabilities, and such assessment inherently involves an exercise of judgment. In assessing loss contingencies related to legal proceedings that are pending against us or unasserted claims that may result in such proceedings, our legal counsel evaluates the perceived merits of any legal proceedings or unasserted claims, as well as the perceived merits of the amount of relief sought or expected to be sought therein.
If the assessment of a loss contingency indicates that it is probable that a loss has been incurred and the amount of the liability can be reasonably estimated, then the estimated liability is accrued in our financial statements. If the assessment indicates that a potentially material loss contingency is not probable, but is reasonably possible, or is probable but cannot be estimated, then the nature of the contingent liability, together with an estimate of the range of possible loss, if determinable and material, would be disclosed. Loss contingencies considered remote are generally not disclosed unless they involve guarantees, in which case the nature of the guarantee would be disclosed. We expense legal costs associated with contingencies as incurred.
Malpractice
We are covered by a claims-made general and professional liability insurance policy with a specified deductible per incident and excess coverage on a claims-made basis. Liability limits related to this policy in 2014 and 2013 is $1,000,000 per occurrence and $3,000,000 in aggregate. We have also purchased additional umbrella insurance coverage with an aggregate limit of $10,000,000. We use a third-party administrator to review and analyze incidents that may result in a claim against us. In conjunction with the third-party administrator, incidents are assigned reserve amounts for the ultimate liability that may result from an asserted claim. Accrued professional claims are included in accounts payable and accrued expenses on the balance sheet and in management’s opinion provide an adequate reserve for loss contingencies.
Various claims and assertions have been made against us in its normal course of providing services. In addition, other claims may be asserted arising from services provided to patients in the past. In the opinion of management, adequate provision has been made for losses which may occur from such asserted and unasserted claims that are not covered by liability insurance.
Goodwill
Goodwill represents the excess of the cost of an acquired business over the net amounts assigned to assets acquired and liabilities assumed. We recorded goodwill in conjunction with our 2013 and 2012 acquisitions and allocated it to each reporting unit. We had goodwill totaling $42.6 million and $39.3 million at December 31, 2013 and 2012. As required, we perform a goodwill impairment test at least annually or more frequently if there is an indication of impairment. We performed our annual goodwill impairment test in June 2013 for our reporting units.
Goodwill impairment is evaluated using a two-step process. The first step of the goodwill impairment test involves a comparison of the fair value of each of our reporting units with their carrying values. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test shall be performed. The second step compares the implied fair value of the reporting unit’s goodwill to the carrying amount of its goodwill by performing a hypothetical purchase price allocation on the reporting unit’s assets and liabilities using the fair value of the reporting unit as the purchase price in the calculation. If the amount of goodwill resulting from this hypothetical purchase price allocation is less than the recorded amount of goodwill, the recorded goodwill is written down to the new amount.
The fair value of our reporting units is determined using an income approach. Several estimates and judgments are required in the application of this model. Our income approach estimates fair value by discounting each reporting unit’s estimated future cash flows using a weighted-average cost of capital that reflects current market conditions and the risk profile of each reporting unit. To arrive at our future cash flows, we use estimates of economic and market information, including growth rates in revenues, costs, estimates of future expected changes in operating margins, tax rates, and also cash needs and expenditures. Other significant estimates and assumptions include terminal value growth rates, future estimates of capital expenditures and changes in future working capital requirements. Estimates of fair value derived from the income approach are validated using the market approach, where reporting unit revenue and earnings multiples are compared with those from comparable publicly traded companies.
Several of the assumptions used in our discounted cash flow analysis are based upon our annual financial forecast. Our annual planning process takes into consideration many factors including historical results and operating performance, related industry trends, pricing strategies, customer analysis, operational issues, competitor analysis, and marketplace data, among others. Assumptions are also made for growth rates for periods beyond the financial forecast period. Our estimates of fair value are sensitive to changes in all of these variables, certain of which relate to conditions outside our control. If any one of the above assumptions changes or fails to materialize, the resulting decline in our estimated fair value could result in an impairment charge to goodwill associated with the applicable reporting unit.
Self-insured Medical Benefits
We maintain self-insurance retentions with respect to health benefits for our employees. We estimate the accruals for the liabilities based on industry development factors and historical claim trend experience. Although management believes adequate reserves have been provided for expected liabilities arising from our self-insured obligations, projections of future losses are inherently uncertain, and it is reasonably possible that estimates of these liabilities will change over the near term as circumstances develop.
Derivatives
We evaluate all financial instruments for freestanding and embedded derivatives. Warrants and conversion features related to preferred stock do not have readily determinable fair values and therefore require significant management judgment and estimation. We use a Binomial pricing model to estimate the fair value of warrant and preferred stock conversion features at the end of each applicable reporting period. Changes in the fair value of these derivatives during each reporting period are included in the statement of income. Inputs into the Binomial pricing model require estimates, including such items as estimated volatility of the Company’s stock, risk-free interest rate and the estimated life of the financial instruments being fair valued.
Series C Preferred Stock
As more fully described in Note 12, we issued Series C Preferred Stock, which is classified in temporary equity in accordance with ASC 480-10-S99-3A on the Consolidated Balance Sheets. The Series C Preferred Stock has redeemable features which are not in our control and therefore should not be included in permanent equity. The Series C Preferred Stock had similar characteristics of an “Increasing Rate Security” as described by Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin Topic 5Q, Increasing Rate Preferred Stock. Discounts on the increasing rate preferred stock are amortized over the expected life of the preferred stock (4 years), by charging imputed dividend cost against retained earnings and increasing the carrying amount of the preferred stock by a corresponding amount. The discount at the time of issuance is computed as the present value of the difference between dividends that will be payable in future periods and the dividend amount for a corresponding number of periods, discounted at a market rate for dividend yield on comparable securities. The amortization in each period is the amount which, together with the stated dividend in the period, results in a constant rate of effective cost with regard to the carrying amount of the preferred stock.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standard Board (FASB) issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”). ASU 2014-09 supersedes the revenue recognition requirements in ASC Topic 605, Revenue Recognition, and most industry-specific guidance. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This guidance is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period, under either full or modified retrospective adoption. Early application is not permitted. We plan to adopt ASU 2014-09 beginning January 1, 2017, and are currently assessing the potential effects of these changes to our consolidated financial statements.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See “Index to Consolidated Financial Statements of University General Health System, Inc.” included on page for information required under this Item 8.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls Procedures
Disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) are designed to ensure that information required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms. Disclosure and control procedures are also designed to ensure that such information is accumulated and communicated to management, including our Chief Executive Officer and our Chief Financial Officer, to allow timely decisions regarding required disclosures.
As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. In designing and evaluating the disclosure controls and procedures, management recognizes that there are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their desired control objectives. Additionally, in evaluating and implementing possible controls and procedures, management is required to apply its reasonable judgment.
Based on the evaluation described above, our Chief Executive Officer and Chief Financial Officer have concluded that, our disclosure controls and procedures were not effective as of December 31, 2013.
Changes in Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control system was designed to provide reasonable assurance to our management and Board of Directors regarding the preparation and fair presentation of published financial statements.
Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2013. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on its assessment, our management believes that, as of December 31, 2013, our internal control over financial reporting was not effective based on those criteria. We identified material weaknesses in our internal control over financial reporting. A material weakness is a deficiency, or a combination of control deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. We assessment identified certain material weaknesses which are set forth below:
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The material weaknesses relate to inadequate accounting and compliance staffing, lack of consistent policies and procedures
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Inadequate review and monitoring of controls, including our lack of an audit committee and surrounding the revenue cycle management process.
Planned Remediation Efforts to Address Material Weakness
We are committed to improving our financial organization. As part of this commitment, we have engaged third party resources with technical accounting expertise within the accounting function to assist with the monitoring and review application of US GAAP and SEC disclosure requirements. In addition, we believe that preparing and implementing sufficient written policies and checklists will remedy the material weaknesses pertaining to insufficient written policies and procedures for accounting and financial reporting with respect to the requirements and application of US GAAP and SEC disclosure requirements. We are in the process of implementing an on-going process of designing and implementing controls to correct identified internal control deficiencies and conducting ongoing evaluations to ensure all deficiencies have been identified. We believe that after a sufficient period of operation of the controls implemented to remediate the control deficiencies.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The following table sets forth information regarding the members of our board of directors, executive officers and other significant employees. All directors hold office for three-year terms and subject to the provisions of our articles of incorporation until the election and qualification of their successors. Officers are elected annually by the board of directors and serve at the discretion of the board. There are no family relationships between any of the directors and executive officers listed in the table. There are no arrangements or understandings between any executive officer and any other person pursuant to which he or she was selected as an officer.
Executive Officers, Directors and Significant Employees of the Registrant
Hassan Chahadeh, M.D has been Chairman, Chief Executive Officer and Director of the Company since April 1, 2011. Dr. Chahadeh was one of the founders of the Company. As Managing General Partner & Founder of University General Hospital, from August 2005 to March 2011, he has been intimately involved in the initial design, development and operational restructuring of the hospital. Being a practicing physician he is acutely aware of the prerequisites to successfully attract and retain loyal and productive physicians to a regional health care network. Dr. Chahadeh received his medical degree at Damascus University in Syria. He studied general surgery and anesthesiology at Baylor College of Medicine in Houston. In addition to the general residencies, Dr. Chahadeh also achieved certifications in advanced microsurgery and cardiovascular anesthesia. Upon completion of his residencies, he pursued a fellowship in Pain Management at the University of Texas MD Anderson Cancer Center in Houston. He is Board Certified in Anesthesiology with added qualifications in pain management. As an experienced businessman, Dr. Chahadeh has a diverse background in the development and management of healthcare entities including ambulatory surgery, imaging and wound care centers and their associated real estate ventures.
Michael L. Griffin has been Chief Financial Officer and Director of the Company since April 1, 2011. From June 2009 to March 2010, he served as Chief Financial Officer of Luxxus Health where he served as an advisor to University General Hospital. From November 2002 to May 2009, he served as Chief Financial Officer of Prexus Health. Mr. Griffin has over twenty-five years of experience in the healthcare industry. He brings to the Company a diverse background in healthcare finance, capital markets, operations and development. His experience as an auditor with Peat Marwick and Chief Financial Officer for multiple hospital systems has provided him with a unique understanding of the healthcare industry. In addition as Chief Executive Officer for Simmons Healthcare, his role led him to such places as Australia to oversee development of medical facilities. Mr. Griffin is responsible for overseeing the Company’s Financial Reporting, Capital Financing, Budgeting, Patient Revenue Cycle and Billing, Facility Construction and Development and Forecasting for New Ancillary Services.
Donald W. Sapaugh has been President and Director of the Company since June 28, 2011. From January 2000 to June 2011 he served as the Founder, President and Chief Executive Officer of TrinityCare Senior Living. Mr. Sapaugh has over 30 years of healthcare experience. In 1996, he founded PremierCare, a company devoted to seniors to avoid costly inpatient hospitalization, and provided management services with over ten hospitals in six states. Mr. Sapaugh served as the Chief Executive Officer of Rapha Treatment Centers from May 1986 to May 1996. Mr. Sapaugh served in various financial management positions and as a Chief Financial Officer in five different general acute care and psychiatric hospitals from 1978 until 1986. Mr. Sapaugh has an extensive background in development, acquisitions, and mergers. He also has public company experience where he served as Chairman and Chief Executive Officer, as well as a consultant and board member to many public companies.
Edward T. Laborde, Jr. joined the Company in January 2011 as General Counsel, Secretary and Director. From 2004 to 2011, Mr. Laborde served as a Shareholder in the Corporate Securities and Finance Practice Group of the Houston office of Winstead PC. Mr. Laborde is an experienced corporate, securities and finance attorney working in a variety of industries, including the development of health care facilities. He served as lawyer in the Corporate Securities Practice Group of Houston based Chamberlain Hrdlicka from 1993 to 2004, and was made a Shareholder of Chamberlain Hrdlicka in January 2000. His experience includes acting as outside counsel to the developers of the Company and other healthcare and healthcare real estate development projects on a national scale. Areas under Mr. Laborde’s oversight and supervision in his healthcare practice have included real estate development and construction, leasing and lease financing, physician syndication and private placements, vendor and payor contracting, bank and lease financings, tax planning, government relations, and administrative proceedings. Prior to attending law school, Mr. Laborde was a corporate insurance broker representing Fortune 500 corporations in the placement of multi-layered property and casualty insurance programs. Mr. Laborde received his law degree from Tulane Law School and his undergraduate degree from Georgetown University.
Kris Trent joined the Company in May 2013 as Chief Accounting Officer. Ms. Trent oversees the Company’s accounting, internal and external financial reporting, tax, financial planning and analysis. Ms. Trent was previously a Partner with one of America’s “Big Four” audit, tax and advisory services firms where she was employed from January 1997 until April 2013. During her tenure, she served as the audit engagement partner on several public multinationals as well as the lead audit partner on several other multinational private companies. Her responsibilities included auditing, evaluating accounting implications throughout all phases of the audit, and ensuring that the companies complied with SOX 404 requirements.
Harmonee Vice joined the Company in January 2007 as Director of Human Resources of University General Hospital and was subsequently promoted to Director of Operations in May 2008. In January 2009, Ms. Vice was promoted to Chief Operating Officer of the hospital. In this role Ms. Vice coordinates the overall business operations. Ms. Vice is responsible for helping the hospital meet its strategic goals, implementing new service lines, strengthening the internal accountability systems, overseeing effective management and fiscal viability of the hospital departments. She has hands on experience in recruitment of physicians and professional staff focusing on high quality healthcare and service excellence. Ms. Vice has been responsible for numerous hospital departments including Human Resources, Risk Management, Quality, Marketing, Physician Relations, Laboratory and Imaging with over 15 years healthcare experience and has held a variety of positions within the HCA Holdings, Inc. and Hospital Partners of America Inc.
David Kreye joined the Company January 2014 as Chief Executive Officer of University General Hospital. Mr. Kreye oversees all aspects of the hospital operations. From 2011 to 2013, Mr. Kreye served as the Chief Executive of Lakeway Regional Medical Center (“Lakeway”). Prior to joining Lakeway, from 2008 to 2011, Mr. Kreye was the Chief Executive Officer of Health Management Associates. Prior to that time, from 2007 to 2008, Mr. Kreye served as Chief Operating Officer of Vanguard Health Systems, North Central Baptist Hospital. Mr. Kreye has extensive hospital management experience. Mr. Kreye brings to the Company a diverse background in healthcare management, including strategic planning, establish a culture of service, introduction and implementation of physician introduction and implementation of physician recruitment program, service line objectives, staffing standards, daily expense focus, revenue capture, purchasing standardization and revenue growth.
Randall J. Butler joined the Company in August 2012 as Chief Executive Officer of UGHS Physician Services, Inc. Mr. Butler oversees all aspects of the UGHS Physician Services. Mr. Butler is a president and owner of HealthExec Market Group and Management Affiliates of NE Houston since 2009. Mr. Butler is also the Chief Executive Officer and a member of the board of directors of Basaldua and Heller, PA since 2009. Mr. Butler has over 18 years of healthcare experience including healthcare operations, business development and consulting.
Director Relationships and Legal Proceedings
Our directors are employees of the Company. They do not hold any directorships in other reporting companies and do not qualify as “independent director” under the Rules of NASDAQ, Marketplace Rule 4200(a)(15). There are no family relationships among directors, nominees or executive officers of the Corporation.
To our knowledge, during the last five years, none of our directors and executive officers has:
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Had a bankruptcy petition filed by or against any business of which such person was a general partner or executive officer either at the time of the bankruptcy or within two years prior to that time.
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Been convicted in a criminal proceeding or been subject to a pending criminal proceeding, excluding traffic violations and other minor offenses.
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Been subject to any order, judgment or decree, not subsequently reversed, suspended or vacated, of any court of competent jurisdiction, permanently or temporarily enjoining, barring, suspending or otherwise limiting his involvement in any type of business, securities or banking activities.
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Been found by a court of competent jurisdiction (in a civil action), the SEC, or the Commodities Futures Trading Commission to have violated a federal or state securities or commodities law, and the judgment has not been reversed, suspended or vacated.
Directors Qualifications
Directors are responsible for overseeing our business consistent with their fiduciary duty to shareholders. This significant responsibility requires highly-skilled individuals with various qualities, attributes and professional experience. The board believes that there are general requirements for service on our board of directors that are applicable to all directors and that there are other skills and experience that should be represented on the board as a whole but not necessarily by each director. The board considers the qualifications of director and director candidates individually and in the broader context of the board’s overall composition and our current and future needs.
In its assessment of each potential candidate, including those recommended by shareholders, the board will consider the nominee’s judgment, integrity, experience, independence, understanding of our business or other related industries and such other factors it determines are pertinent in light of the current needs of the board. The board also takes into account the ability of a director to devote the time and effort necessary to fulfill his or her responsibilities to UGHS.
The board requires that each director be a recognized person of high integrity with a proven record of success in his or her field. Each director must demonstrate innovative thinking, familiarity with and respect for corporate governance requirements and practices, an appreciation of multiple cultures and a commitment to sustainability and to dealing responsibly with social issues. In addition to the qualifications required of all directors, the Board conducts interviews of potential director candidates to assess intangible qualities including the individual’s ability to ask difficult questions and, simultaneously, to work collegially. The board does not have a specific diversity policy, but considers diversity of race, ethnicity, gender, age, cultural background and professional experiences in evaluating candidates for board membership. Diversity is important because a variety of points of view contribute to a more effective decision-making process.
Qualifications, Attributes, Skills and Experience to be Represented on the Board as a Whole
The board has identified particular qualifications, attributes, skills and experience that are important to be represented on the board as a whole, in light of our current needs and our business priorities. The board believes that it should include some directors with a high level of financial literacy and some directors who possess relevant business experience as Executives, directors, consultants, professional or other capacities in healthcare industry. Each director identified as having experience in industries which are or have been highly competitive (all) or highly regulated, especially the healthcare industry. Each director was deemed of sufficient experiences, viewpoints, and expertise necessary to perform the duties of a public company director, as well as being able to vigorously perform his duties as a director of the Company.
Presently, Dr. Chahadeh, Mr. Griffin, Mr. Sapaugh and Mr. Laborde are the directors of the Company. They possess many of the skills and experience needed for our business. They are experienced in the healthcare industry for many years. The board plans to eventually increase its membership to include independent directors with skills and experience complementary to our board of directors.
Board Leadership Structure and Role in Risk Oversight
Dr. Chahadeh is our chairman and Chief Executive Officer. The board’s role in the risk oversight of the Company includes, among other things:
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appointing, retaining and overseeing the work of the independent auditors, including resolving disagreements between management and the independent auditors relating to financial reporting;
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approving all auditing and non-auditing services permitted to be performed by the independent auditors;
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reviewing annually the independence and quality control procedures of the independent auditors;
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reviewing and approving all proposed related party transactions;
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discussing the annual audited financial statements with the management;
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meeting separately with the independent auditors to discuss critical accounting policies, management letters, recommendations on internal controls, the auditor’s engagement letter, independence letter and other material written communications between the independent auditors and management.
Compliance with Section 16(a) of Exchange Act
Section 16(a) of the Exchange Act requires our executive officers and directors and persons who own more than 10% of a registered class of our equity securities to file with the SEC initial statements of beneficial ownership, reports of changes in ownership and annual reports concerning their ownership of our common stock and other equity securities, on Form 3, 4 and 5 respectively. Executive officers, directors and greater than 10% shareholders are required by the SEC regulations to furnish our company with copies of all Section 16(a) reports they file.
Based solely on our review of the copies of such reports received by us and on written representations by our officers and directors regarding their compliance with the applicable reporting requirements under Section 16(a) of the Exchange Act, we believe that, with respect to the year ended December 31, 2012, our officers and directors, and all of the persons known to us to own more than 10% of our common stock, filed all required reports on a timely basis.
Code of Ethics
We have adopted a Code of Ethics that applies to our principal executive officer, principal financial officer, principal accounting officer or controller, and persons performing similar functions. Our code of ethics is filed as Exhibit 14 to our annual report on Form 10-K for the year ended December 31, 2011. Our Code of Ethics is available free of charge by writing to Corporate Secretary at 7501 Fannin Street, Houston, Texas 77054. We intend to post on our website any amendments to such code or any waiver from a provision of the code relating to the elements of a “code of ethics” under Securities and Exchange Commission rules, where such waiver is to the principal executive officer, principal financial officer, principal accounting officer or controller (or persons performing similar functions).
Meetings of Our Board of Directors
Our Board of Directors held fourteen (14) meetings during the year ended December 31, 2013.
Board Committees
Audit Committee. We intend to establish an audit committee of the board of directors, which will consist of soon-to-be-nominated independent directors. The audit committee’s duties would be to recommend to our board of directors the engagement of independent auditors to audit our financial statements and to review our accounting and auditing principles. The audit committee would review the scope, timing and fees for the annual audit and the results of audit examinations performed by the internal auditors and independent public accountants, including their recommendations to improve the system of accounting and internal controls. The audit committee would at all times be composed exclusively of directors who are, in the opinion of our board of directors, free from any relationship which would interfere with the exercise of independent judgment as a committee member and who possess an understanding of financial statements and generally accepted accounting principles.
Audit Committee Financial Expert. Our board of directors currently acts as our audit committee. Because we are still a developing company, our board of directors is still in the process of finding an “audit committee financial expert” as defined in Regulation S-K and directors that are “independent” as that term is used in Section 10A of the Exchange Act.
Compensation Committee. We intend to establish a compensation committee of the board of directors. The compensation committee would review and approve our salary and benefits policies, including compensation of executive officers.
Director Compensation
We did not compensate our directors for board services for the year 2013. However, in the future, we intend to implement a market-based director compensation program.
Limitations on Liability
Article Sixteen of our Articles of Incorporation provide that no director or officer of the Corporation shall be personally liable to the Corporation or its shareholders for damages for breach of fiduciary duty as a director or officer, except: (A) for acts or omissions that involve intentional misconduct, fraud or a knowing violation of law; or (B) the payment of distributions in violation of Nevada Revised Statues Sec. 78.300. If the General Corporation law of the State of Nevada is amended after the date of filing of these Articles to further eliminate or limit the personal liability directors, then the liability of a director of the Corporation shall be eliminated or limited to the fullest extent permitted by the General Corporation Law of the State of Nevada, as so amended.
We are also permitted to apply for insurance on behalf of any director, officer, employee or other agent for liability arising out of his actions, whether or not the Nevada General Corporation Law would permit indemnification.
Indemnification against Public Policy
Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers or persons controlling an issuer pursuant to the foregoing provisions, the opinion of the Commission is that such indemnification is against public policy as expressed in the Securities Act of 1933 and is therefore unenforceable. In the event that a claim for indemnification against such liabilities (other than director, officer or controlling person in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, we will, unless in the opinion of our counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by us is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue.
The effect of indemnification may be to limit our rights and our shareholders (through shareholders’ derivative suits on behalf of UGHS) to recover monetary damages and expenses against a director for breach of fiduciary duty.
Shareholder Communications
Currently, we do not have a policy with regard to the consideration of any director candidates recommended by security holders. To date, no security holders have made any such recommendations.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth information concerning the compensation for services rendered in all capacities to UHGS and its subsidiaries for the years ended December 31, 2013 and 2012 for our Chairman and Chief Executive Officer and our most highly compensated executive officers.
(1) The following clarifying information is provided:
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Dr. Chahadeh’s base salary was increased in July 2013 from $600,000 to $850,000 and subsequently was increased to $1,350,000 in September 2013.
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Mr. Griffin’s base salary was increased in July 2013 from $550,000 to $564,714 and subsequently was increased to $700,000 in September 2013.
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Mr. Sapaugh’s base salary was increased in July 2013 from $500,000 to $514,510 and subsequently was increased to $600,000 in September 2013.
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Mr. Laborde’s base salary was increased in July 2013 from $500,000 to $509,103 and subsequently was increased to $600,000 in September 2013.
(2) Dr. Chahadeh’s base salary and Mr. Griffin’s base salary were increased in April 2012 from $456,000 to $600,000.
(3) Dr. Chahadeh and Mr. Griffin joined the Company on April 1, 2011 at a base salary of $456,000.
(4) On June 28, 2011, the Board of Directors of the Company appointed Mr. Sapaugh as the President and Director of the Company. Mr. Sapaugh commenced employment with the Company on September 1, 2011 at a base salary of $456,000.
(5) In consideration for his decision to accept employment with the Company on January 14, 2011, Mr. Laborde received a lump-sum payment of $30,000 and his base salary of $456,000.
(6) Mr. Butler joined the Company in August 2012, at a base salary of $420,000. Mr. Butler’s base salary was increased to $441,000 in July 2013.
(7) All other compensation includes auto allowances of $25,027 for Dr. Chahadeh and the remaining amounts represent payments of paid-time off obligations.
Employment Agreements
We have entered into employment agreements with the following Named Executive Officers (the “Executive Employment Agreements”):
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Hassan Chahadeh, our Chairman and Chief Executive Officer, effective on April 1, 2012,
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Michael L. Griffin, our Chief Financial Officer and Director, effective on April 1, 2012,
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Donald W. Sapaugh, our President and Director, effective on September 1, 2011, and
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Edward T. Laborde, Jr., our Secretary, General Counsel and Director, effective on January 14, 2011.
The Executive Employment Agreements establish the duties and compensation of these Named Executive Officers and provide for their continued employment with us. The following information reflects the material terms of each of the Executive Employment Agreements (as defined in the respective Executive Employment Agreements).
The Company’s executive officers, including these Named Executive Officers, are employees of the Company’s wholly-owned subsidiary, UGHS Management Services, Inc.
Term. The Executive Employment Agreements provide for an initial term of three (3) years with renewal on each anniversary thereafter for an additional one-year term unless there is an affirmative decision not to renew the contract by us or by Executive.
Base Salary and Benefits. The Executive Employment Agreements provide each Executive with an annual base salary of $456,000 for the first calendar year or portion thereof. In each subsequent calendar year during the term of the agreements, we shall pay to each Executive an annual base salary determined by the Board of Directors following its annual salary performance review. During the term of employment of each Executive hereunder, each Executive shall participate in all employee benefit plans sponsored by us for our executive employees, including but not limited to sick leave and disability leave, Executive and Executive’s dependents under our health insurance plan and dental insurance and pension and/or profit sharing plans; provided, the nature, amount and limitations of such plans shall be determined from time to time by the Board of Directors. The agreements also provide for Executive’s participation in any and all retirement and employee benefit plans maintained by us on behalf of our employees, as well as fringe benefits normally associated with Executive’s position with us or made available to all other employees.
Termination
In General. The Executive Employment Agreements provide that if the Executive is terminated by us or by the Executive, the Executive will be entitled to receive an amount equal to the sum of (i) the Executive’s earned but unpaid Annual Base Salary through the date of termination of employment at the rate in effect at the time of such termination, (ii) vacation pay earned but not taken to the date of such termination, and (iii) all other amounts previously deferred by Executive or earned but not paid as of such date under all Company incentive or deferred compensation plans or programs.
If the Executive is terminated by us without Cause (as defined below) or terminates his employment for Good Reason (as defined below), the Executive will be entitled to receive the following amounts:
(i) An amount equal to Executive’s Annual Base Salary then in effect, payable in a single lump sum within 30 days of such termination; and
(ii) An amount equal to the product of (A) the maximum monthly premium payment that may be charged to continue coverage for Executive and Executive’s dependents under our health insurance plan under COBRA, and under all life insurance and disability policies provided by us for Executive multiplied by (B)
(iii) 12 months (payable over such period). Any unpaid amount under this clause (ii) will cease if Executive obtains substantially similar coverage under new employment.
If the Executive is terminated by us for Cause, or if the Executive terminates employment without Good Reason, the payments due to Executive shall be limited to the amounts (i) the Executive’s earned but unpaid Annual Base Salary through the date of termination of employment at the rate in effect at the time of such termination, (ii) vacation pay earned but not taken to the date of such termination, and (iii) all other amounts previously deferred by Executive or earned but not paid as of such date under all our incentive or deferred compensation plans or programs.
If at any time during the term of Executive’s employment hereunder, Executive is unable, due to physical or mental disability, to perform effectively Executive’s duties hereunder, we shall continue payment of base salary as during the first 3 month period of such disability to the extent not covered by our disability insurance policies. Upon the expiration of such 3 month period, UGHS, at its sole option, may continue payment of Executive’s salary for such additional periods as we elect, or may terminate Employee’s employment hereunder without any further compensation obligations to Executive hereunder. If Executive should die during the term of Executive’s employment hereunder, Executive’s employment and our obligations hereunder for compensation payments shall terminate as of the end of the month in which Executive’s death occurs.
Covenant Not to Compete. The following information reflects the material terms of each of the Executive Employment Agreements except that of Mr. Laborde.
(a) During Executive’s employment with us or any of our Affiliates and thereafter during the Restricted Period (as defined below), regardless of the reason for the termination of Executive’s employment, Executive will not engage in or carry on, directly or indirectly, either for himself or as a member of a partnership or as a shareholder, investor, owner, officer or director of a company or other entity, or as an employee, agent, associate or consultant of any person, partnership, corporation or other entity, any business that directly competes with any services or products produced, sold, conducted, developed, or in the process of development by us or our Affiliates on the date of termination of Executive’s employment within a 35 mile radius of such business or entity
(b) Notwithstanding the foregoing, Executive shall not be deemed to be in violation of Section 12(a) based solely on the ownership of less than one percent (1%) of any class of securities of a publicly-held company whose gross assets exceed $100,000,000.
(c) Executive acknowledges that the limitations set forth herein on Executive’s rights to compete with us and our Affiliates are reasonable and necessary for the protection of us and our Affiliates. In this regard, Executive specifically agrees that the limitations as to period of time and geographic area, as well as all other restrictions on Executive’s activities specified herein, are reasonable and necessary for the protection of us and our Affiliates. In particular, Executive acknowledges that the parties anticipate that Executive will be actively seeking markets for the products and services of us and our Affiliates throughout the United States during Executive’s employment with us.
(d) In the event that there shall be any violation of the covenant not to compete set forth in this section, then the time limitation thereof shall be extended for a period of time equal to the period of time during which such violation continues; and in the event we are required to seek relief from such violation in any court, board of arbitration or other tribunal, then the covenant shall be extended for a period of time equal to the pendency of such proceedings, including all appeals.
(e) Executive agrees that the remedy at law for any breach by Executive of this section will be inadequate and that we shall also be entitled to injunctive relief.
Change in Control.
If a Change of Control (as defined below) occurs and if during the Protected Period (as defined below) Executive’s employment is terminated or not renewed, whether by us or by Executive, then we shall promptly pay or otherwise provide to Executive the benefits set forth below:
(i) An amount equal to Executive’s Annual Base Salary then in effect, payable in a single lump sum within 30 days of such termination; and
(ii) An amount equal to the product of (A) the maximum monthly premium payment that may be charged to continue coverage for Executive and Executive’s dependents under our health insurance plan under COBRA and under all life insurance and disability policies provided by us for Executive, multiplied by (B) 12 months (payable over such period). Any unpaid amount under this clause (ii) will cease if Executive obtains substantially similar coverage under new employment.
Gross-Up Payments. If any payment to the Named Executive Officer due to a Change in Control subjects the Executive to any excise tax, we will pay to the Executive a gross-up payment to compensate the Executive for the amount of the excise tax.
Defined Terms. Definitions for some of the terms used in this discussion in the order they are first used areas below:
“Cause” when used in connection with the termination of employment with the Company, means the termination of Employee’s employment by the Company by reason of (i) the conviction of Employee of a crime involving moral turpitude by a court of competent jurisdiction; (ii) the proven commission by Employee of an act of fraud upon the Company; (iii) the willful and proven misappropriation of any funds or property of the Company by Employee; (iv) the willful, continued and unreasonable failure by Employee to perform material duties assigned to Employee after reasonable written notice and opportunity to cure such performance has been given by the Company; (v) the knowing engagement by Employee in any direct, material conflict of interest with the Company without compliance with the Company’s conflict of interest policy, if any then in effect; (vi) the knowing engagement by Employee, without the approval of the General Partner of the Company, in any activity which would result in a material injury to the Company or any of its Affiliates; or (vii) the knowing engagement in any activity which would constitute a material violation of the provisions of the Company’s Insider Trading Policy or Business Ethics Policy, if any, then in effect.
“Good Reason” means the occurrence of any of the following events:
(a) Employee is assigned duties, taken as a whole, that are materially inconsistent with, or materially diminished from, Employee’s positions, duties, responsibilities and status with the Company immediately prior to such action, or Employee’s status,’ reporting responsibilities, titles or offices are materially diminished from those in effect immediately prior to such action, or Employee’s duties and responsibilities are materially increased without a corresponding reasonable increase in the Employee’s compensation (provided that in the case of such a change within a Protected Period, such increase must be satisfactory to the Employee in Employee’s sole reasonable judgment), except in each case in connection with the termination of Employee’s employment by the Company for Cause or on account of disability, or as a result of the Employee’s death, or by the Employee for other than Good Reason; provided, however, that, Good Reason shall not be triggered under this subsection (a) by an immaterial action not taken in bad faith or by an action that is remedied by the Company promptly after receipt of written notice from Employee; or
(b) Employee’s Annual Base Salary is reduced (i) within a Protected Period, from that in effect immediately prior to the commencement of a Protected Period or as the same may be increased from time to time thereafter, or (ii) other than within a Protected Period, from that which was in effect prior to such action unless such reduction is part of a general reduction in compensation within the officer ranks due to economic or company-wide considerations; or
(c) The Company (i) within a Protected Period, fails to continue in effect any benefit or compensation plan, including, but not limited to, the annual bonus plan, qualified retirement plan, executive life insurance plan and/or health and accident plan, in which Employee is participating immediately prior to the commencement of the Protected Period, or plans providing, in the sole reasonable judgment of Employee, Employee with substantially similar benefits, or the Company takes any action that would adversely affect Employee’s participation in or reduce Employee’s benefits under any of such plans (excluding any such action by the Company that is required by law), or (ii) other than within a Protected Period, takes any action to materially reduce or eliminate Employee’s participation in the Company’s benefit or compensation plans unless such reduction or elimination is part of a general reduction in benefits within the officer ranks due to economic or company-wide considerations; or
(d) The Company requires the Employee to take any action that Employee reasonably concludes would violate or conflict ethical rules governing attorney conduct or other applicable law; or
(e) The Company requires Employee at any time to relocate more than 50 miles from Houston, Texas; or
(f) The amendment, modification or repeal of any provision of the Certificate of Formation of the Company, the Partnership Agreement or any other governing document of the Company that was in effect immediately prior to the commencement of a Protected Period, if such amendment, modification or repeal would materially adversely affect Employee’s rights to indemnification by the Company; or
(g) The Company shall violate or breach any obligation of the Company (regardless whether such obligation be set forth in the Partnership Agreement and/or in this Agreement or any other separate agreement entered into between the Company and Employee) to indemnify Employee against any claim, loss, expense or liability sustained or incurred by Employee by reason, in whole or in part, of the fact that Employee is or was an officer or director of the Company; or
(h) The Company shall violate or breach any other material obligation of the Company owing to Employee relating to Employee’s employment with the Company, provided that in the event of a violation or breach that is reasonably subject to being cured by the Company, Good Reason shall only occur if the Company shall fail or refuse to commence a cure within 15 days after written notice thereof is given by Employee to the Company or shall thereafter fail to diligently prosecute such cure to completion; or
(i) The Company shall fail to keep in force, for the benefit of Employee, directors’ and officers’ insurance policy with coverage amounts and scope at least equal to the coverage amounts in effect on the date hereof; or
(j) The Company shall fail to obtain from a successor (including a successor to a material portion of the business or assets of the Company) a satisfactory assumption in writing of the Company’s obligations under this Agreement; or
(k) The Company shall fail to provide Employee with office space, related facilities and support personnel (including, but not limited to, administrative and secretarial assistance) that are both commensurate with the Employee’s position and Employee’s responsibilities to and position with the Company and not materially dissimilar to the office space, related facilities and support personnel provided to other executive officers of the Company; or
(l) The Company notifies Employee of the Company’s intention not to observe or perform one or more of the material obligations of the Company under this Agreement.
“Change of Control” means the acquisition by any individual, entity or group (within the meaning of Section 13(d)(3) or 14(d)(2) of the Exchange Act (a “Designated Person”) of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”)) of 50% or more of either (1) the then outstanding partnership interests of the Company (the “Outstanding Company Common Stock”), Management Control or (2) the combined voting power of the then outstanding voting securities of the Company entitled to vote generally in the election of managers (the “Outstanding. Company Voting Securities”); provided, however, that the following acquisitions shall not constitute a Change of Control: (a) any acquisition of Common Stock of the Company or voting securities of the Company directly from the Company (excluding an acquisition by virtue of the exercise of a conversion privilege), (b) any acquisition of Common Stock of the Company or voting securities of the Company by the Company (c) any acquisition of Common Stock of the Company or voting securities of the Company by any employee benefit plan(s) (or related trust(s)) sponsored or maintained by the Company or any corporation controlled by the Company and approved by the incumbent General Partner, or (d) any acquisition by any corporation pursuant to a reorganization, merger or consolidation, if, immediately following such reorganization, merger or consolidation, the conditions described in clauses (1), (2) and (3) of paragraph (iii) below of this definition are satisfied.
“Protected Period” means the period of time beginning with a Change of Control and ending six months following such Change of Control; provided, however, that if any event has occurred which could reasonably be expected to result in a Change of Control and a Change of Control occurs within six months after such event, then the Protected Period will begin on the date of such event.
“Restricted Period” means the period beginning on the date of the termination or resignation of Employee’s employment with the Company and its Affiliates and ending as follows, as applicable:
(i) one (1) year after the termination of Employee’s employment if Employee is not entitled to benefits under Section 7(a) or 10(c); or;
(ii) two (2) years after the termination of Employee’s employment, if Employee receives all of the benefits under Section 7(a) or 10(c) (after giving effect to any permissible setoff).
Equity Compensation Plan Information
We currently do not have any equity compensation plans; however we are currently considering the implementation of an equity compensation plan.
Directors’ and Officers’ Liability Insurance
We currently have insurance insuring directors and officers against liability.
Compensation Discussion and Analysis
We strive to provide our named executive officers (as defined in Item 402 of Regulation S-K) with a competitive base salary that is in line with their roles and responsibilities when compared to peer companies of comparable size in similar locations. The base salary level is established and reviewed based on the level of responsibilities, the experience and tenure of the individual and the current and potential contributions of the individual. The base salary is compared to the list of similar positions within comparable peer companies and consideration is given to the executive’s relative experience in his or her position. Base salaries are reviewed periodically and at the time of promotion or other changes in responsibilities.
We plan to implement a more comprehensive compensation program, which takes into account other elements of compensation, including, without limitation, short and long term compensation, cash and non-cash, and other equity-based compensation such as stock options. We expect that this compensation program will be comparable to the programs of our peer companies and aimed to retain and attract talented individuals. We will also consider forming a compensation committee to oversee the compensation of our named executive officers. The majority of the members of the compensation committee would be independent directors.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table sets forth certain information with respect to the beneficial ownership of our voting securities by (i) any person or entity known by us to be the beneficial owner of more than five percent (5.0%) of our outstanding common stock (ii) each director, (iii) each of our Named Executive Officers and (iv) all executive officers and significant employees as a group as of June 23, 2014.
* The address of each beneficial owner, unless otherwise noted, is c/o University General Health System, Inc., 7501 fanning Street, Houston, Texas 77054.
(1) The information is based on the Schedule 13G/A filed with the Securities and Exchange Commission (the “SEC”) on March 28, 2011 by the Company and by the reporting person’s Form 5 reporting on beneficial ownership as of February 15, 2013.
(2) The address of the beneficial owner, unless otherwise noted, is Yorktown Plaza, 5373 West Alabama, Suite 121, Houston, Texas 77056.
(3) Percentage ownership of executive officer and significant employees is based on 379,287,816 as of June 23, 2014.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Information with respect to this item may be found in Note 9 to the Consolidated Financial Statements in “Index to Consolidated Financial Statements of University General Health System, Inc.” included on page for information required under this Item 8, which is incorporated herein by reference.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The aggregate fees billed and expected to be billed by our independent registered public accounting firms and auditors for professional services rendered to us for the years ended December 31, 2013 and 2012 were as follows:
(1) On December 29, 2012, we, at the direction of the Board of Directors, dismissed Moss, Krusick & Associates, LLC (“MKA”) as our independent registered public accounting firm, effective December 29, 2012. MKA had served as our independent registered public accounting firm since March 9, 2011 and effective June 15, 2011 was approved by the Board to audit our consolidated financial statements for the year ended December 31, 2011. Effective December 29, 2012, the Company’s Board approved the engagement of Crowe Horwath LLP (“Crowe”) as the Company’s new independent registered public accounting firm to audit the Company’s consolidated financial statements for the year ending December 31, 2012. The total fees billed by Crowe for 2012 was $1,100,000. On May 31, 2013, the Board dismissed Crowe, and on June 3, 2013 engaged MKA as the Company’s new independent registered public accounting firm to audit the Company’s consolidated financial statements for the year ending December 31, 2012.
There were no fees billed by our principle accountant in either 2013 or 2012 for Audit-Related Fees, Tax Fees or All Other Fees. These services were performed by separate outside accounting firms.
All of the services rendered to us by our independent registered public accountants were pre-approved by our Board of Directors.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Documents filed as part of this report:
1. Financial Statements:
See “Index to Consolidated Financial Statements of University General Health System, Inc.” on page, the Reports of Independent Registered Public Accounting Firms on page, and the Financial Statements on pages to, of this Form 10-K, all of which are incorporated herein by reference.
2. Financial Statement Schedules:
All schedules are omitted because they are not applicable or not required or because the required information is shown in the Consolidated Financial Statements or Notes thereto on pages to, which are incorporated herein by reference.
3. Exhibits Index:
The following documents are the exhibits to this Form 10-K. For convenient reference, each exhibit is listed according to the Exhibit Table of Item 601 of Regulation S-K.
 Management contract or compensatory plan or arrangement.
* Filed electronically herewith.
** Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS OF UNIVERSITY GENERAL HEALTH SYSTEM, INC.
REPORT OF INDEPENDENT REGISTERED CERTIFIED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders
University General Health System, Inc.
Houston, Texas
We have audited the accompanying consolidated balance sheets of University General Health System, Inc. and subsidiaries (the “Company”) as of December 31, 2013 and 2012, and the related consolidated statements of operations, shareholders’ equity (deficit), and cash flows for each of the two years in the period ended December 31, 2013. The Company’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of University General Health System, Inc. and subsidiaries as of December 31, 2013 and 2012, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2013 in conformity with accounting principles generally accepted in the United States of America.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company has negative working capital and relative low levels of cash and cash equivalents. These conditions raise substantial doubt about its ability to continue as a going concern. Management’s plans regarding those matters are also described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ Moss, Krusick & Associates, LLC
Winter Park, Florida
July 2, 2014
UNIVERSITY GENERAL HEALTH SYSTEM, INC.
Consolidated Balance Sheets
The accompanying notes are an integral part of these consolidated financial statements.
UNIVERSITY GENERAL HEALTH SYSTEM, INC.
Consolidated Statements of Operations
The accompanying notes are an integral part of these consolidated financial statements.
UNIVERSITY GENERAL HEALTH SYSTEM, INC.
Consolidated Statements of Cash Flows
The accompanying notes are an integral part of these consolidated financial statements.
UNIVERSITY GENERAL HEALTH SYSTEM, INC.
Consolidated Statements of Shareholders’ Equity
The accompanying notes are an integral part of these consolidated financial statements.
University General Health System, Inc.
Notes to the Consolidated Financial Statements
NOTE 1 - DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business
On March 28, 2011, pursuant to an Agreement and Plan of Reorganization (“Reorganization Agreement”) executed on March 10, 2011, SeaBridge Freight, Corp. (“SeaBridge”), a publicly reporting Nevada corporation, acquired University General Hospital, LP (the “UGH LP”), a Texas limited partnership and University Hospital Systems, LLP (the “UGH GP”), a Delaware limited liability partnership (collectively the “UGH Partnerships”) in exchange for the issuance of 232,416,956 shares of common stock, a majority of the common stock, to the former partners of the UGH Partnerships.
For financial accounting purposes, this acquisition (referred to as the “Merger”) was a reverse acquisition of SeaBridge by the UGH Partnerships and was treated as a recapitalization with the UGH Partnerships as the accounting acquirer. Accordingly, the 2011 financial statements have been prepared to give retroactive effect of the reverse acquisition completed on March 28, 2011 and represent the operations of UGH Partnerships.
In connection with and immediately following the Merger, SeaBridge changed its name to University General Health System, Inc. (“UGHS”, or the “Company”) and divested of its wholly-owned subsidiary, SeaBridge Freight, Inc. SeaBridge was in the business of providing container-on-barge, break-bulk and out-of-gauge freight transport service between Port Manatee of Tampa Bay, Florida and Port Brownsville, Texas. In consideration of the divestiture, the Company received and cancelled 135,000,000 outstanding shares of common stock of the Company from existing shareholders. After the completion of the merger, approximately 232,416,956 common shares were held by the former UGH partners and approximately 22,002,375 were held by former SeaBridge shareholders.
After the Merger, the Company is a diversified, integrated, multi-specialty health care provider that delivers concierge physician and patient oriented services providing timely and innovative health solutions that are competitive, efficient and adaptive in today’s health care delivery environment. The Company owned and operated University General Hospital (the “UGH”), a 69-bed acute care hospital in Houston, Texas. UGH commenced business operations as a general acute care hospital on September 27, 2006. The Company is headquartered in Houston, Texas.
In June 2011, the Company completed the acquisitions of the three senior living communities: Trinity Oaks of Pearland, Texas, Trinity Shores of Port Lavaca, Texas, and Trinity Hills of Knoxville, Tennessee. The Company also acquired 51.0% of the ownership interests of TrinityCare Senior Living, LLC (“TrinityCare”), a developer and manager of senior living communities. As the Company’s majority-owned subsidiary, TrinityCare continues to manage the three existing senior living communities, and will continue to develop additional communities across the United States and internationally. Additionally, effective June 30, 2011, the Company acquired specialized health care billing, coding and other revenue cycle management companies, Autimis, LLC, and Autimis Medical Billing, LLC. On December 31, 2011, the Company completed the acquisition of Sybaris Group, LLC (“Sybaris”), a luxury hospitality service provider and facility management company. The acquisition of Sybaris allows the Company to grow more rapidly and leverage the scalability of its business model. In connection with the acquisition of Sybaris, the Company changed its Revenue Management operating segment name to Support Services, Inc. (“Support Services”) and additionally Sybaris changed its name to Sybaris Group, Inc. and is included in the Support Services operating segment. In 2013 and 2012, the Company has completed several hospital outpatient departments (HOPDs) acquisitions that enhance its capabilities in existing markets and in new markets. Additionally, the Company acquired South Hampton Community Hospital in Dallas, Texas in December 2012.
As of December 31, 2013, the Company conducted operations through its wholly-owned subsidiaries, UGHS Hospitals, Inc., UGHS Ancillary Services, Inc., UGHS Management Services, Inc., UGHS Real Estate, Inc., UGHS Physician Services, Inc., UGHS Senior Living of Pearland, LLC, UGHS Senior Living of Port Lavaca, LLC, UGHS Senior Living of Knoxville, LLC, UGHS Autimis Billing, Inc., UGHS Autimis Coding, Inc. and Sybaris Group, Inc.
Principles of Consolidation and Reporting
The Company presents its financial statements in accordance with generally accepted accounting principles in the United States of America (“GAAP”). The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated upon consolidation.
University General Health System, Inc.
Notes to the Consolidated Financial Statements - (Continued)
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principle in the United States of America requires management to make a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Management bases its estimates on historical experience and on various assumptions which are believed to be reasonable under the circumstances.
Reclassification
Certain reclassifications have been made to prior year’s financial statements to conform to the current year financial statement presentation.
Cash and Cash Equivalents
Cash and cash equivalents consist of highly liquid financial instruments, which have original maturities of three months or less when purchased. Cash is deposited with commercial banks and may have deposits totaling amounts in excess of the federally insured limits from time to time.
Concentration of Credit Risk
Financial instruments which potentially subject the Company to concentrations of credit risk primarily include accounts receivable. The Company’s concentration of credit risk with respect to accounts receivable is high due to Blue Cross Blue Shield of Texas comprising 16.6% of total accounts receivable. The Company provides for bad debts principally based upon the aging of accounts receivable and uses specific identification to write off amounts against its allowance for doubtful accounts. The Company believes the allowance for doubtful accounts adequately provides for estimated losses as of December 31, 2013 and 2012. The Company has a risk of incurring losses if such allowances are not adequate.
Accounts Receivable
Accounts receivable primarily consist of amounts due from third-party payors and patients. Receivables from government-related programs consist of Medicare and Medicaid. Commercial and managed care receivables consist of receivables from various payors involved in diverse activities and subject to differing economic conditions. Self-pay revenues are derived primarily from patients who do not have any form of healthcare coverage. The revenues associated with self-pay patients are generally reported at the Company’s gross charges. The Company evaluates these patients, after the patient’s medical condition is determined to be stable, for their ability to pay based upon federal and state poverty guidelines, qualifications for Medicaid or other governmental assistance programs. Accounts receivables are stated at estimated net realizable value. The breakdown of accounts receivable by payer classification as of December 31, 2013 and 2012 consists of the following:
Accounts receivable are based on gross patient receivables of $168,789,697 and $112,109,840, net of contractual adjustments of $110,868,664 and $70,298,242 as of December 31, 2013 and 2012, respectively. Additionally, the Company had other accounts receivable of $1,983,920 and $551,882 as of December 31, 2013 and 2012. The Company maintains allowances for uncollectible accounts for estimated losses resulting from the payors’ inability to make payments on accounts. The Company assesses the reasonableness of the allowance account based on historic write-offs, the aging of accounts and other current conditions. Furthermore, management continually monitors and adjusts the allowances associated with its receivables.
University General Health System, Inc.
Notes to the Consolidated Financial Statements - (Continued)
Substantially all of our accounts receivable are related to providing healthcare services to patients. Collection of these accounts receivable is our primary source of cash and is critical to our operating performance. Our primary collection risks relate to non-governmental payors who insure these patients, and deductibles, co-payments and self-insured amounts owed by the patient. At December 31, 2013 and 2012, deductibles, co-payments and self-insured amounts owed by the patient accounted for approximately 1.4% and 1.9% of our accounts receivable balance before doubtful accounts. Our general policy is to verify insurance coverage prior to the date of admission for a patient admitted to our hospitals and to verify insurance coverage prior to a patient’s first outpatient visit. Our estimate for the allowance for doubtful accounts is calculated by providing a reserve allowance based upon the age of an account balance. Generally we apply the collection rates to the gross accounts receivable amounts for the first 120 days for both inpatient and outpatient to determine the contractual adjustment, the remaining amount is assessed for collectability. As such, we then apply a graduated reserve to uncollectible accounts for greater than 121 days. This method is monitored based on our historical cash collections experience and other factors, including management’s plans related to collections. Collections are impacted by the effectiveness of our collection efforts with non-governmental payors and regulatory or administrative disruptions with the fiscal intermediaries that pay our governmental receivables. The allowance for doubtful accounts was $36,802,691 and $21,422,475 as of December 31, 2013 and 2012, respectively.
Inventories
Inventories consist of medical and pharmacy supplies which are valued at the lower of cost or market, using the first-in, first-out method.
Property, Equipment and Leasehold Improvements, Net
Property and equipment are initially stated at cost and fair value at date of acquisition. Depreciation is calculated on the straight-line method over the estimated useful lives of the assets. Upon retirement or disposal of assets, the asset and accumulated depreciation accounts are adjusted accordingly, and any gain or loss is reflected in earnings or loss of the respective period. Maintenance costs and repairs are expensed as incurred; significant renewals and betterments are capitalized. Assets held under capital leases are classified as property and equipment and amortized using the straight-line method over the shorter of the useful lives or lease terms, and the related obligations are recorded as debt. Amortization of assets under capital leases and of leasehold improvements is included in depreciation expense. The Company records operating lease expense on a straight-line basis unless another systematic and rational allocation is more representative of the time pattern in which the leased property is physically employed. The Company amortizes leasehold improvements, including amounts funded by landlord incentives or allowances, for which the related deferred rent is amortized as a reduction of lease expense, over the shorter of their economic lives or the lease term. The estimated useful lives in years are generally as follows:
Intangible Assets
As part of the acquisitions of and TrinityCare and Autimis on June 30, 2011, the Company acquired the rights to the developed software, customer relationships, tradename, and non-compete agreements which were identified as finite-lived intangible assets.
University General Health System, Inc.
Notes to the Consolidated Financial Statements - (Continued)
The fair value of customer relationship, tradename and non-compete agreements were capitalized as of the acquisition date and subsequently amortized using a straight-line method to depreciation and amortization expense over their estimated period of use of five years. The Company recorded the developed software technology of Autimis as an allocation of purchase price based on the fair value. The software is amortized on a straight-line basis over the estimated 10 year life. The balance of the intangible asset, net of accumulated amortization of was $4,499,653 and $5,919,000 at December 31, 2013 and 2012, respectively. The amortization expense for intangible asset was $1,454,000 and $1,712,000 for the years ended December 31, 2013 and 2012, respectively. Future estimated amortization expense for the carrying amount of intangible assets as of December 31, 2013 is expected to be as follows:
Debt Issuance Costs
Debt issuance costs are accounted for as a deferred charge and are amortized on a straight-line basis over the terms of the related financing agreements. The balance of the debt issuance costs, net of accumulated amortization of $2,709,980 and $1,425,533, is $440,135 and $1,724,582 at December 31, 2013 and 2012, respectively.
Impairment of Long-lived Assets
Long-lived assets, which include property, plant and equipment, are reviewed to determine whether any events or changes in circumstances indicate that the carrying amount of an asset, or related groups of assets, may not be fully recoverable from estimated future cash flows.
The Company evaluates its long-lived assets for possible impairment annually or whenever events or changes in circumstances indicate that the carrying amount of the asset, or related group of assets, may not be recoverable from estimated future undiscounted cash flows. If the estimated future undiscounted cash flows are less than the carrying value of the assets, the Company calculates the amount of impairment if the carrying value of the long-lived assets exceeds the fair value of the assets. The fair value of the assets is estimated based on appraisals, established market values of comparable assets or internal estimates of future net cash flows expected to result from the use and ultimate disposition of the asset. The estimates of these future cash flows are based on assumptions and projections it believes to be reasonable and supportable. The estimates require the Company’s subjective judgments and take into account assumptions about revenue and expense growth rates. These assumptions may vary by type of facility and presume stable, improving or, in some cases, declining results at its hospitals, depending on the circumstances. During 2013 and 2012, there were no changes in circumstances regarding the hospitals and equipment to indicate that the carrying amount of these assets may not be fully recoverable from estimated future undiscounted cash flows. Therefore, no such impairment was identified at December 31, 2013 and 2012.
Malpractice
The Company is covered by a claims-made general and professional liability insurance policy with a specified deductible per incident and excess coverage on a claims-made basis. Liability limits related to this policy in 2014 and 2013 is $1,000,000 per occurrence and $3,000,000 in aggregate. The Company has also purchase additional umbrella insurance coverage with an aggregate limit of $10,000,000. The Company uses a third-party administrator to review and analyze incidents that may result in a claim against the Company. In conjunction with the third-party administrator, incidents are assigned reserve amounts for the ultimate liability that may result from an asserted claim. Accrued professional claims are included in accounts payable and accrued expenses on the balance sheet and in management’s opinion provide an adequate reserve for loss contingencies.
Various claims and assertions have been made against the Company in its normal course of providing services. In addition, other claims may be asserted arising from services provided to patients in the past. In the opinion of management, adequate provision has been made for losses which may occur from such asserted and unasserted claims that are not covered by liability insurance.
Goodwill
Goodwill represents the excess of the cost of an acquired business over the net amounts assigned to assets acquired and liabilities assumed. The Company recorded goodwill in conjunction with its 2013 and 2012 acquisitions and allocated amounts to each reporting unit. The Company had goodwill totaling $42,613,953 at December 31, 2013 and $39,271,829 at December 31, 2012. As required, the Company performs a goodwill impairment test at least annually or more frequently if there is an indication of impairment. The Company performed its annual goodwill impairment test in June 2013 for all of its identified reporting units.
University General Health System, Inc.
Notes to the Consolidated Financial Statements - (Continued)
Goodwill impairment is evaluated using a two-step process. The first step of the goodwill impairment test involves a comparison of the fair value of each of the reporting units with their carrying values. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test shall be performed. The second step compares the implied fair value of the reporting unit’s goodwill to the carrying amount of its goodwill by performing a hypothetical purchase price allocation on the reporting unit’s assets and liabilities using the fair value of the reporting unit as the purchase price in the calculation. If the amount of goodwill resulting from this hypothetical purchase price allocation is less than the recorded amount of goodwill, the recorded goodwill is written down to the new amount.
The fair value of the Company’s reporting units are determined using an income approach. Several estimates and judgments are required in the application of this model. The Company’s income approach estimates fair value by discounting each reporting unit’s estimated future cash flows using a weighted-average cost of capital that reflects current market conditions and the risk profile of each reporting unit. To arrive at its future cash flows, the Company uses estimates of economic and market information, including growth rates in revenues, costs, estimates of future expected changes in operating margins, tax rates, and also cash needs and expenditures. Other significant estimates and assumptions include terminal value growth rates, future estimates of capital expenditures and changes in future working capital requirements. Estimates of fair value derived from the income approach are validated using the market approach, where reporting unit revenue and earnings multiples are compared with those from comparable publicly traded companies.
Several of the assumptions used in the Company’s discounted cash flow analysis are based upon its annual financial forecast. The Company’s annual planning process takes into consideration many factors including historical results and operating performance, related industry trends, pricing strategies, customer analysis, operational issues, competitor analysis, and marketplace data, among others. Assumptions are also made for growth rates for periods beyond the financial forecast period. The Company’s estimates of fair value are sensitive to changes in all of these variables, certain of which relate to conditions outside its control. If any one of the above assumptions changes or fails to materialize, the resulting decline in its estimated fair value could result in an impairment charge to goodwill associated with the applicable reporting unit.
Fair Value of Financial Instruments
All financial instruments, including derivatives, are to be recognized on the balance sheet initially at fair value. Subsequent measurement of all financial assets and liabilities except those held-for-trading and available for sale are measured at amortized cost determined using the effective interest rate method. Held-for-trading financial assets are measured at fair value with changes in fair value recognized in earnings. Available-for-sale financial assets are measured at fair value with changes in fair value recognized in comprehensive income and reclassified to earnings when derecognized or impaired.
At each balance sheet date, the Company assesses financial assets for impairment with any impairment recorded in the consolidated statement of operations. To assess loans and receivables for impairment, the Company evaluates the probability of collection of accounts receivable and records an allowance for doubtful accounts, which reduces loans and receivables to the amount management reasonably believes will be collected. In determining the amount of the allowance, the following factors are considered: the length of the time the receivable has been outstanding, specific knowledge of each customer’s financial condition and historical experience. The Company does not utilize financial derivatives or other contracts to manage commodity price risks. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price).
Fair value measurements are categorized using a valuation hierarchy for disclosure of the inputs used to measure fair value, which prioritized the inputs into three broad levels:
Level 1-Quoted prices are available in active markets for identical assets or liabilities as of the reporting date. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis.
University General Health System, Inc.
Notes to the Consolidated Financial Statements - (Continued)
Level 2-Pricing inputs are other than quoted prices in active markets included in level 1, which are either directly or indirectly observable as of the reported date and includes those financial instruments that are valued using models or other valuation methodologies.
Level 3-Pricing inputs include significant inputs that are generally less observable from objective sources. These inputs may be used with internally developed methodologies that result in management’s best estimate of fair value.
The following tables presents the Company’s derivative liabilities measured at fair value on a recurring basis in the Consolidated Balance Sheets:
The carrying amounts of cash and cash equivalents, accounts receivable and accounts payable approximate fair value because of the short maturity of these instruments.
The fair value of the Company’s long-term debt is approximately its carrying value since the debt obligations bear interest at a rate consistent with market rates. The fair value of the Company’s intangible assets was originally determined as a part of an acquisition based measure of fair value and is currently carried at amortized cost.
Derivatives
The Company evaluates all financial instruments for freestanding and embedded derivatives. Warrants and conversion features related to preferred stock do not have readily determinable fair values and therefore require significant management judgment and estimation. The Company uses a Binomial pricing model to estimate the fair value of warrant and preferred stock conversion features at the end of each applicable reporting period. Changes in the fair value of these derivatives during each reporting period are included in the statement of income. Inputs into the Binomial pricing model require estimates, including such items as estimated volatility of the Company’s stock, risk-free interest rate and the estimated life of the financial instruments being fair valued.
University General Health System, Inc.
Notes to the Consolidated Financial Statements - (Continued)
Commitments and Contingencies
Certain conditions may exist as of the date the financial statements are issued, which may result in a loss to the Company, but which will only be resolved when one or more future events occur or fail to occur. The Company’s management and its legal counsel assess such contingent liabilities and such assessment inherently involves an exercise of judgment. In assessing loss contingencies related to legal proceedings that are pending against the Company or unasserted claims that may result in such proceedings, the Company’s legal counsel evaluates the perceived merits of any legal proceedings or unasserted claims, as well as the perceived merits of the amount of relief sought or expected to be sought therein.
If the assessment of a loss contingency indicates that it is probable that a loss has been incurred and the amount of the liability can be reasonably estimated, then the estimated liability is accrued in the Company’s financial statements. If the assessment indicates that a potentially material loss contingency is not probable, but is reasonably possible, or is probable but cannot be estimated, then the nature of the contingent liability, together with an estimate of the range of possible loss, if determinable and material, would be disclosed. Loss contingencies considered remote are generally not disclosed unless they involve guarantees, in which case the nature of the guarantee would be disclosed. The Company expenses legal costs associated with contingencies as incurred.
Series C Preferred Stock
As more fully described in Note 14, the Company issued Series C Preferred Stock, which is classified in temporary equity in accordance with ASC 480-10-S99-3A on the Consolidated Balance Sheets. The Series C Preferred Stock has redeemable features which are not in the Company’s control and therefore should not be included in permanent equity. The Series C Preferred Stock had similar characteristics of an “Increasing Rate Security” as described by Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin Topic 5Q, Increasing Rate Preferred Stock. Discounts on the increasing rate preferred stock are amortized over the expected life of the preferred stock (4 years), by charging imputed dividend cost against retained earnings and increasing the carrying amount of the preferred stock by a corresponding amount. The discount at the time of issuance is computed as the present value of the difference between dividends that will be payable in future periods and the dividend amount for a corresponding number of periods, discounted at a market rate for dividend yield on comparable securities. The amortization in each period is the amount which, together with the stated dividend in the period, results in a constant rate of effective cost with regard to the carrying amount of the preferred stock.
Electronic Health Record Incentive Payments.
The American Recovery and Reinvestment Act of 2009 provides for Medicare and Medicaid incentive payments beginning in 2011 for eligible hospitals and professionals that adopt and meaningfully use certified electronic health record (“EHR”) technology. The Company recognizes income related to Medicare and Medicaid incentive payments using a gain contingency model that is based upon when the Company’s eligible hospitals have demonstrated meaningful use of certified EHR technology for the applicable period and the cost report information for the full cost report year that will determine the final calculation of the incentive payment is available.
Medicaid EHR incentive calculations and related payment amounts are based upon prior period cost report information available at the time the Company’s eligible hospitals adopt, implement or demonstrate meaningful use of certified EHR technology for the applicable period, and are not subject to revision for cost report data filed for a subsequent period. Thus, incentive income recognition occurs at the point the Company’s eligible hospitals adopt, implement or demonstrate meaningful use of certified EHR technology for the applicable period, as the cost report information for the full cost report year that will determine the final calculation of the incentive payment is known at that time.
Medicare EHR incentive calculations and related initial payment amounts are based upon the most current filed cost report information available at the time the Company’s eligible hospitals demonstrate meaningful use of certified EHR technology for the applicable period. However, unlike Medicaid, this initial payment amount will be adjusted based upon an updated calculation using the annual cost report information for the cost report period that began during the applicable payment year. Thus, incentive income recognition occurs at the point the Company’s eligible hospitals demonstrate meaningful use of certified EHR technology for the applicable period and the cost report information for the full cost report year that will determine the final calculation of the incentive payment is available.
University General Health System, Inc.
Notes to the Consolidated Financial Statements - (Continued)
In 2013, the Company recognized $200,222 of EHR incentive income related to the Medicaid program and $1,032,670 of EHR incentive income related to the Medicare program. The recognized amount has been included in the “Other Income” in the consolidated statement of operations in the current year.
Income Taxes
The Company accounts for income taxes under the Accounting Standards Codification ASC No. 740, Income Taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which these temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some or all of the deferred tax assets may not be realized.
The Company records and reviews quarterly its uncertain tax positions. The Company recognizes the financial statement effects of a tax position when it is more likely than not, based on the technical merits, that the position will be sustained upon examination. The Company measures a tax position that meets the more-likely-than-not recognition threshold as the largest amount of tax benefit that is greater than 50 percent likely of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. In its measurement of a tax position that meets the more-likely-than-not recognition threshold, the Company considers the amounts and probabilities of the outcomes that could be realized upon settlement using the facts and circumstances and information available at the reporting date.
Earnings per Share
Basic earnings per share is computed using the weighted average number of common shares outstanding during the measurement period. Diluted earnings per share is computed using the weighted average number of common shares and all potentially dilutive common share equivalents outstanding during the measurement period. For the years ended December 31, 2013 and 2012, 16,712,598 and 16,628,937, common shares attributable to Series C convertible preferred stock and 10,841,810 and 3,361,501Preferred C Warrants, respectively, would have been considered dilutive securities but were excluded from the calculation of diluted earnings per share because the effect was anti-dilutive due to the net loss for the reported period.
The following table summarizes the components used to determine total diluted shares:
University General Health System, Inc.
Notes to the Consolidated Financial Statements - (Continued)
Revenue Recognition
The Company recognizes revenues in the period in which services are performed. The Company derives a significant portion of its revenues from the hospital segment. Accordingly, the revenues reported in the Company’s Consolidated Statements of Operations are recorded at the net amount expected to be received.
Hospital Segment
The Company recognizes net patient service revenues in the reporting period in which it performs the service based on its current billing rates (i.e., gross charges), less adjustments and estimated discounts for contractual allowances (principally for patients covered by Medicare, Medicaid, managed care and other health plans). The Company records gross service charges in its accounting records on an accrual basis using its established rates for the type of service provided to the patient. The Company recognizes an estimated contractual allowance to reduce gross patient charges to the amount it estimates it will actually realize for the services rendered based upon previously agreed to rates with a payor. Such estimated contractual allowances are based primarily upon historical collection rates for various payers, and assumes consistency with regard to patients discharged in similar time periods for the same payor classes. Payors include federal and state agencies, including Medicare and Medicaid, managed care health plans, commercial insurance companies and patients.
Revenues related to the Company’s hospital segment consist primarily of net patient service revenues, which are based on the facilities’ established billing rates less adjustments and discounts. Summary information for revenues for the years ended December 31, 2013 and 2012 is as follows:
The hospitals have agreements with third-party payors that provide for payments to the hospitals at amounts different from its established rates. Payment arrangements include prospectively-determined rates per discharge, reimbursed costs, discounted charges, and per diem payments. Net patient service revenue is reported at the estimated net realizable amount from patients, third-party payors, and others for services rendered, including estimated contractual adjustments under reimbursement agreements with third party payors. Allowances and discounts are accrued on an estimated basis in the period the related services are rendered and adjusted in future periods. These allowance and discounts are related to the Medicare and Medicaid programs and managed care contracts.
The process of estimating contractual allowances requires the Company to estimate the amount expected to be received based on payor contract provisions. The key assumption in this process is the estimated contractual reimbursement percentage, which is based on payor classification and historical paid claims data. Due to the complexities involved in these estimates, actual payments the Company receives could be different from the amounts it estimates and records. If the actual contractual reimbursement percentage under government programs and managed care contracts differed by 1.0% at December 31, 2013 from its estimated reimbursement percentage, net revenues for the year ended December 31, 2013 and 2012, would have changed by approximately $3.6 million and $4.5 million, and net accounts receivable at December 31, 2013 and 2012 would have changed by approximately $0.5 million and $0.9 million, respectively.
Final settlements under some of these programs are subject to adjustment based on administrative review and audit by third parties. The Company accounts for adjustments to previous program reimbursement estimates as contractual allowance adjustments and reports them in the periods that such adjustments become known.
University General Health System, Inc.
Notes to the Consolidated Financial Statements - (Continued)
The following table sets forth the revenues (after contractual adjustments and discounts) and percentages from major payor sources for the Company’s hospital segment during the periods indicated:
Senior Living Segment
Revenues related to the Company’s Senior Living segment consist primarily of resident fees, entrance fees, community fees and management fees. Resident fee revenue is recorded when services are rendered and consists of fees for basic housing, support services and fees associated with additional services such as personalized assisted living care. Residency agreements are generally non-binding, for a term of one year, with resident fees billed monthly in advance.
The UGHS Senior Living Facilities have residency agreements that require the resident to pay an upfront fee prior to occupying the senior living community. The non-refundable portion of the entrance fee is recorded as deferred revenue and amortized over the estimated stay of the resident based on an actuarial valuation.
TrinityCare Senior Living, LLC provides management services to the UGHS Senior Living Facilities, as well as an assisted living community and two memory care greenhouses in Georgia. Management fee revenue is determined by an agreed upon percentage of gross revenues and recorded as services are provided. Management fee revenue received from the UGHS Senior Living Facilities has been eliminated in consolidation.
Support Services Segment
Billing and coding revenues are generated from revenue cycle management services provided by UGHS Autimis Billing Inc. and UGHS Autimis Coding Inc. to UGH LP and other third-party clients. Fees charged for these services are defined in service agreements and based upon a stated percentage of cash collections. Food and support services revenues are generated from environmental, food and nutrition, and facilities management services by Sybaris Group Inc. to clients in the Houston metropolitan area. Revenue is recognized as services are performed. Billing, coding and food and support services revenue received from the Hospital operating segment has been eliminated in consolidation.
Business Combinations
The Company accounts for its business acquisitions under the acquisition method of accounting as indicated in ASC No. 805, Business Combinations, which requires the acquiring entity in a business combination to recognize the fair value of all assets acquired, liabilities assumed and any non-controlling interest in the acquiree; and establishes the acquisition date as the fair value measurement point. Accordingly, the Company recognizes assets acquired and liabilities assumed in business combinations, including contingent assets and liabilities and non-controlling interest in the acquiree, based on fair value estimates as of the date of acquisition. In accordance with ASC No. 805, the Company recognizes and measures goodwill as of the acquisition date, as the excess of the fair value of the consideration paid over the fair value of the identified net assets acquired.
All acquisition-related transaction costs have been expensed as incurred rather than capitalized as a part of the cost of the acquisition.
University General Health System, Inc.
Notes to the Consolidated Financial Statements - (Continued)
Acquired Assets and Assumed Liabilities
Pursuant to ASC No. 805-10-25, if the initial accounting for a business combination is incomplete by the end of the reporting period in which the combination occurs, but during the allowed measurement period not to exceed one year from the acquisition date, the Company retrospectively adjusts the provisional amounts recognized at the acquisition date, by means of adjusting the amount recognized for goodwill.
Segment Information
The Company identified three reportable segments: Hospital (UGH LP, UGH GP, UGHS Services, UGHS Hospital, UGHS Management, UGHS Physician Services Inc., and UGHS Real Estate), Senior Living (UGHS Pearland, UGHS Port Lavaca, UGHS Knoxville and TrinityCare) and Support Services (UGHS Billing Inc., UGHS Coding Inc., and Sybaris Group, Inc.). The aggregation of operating segments into three reportable segments requires management to evaluate whether there are similar expected long-term economic characteristics for each operating segment, and is an area of significant judgment. If the expected long-term economic characteristics of the Company’s operating segments were to become dissimilar, then the Company could be required to re-evaluate the number of reportable segments.
Subsequent Events
The Company evaluates subsequent events through the date when financial statements are issued. The Company, which files reports with the Securities and Exchange Commission (“SEC”), considers its consolidated financial statements issued when they are widely distributed to users, such as upon filing of the financial statements on Electronic Data Gathering, Analysis and Retrieval system (“EDGAR”), the SEC’s EDGAR.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standard Board (FASB) issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”). ASU 2014-09 supersedes the revenue recognition requirements in ASC Topic 605, Revenue Recognition, and most industry-specific guidance. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This guidance is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period, under either full or modified retrospective adoption. Early application is not permitted. The Company plans to adopt ASU 2014-09 beginning January 1, 2017, and is currently assessing the potential effects of these changes to its consolidated financial statements.
NOTE 2 - GOING CONCERN
The Company had a net loss attributable to the Company of $34,546,168 and net cash provided by operating activities of $9,129,133 for the year ended December 31, 2013 as compared to net loss of $3,420,330 and net cash provided by operating activities of $8,241,431 for the analogous period of 2012. However, the Company had negative working capital of $57,836,737 as of December 31, 2013 as compared to $41,797,619 as of December 31, 2012. Cash and cash equivalents were $1,708,898 at December 31, 2013 as compared to $1,188,230 at December 31, 2012. The negative working capital and relative low levels of cash and cash equivalents amounts, significant increase in operating expenses, and required past due payroll taxes and related interest and penalties and income tax payments raise substantial doubt concerning the Company’s ability to continue as a going concern for a reasonable period of time.
The Company is also currently working with certain vendors to extend payment terms. Further, management believes that the Company has additional opportunities to raise capital in the public markets and is in current negotiations with investors and banks to raise capital and secure additional financing.
There can be no assurance that the plans and actions proposed by management will be successful or that unforeseen circumstances will not require the Company to seek additional funding sources in the future or effectuate plans to conserve liquidity. In addition, there can be no assurance that in the event additional sources of funds are needed they will be available on acceptable terms, if at all. If we ultimately are unable to pay past due payroll taxes and related interest and penalties and income tax payments satisfactory to the IRS, then the IRS may force us to cease our operations. The accompanying consolidated financial statements have been prepared on a going concern basis which contemplates the realization of assets and satisfaction of liabilities in the normal course of business.
University General Health System, Inc.
Notes to the Consolidated Financial Statements - (Continued)
NOTE 3 - ACQUISITIONS
2013 Acquisitions
Woodlands Physical Therapy
On February 15, 2013, the Company acquired a physical therapy center (the “Woodlands Center”) from The Houston Spine and Rehabilitation Center, a health service operations company near The Woodlands, Texas. The Company operates the Woodlands Center as an HOPD of UGH under the name “UGH Woodlands Physical Therapy.” The purpose of the acquisition was to expand the Company’s regional network into the northern areas of metropolitan Houston and increase market share.
The total purchase consideration for the Woodlands Center was $99,160 in cash. The purchase included fixed assets of $79,508 and non-compete consideration of $19,652. The Company also agreed to assume accrued paid time off totaling $6,474 and a commitment bonus of $20,000 according to the acquired employment agreement. As a result, the Company recorded a goodwill balance of $26,474. The total purchase consideration was based upon a fair market valuation of the acquired assets determined by the Company.
In addition, the Company expensed transaction and acquisition-related costs of $190,000 for competing offers, which the seller agreed was for good and valuable consideration, not to solicit or accept any offers prior to the closing date to purchase any of the assets or acquire any of the equity interests in the seller’s business. These competing offers costs are included in general and administrative expenses on the Company’s consolidated statement of operations.
Physical Therapy of Ennis
On March 25, 2013, the Company acquired a physical therapy center in Ennis, Texas, approximately 32 miles from University General Hospital Dallas. The Company operates the center as an HOPD of University General Hospital Dallas under the name “UGH Physical Therapy of Ennis.” The purpose of the acquisition was to expand the Company’s regional network into the Dallas surrounding areas and increase market share.
The total purchase consideration for the UGH Physical Therapy of Ennis was for $580,000 in cash. The purchase included fixed assets of $55,256. As a result, the Company recorded a goodwill balance of $524,744. The total purchase consideration was based upon a fair market valuation of the acquired assets determined by the Company.
Living Well Diagnostic Imaging Center
On May 10, 2013, the Company acquired Living Well Diagnostic Imaging center in Waxahachie, Texas, approximately 22 miles south of University General Hospital Dallas. Living Well Diagnostic Imaging center is a free-standing diagnostic imaging facility. The Company operates the center as an HOPD of University General Hospital under the name “Living Well Diagnostic Imaging Center.” The purpose of the acquisition was to expand the Company’s regional network and increase market share.
The total purchase consideration for the Living Well Diagnostic Imaging Center was $991,904, consisting of, (i) $136,904 cash, (ii) a promissory note of $325,000 and (iii) assumption sellers debt $530,000. The considerations paid for the acquired assets and the fair values of the assets recognized and liabilities assumed in the Consolidated Balance Sheets at the acquisition date included fixed assets of $293,543, leasehold improvements of $299,509 and other assets of $16,904. The Company also agreed to assume accrued paid time off totaling $3,500. As a result, the Company recorded a goodwill balance of $385,448. The total purchase consideration was based upon a fair market valuation of the acquired assets determined by the Company.
University General Health System, Inc.
Notes to the Consolidated Financial Statements - (Continued)
Texas Anesthesia and Pain Management Institute
On June 1, 2013, the Company acquired Texas Anesthesia and Pain Management Institute in Waxahachie, Texas. The Company operates under the name “UGHS Texas Anesthesia and Pain Management.” The purpose of the acquisition was to expand the Company’s regional network areas and increase market share.
The total purchase consideration for the UGHS Texas Anesthesia and Pain Management was $1,000,000, consisting of, (i) $200,000 cash paid on the acquisition date and (ii) a promissory note of $800,000. The promissory note has a 24 month term with an interest rate of 5.0%, payable in 22 installments. The consideration paid for the acquired assets and the fair values of the assets recognized and liabilities assumed in the Consolidated Balance Sheets at the acquisition date included fixed assets of $118,000. As a result, the Company recorded a goodwill balance of $882,000. The total purchase consideration was based upon a fair market valuation of the acquired assets determined by the Company.
Waxahachie Diagnostic Center
On July 1, 2013, the Company acquired an ambulatory surgery center in Waxahachie, Texas. The Company operates the center as an HOPD of University General Hospital Dallas under the name “UGHS Waxahachie Diagnostic Center”. The purpose of the acquisition was to expand the Company’s regional network into the Dallas surrounding areas and increase market share.
The total purchase consideration for the UGHS Waxahachie Diagnostic Center was $950,000, consisting of, (i) $600,000 cash and (ii) a promissory note of $350,000. The considerations paid for the acquired assets and the fair values of the assets recognized and liabilities assumed in the Consolidated Balance Sheets at the acquisition date included fixed assets of $250,000 and assumed accrued paid time off totaling $2,793. As a result, the Company recorded a goodwill balance of $702,793. The total purchase consideration was based upon a fair market valuation of the acquired assets determined by the Company.
Clint Foster & Associates
On October 1, 2013, the Company acquired four free-standing physical therapy and rehabilitation centers (the “Foster Centers”). The Company operates the centers as HOPDs of University General Hospital under the name “UGH Clint Foster & Associates. The purpose of the acquisition was to expand the Company’s regional network into the Houston surrounding areas and increase market share.
The total purchase consideration for the Foster Centers was $899,000, consisting of, (i) assumed $549,000 debt and (ii) a promissory note of $350,000. The considerations paid for the acquired assets and the fair values of the assets recognized and liabilities assumed in the Consolidated Balance Sheets at the acquisition date included fixed assets of $372,898 and assumed accrued paid time off totaling $22,878. As a result, the Company recorded a goodwill balance of $548,980. The total purchase consideration was based upon a fair market valuation of the acquired assets determined by the Company.
Texas Rehabilitation Institute.
On October 8, 2013, we acquired a physical therapy rehabilitation center (the “Physical Therapy Rehabilitation Center”) from Texas Spine Institute, LLP. We operate the Physical Therapy Rehabilitation Center as HOPD under the name “UGHD Texas Rehabilitation”. The purpose of the acquisition was to expand the Company’s regional network into the Dallas surrounding areas and increase market share.
The total purchase consideration for the Physical Therapy Rehabilitation Center was $275,000, consisting of, (i) $163,418 cash and (ii) assumed $111,582 debt. The considerations paid for the acquired assets and the fair values of the assets recognized and liabilities assumed in the Consolidated Balance Sheets at the acquisition date included fixed assets of $139,000 and assumed accrued paid time off totaling $8,736. As a result, the Company recorded a goodwill balance of $147,736. The total purchase consideration was based upon a fair market valuation of the acquired assets determined by the Company.
The Houston Spine and Rehabilitation Centers.
On November 26, 2013, we acquired a physical health services (the “Houston Spine and Rehabilitation Centers” from The Houston Spine and Rehabilitation Centers, P.A. We operate the Houston Spine and Rehabilitation Center as HOPS under the name “UGH Houston Spine and Rehabilitation Centers”.
University General Health System, Inc.
Notes to the Consolidated Financial Statements - (Continued)
The total purchase consideration for The Houston Spine and Rehabilitation Centers was $93,265 cash. The considerations paid for the acquired assets and the fair values of the assets recognized and liabilities assumed in the Consolidated Balance Sheets at the acquisition date included fixed assets of $58,000 and intangible of $15,000. As a result, the Company recorded a goodwill balance of $20,265. The total purchase consideration was based upon a fair market valuation of the acquired assets determined by the Company.
In addition, the Company expensed transaction and acquisition-related costs of $50,000 for competing offers, which the seller agreed was for good and valuable consideration, not to solicit or accept any offers prior to the closing date to purchase any of the assets or acquire any of the equity interests in the seller’s business. These competing offers costs are included in general and administrative expenses on the Company’s consolidated statement of operations.
During 2013, the Company also completed other smaller acquisitions of physician services located in Houston Texas. The Company, in the aggregate, paid $250,000 in total consideration for these physician services centers.
These acquisitions were accounted for under the acquisition method of accounting. Accordingly, the Company conducted assessments of net assets acquired and recognized amounts for identifiable assets acquired and liabilities assumed at their estimated acquisition date fair values, while transaction and integration costs associated with the acquisitions were expensed as incurred. The initial accounting for the business combinations is not complete and adjustments to provisional amounts, or recognition of additional assets acquired or liabilities assumed, may occur as more detailed analyses are completed and additional information is obtained about the facts and circumstances that existed as of the acquisition dates.
The following is a summary of acquisitions completed by the Company during the year ended December 31, 2012:
Baytown Center
On April 13, 2012, the Company completed the assets acquisition of Baytown Endoscopy Center, LLC (the “Baytown Center”). The Baytown Center is a three-bed ambulatory surgery center which operates as a hospital outpatient department (HOPD) of the Company’s hospital segment under the name “UGH Baytown Endoscopy Center”. Primary procedures at the Baytown Center include gastroenterology and pain management. The Baytown Center is co-managed with Jacinto Medical Group, P.A., which is a multi-specialty group of physicians operating in Baytown. The transaction was financed primarily with issuing a one-year promissory note payable of $161,915.
Diagnostic Imaging and Physical Therapy
On June 1, 2012, the Company acquired a Diagnostic Imaging and Physical Therapy Centers (the “1960 Centers”) from 1960 Family Practice, PA., a multi-specialty group of physicians practicing in northern areas of Houston. The Company operates these centers as HOPDs of the Hospital segment under the names “UGH Diagnostic Imaging” and “UGH Physical Therapy.” The purpose of the acquisition was to expand the Company’s regional network into the northern areas of metropolitan Houston and increase market share. The total purchase consideration for the 1960 Centers was $7,142,950.
Kingwood Diagnostic and Rehabilitation Center
On July 30, 2012, through wholly-owned subsidiaries, the Company acquired diagnostic imaging, physical therapy and sleep centers (the “Kingwood Centers”) from Management Affiliates of Northeast Houston, LLC, a Kingwood, Texas-based health service operations company. The Company operates the Kingwood Centers as HOPDs of the Hospital segment under the name “UGH Kingwood Diagnostic and Rehabilitation Center.” This acquisition contributed to the expansion of the Company’s regional network in the north Houston metropolitan area. The total purchase consideration for the Kingwood Centers was $344,163.
Robert Horry Center for Sports and Physical Rehabilitation
On August 24, 2012, the Company executed an asset acquisition agreement with Robert Horry Center for Sports and Physical Rehabilitation (“Robert Horry Center”), pursuant to which the Company acquired the business assets and properties of the Robert Horry Center, which are free-standing facilities which operate as a hospital outpatient department (HOPD) of UGH. The purpose of the acquisition was to expand the Company’s capability and increase market share. The purchase price consideration for the Robert Horry Center for Sports was $47,000. The purchase included the acquisition of assets and assumption of leases and contracts and liabilities related to accrued paid time off. The total purchase consideration was based upon a fair market valuation of the Robert Horry Center determined by the Company.
University General Health System, Inc.
Notes to the Consolidated Financial Statements - (Continued)
Baytown Diagnostic Imaging and Sleep Evaluation Centers
On November 27, 2012, the Company acquired a Diagnostic Imaging and a Sleep Evaluation Center (the “Baytown Centers”) from Jacinto Medical Group, PA. The Company operates these centers as HOPDs of UGH under the names “UGH Baytown Imaging” and “UGH Baytown Sleep.” The purpose of the acquisitions was to expand UGH’s regional network into the east areas of metropolitan Houston and increase market share. The total purchase consideration for the Diagnostic Imaging Center was $1,421,129.
South Hampton Community Hospital
On December 14, 2012, the Company acquired South Hampton Community Hospital Complex (the “South Hampton Community Hospital”) from Dufek Massif Hospital Corporation, the owner of South Hampton Community Hospital and a medical office building on the medical complex. The Company acquired 100% of the capital stock of Dufek Massif Hospital Corporation. The Hospital is a 111-bed general acute care hospital that provides health services across multiple specialties. The Company operates the South Hampton Community Hospital Complex under the name “UGHS Dallas Hospitals, Inc.” The Company acquired South Hampton Community Hospital to enhance capabilities in new markets where it can leverage the established market presence of South Hampton Community Hospital and its expertise to expand services and pursue other initiatives that the Company believes will result in attractive growth. The Company has included the financial results of UGHS Dallas Hospitals, Inc. in the consolidated financial statements from the date of acquisition. UGHS Dallas Hospitals Inc. is included in the Hospital segment.
The total purchase consideration for the UGHS Dallas Hospitals, Inc. was approximately $30.0 million, consisting of (i) $1.5 million initial cash paid on acquisition date at December 14, 2012 and (ii) $28.5 million loan with First National Bank which bears interest at a rate of 4.25% per annum and is payable monthly based on a 20 year amortization schedule, and matures in 10 years, with all accrued interest and remaining principal due and payable on January 5, 2023. The Company also agreed to assume certain liabilities associated with the operation of the South Hampton Community Hospital as additional consideration for the transaction. The total purchase consideration was based upon a fair market valuation of South Hampton Community Hospital determined by the Company through negotiations with the seller and is supported by the valuation report obtained from a third party appraisal firm.
This acquisition was accounted for under the acquisition method of accounting. Accordingly, the Company conducted assessments of net assets acquired and recognized amounts for identifiable assets acquired and liabilities assumed at their estimated acquisition date fair values, while transaction and integration costs associated with the acquisitions were expensed as incurred.
University General Health System, Inc.
Notes to the Consolidated Financial Statements - (Continued)
The following table summarizes the consideration paid for the South Hampton Community Hospital acquired assets and the final acquisition accounting for the fair values of the assets recognized and liabilities assumed in the Consolidated Balance Sheets at the acquisition date.
Summary of Unaudited Pro-forma Information
The unaudited pro-forma information below for the years ended December 31, 2013 and 2012 gives effect to the acquisitions as if the acquisitions had occurred on January 1, 2012. The pro-forma financial information is not necessarily indicative of the results of operations if the acquisitions had been effective as of this date.
University General Health System, Inc.
Notes to the Consolidated Financial Statements - (Continued)
NOTE 4 - PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS, NET
Property, equipment, leasehold improvements, computer equipment and software and related accumulated depreciation and amortization are summarized as follows at December 31, 2013 and 2012:
Depreciation expense during the years ended December 31, 2013 and 2012 was $8,550,303 and $6,043,104, respectively.
NOTE 5 - GOODWILL
The Company performs an impairment test for goodwill annually as of June 30, 2013, or more frequently if indicators of potential impairment exist. The Company’s goodwill impairment test involves a comparison of the fair value of each of its reporting units with its carrying amount. Fair value is estimated using discounted cash flows and a discount rate based on the weighted average cost of capital of the reporting unit.
The fair value of the Company’s reporting units exceeded the carrying value as of its June 2013 annual impairment test. Accordingly, the Company determined that goodwill was not impaired for its segments, thus the second step of the impairment test was not considered. As a result, there was no change in the carrying value of goodwill as of June 30, 2013.
The changes in the carrying amount of goodwill by reportable segment for the two years ended December 31, 2013 and 2012 were as follows:
University General Health System, Inc.
Notes to the Consolidated Financial Statements - (Continued)
NOTE 6 - ACCRUED EXPENSES
The components of accrued expenses were as follows:
NOTE 7 - DEBT OBLIGATIONS
Line of Credit
On September 28, 2012, the Company entered into a Credit and Security Agreement for a $15.0 million secured revolving credit facility (the “Revolving Credit Facility”) that matures on September 28, 2015. The Revolving Credit Facility includes an additional amount of revolving loan commitment feature to increase the size of the facility to $25.0 million. In June 2013, the secured revolving credit facility increased to $22.5 million. Borrowings under the Revolving Credit Facility are limited to the availability under a borrowing base that is determined principally on eligible account receivable as defined by the Revolving Credit Facility agreement. The daily interest rates under the Revolving Credit Facility are determined by a LIBOR rate plus an applicable margin, as set forth in the Revolving Credit Facility agreement. All of the Company’s assets are pledged as collateral under the Revolving Credit Facility. The Revolving Credit Facility is used by the Company to provide financing for working capital, capital expenditures and other general corporate purposes, as well as to support its outstanding indebtedness requirements. The Revolving Credit Facility contains certain affirmative covenants, negative covenants and financial covenants including restrictions on the payment of dividends, as set forth in the Revolving Credit Facility Agreement. The Revolving Credit Facility agreement included unused line fee of 0.5% per annum. Excess borrowing availability under the Revolving Credit Facility at December 31, 2013 was $2,427,074. At December 31, 2013, the Company was in compliance with all of the financials debt covenants of the Revolving Credit Facility and expects to remain in compliance during the year 2014. The interest rate on outstanding borrowings and average daily borrowings under the Revolving Credit Facility were 4.5% and $346,777, respectively. The Company had an outstanding balance on its Revolving Credit Facility as of December 31, 2013 of $20,072,926.
University General Health System, Inc.
Notes to the Consolidated Financial Statements - (Continued)
Notes Payable
The Company’s third party notes payable consisted of the following:
In 2006, the Company entered into a $9,000,000 construction loan with Amegy Bank. Advances under this loan were originally scheduled to mature on March 27, 2007. This loan is secured by the Company’s accounts receivable, contract rights, general intangibles instruments, cash and cash equivalents and all other asset accounts. The loan contains various terms and conditions, including operational and financial restrictions and limitations, and affirmative covenants. The covenants include financial covenants measured on a quarterly basis which require the Company to maintain maximum leverage and minimum fixed charge ratios as defined in the loan agreement. In June 2011, the Company and Amegy Bank agreed to extend the terms of the loan to January 15, 2012 and subsequently extended to April 15, 2012, bearing interest rate at 6.0%, modified the monthly payments of the note payable and provided a waiver to the Company for violations of financial covenants. As of May 10, 2012, the Company and Amegy Bank agreed to extend the term of the line of credit from April 15, 2012 to September 15, 2012, then subsequently extended to December 31, 2013, and modified the interest rate to 6.5%. The Company paid off the outstanding loan in 2013. At December 31, 2012, the total outstanding balance of these notes was $1,767,126.
In November 2006, the Company entered into a $1,000,000 promissory note with a financial institution, bearing interest at the fixed rate of 3.25% and due on demand. The note was modified on January 8, 2007 requiring monthly payments of interest only. In June 2012, the note was modified to require paying interest rate of 4.25% and payable on November 29, 2013. The Company agreed to pay these regular monthly payments of all accrued unpaid interest assessed on the outstanding principal balance due as of each payment date. At December 31, 2013 and 2012, the amount outstanding on this note was $196,821 and $481,530, respectively.
University General Health System, Inc.
Notes to the Consolidated Financial Statements - (Continued)
On September 15, 2011, the Company entered into a settlement of litigation with Siemens Medical Solutions. As the final settlement in May 2014, the Company is obligated to pay Siemens an aggregate of $4,844,918, due May 2014, bears interest rate of 5.0% until paid. As of December 31, 2013 and 2012, the outstanding balance was $4,844,918 and $2,740,643.
On May 31, 2012, the Company entered into a $2,000,000 promissory note and on October 11, 2012 the Company entered into another $1,000,000 promissory note with Northwest Anesthesia and Pain, P.A. (“NWAP”). In lieu of cash interest on the principal balance of these notes, NWAP received interest in the form of an aggregate of 2,000,000 shares of the Company’s common stock on May 31, 2012 and 450,000 shares of the Company’s common stock on October 1, 2012, $0.001 par value per share of the Company, which were equivalent to 22.3% and 25.8% per annum. These notes are payable on July 31, 2013 and June 30, 2013. On September 24, 2013, the Company and NWAP agreed to extend the term of the $2,000,000 and $1,000,000 notes to March 15, 2014 and January 15, 2014. In lieu of cash interest on the principal balance on these notes, the Company issued 671,875 common shares, $0.001 par value per share of the Company, which were equivalent to 14.5% and 14.7% per annum. At December 31, 2013 and 2012, the amount outstanding on these notes was $3,000,000.
In October 2011 Sigma Opportunity Fund, LLC (the “Service Provider”) purchased 625,000 shares of common stock, par value $0.001 per share, of the Company for an aggregate purchase price of $200,000 in cash. In addition, The Service Provider agreed to finance the acquisition of TrinityCare and provide funds for the retirement of certain debts of the Company which yielded a favorable settlement for the Company. The financing agreement entered into was a $2,000,000 note purchase agreement with the Service Provider on October 27, 2011. The note purchase agreement is securitized by 100% of the assets of the Company. Advances under this note purchase agreement mature April 27, 2012, and bear interest rate at 18.0% per annum. Principal is payable on the maturity date, but under certain conditions may be extended. The note purchase agreement contains certain covenants including limitations on certain indebtedness, limitations on asset sales and liquidations and limitations on certain issuances. At December 27, 2011, $2,000,000 was outstanding under the note purchase agreement. The Company has paid this note purchase agreement in full as of May 3, 2012. On September 28, 2012 the Company entered into a second $1,000,000 note purchase agreement with the Service Provider to purchase 625,000 shares of common stock, par value $0.001 per share, of the Company for an aggregate purchase price of $162,500 in cash. On December 27, 2012, the Company entered into a third $2,000,000 note purchase agreement with the Service Provider to purchase 650,000 shares of common stock, par value $0.001 per share, of the Company for an aggregate purchase price of $208,000 in cash. Advances under the second and third notes purchase agreements mature on February 8, 2013 and June 26, 2013, and bear interest rate at 12.0% and 18.0% per annum. The notes purchase agreements are securitized by 100% of the assets of the Company. The total principal is payable on the maturity date, but under certain conditions may be extended. The notes purchase agreements contain certain covenants including limitations on certain indebtedness, limitations on asset sales and liquidations and limitations on certain issuances. The Company paid off the outstanding balance of the loan in 2013. At December 31, 2012, the amount outstanding on these notes was $3,000,000.
On September 28, 2012, the Company entered into a secured term loan with an original principal amount of $4,000,000 with MidCap Financial, LLC, bearing interest at 7.0% and over a period of nine months beginning on January 1, 2013. The purpose of this term loan is to pay UGH’s payroll tax delinquencies to the Internal Revenue Service. The Company paid off the loan in 2013. At December 31, 2012, the outstanding balance on this loan was $4,000,000.
In connection with the UGH Diagnostic Imaging and UGH Physical Therapy acquisition, the Company entered into a promissory note of $6,714,000 with sellers on June 1, 2012. The promissory note bears an interest rate of 5.0% and is payable on July 15, 2013. At December 31, 2013 and 2012, the amount outstanding on this note was $4,755,750 and $5,315,250.
In connection with the TrinityCare acquisition, the Company entered into subordinated promissory notes of $2,815,089 with sellers in June 2011. The promissory notes bear interest rate of 6.0% and are payable over two years. At December 31, 2013 and 2012, the amount outstanding on these notes was $2,005,830 and $2,569,231, respectively. In addition, the Company assumed three mortgage notes totaling $17,463,982 at the acquisition date. The mortgage notes bear interest rate ranging from 5.0% to 6.5%. In August 2012, the Company and the financial institutions agreed to extend the terms of two mortgage notes for an additional 18 months, which matured in January 2014. The Company engaged Lancaster Pollard Mortgage Company to refinance two mortgage notes using the United States Department of Housing and Urban Development (“HUD”) Section 232 for terms up to 35 years, bearing interest rates at 3.92% and 4.23%. As of December 31, 2013 and 2012, the total outstanding on these notes was $16,488,390 and $16,209,635, respectively.
University General Health System, Inc.
Notes to the Consolidated Financial Statements - (Continued)
In 2008, UGH LP entered into Subscription Agreements with certain partners, pursuant to which UGH LP sold to the partners in the aggregate of nine units (9) of limited partner interests for $900,000 of the Partnership’s 15.0% Subordinated Promissory Notes due 2028. As of December 31, 2013 and 2012 the total outstanding balance of these notes was $400,000 and $700,000.
On June 30, 2012, the Company entered into two new notes with a financial institution in the amount of $1,100,363, bearing interest rate of 3.51%. The purpose of these finance agreements is to purchase general liability and malpractice insurance policies for the Company. At December 31, 2013 and 2012, the outstanding balance was $0 and $885,882, respectively.
In connection with the UGH Kingwood Diagnostic and Rehabilitation Center acquisition, the Company assumed four promissory notes totaling $1,230,569 from the sellers on July 30, 2012. The promissory notes bear interest rates ranging from 0.0% to 9.0% and will be repaid with monthly installments which will be maturing from September 15, 2012 to April 12, 2016. At December 31, 2013 and 2012, the total amount outstanding on these notes was $0 and $372,501, respectively.
In connection with the UGH Baytown Sleep and Diagnostic Imaging Centers acquisitions, the Company entered into two promissory notes of $97,760 and $686,903 with sellers on November 27, 2012. The promissory notes bear interest rate at 5.0% and will be repaid with monthly installments beginning January 15, 2013, which will be maturing on November 30, 2013. At December 31, 2013 and 2012, the total amount outstanding on these notes was $0 and $784,663, respectively.
In connection with the UGHS Dallas Hospitals Inc. acquisition on December 14, 2012, the Company entered into a $28.5 million installment balloon promissory note (the “Purchase Promissory Note”) with First National Bank. The purchase promissory note bears a fixed interest rate at 4.25% per annum, monthly principal and interest payments amortized on a 20-year basis, and a maturity date is ten years from the date of issuance. The interest rate after maturity shall be 18% per annum. The purchase promissory note is secured by 100% stock, real property, inventory and equipment of UGHS Dallas Hospitals, Inc., all as set forth in the loan agreement. The loan contains various terms and conditions, including operational and financial restrictions and limitations, affirmative and negative covenants, all as set forth in the loan agreement. At December 31, 2013 and 2012, the total amount outstanding on these notes was $27,897,938 and $28,500,000, respectively.
In connection with the UGHS Texas Anesthesia and Pain Management acquisition on June 1, 2013, the Company entered into an $800,000 promissory note with the seller. The promissory note bears interest rate at 5.0% per annum. This note has a term of 24 months and matures on June 15, 2015. At December 31, 2013, the outstanding amount on this note was $624,556.
In connection with the Living Well Diagnostic Imagining LLC acquisition on May 10, 2013, the Company entered into a promissory note of $325,000 with the seller. The promissory note bears interest rate at 5.0% per annum. This note has a term of 24 months and matures on June 1, 2015. At December 31, 2013, the outstanding amount on this note was $233,535. In addition, the Company assumed a $530,000 of seller’s debt. This loan has a nine year of a ten year term loan, bears interest rate at 7.47% per annum. At December 31, 2013, the outstanding amount on this note was $497,194.
In connection with the Waxahachie Surgery Pavilion LP acquisition on July 1, 2013, the Company entered into a promissory note of $350,000 with the seller. The promissory note bears interest rate at 5.0% per annum. This note has a term of 12 months and matures on July 1, 2014. At December 31, 2013, the outstanding amount on this note was $350,000.
In connection with the Clint Foster Centers acquisition on October 1, 2013, the Company entered into a promissory note of $350,000 with the seller. The promissory note bears interest rate at 5.0% per annum. This note has a term of three months and matures on January 1, 2014. At December 31, 2013, the outstanding amount on this note was $350,000. In addition, the Company assumed a $549,000 of seller’s debt. This loan has a three-year term, with 0% interest. At December 31, 2013, the outstanding amount on this note was $512,976.
The Company recognized total interest expense on its line of credit and all notes payable of $3,905,445 and $2,776,726 for the years ended December 31, 2013 and 2012, respectively. The Company accrued interest payable of $1,058,001 and $619,610 as of December 31, 2013 and 2012, respectively.
University General Health System, Inc.
Notes to the Consolidated Financial Statements - (Continued)
Total principal payment obligations relating to the Company’s third party notes payable for the next five years and thereafter are as follows:
NOTE 8 - LEASE OBLIGATIONS
Capital Leases
The Company has eleven capital lease obligations with six financing companies and collateralized by underlying assets. The total aggregate net book value of the assets capitalized under these capital lease obligations was $24,247,975 at December 31, 2013. These capital lease obligations have stated interest rates ranging from 3.6% to 15.3%, are payable 0 to 271 monthly installments, and mature between January 9, 2013 and July 30, 2036. As of December 31, 2013 and 2012, the Company had capital lease obligations of $31,929,442 and $31,755,291, respectively. The interest expense related to the capital lease obligation was $2,182,798 and $2,277,904 for the years ended December 31, 2013 and 2012, respectively.
Future minimum annual payments, together with the present value of the minimum lease payments under capital leases at December 31, 2013, are summarized as follows:
University General Health System, Inc.
Notes to the Consolidated Financial Statements - (Continued)
Operating Leases
The Company leases medical office buildings, land, its corporate headquarters and equipment under operating lease agreements expiring on various dates through 2055. Such leases generally contain renewal options and require that the Company pay for utilities, taxes and maintenance expense. Rent expense for operating leases for 2013 and 2012 was $5,691,904 and $2,582,583, respectively. Minimum rental commitments on long-term, non-cancelable operating leases at December 31, 2013 are as follows:
NOTE 9 - RELATED PARTY TRANSACTIONS
Payables to Related Parties
Payables to related parties include advances from employees and amounts due to affiliates for services rendered consisted of the following:
Related Party Costs and Expenses
The following table summarizes related party costs and expenses that are reflected in the accompanying Consolidated Statements of Operations:
Food Services, Plant Operations & Management, Environmental and Other Services Agreement
Prior to the acquisition of Sybaris, certain shareholders of the Company had organized Sybaris Group, LLC (“Sybaris”), a Texas limited liability company, as a service company. The Company and Sybaris entered into a management services agreement, pursuant to which Sybaris provides food services, plant operations and management, environmental and other services to the hospital for an initial term of five years. Compensation under this agreement is based on (i) expense reimbursement for direct costs incurred by Sybaris, (ii) a general expense allowance of six percent (6.0%) of the direct costs incurred by Sybaris and (iii) a service fee of four percent (4.0%) of the direct costs incurred by Sybaris. Amounts payable to Sybaris under this agreement are adjusted annually based on cost of living and other customary adjustments.
On December 31, 2011, the Company acquired certain assets and assumed certain of liabilities of Sybaris. All accounts receivable of Sybaris were specifically excluded from the acquisition and a majority of the accounts receivable balance is owed by the Company. The Company believes the terms of the transaction between Sybaris and the Company are fair, reasonable and reflects fair market value. At December 31, 2013 and 2012, the Company had related party payables to Sybaris of $797,657 and $932,507, respectively.
University General Health System, Inc.
Notes to the Consolidated Financial Statements - (Continued)
Other Related Party Transactions
A certain shareholder of the Company organized Sigma Consulting LLC (“Sigma”), a Texas limited liability company, as a service company. Sigma provided information technology consulting services to UGH LP, and for the years ended December 31, 2013 and 2012, UGH LP incurred total service expenses of $333,939 and $403,908, respectively, which were recorded as general and administrative expenses in the Consolidated Statements of Operations. The Company believes that these payments to Sigma are fair and reasonable for services rendered.
Following the acquisition of Autimis, the Company employed Brandon Griffin, Ryan Griffin and Jordan Griffin (collectively the “Griffins”) to manage daily operations of these entities. Each of the Griffins is a son of Michael Griffin, our Chief Financial Officer. Brandon Griffin is President and Chief Executive Officer of UGHS Autimis Billing Inc. and UGHS Autimis Coding Inc., each of which companies are our wholly-owned subsidiaries (the “Autimis Companies”). Ryan Griffin is Chief Operating Officer of each of the Autimis Companies. Jordan Griffin is Chief Information Officer of each of the Autimis Companies. The Griffins developed the technology infrastructure of Autimis including the Autimis Revenaid Practice Management System, which increases the collections and efficiency of our hospital systems. Our revenue cycle management capabilities under the leadership of the Griffins, give us important competitive advantages over other hospital systems. The total aggregate compensation paid by the Company for the Griffin’s respective services during 2013 and 2012 were $842,066 and $657,189, respectively.
Certain subsidiaries of the Company have engaged Black Mountain Construction Co. Inc. (“Black Mountain”) as general contractor for various construction projects at the Company’s healthcare facilities. Dr. Chahadeh is a director and a 20% owner of Black Mountain and has executed a personal guarantee of Black Mountain’s credit facility. Dr. Chahadeh’s interest in Black Mountain originated in 2011 when he decided to provide seed capital and credit support to the founders of Black Mountain in order to finance its initial operations. His interest has not generated positive personal returns on his investment. In 2013 and 2012, the Company paid Black Mountain $1,937,225 and $1,390,000, respectively for the Company’s construction projects for which Black Mountain was the general contractor. The Company capitalized the amount paid to Black Mountain as construction costs.
UGHS Senior Living of Pearland, LLC, a wholly owned subsidiary of the Company (“Pearland Senior Living”), has engaged Somnio Solutions to provide food service to its Pearland, Texas senior living community. Somnio Solutions is owned by Kyle Sapaugh, the son of Donald W. Sapaugh, the President of the Company. Pearland Senior Living pays Somnio Solutions approximately $35,000 per month for food, supplies salaries and other expenses. The Company believes that these payments to Somnio Solutions are fair and reasonable for services rendered.
UGH LP has engaged Management Affiliates of Northeast Houston, LLC (“Management Northeast”) to provide skills and supervision to develop and manage the UGH Kingwood Diagnostic and Rehabilitation Center. Randall Butler is a president and the owner of Management Northeast. Randall Butler is Chief Executive Officer of UGHS Physician Services, Inc. The total aggregate management fees paid by the Company for Management Northeast’s respective services during 2013 and 2012 were $1,490,379 and $380,000, respectively
Notes Payable to Related Parties
On October 5, 2006, the Company entered into a $2,000,000 loan agreement with Dr. Spiegel, bearing interest at a rate of 10.0%, and which is due on demand. Dr. Spiegel beneficially owns more than ten percent (10%) of the Company’s common stock. The purpose of this loan agreement is to support the Company’s working capital. As of December 31, 2013 and 2012, the outstanding balance on this loan agreement was $965,946 and $1,620,946, respectively.
In addition, the Company has two Trinity notes payable to a shareholder, which are due on demand and non-interest bearing notes. As of December 31, 2013 and 2012, the outstanding balance on this loan agreement was $199,927 and $232,434, respectively.
University General Health System, Inc.
Notes to the Consolidated Financial Statements - (Continued)
NOTE 10 - BENEFIT PLAN
The Company has a contributory 401(k) savings plan (the “401(k) Plan”) covering all full and part-time employees after 30 days of service, who are age 21 or older. Under the 401(k) Plan, participants may contribute up to 100% of their qualifying earnings on a pre-tax basis, and up to the Internal Revenue Service mandated limit. The Company currently matches 50% of each participant’s pre-tax contributions, limited up to 3% of each participant’s compensation under the Plan. The Company may make discretionary matching contributions during the year. The Company’s matching contributions expense for the 401(k) Plan was $124,406 in 2013. The Company did not provide matching contribution in 2012.
NOTE 11 - COMMITMENTS AND CONTINGENCIES
Healthcare Industry
Recently, government activity has increased with respect to investigations and allegations concerning possible violations of fraud and abuse statutes and regulations by healthcare providers. Violations of these laws and regulations could result in expulsion from government healthcare programs together with the imposition of significant fines and penalties, as well as significant repayments for patient services previously billed.
In March 2010, Congress adopted comprehensive health care insurance legislation, Patient Care Protection and Affordable Care Act and Health Care and Educational Reconciliation Act. The legislation, among other matters, is designated to expand access to coverage to substantively all citizens by 2019 through a combination of public program expansion and private industry health insurance. Changes to existing Medicaid coverage and payments are also expected to occur as a result of this legislation. Implementing regulations are generally required for these legislative acts, which are to be adopted over a period of years and, accordingly, the specific impact of any future regulations is not determinable.
In addition to national enforcement initiatives, federal and state investigations have addressed a wide variety of routine health care operations such as: cost reporting and billing practices, including for Medicare outliers; financial arrangements with referral sources; physician recruitment activities; physician joint ventures; and hospital charges and collection practices for self-pay patients. The Company engages in many of these routine health care operations and other activities that could be the subject of governmental investigations or inquiries. For example, the Company has significant Medicare and Medicaid billings, numerous financial arrangements with physicians who are referral sources to the Company hospitals, and joint venture arrangements involving physician investors. Certain of the Company individual facilities have received, and other facilities may receive, government inquiries from, and may be subject to investigation by, federal and state agencies. Any additional investigations of the Company, its executives or managers could result in liabilities or penalties to the Company, as well as adverse publicity.
Dallas
The Company has discovered that prior to the acquisition of South Hampton Community Hospital in Dallas (the “Dallas Hospital”), certain members of the Dallas Hospital’s management team engaged in wrongful billing and coding of claims related to Medicare and other federally funded healthcare plans. The actual overpayments were $188,775 as a result of these actions. The Company has estimated and accrued a total liability of overpayments of $283,163, including fines and penalties of $94,388, from these actions. The Company intends to receive indemnification from the responsible parties in accordance with the acquisition agreement, pursuant to which the Dallas Hospital was acquired.
Litigation
From time to time, the Company may become involved in litigation relating to claims arising out of its operations in the normal course of business. The Company is not involved in any pending legal proceeding or litigation and, to the best of the Company’s knowledge, no governmental authority is contemplating any proceeding to which the Company is a party or to which any of its properties is subject, which would reasonably be likely to have a material adverse effect on the Company, except for the following:
University General Health System, Inc.
Notes to the Consolidated Financial Statements - (Continued)
Prexus
On December 4, 2009, Prexus Health Consultants, LLC and its affiliate, Prexus Health LLC (collectively, “Prexus”), sued UGH LP and Ascension Physician Solutions, LLC (“APS”) in the 270th District Court of Harris County, Texas, Cause No. 2009-77474, seeking (i) $224,863 for alleged breaches of a Professional Services Agreement (the “PSA”) under which Prexus provided billing, coding and transcription services, (ii) $608,005 for alleged breaches of a Consulting Services Agreement (the “CSA”) under which Prexus provided professional management and consulting services, and (iii) lost profit damages for the remaining term of the agreements (UGH LP and APS terminated these contracts effective September 9, 2009). Prexus subsequently added additional claims seeking lost profits and other damages for alleged tortious interference of Prexus contracts. In October 2010, UGH LP and APS filed counterclaims against Prexus seeking $1,687,242 in damages caused by Prexus’ breach of the CSA.
On October 11, 2011, the trial court entered judgment against UGH LP for approximately $2,900,000, including $2,100,000 in lost profits, and $107,000 in attorneys’ fees. The judgment also awarded additional amounts for pre-judgment and post-judgment interest. UGH LP and APS appealed the judgment. On April 2, 2013, the Fourteenth Court of Appeals reformed the judgment to (1) delete the award of $900,000.00 in lost profits as a result of UGH LP’s breach of the PSA and (2) delete the award of $1,200,000.00 in lost profits as a result of APS’s breach of the CSA. As of April 4, 2013, the total amount of the reformed judgment, inclusive of all prejudgment and post-judgment interest and attorneys’ fees, was approximately $1,080,072.63, with interest accruing at the rate of $299.91 per day on the damages, and at a rate of $15.39 per day on the attorneys’ fees. As of December 31, 2013, the Company has reserved $1,053,838 which is inclusive of all pre-judgment and post-judgment interest and attorney’s fees. The Company has been paid outstanding balance in full in May 2014.
Siemens
On June 29, 2010, Siemens Medical Solutions USA, Inc. (“Siemens”) sued UGH LP, University Hospital Systems, LLP (“UHS”) and several individual guarantors in the 215th District Court of Harris County, Texas, Cause No. 2010-40305, seeking approximately $7,000,000 for alleged breaches of (i) a Master Equipment Lease Agreement dated August 1, 2006 and related agreements (the “Lease Agreements”), pursuant to which UGH LP leased certain radiology equipment and (ii) an Information Technology Agreement dated March 31, 2006 and related agreements (the “IT Agreements”) pursuant to which Siemens agreed to provide an information technology system, software and related services. On November 22, 2010 UGH LP filed counterclaims against Siemens seeking approximately $5,850,000 against Siemens for breach of contract, negligent representation and breach of warranty based on Siemens’ breach of the Lease Agreements and the IT Agreements. On February 28, 2011, the court signed an order granting partial summary judgment in favor of Siemens and against UGH LP as to UGH LP’s liability for breach of the Lease Agreements, but not as to damages sought by Siemens.
On October 17, 2011, the parties entered into a Confidential Settlement Agreement and Mutual Release (the “Settlement Agreement”) resolving this dispute. On September 15, 2011, the parties to the Siemens litigation reached a settlement of the pending litigation. As part of the settlement, UGH LP agreed to pay Siemens an aggregate of $4,850,000 over a period of 20 months beginning in October 2011 through May 2013. Thereafter, a dispute arose regarding the Settlement Agreement, and on February 2, 2012 the trial court entered an Agreed Judgment against UGH LP and UHS in the amount of $5,500,000, less credits for amounts paid by UGH LP under the Settlement Agreement. UGH LP was in a dispute with Siemens regarding the settlement agreement entered into on September 15, 2011. Specifically UGH LP disputed the entry of the agreed judgment securing the settlement as a result of an alleged breach of the settlement agreement. UGH LP and UHS timely filed an appeal and suspended enforcement of the Agreed Judgment during the pendency of such appeal. Case No. 01-12-00174-CV, First Court of Appeals, Houston, Texas. UGH LP and UHS also filed a Petition for Writ of Mandamus challenging the trial court’s jurisdiction to enter the Agreed Judgment. Case No. 01-12-00186-CV, First Court of Appeals, Houston, Texas. On February 28, 2013, the First Court of Appeals ruled in favor of UGH LP and UHS, concluding that the trial court rendered a void judgment, and vacating the trial court’s judgment. On March 28, 2013 Siemens filed a new suit against UGH LP and UHS alleging breach of the settlement agreement and seeking entry of the Agreed Judgment.
On May 30, 2014, the trial court entered a judgment awarding Siemens $3,577,333 in actual damages for breach of the Settlement Agreement, $536,306 in pre-judgment interest and $731,279 in attorney fees and other judgment collections. As of December 31, 2013, Company accrued this unpaid amount of $4,844,918 in the Consolidated Balance Sheets as a note payable (see Note 7).
The Company intends to appeal the trial court’s ruling on the breach of the Settlement Agreement entered into on May 30, 2014.
University General Health System, Inc.
Notes to the Consolidated Financial Statements - (Continued)
Internal Revenue Service
The Company currently owes the IRS past due payroll taxes and related interest and penalties. Until paid in full, statutory penalties and interest will continue to accrue. The Company has engaged special counsel to handle this matter and intends to fully satisfy its tax obligations and is seeking long-term financing in this regard. At December 31, 2013 and December 31, 2012, the Company accrued $5,852,673 and $1,610,836, respectively, in the Consolidated Balance Sheets.
NOTE 12 - DERIVATIVES
The table summarizes the Company’s derivative instruments:
The fair values of derivative instruments were estimated using the Binomial pricing model based on the following weighted-average assumptions:
The following table summarizes derivative warrants outstanding and exercisable as at December 31, 2013:
(a) Derivatives cease to exist
In 2012, several Series C Preferred Shareholders converted 1,325 shares of Series C Preferred Stock into 6,518,701 shares of the Company’s common stock. As of the date of conversion, the Company reclassified the fair value of the derivative liability to additional paid in capital as the derivative ceased to exist.
In 2012, 13,618,184 warrants were cashless exercised into 9,414,998 shares of the Company’s common stock. As of the date of conversion, the Company reclassified the fair value of the derivative liability to additional paid in capital as the derivative ceased to exist.
On December 31, 2012, certain Series C Warrants were amended to waive all full ratchet provisions. As of the date of amendment, the Company reclassified the fair value of the remaining derivative liability for the warrants to additional paid in capital as the derivative ceased to exist.
University General Health System, Inc.
Notes to the Consolidated Financial Statements - (Continued)
On March 21, 2013, all remaining Series C Preferred Shareholders agreed to waive all full ratchet provisions. As of the date of amendment, the Company reclassified the fair value of the remaining derivative liability for the Preferred shares to additional paid in capital as the derivative ceased to exist.
(b) Consulting Warrants:
During the year ended December 31, 2012, the Company issued warrants to consultants for services. The warrants have round-down provisions where if the Company sells or grants any option to purchase or sells or grants any right to re-price, or otherwise disposes of or issues (or announces any sale, grant or any option to purchase or other disposition), any common stock or common stock equivalents entitling any person to acquire shares of common stock at an effective price per share that is lower than the then conversion price then the conversion price shall be reduced to equal the base conversion price.
NOTE 13 - EQUITY
Common Stock
Effective April 30, 2012 the Company completed a private placement transaction for the purchase of 35,950,000 shares of its Common Stock at a price of $0.14 per share from a group of accredited investors, resulting in net proceeds to the Company of approximately $5,033,000. The Company used these proceeds to pay tax payments and retired certain outstanding loan balances.
On April 30, 2012, the Company entered into an Executive Stock Agreement with a key executive (the “Executive”), pursuant to which the Company sold to the Executive in the aggregate 1,071,429 shares of common stock (“Executive Shares”) at a purchase price of approximately $0.14 per share, and the Executive entered into a promissory note with the Company for $150,000. The shares purchased by the Executive are subject to repurchase by the Company if, prior to the second anniversary of the issuance date, the Executive’s employment with the Company is terminated for “cause” (as defined in the Executive Stock Agreement) or the Executive resigns from his employment without “good reason” (as defined in the Executive Stock Agreement). The Executive Shares are subject to time vesting that will vest annually over a two-year period (i.e., 50% per year). The Company used the proceeds for working capital purposes. The promissory note is due and payable on December 31, 2022. The promissory note bears interest rate at 4.0%, and the accrued interest shall be paid in full on the date of on which the final principal payment on this note is made.
On May 31, 2012, the Company entered into a $2,000,000 promissory note with Northwest Anesthesia and Pain, P.A. (“NWAP”). In lieu of cash interest on the principal balance of this note, the company issued NWAP 2,000,000 shares of the Company’s common stock, $0.001 par value per share, to the payee valued at $520,000
On June 1, 2012, the Company issued 1,865,000 shares of its common stock in connection with the acquisition of UGH Diagnostic Imaging and UGH Physical Therapy at a price of $0.40 per share.
On July 30, 2012, the Company issued 702,376 shares of its common stock in connection with the acquisition of UGH Kingwood Diagnostic and Rehabilitation Center at a price of approximately $0.25 per share.
Sigma Opportunity Fund, LLC purchased from the Company 1,275,000 shares of common stock, par value $0.001 per share, of the Company for an aggregate purchase price of $370,500 in cash. In addition to assist in the financing of the acquisition of the TrinityCare, and the retirement of certain debt, the Company entered into a note purchase agreement with Sigma Opportunity Fund, LLC (the “Service Provider”) in 2012.
University General Health System, Inc.
Notes to the Consolidated Financial Statements - (Continued)
On October 11, 2012, the Company entered into a $1,000,000 promissory note with NWAP. In lieu of cash interest on the principal balance of this note, the company issued NWAP 450,000 shares of the Company’s common stock, $0.001 par value per share, to the payee valued at $193,500.
On November 27, 2012, the Company issued 771,664 shares of common stock in connection with the acquisition of UGH Baytown Imaging and UGH Baytown Sleep Evaluation Centers at a price of approximately $0.40 per share.
During the fourth quarter of 2012, the Company issued 6,518,701 common shares upon conversion of 1,325 shares of Series C Preferred Stock.
During December 2012, 13,618,184 warrants were exercised through net share settlement resulting in the issuance of 9,414,998 common shares.
On January 15, 2013, the Company issued an aggregate of 10,100,000 shares of its Common Stock to members of its senior management team as discretionary bonus compensation for their performance for prior years. Effective December 31, 2013, the Company’s Board of Directors has determined that it is the best interest of the Company to rescind the issuances of 9,600,000 shares and cause each of the Key Managers to forfeit the shares issued to them in 2013, except Kelly Reidel, Chief Administrative Officer of the Company, who passed away October 1, 2013. As a result, the Company reversed compensation expense of $3,819,600 on December 31, 2013.
On February 8, 2013, the Company and Sigma Opportunity Fund II, LLC (“Sigma”) entered into a purchase agreement, pursuant to which Sigma acquired 325,000 shares of Common Stock for a purchase price of $0.43 per share. The purchase agreement was executed contemporaneously with an agreement to extend the maturity date of Sigma’s $1,000,000 promissory note to June 27, 2013.
On February 20, 2013, the Company issued an aggregate of 250,000 shares of its Common Stock to TriPoint Global Equities, LLC and SBAR Capital Management, LLC pursuant to that certain Advisory Agreement dated as of September 25, 2012 between the Company and TriPoint Global Equities, LLC and SBAR Capital Management, LLC.
On July 1, 2013, the Company and Sigma Opportunity Fund II, LLC (“Sigma”) entered into a purchase agreement, pursuant to which Sigma acquired 500,000 shares of Common Stock for a purchase price of $0.62 per share. The purchase agreement was executed contemporaneously with an agreement to extend the maturity date of Sigma’s $2,000,000 promissory note.
On July 29, 2013, the Company and 683 Capital Management LLC (“Capital Management”) and Rock Hill Global LLC (“Rock Hill”) entered into a purchase agreement, pursuant to which Capital Management and Rock Hill acquired 3,829,787 and 851,064 shares of Common Stock for a purchase price of $0.47 per share. The Company used these proceeds to pay certain outstanding loan balances.
On September 6, 2013, the Company issued an aggregate of 327,660 shares of its Common Stock to TriPoint Global Equities, LLC and SBAR Capital Management, LLC pursuant to that certain Advisory Agreement dated as of September 25, 2012 between the Company and TriPoint Global Equities, LLC and SBAR Capital Management, LLC.
On September 24, 2013, the Company issued an aggregate of 671,875 shares of its common stock, valued at $262,032, to Northwest Anesthesia and Pain, P.A. in exchange for cash interest on the principal balances of two promissory notes.
On November 5, 2013, the Company issued an aggregate of 375,000 shares of its common stock, valued at $195,000, to certain persons as compensation for services rendered by such persons related to the development of the Company’s health delivery network in the Dallas, Texas market.
On December 26, 2013, the Company issued an aggregated of 2,500,000 shares of its common stock, valued at $850,000, to certain shareholders of Series C Preferred Stock in consideration for their agreements to consent to certain agreements to the Certification of Designation applicable to the Series C Stock.
In 2013, the Company issued 14,250,294 common shares upon conversion of 2,896 shares of Series C Preferred Stock.
University General Health System, Inc.
Notes to the Consolidated Financial Statements - (Continued)
In 2013, the Company issued 6,194,015 warrants were exercised through net share settlement resulting in the issuance of 3,370,328 common shares.
Series B Preferred Stock
The Company is authorized to issue up to 20,000,000 shares of preferred stock of $0.001 par value per share, in one or more series, and to determine the price, rights, preferences and privileges of the shares of each such series without any further vote or action by the stockholders. The rights of the holders of common stock will be subject to, and may be adversely affected by, the rights of the holders of any shares of preferred stock that may be issued in the future.
On March 10, 2011, the Company issued 3,000 shares of Series B Preferred Stock to Hassan Chahadeh, M.D. which, except as otherwise required by law, has the number of votes equal to the number of votes of all outstanding shares of capital stock plus one additional vote so that such shareholder shall always constitute a majority of the Company’s voting rights. Therefore, Hassan Chahadeh, M.D. retains the voting power to approve all matters requiring shareholder approval and has significant influence over the Company’s operations. This preferred issuance has no economic value.
NOTE 14 - SERIES C PREFERRED STOCK AND WARRANTS
On May 2, 2012, the Company completed a securities purchase agreement (the “Securities Purchase Agreement”) with institutional investors (the “Purchasers”), for the private issuance and sale to the Purchasers of 3,808 shares of the Company’s Series C Variable Rate Convertible Preferred Stock (the “Preferred Shares”). During 2012, the total greenshoe exercises was $800,000. Each Preferred Share initially convertible into approximately 4,545 shares of the Company’s Common Stock (the “Conversion Shares”) and each warrant initially purchase up to approximately 4,545 shares of the Company’s Common Stock (the “Warrants”) at $0.26, are exercisable at any time, and expire on May 2, 2017. The Preferred Shares were issued at an original issue discount at 12%. After deducting for fees and expenses, the aggregate net proceeds from the sale of the Preferred Shares and Warrants was approximately $3.1 million. The Company used these proceeds to pay tax payments and retired certain outstanding loan balances. At any time after the six month anniversary of the date of issuance of the Preferred Shares, the Company has the right to redeem the Preferred Shares at a premium of 115%, subject to certain conditions. Furthermore, at any time after the six month anniversary of the date of issuance of the Preferred Shares the Company has the right to require the holders to convert their Preferred Shares in the event that the Company’s common stock meets certain trading premiums, and subject to other conditions.
The holders of the Preferred Shares are entitled to receive cumulative dividends at a rate per share of 8% per annum until October 31, 2013, increasing to 16% per annum from November 1, 2013 until January 31, 2014, further increasing to 20% per annum from February 1, 2014 until April 30, 2014 and finally increasing to 25% per annum thereafter, payable quarterly on February 1, May 1, August 1 and November 1, beginning on May 1, 2012. In the event if funds are not legally available for the payment of dividends, then, at the election of such holder, such dividends shall accrue to the next dividend payment date or shall be accreted to, and increase, the outstanding value of the Preferred Share. In addition, dividends are subject to late fees payment. Any dividends that are not paid within three trading days following a dividend payment date shall continue to accrue and shall entail a late fee, which must be paid in cash, at the rate of 18.0% per annum or the lesser rate permitted by applicable law which shall accrue daily from the dividend payment date through and including the date of actual payment in full. On November 1, 2013, the Board declared and paid a quarterly cash dividend of $65,013. In the current year, the Company has paid cash dividends totaling $163,345. At December 31, 2013, the Company accrued $141,740 of the dividend. In addition, the Company has recorded the accretion non-cash dividend for the increasing variable dividend rate for the years ended December 31, 2013 and 2012 in the amount of $1,019,789 and $512,190, respectively.
In the event of any liquidation, dissolution or winding-up of the Corporation, whether voluntary or involuntary, the holders shall be entitled to receive out of the assets, whether capital or surplus, of the corporation an amount equal to the Stated Value, plus any accrued and unpaid dividends thereon and any other fees or liquidated damages then due and owing for each share of Preferred Stock before any distribution or payment shall be made to the holders of any junior securities, and if the assets of the corporation shall be insufficient to pay in full such amounts, then the entire assets to be distributed to the holders shall be ratably distributed among the holders in accordance with the respective amounts that would be payable on such shares if all amounts payable thereon were paid in full. A fundamental transaction or change of control transaction shall not be deemed a liquidation. The corporation shall mail written notice of any such Liquidation, not less than 45 days prior to the payment date stated therein, to each holder.
University General Health System, Inc.
Notes to the Consolidated Financial Statements - (Continued)
Each Preferred Share is convertible at any time at the option of the holder into a number of shares of the Company’s common stock determined by dividing the purchase price of $1,000 by the conversion price of $0.22 per share in effect on the date of the certificate is surrendered for conversion. The conversion price is subject to equitable adjustment in the event of any stock splits, stock dividends, recapitalizations and the like. In addition to any other adjustments hereunder, the Conversion Price shall be permanently and cumulatively reduced, and only reduced, by the percentage by which the Corporation fails to meet the Adjusted Net Income amounts set forth in the agreement.
In 2012, the Company incurred approximately $356,000 of direct costs including warrants issued to the Company placement agents as part of their compensation for the transaction. The expenses were recorded as a contra temporary preferred stock account and are being accreted to expense over the expected maturity of the preferred stock.
In 2013, the total greenshoe exercises was $2,600,000. In addition, the Company has received the total greenshoe exercise in 2012 of $374,181. Each Preferred Share initially convertible into approximately 4,545 shares of the Company’s Common Stock (the “Conversion Shares”) and each warrant initially purchase up to approximately 4,545 shares of the Company’s Common Stock (the “Warrants”) at $0.24, are exercisable at any time, and expire on May 2, 2017.
In 2012, 1,325 of Preferred Shares were converted to the Company’s common shares, resulting in the issuance of 6,518,701 common shares.
In 2013, 2,896 of Series C Preferred Stock were converted to the Company’s common shares, resulting in the issuance of 14,250,295 common shares.
As of December 31, 2013, there were 3,396 shares of Company’s Preferred Shares outstanding and the maximum number of the Company’s common shares could be required to be issued is approximately 16,713,000.
Amendments of Warrants
On December 31, 2012, the Company and each holder of the Warrants entered into a First Amendment to Warrants (the “First Amendment to Warrants”) pursuant to which (i) the full ratchet price protection in the Warrants was deleted, (ii) the Company agreed, subject to certain limited exceptions, not to issue Common Stock for consideration per share less than the then existing exercise price per share under the Warrants without the consent of each holder of the Warrants (each issuance for consideration per share less than the then existing exercise price per share under the Warrants, a “Dilutive Issuance”) and (iii) the holders of the Warrants relinquished their right to require the Company to purchase the Warrants for cash upon the occurrence of certain fundamental transactions. Any new Warrants issued on or after the date hereof by the Company to the Purchasers as “Greenshoe Securities” pursuant to the Securities Purchase Agreement will reflect the amendments to the terms of the Warrants set forth in the First Amendment to Warrants.
Also on December 31, 2012, the Company and the holders of Warrants entered into a Second Amendment to Warrants (the “Second Amendment to Warrants”) (i) to purchase an aggregate of 17,309,090 shares of Common Stock pursuant to which the exercise price per share for such holders was reduced to $0.15 per share if and only if such Warrants are exercised on or before December 31, 2012, (ii) each holder of the Warrants consented to the issuance of Common Stock at an exercise price of $0.15 per share as contemplated by the Second Amendment to Warrants, which issuance would constitute a Dilutive Issuance, (iii) the Post-2012 Exercise Price has been adjusted hereunder to $0.24 as of January 1, 2013 (iv) each holder of Preferred Shares waived the full ratchet price protection that would otherwise be triggered under the Certificate of Designation relating to the Preferred Shares by the issuance of Common Stock at an exercise price of $0.15 as contemplated by the Second Amendment to Warrants.
At December 31, 2013, warrants were outstanding to purchase up to 17,475,548 of the Company’s common shares. During 2013, 6,194,015 of these warrants were exercised through net share settlement resulting in the issuance of 3,370,328 common shares.
NOTE 15 - GAIN ON EXTINGUISHMENT OF LIABILITIES
The Company settled certain accounts payable with vendors, and reduced the accounts payable owed to those vendors. In addition, the Company also settled certain debt obligations with debt holders and reduced principal balance, accrued interest, taxes and penalties due on promissory notes that have been extinguished in accordance with the statute of limitations. For the year ended December 31, 2012, the Company recognized a gain on extinguishment of liabilities of $3,644,068. The Company evaluated the classification of these gain and determined that the gain does not meet the criteria for classification as an extraordinary item. As a result, the gain has been included as “Gain on extinguishment of liabilities” within income from continuing operations in the accompanying Income Statements for the years ended December 31, 2012 and 2012. The Company did not have gain on extinguishment of liabilities in 2013.
University General Health System, Inc.
Notes to the Consolidated Financial Statements - (Continued)
NOTE 16 - INCOME TAXES
The Company has adopted ASC 740-10 which requires the use of the liability method in the computation of income tax expense and the current and deferred income taxes payable (deferred tax liability) or benefit (deferred tax asset).
The Company files separate federal income tax returns for each of its subsidiaries and combined Texas state tax returns in 2013 and 2012.
The provision for income taxes consists of the following:
University General Health System, Inc.
Notes to the Consolidated Financial Statements - (Continued)
Significant components of the Company’s deferred tax assets and liabilities as of December 31, 2013 and 2012 are as follows:
Deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. The Company’s deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of the Company’s deferred tax assets depends upon generating sufficient future taxable income during the period in which the Company’s temporary differences become deductible for tax purposes. Based upon this assessment, the Company must evaluate the need for, and amount of, valuation allowances against the Company’s existing deferred tax assets. To the extent that facts and circumstances change in the future, adjustments to the valuation allowances may be required. In the years ending December 31, 2013 and 2012, the Company provided a valuation allowance against a portion of the deferred tax assets existing as of the reporting date and the change in the valuation allowance between years was provided in the Company’s tax expense. The deferred tax assets at December 31, 2012 include the basis differences that existed as of the date of conversion of the partnerships to a C Corporation in 2011. In addition, the Company has reflected the increase in the valuation allowance of approximately $4 million for the deferred tax assets that existed at the date of the conversion of the Company’s status as a partnership to a C Corporation which were not given benefit in purchase accounting due to the realizability of the benefit of the deferred tax assets not meeting the more likely than not criteria.
In connection with the acquisition of UGHS Dallas Hospitals, Inc, the Company recorded deferred tax liabilities and additional goodwill of $4.9 million at the date of the acquisition, December 14, 2012.
University General Health System, Inc.
Notes to the Consolidated Financial Statements - (Continued)
The income tax provision differs from the amount of income tax determined by applying the U.S. federal income tax rate to pretax income from continuing operations for the years ended December 31, 2013 and 2012 due to the following:
The Company has net operating loss carryforwards for income tax purposes of approximately $13.8 million which, if not utilized, will expire in varying amounts between 2031 and 2032. Section 382 of the Internal Revenue Code imposes limitations on a corporation’s ability to utilize net operating loss carryforwards if it experiences an “ownership change”. In general terms, an ownership change may result from transactions increasing the ownership of certain shareholders in the stock of a corporation by more than 50 percentage points over a three-year period. In the event of an ownership change as defined in the Internal Revenue Code, utilization of our net operating loss carry-forwards would be subject to an annual limitation under Section 382 determined by multiplying the value of our stock at the time of the ownership change by the applicable long-term tax-exempt rate. Any unused net operating loss carry-forwards in excess of the annual limitation may be carried over to later years. The Company may be subject to the limitations under Section 382 as it intends to complete additional acquisitions in 2014 and future years.
The Company is subject to taxation primarily in the United States and Texas. Although the outcome of the tax audits is uncertain, the Company has concluded that there were no significant uncertain tax positions, as defined by ASC No. 740-10, Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109, requiring recognition in its financial statements. However, the Company may, from time to time, be assessed interest and/or penalties. In the event the Company receives an assessment for interest and/or penalties, it will be classified in the financial statements as income tax expense.
The Company is subject to a tax mandated by the State of Texas based on a defined calculation of gross margin (the “margin tax”). The margin tax is calculated by applying a tax rate to a base that considers both revenue and expenses and therefore has the characteristics of an income tax. As a result, the Company recorded $710,332 and $478,051 in state income tax expense for the years ended December 31, 2013 and 2012, respectively.
NOTE 17 - SEGMENT INFORMATION
Under ASC Topic No. 280, Segment Reporting, operating segments are defined as components of an enterprise about which separate Discrete Financial Information is available, that is evaluated regularly by the chief operating decision maker, or decision-making group, in deciding how to allocate resources and in assessing performance. The Company’s chief operating decision-making group is composed of the chief executive officer, chief financial officer and members of senior management. The Company operates in three lines of business-(i) as a hospital, (ii) as a senior living care community, and (iii) as a support services company.
(i) Hospitals. The Company currently owns, manages and operates two hospitals, which offer a variety of medical and surgical services with a total of 180 beds. The hospitals provide inpatient, outpatient and ancillary services including inpatient surgery, outpatient surgery, heart catheterization procedures, physical therapy, diagnostic imaging and respiratory therapy, sleep lab, speech therapy, bariatrics, orthopedics, lab, and wound care. The Company’s hospitals provide 24-7 emergency services and comprehensive inpatient services including critical care and cardiovascular services. This business segment also includes the ownership of free-standing ambulatory surgery centers in markets that the Company targets for expansion.
University General Health System, Inc.
Notes to the Consolidated Financial Statements - (Continued)
(ii) Senior Living. Senior living communities offer housing and 24-hour assistance with activities of daily life to mid-acuity frail and elderly residents. The Company also operates memory care services specially designed for residents with Alzheimer’s disease and progressive dementia.
(iii) Support Services. The Company provides billing, coding and other revenue cycling management services to University General Hospital and University General Hospital Dallas, as well as other clients not affiliated with the Company. The Company’s food and support services group provides a number of interrelated services including food, hospitality and facility services for businesses and healthcare facilities.
University General Health System, Inc.
Notes to the Consolidated Financial Statements - (Continued)
The following table presents selected financial information for the Company’s operating segments: