U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2006
Commission File No. 001-16587
ORION HEALTHCORP, INC.
(NAME OF SMALL BUSINESS ISSUER IN ITS CHARTER)
Delaware 58-1597246
(STATE OR OTHER JURISDICTION (IRS EMPLOYER IDENTIFICATION NO.)
OF INCORPORATION OR ORGANIZATION)
1805 Old Alabama Road
Suite 350, Roswell GA 30076
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
ISSUER'S TELEPHONE NUMBER: (678) 832-1800
SECURITIES REGISTERED UNDER SECTION 12(B) OF THE ACT:
NAME OF EACH EXCHANGE ON
TITLE OF EACH CLASS WHICH REGISTERED
------------------------------------------------ ---------------------------
Class A Common Stock, $0.001 par value per share The American Stock Exchange
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act.)
Yes [ ] No [X]
As of May 9, 2006, 12,713,776 shares of the registrant's Class A Common Stock,
par value $0.001, were outstanding, 10,448,470 shares of the registrant's Class
B Common Stock, par value $0.001, were outstanding and 1,437,572 shares of the
registrant's Class C Common Stock, par value $0.001, were outstanding.
Transitional Small Business Disclosure Format:
Yes [ ] No [X]
ORION HEALTHCORP, INC.
Quarterly Report on Form 10-QSB
For the Quarterly Period Ended March 31, 2006
TABLE OF CONTENTS
Item Page
Number Number
------ --------
PART I -- FINANCIAL INFORMATION
1. Financial Statements
2. Management's Discussion and Analysis or Plan of Operation
3. Controls and Procedures
PART II -- OTHER INFORMATION
1. Legal Proceedings
2. Unregistered Sales of Equity Securities and Use of Proceeds
3. Defaults Upon Senior Securities
4. Submission of Matters to a Vote of Security Holders
5. Other Information
6. Exhibits
SIGNATURES
UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS F-1
INDEX OF EXHIBITS
NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain statements in this Quarterly Report on Form 10-QSB constitute
"forward-looking statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended, (the "Securities Act"), and Section 21E of the
Securities Exchange Act of 1934, as amended, (the "Exchange Act," and
collectively, with the Securities Act, the "Acts"). Forward-looking statements
include statements preceded by, followed by or that include the words "may,"
"will," "would," "could," "should," "estimates," "predicts," "potential,"
"continue," "strategy," "believes," "anticipates," "plans," "expects," "intends"
and similar expressions. Any statements contained herein that are not statements
of historical fact are deemed to be forward-looking statements.
The forward-looking statements in this report are based on current beliefs,
estimates and assumptions concerning the operations, future results, and
prospects of Orion HealthCorp, Inc. and its affiliated companies ("Orion" or the
"Company") described herein. As actual operations and results may materially
differ from those assumed in forward-looking statements, there is no assurance
that forward-looking statements will prove to be accurate. Forward-looking
statements are subject to the safe harbors created in the Acts. Any number of
factors could affect future operations and results, including, without
limitation, changes in federal or state healthcare laws and regulations and
third party payer requirements, changes in costs of supplies, the loss of major
customers, labor and employee benefits, the inability to obtain a forbearance on
the Company's revolving lines of credit as a result of the Company's default of
its financial covenants, increases in interest rates on the Company's
indebtedness as well as general market conditions, competition and pricing, and
the Company's ability to successfully implement its business strategies. The
Company undertakes no obligation to update publicly any forward-looking
statements, whether as a result of new information or future events.
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
The Company's unaudited consolidated condensed financial statements and
related notes thereto are included as a separate section of this report but
included herein, commencing on page F-1.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
The following Management's Discussion and Analysis of Financial Condition
and Results of Operations highlights the principal factors that have affected
the Company's financial condition and results of operations as well as the
Company's liquidity and capital resources for the periods described. All
significant intercompany balances and transactions have been eliminated in
consolidation.
Overview
Orion is a healthcare services organization providing outsourced business
services to physicians, serving the physician market through two subsidiaries,
Medical Billing Services, Inc. ("MBS") and Integrated Physician Solutions, Inc.
("IPS"). MBS provides billing, collection, accounts receivable management,
coding and reimbursement services, reimbursement analysis, practice consulting,
managed care contract management and accounting and bookkeeping services,
primarily to hospital-based physicians such as pathologists, anesthesiologists
and radiologists. MBS currently provides services to approximately 58 clients,
representing 337 physicians. IPS serves the general and subspecialty pediatric
physician market, providing accounting and bookkeeping, human resource
management, accounts receivable management, quality assurance services,
physician credentialing, fee schedule review, training and continuing education
and billing and reimbursement analysis. IPS currently provides services to five
pediatric groups in Illinois and Ohio, representing 37 physicians. The Company
believes the core competency of the Company is its long-term experience and
success in working with and creating value for physicians.
Company History
The Company was incorporated in Delaware on February 24, 1984 as Technical
Coatings, Incorporated. On December 15, 2004, the Company completed a
transaction to acquire IPS (the "IPS Merger") and to acquire Dennis Cain
Physician Solutions, Ltd. ("DCPS") and MBS (the "DCPS/MBS Merger")
(collectively, the "2004 Mergers"). As a result of these transactions, IPS and
MBS became wholly owned subsidiaries of the Company, and DCPS is a wholly owned
subsidiary of MBS. On December 15, 2004, and simultaneous with the consummation
of the 2004 Mergers, the Company changed its name from SurgiCare, Inc. to Orion
HealthCorp, Inc. and consummated its restructuring transactions (the "Closing"),
which included issuances of new equity securities for cash and contribution of
outstanding debt, and the restructuring of its debt facilities. The Company also
created Class B Common Stock and Class C Common Stock, which were issued in
connection with the equity investments and acquisitions.
-1-
Strategic Focus
In 2005, the Company initiated a strategic plan designed to accelerate its
growth and enhance its future earnings potential. As part of this plan, since
the first quarter of 2005, the Company began divesting certain non-strategic
assets and ceased investing in business lines that did not complement the
Company's plan, and redirected financial resources and company personnel to
areas that management believes enhances long-term growth potential.
Specifically, in the first quarter of 2006, the Company sold SurgiCare Memorial
Village, L.P. ("Memorial Village") to First Surgical Memorial Village, L.P.
("First Surgical") and sold San Jacinto Surgery Center, Ltd. ("San Jacinto") to
San Jacinto Methodist Hospital ("Methodist"). Additionally, in early 2006, the
Company was notified by Union Hospital that it was exercising its option to
terminate the management services agreements for Tuscarawas Ambulatory Surgery
Center, LLC ("TASC") and Tuscarawas Open MRI, L.P. ("TOM"). With the completion
of these activities, the Company no longer has any ownership or management
interests in ambulatory surgery and diagnostic centers.
Additionally, the Company believes that it is now positioned to focus on
its physician services business and the physician billing and collections
market, leveraging its existing presence to expand into additional geographic
regions and increase the range of services it provides to physicians. Part of
this strategy will include acquiring financially successful billing companies
focused on providing services to hospital-based physicians and increasing sales
and marketing efforts in existing markets.
Financial Overview
As more fully described below, the Company's results of operations for the
three months ended March 31, 2006 as compared to the same period in 2005 reflect
several important factors, many relating to the impact of transactions which
occurred as part of the Company's strategic plan referred to above.
o The Company sold substantially all of the assets of Memorial Village
and recorded a gain on disposition of discontinued components of
$574,321;
o The Company sold substantially all of the assets of San Jacinto and
recorded a gain on disposition of discontinued components of $94,066;
o The Company paid $112,500 in satisfaction of a $778,000 debt and
recognized a gain on forgiveness of debt totaling $665,463; and
o Income from continuing operations totaled $243,873 for the three
months ended March 31, 2006.
Critical Accounting Policies and Estimates
The preparation of the Company's financial statements is in conformity with
accounting principles generally accepted in the United States, which require
management to make estimates and assumptions that affect the amounts reported in
the financial statements and footnotes. The Company's management bases these
estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments that are not readily apparent from other sources.
These estimates and assumptions affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements, as well as the reported amounts of revenues and
expenses during the reporting period. Changes in the facts or circumstances
underlying these estimates could result in material changes and actual results
could differ from these estimates. The Company believes the following critical
accounting policies affect the most significant areas involving management's
judgments and estimates. In addition, please refer to "Note 1. General" of the
Company's unaudited consolidated condensed financial statements included
beginning on Page F-5 of this report for further discussion of the Company's
accounting policies.
Consolidation of Physician Practice Management Companies. In March 1998,
the Emerging Issues Task Force ("EITF") of the Financial Accounting Standards
Board ("FASB") issued its Consensus on Issue 97-2 ("EITF 97-2"). EITF 97-2
addresses the ability of physician practice management ("PPM") companies to
consolidate the results of medical groups with which it has an existing
contractual relationship. Specifically, EITF 97-2 provides guidance for
consolidation where PPM companies can establish a controlling financial interest
in a physician practice through contractual management arrangements. A
controlling financial interest exists, if, for a requisite period of time, the
PPM has "control" over the physician practice and has a "financial interest"
that meets six specific requirements. The six requirements for a controlling
financial interest include:
(a) the contractual arrangement between the PPM and physician practice (1)
has a term that is either the entire remaining legal life of the physician
practice or a period of 10 years or more, and (2) is not terminable by the
physician practice except in the case of gross negligence, fraud, or other
illegal acts by the PPM or bankruptcy of the PPM;
-2-
(b) the PPM has exclusive authority over all decision making related to (1)
ongoing, major, or central operations of the physician practice, except the
dispensing of medical services, and (2) total practice compensation of the
licensed medical professionals as well as the ability to establish and implement
guidelines for the selection, hiring, and firing of them;
(c) the PPM must have a significant financial interest in the physician
practice that (1) is unilaterally salable or transferable by the PPM and (2)
provides the PPM with the right to receive income, both as ongoing fees and as
proceeds from the sale of its interest in the physician practice, in an amount
that fluctuates based upon the performance of the operations of the physician
practice and the change in fair value thereof.
IPS is a PPM company. IPS's MSAs governing the contractual relationship
with its affiliated medical groups are for forty year terms; are not terminable
by the physician practice other than for bankruptcy or fraud; provide IPS with
decision making authority other than related to the practice of medicine;
provide for employment and non-compete agreements with the physicians governing
compensation; provide IPS the right to assign, transfer or sell its interest in
the physician practice and assign the rights of the MSAs; provide IPS with the
right to receive a management fee based on results of operations and the right
to the proceeds from a sale of the practice to an outside party or, at the end
of the MSA term, to the physician group. Based on this analysis, IPS has
determined that its contracts meet the criteria of EITF 97-2 for consolidating
the results of operations of the affiliated medical groups and has adopted EITF
97-2 in its statement of operations. EITF 97-2 also has addressed the accounting
method for future combinations with individual physician practices. IPS believes
that, based on the criteria set forth in EITF 97-2, any future acquisitions of
individual physician practices would be accounted for under the purchase method
of accounting.
Revenue Recognition. MBS's principal source of revenues is fees charged to
clients based on a percentage of net collections of the client's accounts
receivable. MBS recognizes revenue and bills its clients when the clients
receive payment on those accounts receivable. MBS typically receives payment
from the client within 30 days of billing. The fees vary depending on specialty,
size of practice, payer mix, and complexity of the billing. In addition to the
collection fee revenue, MBS also earns fees from the various consulting services
that MBS provides, including medical practice management services, managed care
contracting, coding and reimbursement services.
IPS records revenue based on patient services provided by its affiliated
medical groups. Net patient service revenue is impacted by billing rates,
changes in current procedural terminology code reimbursement and collection
trends. IPS reviews billing rates at each of its affiliated medical groups on at
least an annual basis and adjusts those rates based on each insurer's current
reimbursement practices. Amounts collected by IPS for treatment by its
affiliated medical groups of patients covered by Medicare, Medicaid and other
contractual reimbursement programs, which may be based on cost of services
provided or predetermined rates, are generally less than the established billing
rates of IPS's affiliated medical groups. IPS estimates the amount of these
contractual allowances and records a reserve against accounts receivable based
on historical collection percentages for each of the affiliated medical groups,
which include various payer categories. When payments are received, the
contractual adjustment is written off against the established reserve for
contractual allowances. The historical collection percentages are adjusted
quarterly based on actual payments received, with any differences charged
against net revenue for the quarter. Additionally, IPS tracks cash collection
percentages for each medical group on a monthly basis, setting quarterly and
annual goals for cash collections, bad debt write-offs and aging of accounts
receivable. IPS is not aware of any material claims, disputes or unsettled
matters with third party payers and there have been no material settlements with
third party payers for the three months ended March 31, 2006 and 2005.
Accounts Receivable and Allowance for Doubtful Accounts. MBS records
uncollectible accounts receivable using the direct write-off method of
accounting for bad debts. Historically, MBS has experienced minimal credit
losses and has not written-off any material accounts during the three months
ended March 31, 2006 or 2005.
IPS's affiliated medical groups grant credit without collateral to its
patients, most of which are insured under third-party payer arrangements. The
provision for bad debts that relates to patient service revenues is based on an
evaluation of potentially uncollectible accounts. The provision for bad debts
includes a reserve for 100% of the accounts receivable older than 180 days.
Establishing an allowance for bad debt is subjective in nature. IPS uses
historical collection percentages to determine the estimated allowance for bad
debts, and adjusts the percentage on a quarterly basis.
Investment in Limited Partnerships. At March 31, 2005, the Company owned a
10% general partnership interest in San Jacinto. The investment is accounted for
using the equity method. Under the equity method, the investment is initially
recorded at cost and is subsequently increased to reflect the Company's share of
the income of the investee and reduced to reflect the share of the losses of the
investee or distributions from the investee. Effective March 1, 2006, the
Company sold its interest in San Jacinto. (See "Results of Operations --
Discontinued Operations".)
-3-
The general partnership interest was accounted for as an investment in
limited partnership due to the interpretation of SFAS 94/Accounting Research
Bulletin 51 and the interpretations of such by Issue 96-16 and Statement of
Position "SOP" 78-9. Under those interpretations, the Company could not
consolidate its interest in an entity in which it held a minority general
partnership interest due to management restrictions, shared operating
decision-making, and capital expenditure and debt approval by limited partners
and the general form versus substance analysis.
Goodwill and Other Intangible Assets. Goodwill and intangible assets
represent the excess of cost over the fair value of net assets of companies
acquired in business combinations accounted for using the purchase method. In
July 2001, the FASB issued SFAS No. 141, "Business Combinations," and SFAS No.
142, "Goodwill and Other Intangible Assets." SFAS No. 141 eliminates
pooling-of-interest accounting and requires that all business combinations
initiated after June 30, 2001, be accounted for using the purchase method. SFAS
No. 142 eliminates the amortization of goodwill and certain other intangible
assets and requires the Company to evaluate goodwill for impairment on an annual
basis by applying a fair value test. SFAS No. 142 also requires that an
identifiable intangible asset that is determined to have an indefinite useful
economic life not be amortized, but separately tested for impairment using a
fair value-based approach at least annually. The Company evaluates its goodwill
and other intangible assets in the fourth quarter of each fiscal year, unless
circumstances require testing at other times.
Recent Accounting Pronouncements
In December 2004, the FASB published SFAS No. 123 (revised 2004),
"Share-Based Payment" ("SFAS 123(R)"). SFAS 123(R) requires that the
compensation cost relating to share-based payment transactions, including grants
of employee stock options, be recognized in the financial statements. That cost
will be measured based on the fair value of the equity or liability instruments
issued. SFAS 123(R) covers a wide range of share-based compensation arrangements
including stock options, restricted share plans, performance-based awards, share
appreciation rights, and employee share purchase plans. SFAS 123(R) is a
replacement of SFAS No. 123, "Accounting for Stock-Based Compensation," and
supersedes Auditing Practices Board Opinion No. 25, "Accounting for Stock Issued
to Employees," and its related interpretive guidance ("APB 25").
The effect of SFAS 123(R) will be to require entities to measure the cost
of employee services received in exchange for stock options based on the
grant-date fair value of the award, and to recognize the cost over the period
the employee is required to provide services for the award. SFAS 123(R) permits
entities to use any option-pricing model that meets the fair value objective in
SFAS 123(R). The Company was required to apply SFAS 123(R) for its quarter
ending March 31, 2006.
SFAS 123(R) allows two methods for determining the effects of the
transition: the modified prospective transition method and the modified
retrospective method of transition. The Company has adopted the modified
prospective transition method beginning in 2006.
Results of Operations
The IPS Merger was treated as a reverse acquisition, meaning that the
purchase price, comprised of the fair value of the outstanding shares of the
Company prior to the transaction, plus applicable transaction costs, were
allocated to the fair value of the Company's tangible and intangible assets and
liabilities prior to the transaction, with any excess being considered goodwill.
IPS was treated as the continuing reporting entity, and, thus, IPS's historical
results became those of the combined company. The Company's results for the
three months ended March 31, 2006 and 2005 include the results of IPS, MBS and
the Company's ambulatory surgery and diagnostic center business. The
descriptions of the business and results of operations of MBS set forth in this
report include the business and results of operations of DCPS. This discussion
should be read in conjunction with the Company's unaudited consolidated
condensed financial statements for the three months ended March 31, 2006 and
2005 and related notes thereto, which are included as a separate section of this
report commencing on page F-1.
Pursuant to paragraph 43 of SFAS 144, which states that, in a period in
which a component of an entity either has been disposed of or is classified as
held for sale, the income statement of a business enterprise for current and
prior periods shall report the results of operations of the component, including
any gain or loss recognized, in discontinued operations. As such, the Company's
financial results for the three months ended March 31, 2005 have been
reclassified to reflect the operations, including its surgery and diagnostic
center businesses, which were discontinued in 2005.
The following table sets forth selected statements of operations data
expressed as a percentage of the Company's net operating revenue for the three
months ended March 31, 2006 and 2005, respectively. The Company's historical
results and period-to-period comparisons are not necessarily indicative of the
results for any future period.
-4-
Three Months Ended March 31,
2006 2005
------------ ------------
Net operating revenues 100.0% 100.0%
Total operating expenses 104.9% 117.6%
------------ ------------
Loss from continuing operations before
other income (expenses) (4.9%) (17.6%)
Total other income (expenses), net 7.6% (0.8%)
------------ ------------
Income (loss) from continuing operations 2.7% (18.4%)
Discontinued operations
Income (loss) from operations of
discontinued components, including
net gain on disposal 8.0% (3.7%)
------------ ------------
Net income (loss) 10.7% (22.1%)
============ ============
Three Months Ended March 31, 2006 as Compared to Three Months Ended March 31,
2005
The following table sets forth, for the periods indicated, the consolidated
statements of operations of the Company.
For the Three Months
Ended March 31,
2006 2005
------------ ------------
(Unaudited) (Unaudited)
Net operating revenues $ 7,154,014 $ 7,629,822
Operating expenses
Salaries and benefits 2,761,932 3,048,901
Physician group distribution 2,103,305 2,333,086
Facility rent and related costs 401,386 427,840
Depreciation and amortization 409,897 883,222
Professional and consulting fees 346,068 415,561
Insurance 181,239 212,505
Provision for doubtful accounts 158,750 338,509
Other expenses 1,138,922 1,309,324
------------ ------------
Total operating expenses 7,501,499 8,968,948
------------ ------------
Loss from continuing operations before
other income (expenses) (347,485) (1,339,126)
------------ ------------
Other income (expenses)
Interest expense (112,512) (56,297)
Gain on forgiveness of debt 665,463 -
Other expense, net (9,664) (2,625)
------------ ------------
Total other income (expenses), net 543,287 (58,922)
------------ ------------
Income (loss) from continuing operations 195,802 (1,398,048)
Discontinued operations
Income (loss) from operations of
discontinued components, including net
gain on disposal of $668,387 for the
three months ended March 31, 2006 575,422 (282,582)
------------ ------------
Net income (loss) $ 771,224 $(1,680,630)
============ ============
-5-
Net Operating Revenues. Net operating revenues of the Company consist of
patient service revenue, net of contractual adjustments, related to the
operations of IPS's affiliated medical groups, billing services revenue related
to MBS and other revenue. For the three months ended March 31, 2006,
consolidated net operating revenues decreased $475,809, or 6.2%, to $7,154,014,
as compared with $7,629,822 for the three months ended March 31, 2005.
MBS's net operating revenues totaled $2,394,290 for the three months ended
March 31, 2006 as compared to net operating revenues totaling $2,540,515 for the
same period in 2005, a decrease of $146,225, or 5.8%. The decrease in net
operating revenues for MBS was primarily the result of the loss of two customers
in August 2005 which accounted for approximately $226,000 in net operating
revenues in the first quarter of 2005. This decrease was partially offset by the
addition of two new customers in the first quarter of 2006 accounting for
approximately $69,000 in net operating revenues.
IPS's net patient service revenue decreased $329,584, or 6.5%, from
$5,089,307 for the three months ended March 31, 2005 to $4,759,723 for the three
months ended March 31, 2006. The decrease in net patient service revenue for
IPS's affiliated medical groups was primarily the result of decreases in patient
volume as a consequence of a diminished cold and flu season in the first three
months of 2006 as compared with the same period in 2005. Three of IPS's four
clinic-based affiliated pediatric groups experienced decreases in patient volume
in the first quarter of 2006, with total procedures and office visits for all
clinic-based facilities decreasing 5,611 and 2,991, respectively, to 99,821 and
44,826 for the three months ended March 31, 2006.
Other revenue, which represents revenue from the Company's vaccine program,
a group purchasing alliance for vaccines and medical supplies, totaled $23,933
for the first three months of 2005, increasing $55,508, or 231.9%, to $79,441
for the three months ended March 31, 2006. The vaccine program, which had a
total of 428 enrolled participants at December 31, 2005, added approximately 54
members during the first quarter of 2006.
Operating Expenses
Salaries and Benefits. Consolidated salaries and benefits decreased
$335,041 to $2,713,861 for the three months ended March 31, 2006, as compared to
$3,048,901 for the same period in 2005.
MBS's salaries and benefits totaled $1,451,043 for the three months ended
March 31, 2006 as compared to $1,514,132 for the three months ended March 31,
2005, a decrease of 63,090. This decrease is a result of a reduction in health
benefit costs related to the consolidation of MBS's benefit plans with the IPS
benefit plans at the beginning of 2006, thereby allowing greater negotiating
leverage with benefit providers.
Clinical salaries & benefits include wages for the nurse practitioners,
nursing staff and medical assistants employed by the affiliated medical groups
and are directly related to increases and decreases in productivity and patient
volume. Clinical salaries, bonuses, overtime and health insurance collectively
totaled $476,264 for the first three months of 2006, an increase of $13,152 over
the same period in 2005. There was one additional medical assistant on the
payroll of one of IPS's affiliated medical groups in the first quarter of 2006
as compared to the staffing levels for the first three months of 2005. These
expenses represented approximately 9.3% and 8.3% of net operating revenue for
the three months ended March 31, 2006 and 2005, respectively.
In August 2005, the Company consolidated its corporate operations into the
Roswell, Georgia office. Prior to the staff reductions resulting from this
corporate consolidation, salaries and benefits related to corporate staff in
Houston, Texas totaled $297,674 for the three months ended March 31, 2005.
Administrative salaries and benefits, excluding MBS and the former staff of
the Company's Houston, Texas office, represent the employee-related costs of all
non-clinical practice personnel at IPS's affiliated medical groups as well as
the Company's corporate staff in Roswell, Georgia. These expenses increased
$60,642, or 7.8%, from $773,983 for the three months ended March 31, 2005 to
$834,625 for the same period in 2006. The additional expense can be attributed
-6-
primarily to the following: (i) the adoption of SFAS 123(R) in the first quarter
of 2006, which resulted in stock option compensation expense totaling
approximately $48,000; and (ii) the addition of one billing FTE and the
promotion of three employees to supervisor at two of IPS's affiliated medical
groups as the result of billing office reorganizations.
Physician Group Distribution. Physician group distribution decreased
$229,781, or 9.8%, for the three months ended March 31, 2006 to $2,103,305, as
compared with $2,333,086 for the three months ended March 31, 2005. Pursuant to
the terms of the MSAs governing each of IPS's affiliated medical groups, the
physicians of each medical group receive disbursements after the payment of all
clinic facility expenses as well as a management fee to IPS. The management fee
revenue and expense, which is eliminated in the consolidation of the Company's
financial statements, is either a fixed fee or is calculated based on a
percentage of net operating income. For the three months ended March 31, 2006,
management fee revenue totaled $344,472 and represented approximately 14.1% of
net operating income as compared to management fee revenue totaling $371,287 and
representing approximately 13.7% of net operating income for the same period in
2005. Physician group distribution represented 44.2% of net operating revenues
in the first quarter of 2006, compared to 45.8% of net operating revenues for
the three months ended March 31, 2005. The decrease in physician group
distribution for the three months ended March 31, 2006 was directly related to
the decrease in net patient service revenue, which was primarily the result of
decreased patient volume during the first three months of 2006.
Facility Rent and Related Costs. Facility rent and related costs decreased
$26,454, or 6.2%, from $427,840 for the three months ended March 31, 2005 to
$401,386 for the three months ended March 31, 2006.
MBS's facility rent and related costs totaled $129,453 for the three months
ended March 31, 2006 as compared to $119,821 for the same period in 2005. This
increase can be explained generally by increases in utilities and off-site
storage costs for the first three months of 2006.
Facility rent and related costs associated with IPS's affiliated medical
groups and Orion's corporate office totaled $257,794 for the three months ended
March 31, 2006 compared to $281,727 for the same period in 2005. Rent expense
related to the Company's corporate office in Roswell, Georgia decreased for the
first quarter of 2006 due to approximately $27,000 in rent payments received for
the sublease between eClinicalWeb and the Company as a result of the IntegriMED
Agreement in June 2005.
In August 2005, the Company consolidated its corporate operations into the
Roswell, Georgia office. Prior to this consolidation, facility-related costs
such as utilities and personal property taxes associated with the Company's
former office in Houston, Texas totaled $12,153 for the three months ended March
31, 2005.
Depreciation and Amortization. Consolidated depreciation and amortization
expense totaled $409,897 for the three months ended March 31, 2006, a decrease
of $473,325 from the three months ended March 31, 2005.
For the three months ended March 31, 2006, depreciation expense related to
the fixed assets of MBS totaled $17,586 as compared to $21,617 for the same
period in 2005. Deprecation expense related to the fixed assets of IPS and Orion
totaled $40,577 and $32,350 for the three months ended March 31, 2006 and 2005,
respectively. Depreciation expense associated with fixed assets related to the
Company's former Houston, Texas office, which was closed in August 2005, totaled
$11,086 for the three months ended March 31, 2005.
As part of the DCPS/MBS Merger, the Company purchased MBS and DCPS for a
combination of cash, notes and stock. Since the consideration for this purchase
transaction exceeded the fair value of the net assets of MBS and DCPS at the
time of the purchase, a portion of the purchase price was allocated to
intangible assets. The amortization expense related to the intangible assets
recorded as a result of the DCPS/MBS Merger totaled $265,523 for the three
months ended March 31, 2006 and 2005, respectively.
Amortization expense related to the MSAs for IPS's affiliated medical
groups totaled $86,211 and $120,949 for the three months ended March 31, 2006
and 2005, respectively. The decrease is directly related to the Mutual Release
and Settlement Agreement (the "Sutter Settlement") with John Ivan Sutter, M.D.,
PA ("Dr. Sutter") to settle disputes that had arisen between IPS and Dr. Sutter
and to avoid the risk and expense of litigation. As part of the Sutter
Settlement, which was executed on October 31, 2005, Dr. Sutter and IPS agreed
that Dr. Sutter would purchase the assets owned by IPS and used in connection
with Dr. Sutter's practice, in exchange for termination of the related MSA.
As part of the IPS Merger, the purchase price, comprised of the fair value
of the outstanding shares of the Company prior to the transaction, plus
applicable transaction costs, was allocated to the fair value of the Company's
tangible and intangible assets and liabilities prior to the transaction, with
any excess being considered goodwill. As a result of the dispositions related to
-7-
the Company's surgery and diagnostic center business, which was discontinued in
2005, and the uncertainty of future cash flows related to the Company's surgery
center business, the Company impaired substantially all of the intangible assets
related to the IPS Merger in 2005. Therefore, there was no amortization expense
related to the intangible assets in the first quarter of 2006. Amortization
expense for the intangible assets recorded as a result of the IPS Merger totaled
$431,697 for the three months ended March 31, 2005. (See "Discontinued
Operations" for additional discussion regarding the disposition of intangible
assets and goodwill recorded as a result of the IPS Merger.)
Professional and Consulting Fees. For the three months ended March 31,
2006, professional and consulting fees totaled $346,068, a decrease of $69,492,
or 16.7%, from the same period in 2005.
For the first three months of 2006, MBS recorded professional and
consulting expenses totaling $40,855 as compared with $73,486 for the first
three months of 2005, a decrease of $32,630. This change is primarily the result
of a decrease in contract labor used in the first quarter of 2005 as a result of
staffing shortages. This contract labor was not utilized in the first quarter of
2006 because MBS's position inventory is fully staffed.
IPS's and Orion's professional and consulting fees, which include the costs
of corporate accounting, financial reporting and compliance, and legal fees,
decreased from $342,075 for the three months ended March 31, 2005 to $305,213
for the three months ended March 31, 2006. The decrease is primarily the result
of reduced legal fees and expenses related to the divestiture of the Company's
surgery and diagnostic business in 2005.
Insurance. Consolidated insurance expense, which includes the costs of
professional liability for affiliated physicians, property and casualty and
general liability insurance and directors and officers' liability insurance,
decreased from $212,505 for the three months ended March 31, 2005 to $181,239
for the three months ended March 31, 2006. Insurance expense related to the
directors and officers' liability policies in the first quarter of 2005 included
approximately $35,000 of premiums for run-off policies related to SurgiCare and
IPS. The run-off policies were expensed fully in 2005.
Provision for Doubtful Accounts. The Company's consolidated provision for
doubtful accounts, or bad debt expense, decreased $179,759, or 53.1%, for the
three months ended March 31, 2006 to $158,750. The entire provision for doubtful
accounts for the quarter ended March 31, 2006 related to IPS's affiliated
medical groups and accounted for 3.3% of IPS's net operating revenues as
compared to 6.7% of IPS's net operating revenues for the same period in 2005.
The total collection rate, after contractual allowances, for IPS's affiliated
medical groups was 68.8% for the three months ended March 31, 2006, compared to
63.3% for the same period in 2005.
Other Expenses. Consolidated other expenses totaled $1,138,922 for the
three months ended March 31, 2006, a decrease of $170,403 from the same period
in 2005. Other expenses include general and administrative expenses such as
office supplies, telephone & data communications, printing & postage, transfer
agent fees, and board of directors' compensation and meeting expenses, as well
as some direct clinical expenses, which are expenses that are directly related
to the practice of medicine by the physicians that practice at the affiliated
medical groups managed by IPS.
MBS's other expenses totaled $286,698 for the three months ended March 31,
2006 as compared to $339,875 for the three months ended March 31, 2005. Of the
total decrease, approximately $16,500 and $21,000 related to decreases in office
supplies and postage and courier expenses, respectively, in the first three
months of 2006 as compared to the same period in 2005. These expense
fluctuations are the direct result of the decrease in net operating revenues in
the first quarter of 2006. Additionally, MBS renegotiated its long distance
rates in the fall of 2005, which resulted in approximately $12,000 in cost
savings in the first three months of 2006 as compared to the same period in
2005.
For the three months ended March 31, 2006, IPS's direct clinical expenses,
other than salaries and benefits, totaled $565,837, an increase of $15,869 over
first quarter 2005 direct clinical expenses, which totaled $549,974. Vaccine
expenses accounted for approximately $13,500 of the total increase in direct
clinical expenses in the first three months of 2006. IPS's affiliated medical
groups began using two new vaccines in late 2005 -- Menactra and Decavac --
which replaced lower-priced vaccines previously utilized by the medical groups.
The Company's and IPS's general and administrative expenses totaled
$170,822 for the three months ended March 31, 2006, a decrease of $131,228 from
the same period in 2005. Of the total decrease, approximately $124,000 relates
to cost efficiencies and expense reductions as a result of the consolidation of
corporate functions into the Company's Roswell, Georgia office in August 2005.
Additionally, board of directors' compensation expense in the first three months
of 2005 included approximately $20,500 in meeting expenses related to a board
meetings and conference calls immediately following the 2004 Mergers.
-8-
Other Income and Expenses.
Interest Expense. Consolidated interest expense totaled $112,512 for the
three months ended March 31, 2006, an increase of $56,215 from the same period
in 2005. Interest expense activity in the first quarter of 2006, including
increases from the first three months of 2005, can be explained generally by the
following:
o Brantley Debt. In March and April 2005, the Company borrowed an
aggregate of $1,250,000 from Brantley Partners IV, L.P. ("Brantley
IV"). (See "Liquidity and Capital Resources.") Interest expense
related to these notes totaled approximately $28,000 for the three
months ended March 31, 2006.
o Line of Credit. As part of the restructuring transactions, the Company
also entered into a new secured two-year revolving credit facility
pursuant to the Loan and Security Agreement (the "Loan and Security
Agreement"), dated December 15, 2004, by and among the Company,
certain of its affiliates and subsidiaries, and CIT Healthcare, LLC
(formerly known as Healthcare Business Credit Corporation)("CIT"),
borrowing $1.6 million under this facility concurrently with the
Closing. (See "Liquidity and Capital Resources" for additional
discussion regarding the Loan and Security Agreement.) Interest
expense related to this line of credit totaled $63,444 for the three
months ended March 31, 2006, compared to $42,464 for the three months
ended March 31, 2005. The increase in interest expense on the line of
credit facility was a direct result of interest rate increases for the
first three months of 2006 as compared to the same period in 2005. In
December 2005, the Company received notification from CIT stating that
certain events of default under the Loan and Security Agreement had
occurred as a result of the Company being out of compliance with two
financial covenants. As a result of the events of default, CIT raised
the interest rate for monies borrowed under the Loan and Security
Agreement to a default rate of prime rate plus 6% as compared to the
stated interest rate of prime rate plus 3% as of the Closing. (See
"Part II, Item 3. Defaults Upon Senior Securities" for additional
discussion regarding the Company's defaults under the Loan and
Security Agreement.) The loan balance for this facility was $1,162,659
and $1,621,487 at March 31, 2006 and 2005, respectively. Additionally,
the average prime rate for the first quarter of 2006 was 7.42% as
compared to 5.42% for the same three-month period in 2005.
Gain on Forgiveness of Debt. On August 25, 2003, the Company's lender, DVI,
announced that it was seeking protection under Chapter 11 of the United States
Bankruptcy laws. Both IPS and SurgiCare had loans outstanding to DVI in the form
of term loans and revolving lines of credit. As part of the IPS Merger, the
Company negotiated a discount on the term loans and a buy-out of the revolving
lines of credit. As part of that agreement, the Company executed a new loan
agreement with U.S. Bank Portfolio Services, as Servicer for payees, for payment
of the revolving lines of credit and renegotiation of the term loans. In the
first quarter of 2006, the Company negotiated an 85% discount on the revolving
line of credit, which had a balance of $778,000 at December 31, 2005. As of
March 13, 2006, the Company had made aggregate payments in the amount of
$112,500 in satisfaction of the $778,000 debt, and recognized a gain on
forgiveness of debt totaling $665,463 for the three months ended March 31, 2006.
Discontinued Operations.
Bellaire SurgiCare. As of the Closing, the Company's management expected
the case volumes at Bellaire SurgiCare, Inc. ("Bellaire SurgiCare") to improve
in 2005. However, by the end of February 2005, it was determined that the
expected case volume increases were not going to be realized. On March 1, 2005,
the Company closed Bellaire SurgiCare and consolidated its operations with the
operations of Memorial Village. The Company tested the identifiable intangible
assets and goodwill related to the surgery center business using the present
value of cash flows method. As a result of the decision to close Bellaire
SurgiCare and the resulting impairment of the joint venture interest and
management contracts related to the surgery centers, the Company recorded a
charge for impairment of intangible assets of $4,090,555 for the year ended
December 31, 2004. The Company also recorded a loss on disposal of this
discontinued component (in addition to the charge for impairment of intangible
assets) of $163,049 for the quarter ended March 31, 2005. The operations of this
component are reflected in the Company's consolidated condensed statements of
operations as `loss from operations of discontinued components' for the three
months ended March 31, 2005. There were no operations for this component after
March 31, 2005.
-9-
The following table contains selected financial statement data related to
Bellaire SurgiCare as of and for the three months ended March 31, 2005:
March 31, 2005
Income statement data: --------------
Net operating revenues $ 161,679
Operating expenses 350,097
--------------
Net loss $ (188,418)
--------------
Balance sheet data:
Current assets $ -
Other assets -
--------------
Total assets $ -
--------------
Current liabilities $ -
Other liabilities -
--------------
Total liabilities $ -
--------------
Capital Allergy and Respiratory Disease Center ("CARDC"). On April 1, 2005,
IPS entered into a Mutual Release and Settlement Agreement (the "CARDC
Settlement") with Dr. Bradley E. Chipps, M.D. and CARDC to settle disputes as to
the existence and enforceability of certain contractual obligations. As part of
the CARDC Settlement, Dr. Chipps, CARDC, and IPS agreed that CARDC would
purchase the assets owned by IPS and used in connection with CARDC, in exchange
for termination of the MSA between IPS and CARDC. Additionally, among other
provisions, after April 1, 2005, Dr. Chipps, CARDC and IPS have been released
from any further obligation to each other arising from any previous agreement.
As a result of the CARDC dispute, the Company recorded a charge for impairment
of intangible assets related to CARDC of $704,927 for the year ended December
31, 2004. The Company also recorded a gain on disposal of this discontinued
component (in addition to the charge for impairment of intangible assets) of
$506,625 for the quarter ended March 31, 2005. For the quarter ended June 30,
2005, the Company reduced the gain on disposal of this discontinued component by
$238,333 as the result of post-settlement adjustments related to the
reconciliation of balance sheet accounts. The operations of this component are
reflected in the Company's consolidated condensed statements of operations as
`loss from operations of discontinued components' for the three months ended
March 31, 2005. There were no operations for this component in the Company's
financial statements after March 31, 2005.
The following table contains selected financial statement data related to
CARDC as of and for the three months ended March 31, 2005:
March 31, 2005
--------------
Income statement data:
Net operating revenues $ 848,373
Operating expenses 809,673
--------------
Net income $ 38,700
--------------
Balance sheet data:
Current assets $ -
Other assets -
--------------
Total assets $ -
--------------
Current liabilities $ -
Other liabilities -
--------------
Total liabilities $ -
--------------
IntegriMED. On June 7, 2005, InPhySys, Inc. (formerly known as IntegriMED,
Inc.) ("IntegriMED"), a wholly owned subsidiary of IPS, executed an Asset
Purchase Agreement (the "IntegriMED Agreement") with eClinicalWeb, LLC
("eClinicalWeb") to sell substantially all of the assets of IntegriMED. As a
result of this transaction, the Company recorded a loss on disposal of this
discontinued component of $47,101 for the quarter ended June 30, 2005. The
operations of this component are reflected in the Company's consolidated
condensed statements of operations as `loss from operations of discontinued
components' for the three months ended March 31, 2005. There were no operations
for this component in the Company's financial statements after June 30, 2005.
-10-
The following table contains selected financial statement data related to
IntegriMED as of and for the three months ended March 31, 2005:
March 31, 2005
--------------
Income statement data:
Net operating revenues $ 109,616
Operating expenses 506,736
--------------
Net loss $ (397,120)
--------------
Balance sheet data:
Current assets $ 327,889
Other assets 159,744
--------------
Total assets $ 487,633
--------------
Current liabilities $ 416,029
Other liabilities -
--------------
Total liabilities $ 416,029
--------------
TASC and TOM. On June 13, 2005, the Company announced that it had accepted
an offer to purchase its interests in TASC and TOM in Dover, Ohio. On September
30, 2005, the Company executed purchase agreements to sell its 51% ownership
interest in TASC and its 41% ownership interest in TOM to Union Hospital
("Union"). Additionally, as part of the transactions, TASC, as the sole member
of TASC Anesthesia, L.L.C. ("TASC Anesthesia"), executed an Asset Purchase
Agreement to sell certain assets of TASC Anesthesia to Union. The limited
partners of TASC and TOM also sold a certain number of their units to Union such
that at the closing of these transactions, Union owned 70% of the ownership
interests in TASC and TOM. The Company no longer has an ownership interest in
TASC, TOM or TASC Anesthesia. As a result of these transactions, as well as the
uncertainty of future cash flows related to the Company's surgery center
business, the Company recorded a charge for impairment of intangible assets of
$6,362,849 for the three months ended June 30, 2005. Also as a result of these
transactions, the Company recorded a gain on disposal of this discontinued
component (in addition to the charge for impairment of intangible assets) of
$1,357,712 for the quarter ended December 31, 2005. The Company allocated the
goodwill recorded as part of the IPS Merger to each of the surgery center
reporting units and recorded a loss on the write-down of goodwill related to
TASC and TOM totaling $789,173 for the quarter ended December 31, 2005, which
reduced the gain on disposal. The operations of this component are reflected in
the Company's consolidated condensed statements of operations as `loss from
operations of discontinued components' for the three months ended March 31,
2005. There were no operations for this component in the Company's financial
statements after September 30, 2005.
The following table contains selected financial statement data related to
TASC and TOM as of and for the three months ended March 31, 2005:
March 31, 2005
--------------
Income statement data:
Net operating revenues $ 796,842
Operating expenses 831,387
--------------
Net income (loss) $ (34,545)
--------------
Balance sheet data:
Current assets $ 813,520
Other assets 1,482,378
--------------
Total assets $ 2,295,898
--------------
Current liabilities $ 662,796
Other liabilities 777,845
--------------
Total liabilities $ 1,440,641
--------------
Sutter. On October 31, 2005, IPS executed the Sutter Settlement with Dr.
Sutter to settle disputes that had arisen between IPS and Dr. Sutter and to
avoid the risk and expense of litigation. As part of the Sutter Settlement, Dr.
Sutter and IPS agreed that Dr. Sutter would purchase the assets owned by IPS and
used in connection with Dr. Sutter's practice, in exchange for termination of
the related MSA. Additionally, among other provisions, after October 31, 2005,
Dr. Sutter and IPS have been released from any further obligation to each other
arising from any previous agreement. As a result of this transaction, the
Company recorded a loss on disposal of this discontinued component (in addition
to the charge for impairment of intangible assets) of $279 for the quarter ended
December 31, 2005. The operations of this component are reflected in the
Company's consolidated condensed statements of operations as `loss from
-11-
operations of discontinued components' for the three months ended March 31,
2005. There were no operations for this component in the Company's financial
statements after October 31, 2005.
The following table contains selected financial statement data related to
Sutter as of and for the three months ended March 31, 2005:
March 31, 2005
--------------
Income statement data:
Net operating revenues $ 108,900
Operating expenses 105,438
--------------
Net income $ 3,462
--------------
Balance sheet data:
Current assets $ 112,581
Other assets 15,511
--------------
Total assets $ 128,092
--------------
Current liabilities $ 11,837
Other liabilities -
--------------
Total liabilities $ 11,837
--------------
Memorial Village. In November 2005, the Company decided that, as a result
of ongoing losses at Memorial Village, it would need to either find a buyer for
the Company's equity interests in Memorial Village or close the facility. In
preparation for this pending transaction, the Company tested the identifiable
intangible assets and goodwill related to the surgery center business using the
present value of cash flows method. As a result of the decision to sell or close
Memorial Village, as well as the uncertainty of cash flows related to the
Company's surgery center business, the Company recorded a charge for impairment
of intangible assets of $3,461,351 for the three months ended September 30,
2005. On February 8, 2006, Memorial Village executed an Asset Purchase Agreement
(the "Memorial Agreement") for the sale of substantially all of its assets to
First Surgical. Memorial Village was approximately 49% owned by Town & Country
SurgiCare, Inc., a wholly owned subsidiary of the Company. The Memorial
Agreement was deemed to be effective as of January 31, 2006. As a result of this
transaction, the Company recorded a gain on the disposal of this discontinued
component (in addition to the charge for impairment of intangible assets) of
$574,321 for the quarter ended March 31, 2006. The Company allocated the
goodwill recorded as part of the IPS Merger to each of the surgery center
reporting units and recorded a loss on the write-down of goodwill related to
Memorial Village totaling $2,005,383 for the quarter ended December 31, 2005.
The operations of this component are reflected in the Company's consolidated
statements of operations as `loss from operations of discontinued components'
for the three months ended March 31, 2006 and 2005, respectively.
The following table contains selected financial statement data related to
Memorial Village as of and for the three months ended March 31, 2006 and 2005,
respectively:
March 31, 2006 March 31, 2005
-------------- --------------
Income statement data:
Net operating revenues $ 17,249 $ 584,176
Operating expenses 170,285 690,340
--------------------------------
Net loss $ (153,036) $ (106,164)
--------------------------------
Balance sheet data:
Current assets $ - $ 861,111
Other assets - 767,497
--------------------------------
Total assets $ - $ 1,628,608
--------------------------------
Current liabilities $ -- $ 729,567
Other liabilities -- 725,884
--------------------------------
Total liabilities $ -- $ 1,455,451
--------------------------------
San Jacinto. On March 1, 2006, San Jacinto executed an Asset Purchase
Agreement for the sale of substantially all of its assets to Methodist. San
Jacinto was approximately 10% owned by Baytown SurgiCare, Inc., a wholly owned
subsidiary of the Company, and is not consolidated in the Company's financial
statements. As a result of this transaction, the Company recorded a gain on
-12-
disposal of this discontinued operation of $94,066 for the quarter ended March
31, 2006. The Company allocated the goodwill recorded as part of the IPS Merger
to each of the surgery center reporting units and recorded a loss on the
write-down of goodwill related to San Jacinto totaling $694,499 for the quarter
ended December 31, 2005.
Orion. Prior to the divestiture of the Company's ambulatory surgery center
business, the Company recorded management fee revenue, which was eliminated in
the consolidation of the Company's financial statements, for Bellaire SurgiCare,
TASC and TOM and Memorial Village. The management fee revenue for San Jacinto
was not eliminated in consolidation. The management fee revenue associated with
the discontinued operations in the surgery center business totaled $60,071 for
the quarter ended March 31, 2006. For the quarter ended March 31, 2005, the
Company generated management fee revenue of $106,252 and a minority interest
loss in Memorial Village of $39,447.
The following table summarizes the components of income (loss) from
operations of discontinued components:
March 31, 2006 March 31, 2005
-------------- --------------
Bellaire SurgiCare
Net loss $ - $ (188,418)
Loss on disposal - (163,049)
CARDC
Net income - 38,700
Gain on disposal - 506,625
IntegriMED
Net loss - (397,120)
TASC and TOM
Net loss - (34,545)
Sutter
Net income - 3,462
Memorial Village
Net loss (153,036) (115,041)
Gain on disposal 574,321 -
San Jacinto
Gain on disposal 94,066 -
Orion
Net income 60,071 66,805
--------------------------------
Total income (loss) from
operations of discontinued
components, net gain (loss) on
disposal $ 575,422 $ (282,581)
================================
Liquidity and Capital Resources
Net cash provided by operating activities totaled $486,328 for the three
months ended March 31, 2006 compared to cash used in operating activities of
$749,399 for the three months ended March 31, 2005. The net impact of
discontinued operations on net cash provided by activities in the first quarter
of 2006 totaled $230,743.
For the three months ended March 31, 2006, net cash provided by investing
activities totaled $461,327 compared to $84,592 in net cash used by investing
activities for the same period in 2005. The net impact of discontinued
operations on net cash provided by investing activities totaled $430,244 in the
first quarter of 2006.
Net cash used in financing activities totaled $748,913 for the three months
ended March 31, 2006 as compared to $744,493 in net cash provided by financing
activities for the three months ended March 31, 2005. The change in cash uses
related to financing activities from 2005 to 2006 can be explained generally by
the following:
o Net repayments on the CIT revolving credit facility totaled $540,617
in the first three months of 2006, including approximately $300,000 in
repayments related to discontinued operations;
o As discussed below, in March of 2005, the Company borrowed $1,025,000
from Brantley IV.
-13-
o The Company made aggregate payments in the amount of $112,500 in
satisfaction of a $778,000 debt, and recognized a gain on forgiveness
of debt totaling $665,463 for the three months ended March 31, 2006;
and
o The Company repaid approximately $200,000 in satisfaction of a working
capital note from the sellers of MBS in the first quarter of 2006.
The Company's unaudited consolidated condensed financial statements have
been prepared in conformity with GAAP, which contemplate the continuation of the
Company as a going concern. The Company incurred substantial operating losses
during 2005, and, despite an operating profit in the first quarter of 2006, has
used substantial amounts of working capital in its operations. Additionally, as
described more fully below, the Company received notification from CIT in
December 2005 that certain events of default under the Loan and Security
Agreement had occurred as a result of the Company being out of compliance with
two financial covenants relating to its debt service coverage ratio and its
minimum operating income level. These conditions raise substantial doubt about
the Company's ability to continue as a going concern.
The Company has financed its growth and operations primarily through the
issuance of equity securities, secured and/or convertible debt, most recently by
completing the 2004 Mergers and restructuring transactions in December 2004,
which are described under the caption "Company History," and borrowing from
related parties. On December 15, 2004, the Company also entered into a new
secured two-year revolving credit facility pursuant to the Loan and Security
Agreement. Under this facility, initially up to $4,000,000 of loans could be
made available to the Company, subject to a borrowing base. As discussed below,
the amount available under this credit facility has been reduced. The Company
borrowed $1,600,000 under this facility concurrently with the Closing. The
interest rate under this facility is the prime rate plus 6%. Upon an event of
default, CIT can accelerate the loans or call the Guaranties described below.
(See "Part II, Item 3. Defaults Upon Senior Securities" for additional
discussion regarding the Company's defaults under the Loan and Security
Agreement.) In connection with entering into this new facility, the Company also
restructured its previously-existing debt facilities, which resulted in a
decrease in aggregate debt owed to DVI from approximately $10.1 million to a
combined principal amount of approximately $6.5 million, of which approximately
$2.0 million was paid at the Closing.
Pursuant to a Guaranty Agreement (the "Brantley IV Guaranty"), dated as of
December 15, 2004, provided by Brantley IV to CIT, Brantley IV agreed to provide
a deficiency guaranty in the initial amount of $3,272,727. As discussed below,
the amount of this Brantley IV Guaranty has been reduced. Pursuant to a Guaranty
Agreement (the "Brantley Capital Guaranty" and collectively with the Brantley IV
Guaranty, the "Guaranties"), dated as of December 15, 2004, provided by Brantley
Capital Corporation ("Brantley Capital") to CIT, Brantley Capital agreed to
provide a deficiency guarantee in the initial amount of $727,273. As discussed
below, the amount of this Brantley Capital Guaranty has been reduced. In
consideration for the Guaranties, the Company issued warrants to purchase 20,455
shares of Class A Common Stock, at an exercise price of $0.01 per share, to
Brantley IV, and issued warrants to purchase 4,545 shares of Class A Common
Stock, at an exercise price of $0.01 per share, to Brantley Capital. None of
these warrants, which expire on December 15, 2009, have been exercised as of
March 31, 2006.
On March 16, 2005, Brantley IV loaned the Company an aggregate of
$1,025,000 (the "First Loan"). On June 1, 2005, the Company executed a
convertible subordinated promissory note in the principal amount of $1,025,000
(the "First Note") payable to Brantley IV to evidence the terms of the First
Loan. The material terms of the First Note are as follows: (i) the First Note is
unsecured; (ii) the First Note is subordinate to the Company's outstanding loan
from CIT and other indebtedness for monies borrowed, and ranks pari passu with
general unsecured trade liabilities; (iii) principal and interest on the First
Note is due in a lump sum on April 19, 2006 (the "First Note Maturity Date");
(iv) the interest on the First Note accrues from and after March 16, 2005, at a
per annum rate equal to nine percent (9.0%) and is non-compounding; (v) if an
event of default occurs and is continuing, Brantley IV, by notice to the
Company, may declare the principal of the First Note to be due and immediately
payable; and (vi) on or after the First Note Maturity Date, Brantley IV, at its
option, may convert all or a portion of the outstanding principal and interest
due of the First Note into shares of Class A Common Stock of the Company at a
price per share equal to $1.042825 (the "First Note Conversion Price"). The
number of shares of Class A Common Stock to be issued upon conversion of the
First Note shall be equal to the number obtained by dividing (x) the aggregate
amount of principal and interest to be converted by (y) the First Note
Conversion Price (as defined above); provided, however, the number of shares to
be issued upon conversion of the First Note shall not exceed the lesser of: (i)
1,159,830 shares of Class A Common Stock, or (ii) 16.3% of the then outstanding
Class A Common Stock. As of March 31, 2006, if Brantley IV were to convert the
First Note, the Company would have to issue 1,076,283 shares of Class A Common
Stock. On May 9, 2006, Brantley IV and the Company executed an amendment to the
First Note (the "First and Second Note Amendment") extending the First Note
Maturity Date to August 15, 2006. A copy of the First and Second Note Amendment
is attached hereto as Exhibit 10.1.
On April 19, 2005, Brantley IV loaned the Company an additional $225,000
(the "Second Loan"). On June 1, 2005, the Company executed a convertible
subordinated promissory note in the principal amount of $225,000 (the "Second
Note") payable to Brantley IV to evidence the terms of the Second Loan. The
material terms of the Second Note are as follows: (i) the Second Note is
unsecured; (ii) the Second Note is subordinate to the Company's outstanding loan
from CIT and other indebtedness for monies borrowed, and ranks pari passu with
-14-
general unsecured trade liabilities; (iii) principal and interest on the Second
Note is due in a lump sum on April 19, 2006 (the "Second Note Maturity Date");
(iv) the interest on the Second Note accrues from and after April 19, 2005, at a
per annum rate equal to nine percent (9.0%) and is non-compounding; (v) if an
event of default occurs and is continuing, Brantley IV, by notice to the
Company, may declare the principal of the Second Note to be due and immediately
payable; and (vi) on or after the Second Note Maturity Date, Brantley IV, at its
option, may convert all or a portion of the outstanding principal and interest
due of the Second Note into shares of Class A Common Stock of the Company at a
price per share equal to $1.042825 (the "Second Note Conversion Price"). The
number of shares of Class A Common Stock to be issued upon conversion of the
Second Note shall be equal to the number obtained by dividing (x) the aggregate
amount of principal and interest to be converted by (y) the Second Note
Conversion Price (as defined above); provided, however, the number of shares to
be issued upon conversion of the Second Note shall not exceed the lesser of: (i)
254,597 shares of Class A Common Stock, or (ii) 3.6% of the then outstanding
Class A Common Stock. As of March 31, 2006, if Brantley IV were to convert the
Second Note, the Company would have to issue 234,423 shares of Class A Common
Stock. On May 9, 2006, Brantley IV and the Company executed the First and Second
Note Amendment extending the Second Note Maturity Date to August 15, 2006.
Additionally, in connection with the First Loan and the Second Loan, the
Company entered into a First Amendment to the Loan and Security Agreement (the
"First Amendment"), dated March 22, 2005, with certain of the Company's
affiliates and subsidiaries, and CIT, whereby its $4,000,000 secured two-year
revolving credit facility has been reduced by the amount of the loans from
Brantley IV to $2,750,000. As a result of the First Amendment, the Brantley IV
Guaranty was amended by the Amended and Restated Guaranty Agreement, dated March
22, 2005, which reduced the deficiency guaranty provided by Brantley IV by the
amount of the First Loan to $2,247,727. Also as a result of the First Amendment,
the Brantley Capital Guaranty was amended by the Amended and Restated Guaranty
Agreement, dated March 22, 2005, which reduced the deficiency guaranty provided
by Brantley Capital by the amount of the Second Loan to $502,273. Paul H.
Cascio, the Chairman of the board of directors of the Company, and Michael J.
Finn, a director of the Company, are affiliates of Brantley IV.
As part of the Loan and Security Agreement, the Company is required to
comply with certain financial covenants, measured on a quarterly basis. The
financial covenants include maintaining a required debt service coverage ratio
and meeting a minimum operating income level for the surgery and diagnostic
centers before corporate overhead allocations. As of and for the three months
ended March 31, 2006, the Company was out of compliance with both of these
financial covenants and has notified the lender as such. Under the terms of the
Loan and Security Agreement, failure to meet the required financial covenants
constitutes an event of default. Under an event of default, the lender may (i)
accelerate and declare the obligations under the credit facility to be
immediately due and payable; (ii) withhold or cease to make advances under the
credit facility; (iii) terminate the credit facility; (iv) take possession of
the collateral pledged as part of the Loan and Security Agreement; (v) reduce or
modify the revolving loan commitment; and/or (vi) take necessary action under
the Guaranties. The revolving credit facility is secured by the Company's
assets. As of March 31, 2006, the outstanding principal under the revolving
credit facility was $1,162,659. The full amount of the loan as of March 31, 2006
is recorded as a current liability. In December 2005, the Company received
notification from CIT stating that (i) certain events of default under the Loan
and Security Agreement had occurred as a result of the Company being out of
compliance with two financial covenants relating to its debt service coverage
ratio and its minimum operating income level, (ii) as a result of the events of
default, CIT raised the interest rate for monies borrowed under the Loan and
Security Agreement to the provided "Default Rate" of prime rate plus 6%, (iii)
the amount available under the revolving credit facility was reduced to
$2,300,000 and (iv) CIT reserved all additional rights and remedies available to
it as a result of these events of default. The Company is currently in
negotiations with CIT to obtain, among other provisions, a waiver of the events
of default. In the event CIT declares the obligations under the Loan and
Security Agreement to be immediately due and payable or exercises its other
rights described above, the Company would not be able to meet its obligations to
CIT or its other creditors. As a result, such action would have a material
adverse effect on the Company's ability to continue as a going concern.
As of March 31, 2006, the Company's existing credit facility with CIT had
limited availability to provide for working capital shortages. Although the
Company believes that it will generate cash flows from operations in the future,
there is substantial doubt as to whether it will be able to fund its operations
solely from its cash flows. In April 2005, the Company initiated a strategic
plan designed to accelerate the Company's growth and enhance its future earnings
potential. The plan focuses on the Company's strengths, which include providing
billing, collections and complementary business management services to physician
practices. A fundamental component of the Company's plan is the selective
consideration of accretive acquisition opportunities in these core business
sectors. In addition, the Company ceased investment in business lines that did
not complement the Company's strategic plans and redirected financial resources
and Company personnel to areas that management believes enhances long-term
growth potential. On June 7, 2005, as described in "Discontinued Operations,"
IPS completed the sale of substantially all of the assets of IntegriMED, and on
October 1, 2005, the Company completed the sale of its interests in TASC and TOM
-15-
in Dover, Ohio. Beginning in the third quarter of 2005, the Company successfully
completed the consolidation of corporate functions into its Roswell, Georgia
facility. Additionally, consistent with its strategic plan, the Company sold its
interest in Memorial Village effective January 31, 2006 and in San Jacinto
effective March 1, 2006. These transactions are described in greater detail
under the caption "Discontinued Operations."
The Company intends to continue to manage its use of cash. However, the
Company's business is still faced with many challenges. If cash flows from
operations and borrowings are not sufficient to fund the Company's cash
requirements, the Company may be required to further reduce its operations
and/or seek additional public or private equity financing or financing from
other sources or consider other strategic alternatives, including possible
additional divestitures of specific assets or lines of business. Any
acquisitions will require additional capital. There can be no assurances that
additional financing will be available, or that, if available, the financing
will be obtainable on terms acceptable to the Company or that any additional
financing would not be substantially dilutive to the Company's existing
stockholders.
ITEM 3. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures. The Company maintains a
set of disclosure controls and procedures that are designed to provide
reasonable assurance that information required to be disclosed by the Company in
its reports filed under the Exchange Act is recorded, processed, summarized and
reported accurately and within the time periods specified in the SEC's rules and
forms. As of the end of the period covered by this report, the Company
evaluated, under the supervision and with the participation of its management,
including the Chief Executive Officer and Chief Financial Officer, the design
and effectiveness of its disclosure controls and procedures pursuant to Rule
13a-15(c) of the Exchange Act. Based on that evaluation, the Company's Chief
Executive Officer and Chief Financial Officer concluded that its disclosure
controls and procedures are effective in timely alerting them to material
information relating to the Company (including its consolidated subsidiaries)
required to be included in its periodic filings.
Changes in Internal Controls. During the most recent fiscal quarter, there
have been no changes in our internal controls over financial reporting that have
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
In connection with the DCPS/MBS Merger in December 2004, holders of MBS
common stock, DCPS limited partnership interests and Dennis Cain Management, LLC
("DCM") limited liability company interests received an aggregate of cash,
promissory notes of the Company and shares of the Company's Class C Common
Stock. The purchase price was subject to retroactive increase (including
issuance of up to 450,000 additional shares of Class A Common Stock) or decrease
based on the financial results of the newly formed company and its predecessors
in 2004 and 2005. Pursuant to the merger agreement governing the DCPS/MBS Merger
(the "DCPS/MBS Merger Agreement"), the adjustment was based on whether DCPS and
MBS, on a combined basis, met an earnings before income taxes, depreciation and
amortization ("EBITDA") target of $2 million for the fiscal years ended December
31, 2004 and 2005. The Company accrued a liability in the amount of $840,286 as
of December 31, 2005 based on this provision of the DCPS/MBS Merger Agreement
and adjusted the purchase price accordingly. On April 19, 2006, the Company
executed subordinated promissory notes for an aggregate of $840,286. The notes
will bear interest at the rate of 8% per annum, payable monthly beginning on
April 30, 2006, and will mature on December 15, 2007. A copy of the form of the
subordinated promissory note is attached hereto as Exhibit 10.2. Additionally,
as a result of this purchase price adjustment, the Company issued 285,726 shares
of Class A Common Stock to the former equity holders of MBS, DCPS and DCM on May
9, 2006.
There was no placement agent or underwriter for the subordinated promissory
notes or stock issuances. The Company processed the stock issuances internally.
The shares were not sold for cash. The Company did not receive any consideration
in connection with the subordinated promissory notes or stock issuances. The
shares of Class A Common Stock issued are not convertible or exchangeable. In
connection with the issuance of the Class A Common Stock, the Company relied
upon the exemption from the registration requirements of the Securities Act by
virtue of Section 3(a)(9) of the Securities Act.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
-16-
As part of the Loan and Security Agreement, the Company is required to
comply with certain financial covenants, measured on a quarterly basis. The
financial covenants include maintaining a required debt service coverage ratio
and meeting a minimum operating income level for the surgery and diagnostic
centers before corporate overhead allocations. As of and for the three months
ended March 31, 2006, the Company was out of compliance with both of these
financial covenants and has notified the lender as such. Under the terms of the
Loan and Security Agreement, failure to meet the required financial covenants
constitutes an event of default. Under an event of default, the lender may (i)
accelerate and declare the obligations under the credit facility to be
immediately due and payable; (ii) withhold or cease to make advances under the
credit facility; (iii) terminate the credit facility; (iv) take possession of
the collateral pledged as part of the Loan and Security Agreement; (v) reduce or
modify the revolving loan commitment; and/or (vi) take necessary action under
the Guaranties. The revolving credit facility is secured by the Company's
assets. As of March 31, 2006, the outstanding principal under the revolving
credit facility was $1,162,659. The full amount of the loan as of March 31, 2006
is recorded as a current liability. In December 2005, the Company received
notification from CIT stating that (i) certain events of default under the Loan
and Security Agreement had occurred as a result of the Company being out of
compliance with two financial covenants relating to its debt service coverage
ratio and its minimum operating income level, (ii) as a result of the events of
default, CIT raised the interest rate for monies borrowed under the Loan and
Security Agreement to the provided "Default Rate" of prime rate plus 6%, (iii)
the amount available under the revolving credit facility was reduced from
$2,750,000 to $2,300,000 and (iv) CIT reserved all additional rights and
remedies available to it as a result of these events of default. The Company is
currently in negotiations with CIT to obtain, among other provisions, a waiver
of the events of default. In the event CIT declares the obligations under the
Loan and Security Agreement to be immediately due and payable or exercises its
other rights described above, the Company would not be able to meet its
obligations to CIT or its other creditors. As a result, such action would have a
material adverse effect on the Company`s ability to continue as a going concern.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
Exhibit No. Description
----------- -----------
Exhibit 10.1 First Amendment to Convertible Subordinated Promissory Notes,
dated as of May 9, 2006, by and between Orion HealthCorp, Inc.
and Brantley Partners IV, L.P.
Exhibit 10.2 Form of Subordinated Promissory Note, dated as of April 19,
2006, by and between Orion HealthCorp, Inc. and DCPS Sellers
and MBS Sellers
Exhibit 31.1 Rule 13a-14(a)/15d-14(a) Certification
Exhibit 31.2 Rule 13a-14(a)/15d-14(a) Certification
Exhibit 32.1 Section 1350 Certification
Exhibit 32.2 Section 1350 Certification
-17-
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
ORION HEALTHCORP, INC.
By: /s/ Terrence L. Bauer
-----------------------------------------------
Dated: May 10, 2006 Terrence L. Bauer
President, Chief Executive Officer and Director
(Duly Authorized Representative)
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears on
the signature page to this Report constitutes and appoints Terrence L. Bauer and
Stephen H. Murdock, and each of them, his true and lawful attorneys-in-fact and
agents, with full power of substitution and resubstitution, for him and in his
name, place and stead, in any and all capacities, to sign any and all amendments
to this Report, and to file the same, with all exhibits hereto, and other
documents in connection herewith with the Securities and Exchange Commission,
granting unto said attorneys-in-fact and agents and each of them, full power and
authority to do and perform each and every act and thing requisite and necessary
to be done in and about the premises, as fully to all intents and purposes as he
might or could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents or any of them, or their or his substitutes, may
lawfully do or cause to be done by virtue hereof.
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities
indicated on May 10, 2006.
By: /s/ Terrence L. Bauer By: /s/ Michael J. Finn
-------------------------------- --------------------------------
Terrence L. Bauer Michael J. Finn
President, Chief Executive Officer and Director
Director (Principal Executive Officer)
By: /s/ Paul H. Cascio By: /s/ Joseph M. Valley, Jr.
-------------------------------- --------------------------------
Paul H. Cascio Joseph M. Valley, Jr.
Director and Non-Executive Director
Chairman of the Board
By: /s/ David Crane By: /s/ Stephen H. Murdock
-------------------------------- --------------------------------
David Crane Stephen H. Murdock
Director Chief Financial Officer
(Principal Accounting and
Financial Officer)
-18-
Page Number
-------------
Consolidated Condensed Balance Sheets as of March 31, 2006
(unaudited) and December 31, 2005 F-2
Consolidated Condensed Statements of Operations for the Three
Months Ended March 31, 2006 and 2005 (unaudited) F-3
Consolidated Condensed Statements of Cash Flows for the Three
Months Ended March 31, 2006 and 2004 (unaudited) F-4
Notes to Unaudited Consolidated Condensed Financial Statements F-5
F-1
Orion HealthCorp, Inc.
Consolidated Condensed Balance Sheets
March 31, December 31,
2006 2005
------------ ------------
(Unaudited)
Current assets
Cash and cash equivalents $ 497,550 $ 298,807
Accounts receivable, net 2,497,709 2,798,304
Inventory 197,938 206,342
Prepaid expenses and other current assets 530,759 715,671
Assets held for sale - 975,839
------------ ------------
Total current assets 3,723,956 4,994,962
------------ ------------
Property and equipment, net 685,070 741,966
------------ ------------
Other long-term assets
Intangible assets, excluding goodwill, net 13,445,980 13,797,714
Goodwill 2,490,695 2,490,695
Other assets, net 76,382 92,432
------------ ------------
Total other long-term assets 16,013,057 16,380,841
------------ ------------
Total assets $20,422,083 $22,117,770
============ ============
Current liabilities
Accounts payable and accrued expenses $ 6,149,700 $ 6,738,278
Other current liabilities - 25,000
Income taxes payable - -
Current portion of capital lease obligations 91,879 92,334
Current portion of long-term debt 3,626,449 4,231,674
Liabilities held for sale - 452,027
------------ ------------
Total current liabilities 9,868,027 11,539,313
------------ ------------
Long-term liabilities
Capital lease obligations, net of current
portion 190,365 213,599
Long-term debt, net of current portion 3,086,131 3,871,593
Minority interest in partnership - 35,000
------------ ------------
Total long-term liabilities 3,276,496 4,120,193
------------ ------------
Commitments and contingencies - -
Stockholders' equity
Preferred stock, par value $0.001; 20,000,000
shares authorized; no shares issued and
outstanding - -
Common Stock, Class A, par value $0.001;
70,000,000 shares authorized, 12,428,042
shares issued and outstanding at March 31,
2006 and December 31, 2005, respectively 12,428 12,428
Common Stock, Class B, par value $0.001;
25,000,000 shares authorized, 10,448,470
shares issued and outstanding at March 31,
2006 and December 31, 2005, respectively 10,448 10,448
Common Stock, Class C, par value $0.001;
2,000,000 shares authorized, 1,437,572 shares
issued and outstanding at March 31, 2006 and
December 31, 2005, respectively 1,438 1,438
Additional paid-in capital 56,976,087 56,928,016
Accumulated deficit (49,684,524) (50,455,748)
Treasury stock -- at cost; 9,140 shares (38,318) (38,318)
------------ ------------
Total stockholders' equity 7,277,559 6,458,264
------------ ------------
Total liabilities and stockholders' equity $20,422,083 $22,117,770
============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-2
Orion HealthCorp, Inc.
Consolidated Condensed Statements of Operations
For the Three Months
Ended March 31,
2006 2005
------------ ------------
(Unaudited) (Unaudited)
Net operating revenues $ 7,154,014 $ 7,629,822
Operating expenses
Salaries and benefits 2,761,932 3,048,901
Physician group distribution 2,103,305 2,333,086
Facility rent and related costs 401,386 427,840
Depreciation and amortization 409,897 883,222
Professional and consulting fees 346,068 415,561
Insurance 181,239 212,505
Provision for doubtful accounts 158,750 338,509
Other expenses 1,138,922 1,309,324
------------ ------------
Total operating expenses 7,501,499 8,968,948
------------ ------------
Loss from continuing operations before other income
(expenses) (347,485) (1,339,126)
------------ ------------
Other income (expenses)
Interest expense (112,512) (56,297)
Gain on forgiveness of debt 665,463 -
Other expense, net (9,664) (2,625)
------------ ------------
Total other income (expenses), net 543,287 (58,922)
------------ ------------
Income (loss) from continuing operations 195,802 (1,398,048)
Discontinued operations
Income (loss) from operations of discontinued
components, including net gain on disposal of
$668,387 for the three months ended March 31, 2006 575,422 (282,582)
------------ ------------
Net income (loss) $ 771,224 $(1,680,630)
============ ============
Weighted average common shares outstanding
------------------------------------------
Basic 12,428,042 8,666,531
Diluted 84,127,418 8,666,531
Income (loss) per share
-----------------------
Basic
Net income (loss) per share from continuing
operations $ 0.02 $ (0.16)
Net income (loss) per share from discontinued
operations $ 0.05 $ (0.03)
------------ ------------
Net income (loss) per share $ 0.07 $ (0.19)
============ ============
Diluted
Net income (loss) per share from continuing
operations $ 0.00 $ (0.16)
Net income (loss) per share from discontinued
operations $ 0.01 $ (0.03)
------------ ------------
Net income (loss) per share $ 0.01 $ (0.19)
============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
Orion HealthCorp, Inc.
Consolidated Statements of Cash Flows
For the Three Months
Ended March 31,
2006 2005
-------------------------
"Revised"
Operating activities
Net income (loss) $ 771,224 $(1,680,630)
Adjustments to reconcile net loss to net cash used
in operating activities:
Provision for doubtful accounts 158,750 367,941
Depreciation and amortization 377,547 1,111,585
Gain on forgiveness of debt (665,463) -
Stock option compensation expense 48,071 -
Conversion of notes payable to common stock - 26,031
Impact of discontinued operations 230,743 (304,128)
Changes in operating assets and liabilities:
Accounts receivable 141,845 (679,289)
Inventory 8,404 41,266
Prepaid expenses and other assets 3,183 (253,798)
Other assets 603 8,470
Accounts payable and accrued expenses (588,579) 629,149
Deferred revenues and other liabilities - (15,996)
-------------------------
Net cash provided by (used in) operating activities 486,328 (749,399)
-------------------------
Investing activities
Sale (purchase) of property and equipment 31,083 (84,592)
Impact of discontinued operations 430,244 -
-------------------------
Net cash provided by (used in) investing activities 461,327 (84,592)
-------------------------
Financing activities
Net borrowings (repayments) of capital lease
obligations (23,689) (49,577)
Net borrowings (repayments) on line of credit (240,617) (231,272)
Net borrowings of notes payable - 1,025,000
Net repayments of notes payable (333,308) (94,836)
Net borrowings of other obligations 148,701 95,178
Impact of discontinued operations (300,000) -
-------------------------
Net cash provided by (used in) financing activities (748,913) 744,493
-------------------------
Net increase (decrease) in cash and cash equivalents 198,743 (89,498)
Cash and cash equivalents, beginning of quarter 298,807 701,846
-------------------------
Cash and cash equivalents, end of quarter $ 497,550 $ 612,348
=========================
Supplemental cash flow information
Cash paid during the year for
Income taxes $ - $ -
Interest $ 91,033 $ 50,297
Beginning in the fourth quarter of 2005, the Company separately disclosed the
operating, investing and financing components of the cash flows attributable to
its discontinued operations, which in prior periods were reported on a combined
basis as a single amount.
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
Orion HealthCorp, Inc.
Notes to Unaudited Consolidated Condensed Financial Statements
March 31, 2006 and 2005
Note 1. General
Orion HealthCorp, Inc. (formerly SurgiCare, Inc. "SurgiCare") and its
subsidiaries ("Orion" or the "Company") maintain their accounts on the accrual
method of accounting in accordance with accounting principles generally accepted
in the United States of America ("GAAP"). Accounting principles followed by the
Company and its subsidiaries and the methods of applying those principles, which
materially affect the determination of financial position, results of operations
and cash flows are summarized below.
The unaudited consolidated condensed financial statements include the
accounts of the Company and all of its majority-owned subsidiaries. Orion's
results for the three months ended March 31, 2006 and 2005 include the results
of IPS, MBS and the Company's ambulatory surgery and diagnostic center business.
The descriptions of the business and results of operations of MBS set forth in
these notes include the business and results of operations of DCPS. All material
intercompany balances and transactions have been eliminated in consolidation.
Description of Business
Orion is a healthcare services organization providing outsourced business
services to physicians. The Company serves the physician market through two
subsidiaries, Medical Billing Services, Inc. ("MBS"), which provides billing,
collection and practice management services, primarily to hospital-based
physicians; and Integrated Physician Solutions, Inc. ("IPS"), which provides
business and management services to general and subspecialty pediatric physician
practices.
The Company was incorporated in Delaware on February 24, 1984 as Technical
Coatings, Incorporated. On December 15, 2004, the Company completed a
transaction to acquire IPS (the "IPS Merger") and to acquire Dennis Cain
Physician Solutions, Ltd. ("DCPS") and MBS (the "DCPS/MBS Merger")
(collectively, the "2004 Mergers"). As a result of these transactions, IPS and
MBS became wholly owned subsidiaries of the Company, and DCPS is a wholly owned
subsidiary of MBS. On December 15, 2004, and simultaneous with the consummation
of the 2004 Mergers, the Company changed its name from SurgiCare, Inc. to Orion
and consummated its restructuring transactions (the "Closing"), which included
issuances of new equity securities for cash and contribution of outstanding
debt, and the restructuring of its debt facilities. The Company also created
Class B Common Stock and Class C Common Stock, which were issued in connection
with the equity investments and acquisitions.
In April 2005, the Company initiated a strategic plan designed to
accelerate the Company's growth and enhance its future earnings potential. The
plan focuses on the Company's strengths, which include providing billing,
collections and complementary business management services to physician
practices. As part of this strategic plan, the Company began to divest certain
non-strategic assets. In addition, the Company ceased investment in business
lines that did not complement the Company's strategic plan and redirected
financial resources and Company personnel to areas that management believes
enhance long-term growth potential. Beginning in the third quarter of 2005, the
Company successfully completed the consolidation of corporate functions into its
Roswell, Georgia facility. Consistent with its strategic plan, the Company also
completed a series of transactions involving the divestiture of non-strategic
assets in 2005.
Medical Billing Services
MBS is based in Houston, Texas and was incorporated in Texas on October 16,
1985. DCPS is based in Houston, Texas and was organized as a Texas limited
liability company on September 16, 1998. DCPS reorganized as a Texas limited
partnership on August 31, 2003. MBS (which includes the operations of DCPS)
offers its clients a complete outsourcing service, which includes practice
management and billing and collection services, allowing them to avoid the
infrastructure investment in their own back-office operations. These services
help clients to be financially successful by improving cash flows and reducing
administrative costs and burdens.
MBS provides services to approximately 58 customers throughout Texas. These
customers include anesthesiologists, pathologists, and radiologists, imaging
centers, comprehensive breast centers, hospital labs, cardio-thoracic surgeons
and ambulatory surgery centers ("ASCs.")
Integrated Physician Solutions
F-5
IPS, a Delaware corporation, was founded in 1996 to provide physician
practice management services to general and subspecialty pediatric practices.
IPS commenced its business activities upon consummation of several medical group
business combinations effective January 1, 1999.
As of March 31, 2006, IPS managed nine practice sites, representing five
medical groups in Illinois and Ohio. IPS provides human resources management,
accounting, group purchasing, public relations, marketing, information
technology, and general day-to-day business operations management services to
these medical groups. The physicians, who are all employed by separate
corporations, provide all clinical and patient care related services.
There is a standard forty-year management service agreement ("MSA") between
IPS and the various affiliated medical groups whereby a management fee is paid
to IPS. IPS owns all of the assets used in the operation of the medical groups.
IPS manages the day-to-day business operations of each medical group and
provides the assets for the physicians to use in their practice, for a fixed fee
or percentage of the net operating income of the medical group. All revenues are
collected by IPS, the fixed fee or percentage payment to IPS is taken from the
net operating income of the medical group and the remainder of the net operating
income of the medical group is paid to the physicians and treated as an expense
on IPS's financial statements as "physician group distribution."
On April 1, 2005, IPS entered into a Mutual Release and Settlement
Agreement (the "CARDC Settlement") with Bradley E. Chipps, M.D. ("Dr. Chipps")
and Capital Allergy and Respiratory Disease Center, a medical corporation
("CARDC") to settle disputes as to the existence and enforceability of certain
contractual obligations. As part of the CARDC Settlement, Dr. Chipps, CARDC, and
IPS agreed that CARDC would purchase the assets owned by IPS and used in
connection with CARDC in exchange for termination of the MSA between IPS and
CARDC. Additionally, among other provisions, after April 1, 2005, Dr. Chipps,
CARDC and IPS have been released from any further obligation to each other.
On June 7, 2005, InPhySys, Inc. (formerly known as IntegriMED, Inc.)
("IntegriMED"), a wholly owned subsidiary of IPS, executed an Asset Purchase
Agreement (the "IntegriMED Agreement") with eClinicalWeb, LLC ("eClinicalWeb")
to sell substantially all of the assets of IntegriMED. The IntegriMED Agreement
was deemed to be effective as of midnight on June 6, 2005. As consideration for
the purchase of the acquired assets, eClinicalWeb issued to IntegriMED the
following: (i) a two percent (2%) ownership interest in eClinicalWeb; and (ii)
$69,034 for the payoff of certain leases and purchase of certain software. Also
eClinicalWeb agreed to sublease certain office space from IPS that was occupied
by employees of IntegriMED.
On October 31, 2005, IPS executed a Mutual Release and Settlement Agreement
(the "Sutter Settlement") with John Ivan Sutter, M.D., PA ("Dr. Sutter") to
settle disputes that had arisen between IPS and Dr. Sutter and to avoid the risk
and expense of litigation. As part of the Sutter Settlement, Dr. Sutter and IPS
agreed that Dr. Sutter would purchase the assets owned by IPS and used in
connection with Dr. Sutter's practice, in exchange for termination of the
related MSA. Additionally, among other provisions, after October 31, 2005, Dr.
Sutter and IPS have been released from any further obligation to each other.
Ambulatory Surgery Center Business
As of March 31, 2006, the Company no longer has ownership or management
interests in surgery and diagnostic centers.
On March 1, 2005, the Company closed its wholly owned subsidiary, Bellaire
SurgiCare, Inc. ("Bellaire SurgiCare"), and consolidated its operations with the
operations of SurgiCare Memorial Village, L.P. ("Memorial Village").
In April 2005, due to unsatisfactory financial performance of the Company's
surgery centers and in accordance with its strategic plan, the Company began the
process of divesting its surgery center ownership interests.
On September 30, 2005, Orion executed purchase agreements to sell its 51%
ownership interest in Tuscarawas Ambulatory Surgery Center, L.L.C. ("TASC") and
its 41% ownership interest in Tuscarawas Open MRI, L. P., ("TOM") both located
in Dover, Ohio, to Union Hospital ("Union"). Additionally, as part of the
transactions, TASC, as the sole member of TASC Anesthesia, L.L.C. ("TASC
Anesthesia"), executed an Asset Purchase Agreement to sell certain assets of
TASC Anesthesia to Union. The limited partners of TASC and TOM also sold a
certain number of their units to Union such that at the closing of these
transactions, Union owned 70% of the ownership interests in TASC and TOM.
F-6
As consideration for the purchase of the 70% ownership interests in TASC
and TOM, Union Hospital paid purchase prices of $950,000 and $2,188,237,
respectively. Orion's portion of the total proceeds for TASC, TASC Anesthesia
and TOM, after closing costs of $82,632, was cash in the amount of $1,223,159
and a note due on or before March 30, 2006 in the amount of $530,547. The March
30, 2006 note was not fully paid by Union and the remaining balance of $261,357
was written off against the gain on disposition for the quarter ended December
31, 2005. As a result of these transactions, Orion no longer has an ownership
interest in TASC, TOM or TASC Anesthesia.
Additionally, as part of the TASC and TOM transactions, Orion executed
two-year management services agreements (the "TASC MSA" and the "TOM MSA") with
terms substantially the same as those of the management services agreements
under which Orion performed management services to TASC and TOM prior to the
transactions.
On January 12, 2006, the Company was notified by Union that it was
exercising its option to terminate the TOM MSA as of March 12, 2006. Management
fee revenue related to TOM was $7,217 and $5,623 for the quarters ended March
31, 2006 and 2005, respectively.
On February 3, 2006, the Company was notified by Union that it was
exercising its option to terminate the TASC MSA as of April 3, 2006. Management
fee revenue related to TASC was 21,557 and $26,024 for the quarters ended March
31, 2006 and 2005, respectively.
On February 8, 2006, Memorial Village executed an Asset Purchase Agreement
(the "Memorial Agreement") for the sale of substantially all of its assets to
First Surgical Memorial Village, L.P. ("First Surgical"). Memorial Village is
approximately 49% owned by Town & Country SurgiCare, Inc., a wholly owned
subsidiary of Orion. The Memorial Agreement was deemed to be effective as of
January 31, 2006.
The property sold by Memorial Village to First Surgical (hereinafter
collectively referred to as the "Memorial Acquired Assets") included the
equipment, inventory, goodwill, contracts, leasehold improvements, equipment
leases, books and records, permits and licenses and other personal property
owned by Memorial Village and used in the operation of Memorial Village's
business. The Memorial Acquired Assets did not include any of the following:
accounts receivable, cash and cash equivalents, marketable securities, insurance
policies, prepaid expenses, deposits with utility and/or service providers,
shares of corporations, real estate owned by Memorial Village, or liabilities,
other than those expressly assumed by the First Surgical in the Agreement.
As consideration for the Memorial Acquired Assets, Memorial Village
received a total purchase price of $1,100,000, of which Orion received
approximately $815,000 after payment of certain legal and other post-closing
expenses. The proceeds received by Orion consisted of the following amounts:
i. Approximately $677,000 representing the principal amount of a note
payable owed to Orion from Memorial Village;
ii. Approximately $99,000 representing Orion's pro-rata share of the net
proceeds after payment of certain legal and other post-closing
expenses; and
iii. A reserve fund of approximately $39,000, pending approval of the
assumption of certain capital leases by First Surgical.
On March 1, 2006, San Jacinto Surgery Center, Ltd. ("San Jacinto") executed
an Asset Purchase Agreement (the "San Jacinto Agreement") for the sale of
substantially all of its assets to San Jacinto Methodist Hospital ("Methodist").
San Jacinto is approximately 10% owned by Baytown SurgiCare, Inc., a wholly
owned subsidiary of Orion.
The property sold by San Jacinto to Methodist (hereinafter collectively
referred to as the "San Jacinto Acquired Assets"), included the leasehold title
to real property, together with all improvements, buildings and fixtures, all
major, minor or other equipment, all computer equipment and hardware, furniture
and furnishings, inventory and supplies, current financial, patient,
credentialing and personnel records, interest in all commitments, contracts,
leases and agreements outstanding in respect to San Jacinto, to the extent
assignable, all licenses and permits held by San Jacinto, all patents and patent
applications and all logos, names, trade names, trademarks and service marks,
all computer software, programs and similar systems owned by or licensed to San
Jacinto, goodwill and all interests in property, real, personal and mixed,
tangible and intangible acquired by San Jacinto prior to March 1, 2006. The San
Jacinto Acquired Assets did not include any of the following: restricted and
unrestricted cash and cash equivalents, marketable securities, certificates of
deposit, bank accounts, temporary investments, accounts receivable, notes
receivable intercompany accounts of San Jacinto, and all commitments, contracts,
leases and agreements other than those expressly assumed by Methodist in the San
Jacinto Agreement.
F-7
As consideration for the San Jacinto Acquired Assets, San Jacinto received
a total purchase price of $5,500,000, of which Orion received a net amount of
approximately $598,000. The proceeds received by Orion consisted of the
following amounts:
i. Approximately $450,000 representing Orion's pro-rata share of the
net proceeds; and
ii. Approximately $148,000 representing the principal and interest
amounts of a note payable owed to Orion from San Jacinto.
As part of the closing of the Agreement, Orion was obligated to make
payments, totaling $607,000, from its portion of the proceeds as follows:
i. Approximately $357,000 representing distributions due to the
limited partners of San Jacinto for cash collections previously
received by Orion, and payment of accounts payable and other
expenses; and
ii. Approximately $250,000 to CIT, which represents repayment of the
obligations related to San Jacinto under the Loan and Security
Agreement.
Note 2. Going Concern
The accompanying unaudited consolidated condensed financial statements have
been prepared in conformity with GAAP, which contemplate the continuation of the
Company as a going concern. The Company incurred substantial operating losses
during 2005, and, despite an operating profit in the first quarter of 2006, has
used substantial amounts of working capital in its operations. Additionally, as
described more fully below, the Company received notification from CIT
Healthcare, LLC (formerly known as Healthcare Business Credit Corporation)
("CIT") in December 2005 that certain events of default under the Loan and
Security Agreement had occurred as a result of the Company being out of
compliance with two financial covenants relating to its debt service coverage
ratio and its minimum operating income level. These conditions raise substantial
doubt about the Company's ability to continue as a going concern.
The Company has financed its growth and operations primarily through the
issuance of equity securities, secured and/or convertible debt, most recently by
completing a series of acquisitions and restructuring transactions (the
"Restructuring"), which occurred in December 2004, and borrowing from related
parties. In connection with the closing of these transactions, the Company
entered into a new secured two-year revolving credit facility pursuant to a Loan
and Security Agreement (the "Loan and Security Agreement"), dated December 15,
2004, by and among Orion, certain of its affiliates and subsidiaries, and CIT.
Under this facility, initially up to $4,000,000 of loans could be made available
to Orion, subject to a borrowing base, which is determined based on a percentage
of eligible outstanding accounts receivable less than 180 days old. As discussed
below, the amount available under this credit facility has been reduced. Orion
borrowed $1,600,000 under this facility concurrently with the closing of the
Restructuring. The interest rate under this facility is the prime rate plus 6%.
Upon an event of default, CIT can accelerate the loans or call the Guaranties
described below. (See Note 10. Long-Term Debt and Lines of Credit, for
additional discussion regarding the Company's defaults under the Loan and
Security Agreement.) In connection with entering into this new facility, Orion
also restructured its previously-existing debt facilities, which resulted in a
decrease in aggregate debt owed to DVI Business Credit Corporation and DVI
Financial Services, Inc. (collectively, "DVI") from approximately $10.1 million
to a combined principal amount of approximately $6.5 million, of which
approximately $2.0 million was paid at the Closing.
Pursuant to a Guaranty Agreement (the "Brantley IV Guaranty"), dated as of
December 15, 2004, provided by Brantley Partners IV, L.P. ("Brantley IV") to
CIT, Brantley IV agreed to provide a deficiency guaranty in the initial amount
of $3,272,727. As discussed below, the amount of this Brantley IV Guaranty has
been reduced. Pursuant to a Guaranty Agreement (the "Brantley Capital Guaranty"
and collectively with the Brantley IV Guaranty, the "Guaranties"), dated as of
December 15, 2004, provided by Brantley Capital Corporation ("Brantley Capital")
to CIT, Brantley Capital agreed to provide a deficiency guarantee in the initial
amount of $727,273. As discussed below, the amount of this Brantley Capital
Guaranty has been reduced. In consideration for the Guaranties, Orion issued
warrants to purchase 20,455 shares of Class A Common Stock, at an exercise price
of $0.01 per share, to Brantley IV, and issued warrants to purchase 4,545 shares
of Class A Common Stock, at an exercise price of $0.01 per share, to Brantley
Capital. None of these warrants, which expire on December 15, 2009, have been
exercised as of March 31, 2006.
On March 16, 2005, Brantley IV loaned the Company an aggregate of
$1,025,000 (the "First Loan"). On June 1, 2005, the Company executed a
convertible subordinated promissory note in the principal amount of $1,025,000
(the "First Note") payable to Brantley IV to evidence the terms of the First
Loan. The material terms of the First Note are as follows: (i) the First Note is
F-8
unsecured; (ii) the First Note is subordinate to the Company's outstanding loan
from CIT and other indebtedness for monies borrowed, and ranks pari passu with
general unsecured trade liabilities; (iii) principal and interest on the First
Note is due in a lump sum on April 19, 2006 (the "First Note Maturity Date");
(iv) the interest on the First Note accrues from and after March 16, 2005, at a
per annum rate equal to nine percent (9.0%) and is non-compounding; (v) if an
event of default occurs and is continuing, Brantley IV, by notice to the
Company, may declare the principal of the First Note to be due and immediately
payable; and (vi) on or after the First Note Maturity Date, Brantley IV, at its
option, may convert all or a portion of the outstanding principal and interest
due of the First Note into shares of Class A Common Stock of the Company at a
price per share equal to $1.042825 (the "First Note Conversion Price"). The
number of shares of Class A Common Stock to be issued upon conversion of the
First Note shall be equal to the number obtained by dividing (x) the aggregate
amount of principal and interest to be converted by (y) the First Note
Conversion Price (as defined above); provided, however, the number of shares to
be issued upon conversion of the First Note shall not exceed the lesser of: (i)
1,159,830 shares of Class A Common Stock, or (ii) 16.3% of the then outstanding
Class A Common Stock. As of March 31, 2006, if Brantley IV were to convert the
First Note, the Company would have to issue 1,076,283 shares of Class A Common
Stock. On May 9, 2006, Brantley IV and the Company executed an amendment to the
First Note (the "First and Second Note Amendment") extending the First Note
Maturity Date to August 15, 2006.
On April 19, 2005, Brantley IV loaned the Company an additional $225,000
(the "Second Loan"). On June 1, 2005, the Company executed a convertible
subordinated promissory note in the principal amount of $225,000 (the "Second
Note") payable to Brantley IV to evidence the terms of the Second Loan. The
material terms of the Second Note are as follows: (i) the Second Note is
unsecured; (ii) the Second Note is subordinate to the Company's outstanding loan
from CIT and other indebtedness for monies borrowed, and ranks pari passu with
general unsecured trade liabilities; (iii) principal and interest on the Second
Note is due in a lump sum on April 19, 2006 (the "Second Note Maturity Date");
(iv) the interest on the Second Note accrues from and after April 19, 2005, at a
per annum rate equal to nine percent (9.0%) and is non-compounding; (v) if an
event of default occurs and is continuing, Brantley IV, by notice to the
Company, may declare the principal of the Second Note to be due and immediately
payable; and (vi) on or after the Second Note Maturity Date, Brantley IV, at its
option, may convert all or a portion of the outstanding principal and interest
due of the Second Note into shares of Class A Common Stock of the Company at a
price per share equal to $1.042825 (the "Second Note Conversion Price"). The
number of shares of Class A Common Stock to be issued upon conversion of the
Second Note shall be equal to the number obtained by dividing (x) the aggregate
amount of principal and interest to be converted by (y) the Second Note
Conversion Price (as defined above); provided, however, the number of shares to
be issued upon conversion of the Second Note shall not exceed the lesser of: (i)
254,597 shares of Class A Common Stock, or (ii) 3.6% of the then outstanding
Class A Common Stock. As of March 31, 2006, if Brantley IV were to convert the
Second Note, the Company would have to issue 234,423 shares of Class A Common
Stock. On May 9, 2006, Brantley IV and the Company executed the First and Second
Note Amendment extending the Second Note Maturity Date to August 15, 2006.
Additionally, in connection with the First Loan and the Second Loan, the
Company entered into a First Amendment to the Loan and Security Agreement (the
"First Amendment"), dated March 22, 2005, with certain of the Company's
affiliates and subsidiaries, and CIT, whereby its $4,000,000 secured two-year
revolving credit facility has been reduced by the amount of the loans from
Brantley IV to $2,750,000. As a result of the First Amendment, the Brantley IV
Guaranty was amended by the Amended and Restated Guaranty Agreement, dated March
22, 2005, which reduced the deficiency guaranty provided by Brantley IV by the
amount of the First Loan to $2,247,727. Also as a result of the First Amendment,
the Brantley Capital Guaranty was amended by the Amended and Restated Guaranty
Agreement, dated March 22, 2005, which reduced the deficiency guaranty provided
by Brantley Capital by the amount of the Second Loan to $502,273. Paul H.
Cascio, the Chairman of the board of directors of the Company, and Michael J.
Finn, a director of the Company, are affiliates of Brantley IV.
As part of the Loan and Security Agreement, the Company is required to
comply with certain financial covenants, measured on a quarterly basis. The
financial covenants include maintaining a required debt service coverage ratio
and meeting a minimum operating income level for the surgery and diagnostic
centers before corporate overhead allocations. As of and for the three months
ended March 31, 2006, the Company was out of compliance with both of these
financial covenants and has notified the lender as such. Under the terms of the
Loan and Security Agreement, failure to meet the required financial covenants
constitutes an event of default. Under an event of default, the lender may (i)
accelerate and declare the obligations under the credit facility to be
immediately due and payable; (ii) withhold or cease to make advances under the
credit facility; (iii) terminate the credit facility; (iv) take possession of
the collateral pledged as part of the Loan and Security Agreement; (v) reduce or
modify the revolving loan commitment; and/or (vi) take necessary action under
the Guaranties. The revolving credit facility is secured by the Company's
assets. As of March 31, 2006, the outstanding principal under the revolving
credit facility was $1,162,659. The full amount of the loan as of March 31, 2006
is recorded as a current liability. In December 2005, the Company received
notification from CIT stating that (i) certain events of default under the Loan
and Security Agreement had occurred as a result of the Company being out of
compliance with two financial covenants relating to its debt service coverage
ratio and its minimum operating income level, (ii) as a result of the events of
F-9
default, CIT raised the interest rate for monies borrowed under the Loan and
Security Agreement to the provided "Default Rate" of prime rate plus 6%, (iii)
the amount available under the revolving credit facility was reduced from
$2,750,000 to $2,300,000 and (iv) CIT reserved all additional rights and
remedies available to it as a result of these events of default. The Company is
currently in negotiations with CIT to obtain, among other provisions, a waiver
of the events of default. In the event CIT declares the obligations under the
Loan and Security Agreement to be immediately due and payable or exercises its
other rights described above, the Company would not be able to meet its
obligations to CIT or its other creditors. As a result, such action would have a
material adverse effect on the Company`s ability to continue as a going concern.
As of March 31, 2006, the Company's existing credit facility with CIT had
limited availability to provide for working capital shortages. Although the
Company believes that it will generate cash flows from operations in the future,
there is substantial doubt as to whether it will be able to fund its operations
solely from its cash flows. In April 2005, the Company initiated a strategic
plan designed to accelerate the Company's growth and enhance its future earnings
potential. The plan focuses on the Company's strengths, which include providing
billing, collections and complementary business management services to physician
practices. A fundamental component of the Company's plan is the selective
consideration of accretive acquisition opportunities in these core business
sectors. In addition, the Company ceased investment in business lines that did
not complement the Company's strategic plans and redirected financial resources
and Company personnel to areas that management believes enhance long-term growth
potential. On June 7, 2005, as described in Note 1. General - Description of
Business - Integrated Physician Solutions, IPS completed the sale of
substantially all of the assets of IntegriMED, and on October 1, 2005, the
Company completed the sale of its interests in TASC and TOM in Dover, Ohio.
Beginning in the third quarter of 2005, the Company successfully completed the
consolidation of corporate functions into its Roswell, Georgia facility.
Additionally, consistent with its strategic plan, the Company sold its interest
in Memorial Village effective January 31, 2006 and in San Jacinto effective
March 1, 2006. (See Note 1. General - Description of Business - Ambulatory
Surgery Center Business).
The Company intends to continue to manage its use of cash. However, the
Company's business is still faced with many challenges. If cash flows from
operations and borrowings are not sufficient to fund the Company's cash
requirements, the Company may be required to further reduce its operations
and/or seek additional public or private equity financing or financing from
other sources or consider other strategic alternatives, including possible
additional divestitures of specific assets or lines of business. Any
acquisitions will require additional capital. There can be no assurances that
additional financing will be available, or that, if available, the financing
will be obtainable on terms acceptable to the Company or that any additional
financing would not be substantially dilutive to the Company's existing
stockholders.
Note 3. Revenue Recognition
MBS's principal source of revenues is fees charged to clients based on a
percentage of net collections of the client's accounts receivable. MBS
recognizes revenue and bills it clients when the clients receive payment on
those accounts receivable. MBS typically receives payment from the client within
30 days of billing. The fees vary depending on specialty, size of practice,
payer mix, and complexity of the billing. In addition to the collection fee
revenue, MBS also earns fees from the various consulting services that MBS
provides, including medical practice management services, managed care
contracting, coding and reimbursement services.
IPS records revenue based on patient services provided by its affiliated
medical groups. Net patient service revenue is impacted by billing rates,
changes in Current Procedure Terminology code reimbursement and collection
trends. IPS reviews billing rates at each of its affiliated medical groups on at
least an annual basis and adjusts those rates based on each insurer's current
reimbursement practices. Amounts collected by IPS for treatment by its
affiliated medical groups of patients covered by Medicare, Medicaid and other
contractual reimbursement programs, which may be based on cost of services
provided or predetermined rates, are generally less than the established billing
rates of IPS's affiliated medical groups. IPS estimates the amount of these
contractual allowances and records a reserve against accounts receivable based
on historical collection percentages for each of the affiliated medical groups,
which include various payer categories. When payments are received, the
contractual adjustment is written off against the established reserve for
contractual allowances. The historical collection percentages are adjusted
quarterly based on actual payments received, with any differences charged
against net revenue for the quarter. Additionally, IPS tracks cash collection
percentages for each medical group on a monthly basis, setting quarterly and
annual goals for cash collections, bad debt write-offs and aging of accounts
receivable.
As of March 31, 2006, the Company no longer has ownership or management
interests in surgery and diagnostic centers. Orion's principal source of
revenues from its surgery center business was a surgical facility fee charged to
patients for surgical procedures performed in its ASCs and for diagnostic
services performed at TOM. Orion depended upon third-party programs, including
governmental and private health insurance programs to pay these fees on behalf
of its patients. Patients were responsible for the co-payments and deductibles
F-10
when applicable. The fees varied depending on the procedure, but usually
included all charges for operating room usage, special equipment usage,
supplies, recovery room usage, nursing staff and medications. Facility fees did
not include the charges of the patient's surgeon, anesthesiologist or other
attending physicians, which were billed directly to third-party payers by such
physicians. In addition to the facility fee revenues, Orion also earned
management fees from its operating facilities and development fees from centers
that it developed. ASCs, such as those in which Orion owned an interest prior to
March 31, 2006, depend upon third-party reimbursement programs, including
governmental and private insurance programs, to pay for services rendered to
patients. The Medicare program currently pays ASCs and physicians in accordance
with fee schedules, which are prospectively determined. In addition to payment
from governmental programs, ASCs derive a significant portion of their net
revenues from private healthcare reimbursement plans. These plans include
standard indemnity insurance programs as well as managed care structures such as
preferred provider organizations, health maintenance organizations and other
similar structures.
Note 4. Use of Estimates
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. While management believes current
estimates are reasonable and appropriate, actual results could differ from those
estimates.
Note 5. Segment Reporting
In accordance with SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information," the Company has determined that it has two
reportable segments -- IPS and MBS. The reportable segments are strategic
business units that offer different products and services. They are managed
separately because each business requires different technology, operational
support and marketing strategies. The Company's reportable segments consist of:
(i) IPS, which includes the pediatric medical groups that provide patient care
operating under the MSA; and (ii) MBS, which provides practice management,
billing and collections, managed care consulting and coding and reimbursement
services to hospital-based physicians and clinics. Management chose to aggregate
the MSAs into a single operating segment consistent with the objective and basic
principles of SFAS No. 131 based on similar economic characteristics, including
the nature of the products and services, the type of customer for their
services, the methods used to provide their services and in consideration of the
regulatory environment under Medicare and the Health Insurance Portability and
Accountability Act of 1996.
The following table summarizes key financial information, by reportable
segment, as of and for the three months ended March 31, 2006 and 2005,
respectively:
March 31, 2006
--------------------------------------
IPS MBS Total
------------ ------------ ------------
Net operating revenues $ 4,680,275 $ 2,394,290 $ 7,074,565
Income from continuing operations 258,261 189,569 447,830
Depreciation and amortization 108,605 283,109 391,714
Total assets 8,668,645 10,180,245 18,848,890
March 31, 2005
--------------------------------------
IPS MBS Total
------------ ------------ ------------
Net operating revenues $ 5,065,374 $ 2,540,515 $ 7,605,889
Income from continuing operations 250,338 200,674 451,012
Depreciation and amortization 141,221 287,140 428,361
Total assets 9,870,980 10,699,435 20,570,415
The following schedules provide a reconciliation of the key financial
information by reportable segment to the consolidated totals found in Orion's
consolidated balance sheets and statements of operations as of and for the years
ended March 31, 2006 and 2005, respectively:
F-11
March 31, 2006 March 31, 2005
-------------- --------------
Net operating revenues:
Total net operating revenues for reportable
segments $ 7,074,565 $ 7,605,889
Corporate revenues 79,448 23,933
-------------- --------------
Total consolidated net operating revenues $ 7,154,013 $ 7,629,822
============== ==============
Loss from continuing operations:
Total income from continuing operations for
reportable segments $ 447,830 $ 451,012
Extraordinary gain 665,463 -
Corporate overhead (857,420) (1,849,060)
-------------- --------------
Total consolidated income (loss) from
continuing operations $ 255,872 $ (1,398,048)
============== ==============
Depreciation and amortization:
Total depreciation and amortization for
reportable segments $ 391,714 $ 428,361
Corporate depreciation and amortization 18,183 454,861
-------------- --------------
Total consolidated depreciation and
amortization $ 409,897 $ 883,222
============== ==============
Total assets:
Total assets for reportable segments $ 18,848,890 $ 20,570,415
Corporate assets 1,573,193 6,363,516
Assets related to discontinued operations (1) - 14,942,636
-------------- --------------
Total consolidated assets $ 20,422,083 $ 41,876,567
============== ==============
(1) The balance at March 31, 2005 includes $14,477,085 of intangible
assets and goodwill that were impaired in 2005.
Note 6. Goodwill and Intangible Assets
Goodwill and intangible assets represent the excess of cost over the fair
value of net assets of companies acquired in business combinations accounted for
using the purchase method. In July 2001, the FASB issued SFAS No. 141, "Business
Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS
No. 141 eliminates pooling-of-interest accounting and requires that all business
combinations initiated after June 30, 2001, be accounted for using the purchase
method. SFAS No. 142 eliminates the amortization of goodwill and certain other
intangible assets and requires the Company to evaluate goodwill for impairment
on an annual basis by applying a fair value test. SFAS No. 142 also requires
that an identifiable intangible asset that is determined to have an indefinite
useful economic life not be amortized, but separately tested for impairment
using a fair value-based approach at least annually.
The Company adopted SFAS No. 142 effective January 1, 2002. As a result,
IPS determined that its long-term MSAs, executed as part of the medical group
business combinations consummated in 1999, are an identifiable intangible asset
in accordance with paragraph 39 of SFAS No. 141.
As part of the acquisition and restructuring transactions that closed on
December 15, 2004, the Company recorded intangible assets and goodwill related
to the 2004 Mergers. As of the Closing, the Company's management expected the
case volumes at Bellaire SurgiCare to improve in 2005. However, by the end of
February 2005, it was determined that the expected case volume increases were
not going to be realized. On March 1, 2005, the Company closed Bellaire
SurgiCare and consolidated its operations with the operations of Memorial
Village. The Company tested the identifiable intangible assets and goodwill
related to the surgery center business using the present value of cash flows
method. As a result of the decision to close Bellaire SurgiCare and the
resulting impairment of the joint venture interest and management contracts
related to the surgery centers, the Company recorded a charge for impairment of
intangible assets of $4,090,555 for the year ended December 31, 2004.
As a result of the CARDC Settlement described in Note 1. General --
Description of Business -- Integrated Physician Solutions, the Company recorded
a charge for impairment of intangible assets related to CARDC of $704,927 for
the year ended December 31, 2004.
F-12
On June 13, 2005, the Company announced that it had accepted an offer to
purchase its interests in TASC and TOM in Dover, Ohio. In preparation for this
pending transaction, the Company tested the identifiable intangible assets
related to the surgery center business using the present value of cash flows
method as of June 30, 2005. Based on the pending sales transaction involving
TASC and TOM, as well as the uncertainty of future cash flows related to the
Company's surgery center business, the Company determined that the joint venture
interests associated with TASC, TOM and Memorial Village were impaired and
recorded a charge for impairment of intangible assets of $6,362,849 for the
quarter ended June 30, 2005. The sale of the Company's interests in TASC and TOM
was completed effective as of October 1, 2005. (See Note 1. General --
Description of Business -- Ambulatory Surgery Center Business).
In November 2005, the Company decided that, as a result of ongoing losses
at Memorial Village, it would need to either find a buyer for the Company's
equity interests in Memorial Village or close the facility. In preparation for
this expected transaction, the Company once again tested the identifiable
intangible assets related to the surgery center business using the present value
of cash flows method at September 30, 2005. Based on the decision to sell or
close Memorial Village, as well as the continuing uncertainty of cash flows
related to the Company's surgery center segment, the Company determined that the
joint venture interests for San Jacinto, as well as the management contracts
associated with Memorial Village and San Jacinto, were impaired and recorded an
additional charge for impairment of intangible assets totaling $3,461,351 for
the quarter ended September 30, 2005.
As described in Note 1. General -- Description of Business -- Ambulatory
Surgery Center Business, effective January 31, 2006 and March 1, 2006,
respectively, the Company executed Asset Purchase Agreements to sell
substantially all of the assets of Memorial Village and San Jacinto. Also in the
first quarter of 2006, the Company was notified by Union that it was exercising
its option to terminate the TASC MSA and TOM MSA. As a result of the sales of
Memorial Village and San Jacinto, as well as the termination of the TASC MSA and
TOM MSA, the Company no longer has an ownership or management interest in any
ambulatory surgery centers and, as such, the Company tested the remaining
identifiable intangible assets related to the surgery centers from the IPS
Merger at December 31, 2005. Based on the terminations of the TASC MSA and TOM
MSA, as well as the sales of Memorial Village and San Jacinto, the Company
determined that the management contracts associated with TASC and TOM were
impaired and recorded an additional charge for impairment of intangible assets
of $1,163,830 for the quarter ended December 31, 2005.
As a result of the Sutter Settlement, which is described in Note 1. General
-- Description of Business -- Integrated Physician Solutions, the Company also
recorded an additional $38,440 charge for impairment of intangible assets for
the quarter ended December 31, 2005.
In order to determine whether the goodwill recorded as a result of the IPS
Merger was impaired at December 31, 2005, the Company compared the fair value of
each ASC's assets to its net carrying value. As each of the ASCs was sold
between October 1, 2005 and March 1, 2006, the fair value of each ASC was best
determined by the purchase price of the assets. Since TASC and TOM were sold
effective October 1, 2005, the balance sheet at September 30, 2005 was used to
determine the fair value of its assets. Since the Memorial Village and San
Jacinto transactions took place after year-end, the December 31, 2005 balance
sheets were used to determine the carrying value of the assets of those
entities. The Company determined that the fair value of each ASC was greater
than the carrying value in each case and concluded that there was no impairment
of goodwill at December 31, 2005. As a result of the sale of all of the entities
related to the Company's ambulatory surgery center business, the Company
allocated the goodwill recorded as part of the IPS Merger to each of the surgery
center reporting units and recorded a loss on the write-down of goodwill of
$3,489,055 for the quarter ended December 31, 2005. The charge for the
write-down of goodwill was included in discontinued operations in 2005.
Note 7. Earnings per Share
Basic earnings per share are calculated on the basis of the weighted
average number of shares of Class A Common Stock outstanding at the end of the
reporting periods. Diluted earnings per share, in addition to the weighted
average determined for basic earnings per share, include common stock
equivalents which would arise from the exercise of stock options and warrants
using the treasury stock method, conversion of debt and conversion of Class B
Common Stock and Class C Common Stock.
F-13
For the Three Months Ended March 31,
2006 2005
---------------- ----------------
Net income (loss) $819,295 $(1,680,629)
Weighted average number of shares of Class
A Common Stock outstanding for basic net
loss per share 12,428,042 8,666,531
Dilutive stock options, warrants and (a)
restricted stock units (1) 2,510,347
Convertible notes payable (2) 1,553,200 (b)
Class B Common Stock (3) 53,710,445 (c)
Class C Common Stock (4) 13,925,383 (d)
Weighted average number of shares of Class
A Common Stock outstanding for diluted net
income (loss) per share 84,127,418 8,666,531
Net income (loss) per share -- Basic $0.07 $(0.19)
Net income (loss) per share -- Diluted $0.01 $(0.19)
(1) 2,510,347 options, warrants and restricted stock units were outstanding as
of March 31, 2006.
(2) $1,300,000 of notes were convertible into Class A Common Stock at March 31,
2006. Of the total, $50,000 was convertible into 242,494 shares of Class A
Common Stock based on a conversion price equal to 75% of the average
closing price for the 20 trading days immediately prior to March 31, 2006.
The remaining $1,250,000 was convertible into 1,310,706 shares of Class A
Common Stock at March 31, 2006.
(3) 10,448,470 shares of Class B Common Stock were outstanding at March 31,
2006. Holders of shares of Class B Common Stock have the option to convert
their shares of Class B Common Stock into Class A Common Stock at any time
based on a conversion factor in effect at the time of the transaction. The
conversion factor is designed to yield one share of Class A Common Stock
per share of Class B Common Stock converted, plus such additional shares of
Class A Common Stock, or portions thereof, necessary to approximate the
unpaid portion of the return of the original purchase price for the Class B
Common Stock and a nine percent (9%) return on the original purchase price
for the Class B Common Stock without compounding, from the date of issuance
through the date of conversion. As of March 31, 2006, each share of Class B
Common Stock was convertible into 5.140508175 shares of Class A Common
Stock.
(4) 1,437,572 shares of Class C Common Stock were outstanding at March 31,
2006. Holders of shares of Class C Common Stock have the option to convert
their shares of Class C Common Stock into shares of Class A Common Stock at
any time based on a conversion factor in effect at the time of the
transaction. The conversion factor is designed initially to yield one share
of Class A Common Stock per share of Class C Common Stock converted, with
the number of shares of Class A Common Stock reducing to the extent that
distributions are paid on the Class C Common Stock. The conversion factor
is calculated as (x) the amount by which $3.30 exceeds the aggregate
distributions made with respect to a share of Class C Common Stock divided
by (y) $3.30. The initial conversion factor was one (one share of Class C
Common Stock converts into one share of Class A Common Stock) and is
subject to adjustment as discussed below. If the fair market value used in
determining the conversion factor for the Class B Common Stock in
connection with any conversion of Class B Common Stock is less than $3.30
(subject to adjustment to account for stock splits, stock dividends,
combinations or other similar events affecting Class A Common Stock),
holders of shares of Class C Common Stock have the option to convert their
shares of Class C Common Stock (within 10 days of receipt of notice of the
conversion of the Class B Common Stock) into a number of shares of Class A
Common Stock equal to (x) the amount by which $3.30 exceeds the aggregate
distributions made with respect to a share of Class C Common Stock divided
by (y) the fair market value used in determining the conversion factor for
the Class B Common Stock (the "Anti-Dilution Option"). The aggregate number
of shares of Class C Common Stock so converted by any holder shall not
exceed a number equal to (a) the number of shares of Class C Common Stock
held by such holder immediately prior to such conversion plus the number of
shares of Class C Common Stock previously converted in Class A Common Stock
by such holder multiplied by (b) a fraction, the numerator of which is the
number of shares of Class B Common Stock converted at the lower price and
the denominator of which is the aggregate number of shares of Class B
Common Stock issued at the closing of the 2004 Mergers. If all of the Class
B Common Stock had been converted at March 31, 2006, the holders of Class C
Common Stock would have been eligible to convert 1,308,142 shares of Class
C Common Stock into 13,925,383 shares of Class A Common Stock under the
anti-dilution provision.
The following potentially dilutive securities are not included in the March
31, 2005 calculation of weighted average number of shares of Class A Common
Stock outstanding for diluted net loss per share, because the effect would be
anti-dilutive due to the net loss for the quarter:
a) 889,841 options, warrants and restricted stock units were outstanding at
March 31, 2005.
b) $1,345,000 of notes were convertible into Class A Common Stock at March 31,
2005. Of the total, $320,000 were convertible at either a conversion price
equal to the lower of $2.50 or 75% of the average closing price for the 20
trading days immediately prior to the conversion date. The remaining
$1,025,000 note was convertible into 986,593 shares of Class A Common Stock
at March 31, 2005.
F-14
c) 11,482,261 shares of Class B Common Stock were outstanding at March 31,
2005. Holders of shares of Class B Common Stock have the option to convert
their shares of Class B Common Stock into Class A Common Stock at any time
based on a conversion factor in effect at the time of the transaction. The
conversion factor is designed to yield one share of Class A Common Stock
per share of Class B Common Stock converted, plus such additional shares of
Class A Common Stock, or portions thereof, necessary to approximate the
unpaid portion of the return of the original purchase price for the Class B
Common Stock and a nine percent (9%) return on the original purchase price
for the Class B Common Stock without compounding, from the date of issuance
through the date of conversion.
d) 1,575,760 shares of Class C Common Stock were outstanding at March 31,
2005. The shares of Class C Common Stock are convertible into shares of
Class C Common Stock based on the formula described in (4), above.
Note 8. Employee Stock-Based Compensation
At March 31, 2006, the Company had two stock-based employee compensation
plans. Prior to January 1, 2006, the Company accounted for grants for these
plans under Accounting Principals Board Opinion ("APB") No. 25, "Accounting for
Stock Issued to Employees" ("APB 25") and related interpretations, and applied
SFAS No. 123, "Accounting for Stock-Based Compensation," as amended by SFAS No.
148, "Accounting for Stock-Based Compensation - Transition and Disclosure," for
disclosure purposes only. Under APB 25, stock-based compensation cost related to
stock options was not recognized in net income since the options underlying
those plans had exercise prices greater than or equal to the market value of the
underlying stock on the date of the grant. The Company grants options at or
above the market price of its common stock at the date of each grant.
On June 17, 2005, the Company granted 1,357,000 stock options to certain
employees, officers, directors and former directors of the Company under the
Company's 2004 Incentive Plan, as amended. In the third quarter of 2005, stock
options totaling 360,000 to certain employees were cancelled as a result of
staff reductions related to the consolidation of corporate functions duplicated
at the Company's Houston, Texas and Roswell, Georgia facilities. No options have
been granted in 2006.
On August 31, 2005, the Company granted 650,000 restricted stock units to
certain officers of the Company under the Company's 2004 Incentive Plan, as
amended. No restricted stock units have been granted in 2006.
Effective January 1, 2006, the company adopted SFAS No. 123 (revised 2004),
"Share Based Payment," ("SFAS No. 123(R)") which revises SFAS No. 123 and
supersedes APB 25. SFAS No. 123(R) requires that all share-based payments to
employees be recognized in the financial statements based on their fair values
at the date of grant. The calculated fair value is recognized as expense (net of
any capitalization) over the requisite service period, net of estimated
forfeitures, using the straight-line method under SFAS No. 123(R). The Company
considers many factors when estimated expected forfeitures, including types of
awards, employee class and historical experience. The statement was adopted
using the modified prospective method of application which requires compensation
expense to be recognized in the financial statements for all unvested stock
options beginning in the quarter of adoption. No adjustments to prior periods
have been made as a result of adopting SFAS No. 123(R). Under this transition
method, compensation expense for share-based awards granted prior to January 1,
2006, but not yet vested as of January 1, 2006, will be recognized in the
Company's financial statements over their remaining service period. The cost was
based on the grant date fair value estimated in accordance with the original
provisions of SFAS No. 123. As required by SFAS No. 123(R), compensation expense
recognized in future periods for share-based compensation granted prior to
adoption of the standard will be adjusted for the effects of estimated
forfeitures.
For the three months ended March 31, 2006, the impact of adopting SFAS No.
123(R) on the Company's consolidated condensed statements of operations was an
increase in salaries and benefits expense of $48,071, with a corresponding
decrease in the Company's income from continuing operations, income before
provision for income taxes and net income resulting from the first-time
recognition of compensation expense associated with employee stock options.
There was no material impact on the Company's basic and diluted net income per
share as a result of the adoption of SFAS No. 123(R).
The adoption of SFAS No. 123(R) has no effect on net cash flow. Since the
Company is not presently a taxpayer and has provided a valuation allowance
against deferred income tax assets net of liabilities, there is also no effect
on the Company's consolidated statement of cash flows. Had the Company been a
taxpayer, the Company would have recognized cash flow resulting from tax
deductions in excess of recognized compensation cost as a financing cash flow.
The following table illustrates the pro forma net income and earnings per
share that would have resulted in the three months ended March 31, 2005 from
recognizing compensation expense associated with accounting for employee
stock-based awards under the provisions of SFAS No. 123(R). The reported and pro
F-15
forma net income and earnings per share for the three months ended March 31,
2006 are provided for comparative purposes only, since stock-based compensation
expense is recognized in the financial statements under the provisions of SFAS
No.123(R).
Three Months Ended March 31,
2006 2005
------------- -------------
Net income (loss) -- as reported $771,224 $(1,680,630)
Add: Stock-based employee compensation included in
net income (loss) 48,071 -
----------------------------
Deduct: Total stock-based employee compensation
(expense determined under the fair value-based
method for all awards), net of tax effect (48,071) (26,363)
----------------------------
Net loss -- pro forma $771,224 $(1,706,993)
============================
Net loss per share:
Basic -- as reported $0.07 $(0.19)
Basic -- pro forma $0.07 $(0.20)
Diluted -- as reported $0.01 $(0.19)
Diluted -- pro forma $0.01 $(0.20)
Note 9. Discontinued Operations
Bellaire SurgiCare. As of the Closing, the Company's management expected
the case volumes at Bellaire SurgiCare to improve in 2005. However, by the end
of February 2005, it was determined that the expected case volume increases were
not going to be realized. On March 1, 2005, the Company closed Bellaire
SurgiCare and consolidated its operations with the operations of Memorial
Village. The Company tested the identifiable intangible assets and goodwill
related to the surgery center business using the present value of cash flows
method. As a result of the decision to close Bellaire SurgiCare and the
resulting impairment of the joint venture interest and management contracts
related to the surgery centers, the Company recorded a charge for impairment of
intangible assets of $4,090,555 for the year ended December 31, 2004. The
Company also recorded a loss on disposal of this discontinued component (in
addition to the charge for impairment of intangible assets) of $163,049 for the
quarter ended March 31, 2005. The operations of this component are reflected in
the Company's consolidated condensed statements of operations as `loss from
operations of discontinued components' for the three months ended March 31,
2005. There were no operations for this component after March 31, 2005.
The following table contains selected financial statement data related to
Bellaire SurgiCare as of and for the three months ended March 31, 2005:
March 31, 2005
------------------
Income statement data:
Net operating revenues $ 161,679
Operating expenses 350,097
------------------
Net loss $ (188,418)
------------------
Balance sheet data:
Current assets $ -
Other assets -
------------------
Total assets $ -
------------------
Current liabilities $ -
Other liabilities -
------------------
Total liabilities $ -
------------------
CARDC. On April 1, 2005, IPS entered into the CARDC Settlement with Dr.
Bradley E. Chipps, M.D. and CARDC to settle disputes as to the existence and
enforceability of certain contractual obligations. As part of the CARDC
Settlement, Dr. Chipps, CARDC, and IPS agreed that CARDC would purchase the
assets owned by IPS and used in connection with CARDC, in exchange for
F-16
termination of the MSA between IPS and CARDC. Additionally, among other
provisions, after April 1, 2005, Dr. Chipps, CARDC and IPS have been released
from any further obligation to each other arising from any previous agreement.
As a result of the CARDC dispute, the Company recorded a charge for impairment
of intangible assets related to CARDC of $704,927 for the year ended December
31, 2004. The Company also recorded a gain on disposal of this discontinued
component (in addition to the charge for impairment of intangible assets) of
$506,625 for the quarter ended March 31, 2005. For the quarter ended June 30,
2005, the Company reduced the gain on disposal of this discontinued component by
$238,333 as the result of post-settlement adjustments related to the
reconciliation of balance sheet accounts. The operations of this component are
reflected in the Company's consolidated condensed statements of operations as
`loss from operations of discontinued components' for the three months ended
March 31, 2005. There were no operations for this component in the Company's
financial statements after March 31, 2005.
The following table contains selected financial statement data related to
CARDC as of and for the three months ended March 31, 2005:
March 31, 2005
------------------
Income statement data:
Net operating revenues $ 848,373
Operating expenses 809,673
------------------
Net income $ 38,700
------------------
Balance sheet data:
Current assets $ -
Other assets -
------------------
Total assets $ -
------------------
Current liabilities $ -
Other liabilities -
------------------
Total liabilities $ -
------------------
IntegriMED. On June 7, 2005, as described in Note 1. General -- Description
of Business -- Integrated Physician Solutions, IPS executed an Asset Purchase
Agreement with eClinicalWeb to sell substantially all of the assets of
IntegriMED. As a result of this transaction, the Company recorded a loss on
disposal of this discontinued component of $47,101 for the quarter ended June
30, 2005. The operations of this component are reflected in the Company's
consolidated condensed statements of operations as `loss from operations of
discontinued components' for the three months ended March 31, 2005. There were
no operations for this component in the Company's financial statements after
June 30, 2005.
The following table contains selected financial statement data related to
IntegriMED as of and for the three months ended March 31, 2005:
March 31, 2005
------------------
Income statement data:
Net operating revenues $ 109,616
Operating expenses 506,736
------------------
Net loss $ (397,120)
------------------
Balance sheet data:
Current assets $ 327,889
Other assets 159,744
------------------
Total assets $ 487,633
------------------
Current liabilities $ 416,029
Other liabilities -
------------------
Total liabilities $ 416,029
------------------
TASC and TOM. On June 13, 2005, the Company announced that it had accepted
an offer to purchase its interests in TASC and TOM in Dover, Ohio. These
transactions, which were consummated on September 30, 2005, were deemed to be
F-17
effective as of October 1, 2005, and are described in greater detail in Note 1.
General -- Description of Business -- Ambulatory Surgery Center Business. As a
result of these transactions, as well as the uncertainty of future cash flows
related to the Company's surgery center business, the Company recorded a charge
for impairment of intangible assets of $6,362,849 for the three months ended
June 30, 2005. As a result of these transactions, the Company recorded a gain on
disposal of this discontinued component (in addition to the charge for
impairment of intangible assets) of $1,357,712 for the quarter ended December
31, 2005. The Company allocated the goodwill recorded as part of the IPS Merger
to each of the surgery center reporting units and recorded a loss on the
write-down of goodwill related to TASC and TOM totaling $789,173 for the quarter
ended December 31, 2005, which reduced the gain on disposal. The operations of
this component are reflected in the Company's consolidated condensed statements
of operations as `loss from operations of discontinued components' for the three
months ended March 31, 2005. There were no operations for this component in the
Company's financial statements after September 30, 2005.
The following table contains selected financial statement data related to
TASC and TOM as of and for the three months ended March 31, 2005:
March 31, 2005
------------------
Income statement data:
Net operating revenues $ 796,842
Operating expenses 831,387
------------------
Net loss $ (34,545)
------------------
Balance sheet data:
Current assets $ 813,520
Other assets 1,482,378
------------------
Total assets $ 2,295,898
------------------
Current liabilities $ 662,796
Other liabilities 777,845
------------------
Total liabilities $ 1,440,641
------------------
Sutter. On October 31, 2005, IPS executed the Sutter Settlement with Dr.
Sutter to settle disputes that had arisen between IPS and Dr. Sutter and to
avoid the risk and expense of litigation. As part of the Sutter Settlement, Dr.
Sutter and IPS agreed that Dr. Sutter would purchase the assets owned by IPS and
used in connection with Dr. Sutter's practice, in exchange for termination of
the MSA between IPS and Dr. Sutter. Additionally, among other provisions, after
October 31, 2005, Dr. Sutter and IPS have been released from any further
obligation to each other arising from any previous agreement. As a result of
this transaction, the Company recorded a loss on disposal of this discontinued
component (in addition to the charge for impairment of intangible assets) of
$279 for the quarter ended December 31, 2005. The operations of this component
are reflected in the Company's consolidated condensed statements of operations
as `loss from operations of discontinued components' for the three months ended
March 31, 2005. There were no operations for this component in the Company's
financial statements after October 31, 2005.
The following table contains selected financial statement data related to
Sutter as of and for the three months ended March 31, 2005:
March 31, 2005
------------------
Income statement data:
Net operating revenues $ 108,900
Operating expenses 105,438
------------------
Net income $ 3,462
------------------
Balance sheet data:
Current assets $ 112,581
Other assets 15,511
------------------
Total assets $ 128,092
------------------
Current liabilities $ 11,837
Other liabilities -
------------------
Total liabilities $ 11,837
------------------
F-18
Memorial Village. In November 2005, the Company decided that, as a result
of ongoing losses at Memorial Village, it would need to either find a buyer for
the Company's equity interests in Memorial Village or close the facility. In
preparation for this pending transaction, the Company tested the identifiable
intangible assets and goodwill related to the surgery center business using the
present value of cash flows method. As a result of the decision to sell or close
Memorial Village, as well as the uncertainty of cash flows related to the
Company's surgery center business, the Company recorded a charge for impairment
of intangible assets of $3,461,351 for the three months ended September 30,
2005. As described in Note 1. General - Description of Business - Ambulatory
Surgery Center Business, effective January 31, 2006, the Company executed an
Asset Purchase Agreement to sell substantially all of the assets of Memorial
Village. As a result of this transaction, the Company recorded a gain on the
disposal of this discontinued component (in addition to the charge for
impairment of intangible assets) of $574,321 for the quarter ended March 31,
2006. The Company allocated the goodwill recorded as part of the IPS Merger to
each of the surgery center reporting units and recorded a loss on the write-down
of goodwill related to Memorial Village totaling $2,005,383 for the quarter
ended December 31, 2005. The operations of this component are reflected in the
Company's consolidated statements of operations as `loss from operations of
discontinued components' for the three months ended March 31, 2006 and 2005,
respectively.
The following table contains selected financial statement data related to
Memorial Village as of and for the three months ended March 31, 2006 and 2005,
respectively:
March 31, 2006 March 31, 2005
--------------- ---------------
Income statement data:
Net operating revenues $ 17,249 $ 584,176
Operating expenses 170,285 690,340
--------------------------------
Net loss $ (153,036) $ (106,164)
--------------------------------
Balance sheet data:
Current assets $ - $ 861,111
Other assets - 767,497
--------------------------------
Total assets $ - $ 1,628,608
--------------------------------
Current liabilities $ - $ 729,567
Other liabilities - 725,884
--------------------------------
Total liabilities $ - $ 1,455,451
--------------------------------
San Jacinto. As described in Note 1. General -- Description of Business --
Ambulatory Surgery Center Business, effective March 1, 2006, the Company
executed an Asset Purchase Agreements to sell substantially all of the assets of
San Jacinto, which is 10% owned by Baytown SurgiCare, Inc., a wholly owned
subsidiary of the Company and is not consolidated in the Company's financial
statements. As a result of this transaction, the Company recorded a gain on
disposal of this discontinued operation of $94,066 for the quarter ended March
31, 2006. The Company allocated the goodwill recorded as part of the IPS Merger
to each of the surgery center reporting units and recorded a loss on the
write-down of goodwill related to San Jacinto totaling $694,499 for the quarter
ended December 31, 2005.
Orion. Prior to the divestiture of the Company's ambulatory surgery center
business, the Company recorded management fee revenue, which was eliminated in
the consolidation of the Company's financial statements, for Bellaire SurgiCare,
TASC and TOM and Memorial Village. The management fee revenue for San Jacinto
was not eliminated in consolidation. The management fee revenue associated with
the discontinued operations in the surgery center business totaled $60,071 for
the quarter ended March 31, 2006. For the quarter ended March 31, 2005, the
Company generated management fee revenue of $106,252 and a minority interest
loss in Memorial Village of $39,447.
F-19
The following table summarizes the components of income (loss) from
operations of discontinued components:
March 31, 2006 March 31, 2005
--------------- ---------------
Bellaire SurgiCare
Net loss $ - $ (188,418)
Loss on disposal - (163,049)
CARDC
Net income - 38,700
Gain on disposal - 506,625
IntegriMED
Net loss - (397,120)
TASC and TOM
Net loss - (34,545)
Sutter
Net income - 3,462
Memorial Village
Net loss (153,036) (115,041)
Gain on disposal 574,321 -
San Jacinto
Gain on disposal 94,066 -
Orion
Net income 60,071 66,805
--------------------------------
Total income (loss) from
operations of discontinued
components, including net
gain (loss) on disposal $ 575,422 $ (282,581)
================================
Note 10. Long-Term Debt
Long-term debt is as follows:
As of
March 31, December 31,
2006 2005
------------- -------------
Promissory note due to sellers of MBS, bearing
interest at 8%, interest payable monthly or
on demand, matures December 15, 2007 $ 1,000,000 $ 1,000,000
Working capital due to sellers of MBS, due on
demand - 199,697
Term loan with a financial institution,
non-interest bearing, matures November 15,
2010, net of accretion of $641,467 and
$614,291, respectively 3,101,220 3,108,677
Revolving line of credit with a financial
institution, bearing interest at 6.5%,
interest payable monthly or on demand - 778,006
$2,300,000 revolving line of credit, bearing
interest at prime (7.75% at March 31, 2006)
plus 6%, interest payable monthly, matures
December 14, 2006 (1) 1,162,659 1,703,277
Convertible notes, bearing interest at 18%,
interest payable monthly, convertible on
demand 50,000 50,000
Note payable due to a related party, bearing
interest at 6%, interest payable monthly, due
on demand - 13,611
Insurance financing note payable, bearing
interest at 5.25%, interest payable monthly 148,701 -
F-20
Convertible promissory notes due to a related
party, bearing interest at 9%, mature April
19, 2006 1,250,000 1,250,000
------------- -------------
Total long-term debt 6,712,580 8,103,268
Less: current portion of long-term debt (3,626,449) (4,231,675)
------------- -------------
Long-term debt, net of current portion $3,086,131 $3,871,593
============= =============
(1) As part of the Loan and Security Agreement, the Company is required to
comply with certain financial covenants, measured on a quarterly
basis. The financial covenants include maintaining a required debt
service coverage ratio and meeting a minimum operating income level
for the surgery and diagnostic centers before corporate overhead
allocations. At March 31, 2006, the Company was out of compliance with
both of these financial covenants and has notified the lender as such.
Under the terms of the Loan and Security Agreement, failure to meet
the required financial covenants constitutes an event of default.
Under an event of default, the lender may (i) accelerate and declare
the obligations under the credit facility to be immediately due and
payable; (ii) withhold or cease to make advances under the credit
facility; (iii) terminate the credit facility; (iv) take possession of
the collateral pledged as part of the Loan and Security Agreement; (v)
reduce or modify the revolving loan commitment; and/or (vi) take
necessary action under the Guaranties. The full amount of the loan as
of March 31, 2006 is recorded as a current liability. In December
2005, the Company received notification from CIT stating that (i)
certain events of default under the Loan and Security Agreement had
occurred as a result of the Company being out of compliance with two
financial covenants relating to its debt service coverage ratio and
its minimum operating income level, (ii) as a result of the events of
default, CIT raised the interest rate for monies borrowed under the
Loan and Security Agreement to the provided "Default Rate" of prime
rate plus 6%, (iii) the amount available under the revolving credit
facility was reduced to $2,300,000 and (iv) CIT reserved all
additional rights and remedies available to it as a result of these
events of default. The Company is currently in negotiations with CIT
to obtain, among other provisions, a waiver of the events of default.
In the event CIT declares the obligations under the Loan and Security
Agreement to be immediately due and payable or exercises its other
rights described above, the Company would not be able to meet its
obligations to CIT or its other creditors. As a result, such action
would have a material adverse effect on the Company's ability to
continue as a going concern.
(2) As of March 13, 2006, the Company had retired approximately $778,000
of debt at a discounted price of $112,500.
Note 11. Litigation
On January 1, 1999, IPS acquired Children's Advanced Medical Institutes,
Inc. ("CAMI") in a merger transaction. On that same date, IPS began providing
management services to the Children's Advanced Medical Institutes, P.A. (the
"P.A."), an entity owned by the physicians affiliated with CAMI. The parties'
rights and obligations were memorialized in a merger agreement, a management
services agreement and certain other agreements. On February 7, 2000, the P.A.,
certain physicians affiliated with the P.A., and the former shareholders of CAMI
filed suit against IPS in the U.S. District Court for the Northern District of
Texas, Dallas Division, Civil Action File No. 3-00-CV-0536-L. On May 9, 2001,
IPS (which was formerly known as Pediatric Physician Alliance, Inc.) filed suit
against the P.A., certain physicians who were members of the P.A., and Patrick
Solomon as Escrow Agent of CAMI. The case was filed in the U.S. District Court
for the Northern District of Texas, Dallas Division, Civil Action File No.
3-01CV0877-L. In their complaint, the P.A., the former shareholders of CAMI and
the physicians seek a claim against IPS for approximately $500,000 (which
includes interest and attorneys' fees). IPS asserted a claim against the
physicians for over $5,000,000 due to the overpayments and their alleged breach
of the agreements. An arbitration hearing was held on the claim filed by the
former shareholders of CAMI in January 2004, and the Arbitrator issued an award
against IPS. The U.S. District Court confirmed the award in the amount of
$548,884 and judgment was entered. IPS has accrued approximately $540,000 for
possible losses related to this claim. On June 1, 2005, IPS and the physicians
executed a settlement agreement under which $300,000 of the judgment was paid to
the physicians with the remaining amount of the judgment being returned to IPS.
All claims asserted in the lawsuit and arbitration were dismissed with
prejudice.
On October 5, 2004, Orion's predecessor, SurgiCare, was named as a
defendant in a suit entitled Shirley Browne and Bellaire Anesthesia Management
Consultants, Inc. ("BAMC") v. SurgiCare, Inc., Bellaire SurgiCare, Inc., Sherman
Nagler, Jeffrey Penso, and Michael Mineo, in the 152nd Judicial District Court
of Harris County, Texas, Cause No. 2004-55688. The dispute arises out of the for
cause termination of BAMC's exclusive contract to provide anesthesia services to
Bellaire SurgiCare, Inc. Ms. Browne had filed a charge of discrimination with
the EEOC on February 6, 2004, claiming that she was terminated in retaliation
for having previously complained about discriminatory treatment and a hostile
work environment. She claimed she had been discriminated against based on her
sex, female, and retaliated against in violation of Title VII. The Company
F-21
denied Ms. Browne's allegations of wrongdoing. The EEOC declined to institute an
action and issued a right to sue letter, which prompted the lawsuit. The parties
have reached a final settlement, which was accrued for as of September 30, 2005
and paid on December 27, 2005, on all matters for dismissal of all claims.
On July 12, 2005, Orion was named as a defendant in a suit entitled
American International Industries, Inc. vs. Orion HealthCorp, Inc., previously
known as SurgiCare, Inc., Keith G. LeBlanc, Paul Cascio, Brantley Capital
Corporation, Brantley Venture Partners III, L.P., and Brantley Partners IV, L.P.
in the 80th Judicial District Court of Harris County, Texas, Cause No.
2005-44326. This case involves allegations that the Company made material and
intentional misrepresentations regarding the financial condition of the parties
to the acquisition and restructuring transactions effected on December 15, 2004
for the purpose of inducing American International Industries, Inc. ("AII") to
convert its SurgiCare Class AA convertible preferred stock ("Class AA Preferred
Stock") into shares of Orion Class A Common Stock. AII asserts that the value of
its Class A Common Stock of Orion has fallen as a direct result of the alleged
material misrepresentations by the Company. AII is seeking actual damages of
$3,800,000, punitive damages of $3,800,000, and rescission of the agreement to
convert the Class AA Preferred Stock into Class A Common Stock. The Company and
the other defendants filed an Answer denying the allegations set forth in the
Complaint.
In addition, the Company is involved in various other legal proceedings and
claims arising in the ordinary course of business. The Company's management
believes that the disposition of these additional matters, individually or in
the aggregate, is not expected to have a materially adverse effect on the
Company's financial condition. However, depending on the amount and timing of
such disposition, an unfavorable resolution of some or all of these matters
could materially affect the Company's future results of operations or cash flows
in a particular period.
Note 12. Subsequent Events
On May 9, 2006, Brantley IV and the Company executed the First and Second
Note Amendment, which extends the First Note Maturity Date and Second Note
Maturity Date to August 15, 2006. (See Note 2. Going Concern).
In connection with the DCPS/MBS Merger in December 2004, holders of MBS
common stock, DCPS limited partnership interests and Dennis Cain Management, LLC
("DCM") limited liability company interests received an aggregate of cash,
promissory notes of the Company and shares of the Company's Class C Common
Stock. The purchase price was subject to retroactive increase (including
issuance of up to 450,000 additional shares of Class A Common Stock) or decrease
based on the financial results of the newly formed company and its predecessors
in 2004 and 2005. Pursuant to the merger agreement governing the DCPS/MBS Merger
(the "DCPS/MBS Merger Agreement"), the adjustment was based on whether DCPS and
MBS, on a combined basis, met an earnings before income taxes, depreciation and
amortization ("EBITDA") target of $2 million for the fiscal years ended December
31, 2004 and 2005. The Company accrued a liability in the amount of $840,286 as
of December 31, 2005 based on this provision of the DCPS/MBS Merger Agreement
and adjusted the purchase price accordingly. On April 19, 2006, the Company
executed subordinated promissory notes for an aggregate of $840,286. The notes
will bear interest at the rate of 8% per annum, payable monthly beginning on
April 30, 2006, and will mature on December 15, 2007. Additionally, as a result
of this purchase price adjustment, the Company issued 285,726 shares of Class A
Common Stock to the former equity holders of MBS, DCPS and DCM on May 9, 2006.
F-22
Exhibit Index
-------------
Exhibit No. Description
------------- -----------
Exhibit 10.1 First Amendment to Convertible Subordinated Promissory Notes,
dated as of May 9, 2006, by and between Orion HealthCorp, Inc.
and Brantley Partners IV, L.P.
Exhibit 10.2 Form of Subordinated Promissory Note, dated as of April 19,
2006, by and between DCPS Sellers and MBS Sellers
Exhibit 31.1 Rule 13a-14(a)/15d-14(a) Certification
Exhibit 31.2 Rule 13a-14(a)/15d-14(a) Certification
Exhibit 32.1 Section 1350 Certification
Exhibit 32.2 Section 1350 Certification
-19-