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 SEPTEMBER 30, 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
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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 November 10, 2006, 12,913,776 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 SEPTEMBER 30, 2006
TABLE OF CONTENTS
ITEM NUMBER PAGE NUMBER
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PART I - FINANCIAL INFORMATION
1. Financial Statements 1
2. Management's Discussion and Analysis or Plan of Operation 1
3. Controls and Procedures 28
PART II - OTHER INFORMATION
1. Legal Proceedings 28
2. Unregistered Sales of Equity Securities and Use of Proceeds
3. Defaults Upon Senior Securities 28
6. Exhibits 29
SIGNATURES 30
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, increases in labor and employee benefit costs, the failure to obtain
continued 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, including the impact and expense of any potential acquisitions and
the ability to obtain necessary approvals and financing. 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 59 clients, representing 339 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.
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STRATEGIC FOCUS
In 2005, the Company initiated a strategic plan designed to accelerate
its 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. In 2005 and
early 2006, the Company divested certain non-strategic assets and ceased
investment in business lines that did not complement the Company's strategic
plans, redirecting financial resources and company personnel to areas that
management believes enhances long-term growth potential. With the completion of
these divestitures, the Company no longer has any ownership or management
interests in ambulatory surgery and diagnostic centers.
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, and has identified
several acquisition opportunities to expand its business that are consistent
with its strategic plan. The Company signed definitive agreements in September
2006 for the acquisition of two of these targets and plans to consummate the
transactions in the fourth quarter of 2006. The Company also entered into
definitive agreements for additional equity and mezzanine debt financing in
September 2006, which it expects to consummate simultaneously with the two
acquisitions. On November 9, 2006, the Company filed a definitive proxy
statement with the Securities and Exchange Commission (the "SEC") on Form DEF14A
with respect to the transactions contemplated by the definitive agreements,
which are described in greater detail below, and set a special stockholders
meeting date of November 27, 2006 for approval of certain changes in corporate
structure which will enable the Company to consummate the transactions.
The first acquisition involves the purchase of all of the issued and
outstanding capital stock of Rand Medical Billing, Inc ("Rand"). Rand is a full
service billing agency, providing medical billing exclusively for anatomic and
clinical pathology practices located in Simi Valley, California.
On September 8, 2006 the Company entered into a Stock Purchase
Agreement (the "Rand Stock Purchase Agreement") with Rand Medical Billing, Inc.
and the stockholder of Rand to purchase all of the issued and outstanding
capital stock of Rand for an aggregate purchase price of $9,365,333, subject to
adjustments conditioned upon future revenue results. A portion of the purchase
price is payable by the issuance of such number of shares of the Company's Class
A Common Stock having a value of $600,000 based on the average closing price per
share of the Company's Class A Common Stock for the twenty day period prior to
the closing of the Rand acquisition. The remainder of the purchase price is
payable in a combination of cash and the issuance of an unsecured subordinated
promissory note in the original principal amount of $1,365,333. At the closing
of the Rand acquisition, $6,800,000 of the purchase price will be paid in cash
and the balance will be placed in escrow (including the shares of the Company's
Class A Common Stock) pending resolution of the purchase price adjustments and
subject to claims, if any, for indemnification. The Rand Stock Purchase
Agreement is incorporated by reference to Exhibit 10.1 of the Company's Current
Report on Form 8-K filed on September 11, 2006.
The second acquisition involves the purchase of all the issued and
outstanding capital stock of two related companies, On Line Alternatives, Inc.
("OLA") and On Line Payroll Services, Inc. ("OLP") (collectively, "Online").
OLA is an outsourcing company providing data entry, insurance filing,
patient statements, payment posting, collection follow-up and patient refund
processing to medical practices. Most of OLA's customers are hospital-based
physician practices including radiology, neurology and emergency medicine.
Customers also include some other specialties as plastic surgery, family
practice, internal medicine and orthopedics. All billing functions are the
responsibility of OLA, and include credentialing and accounts payable
processing. OLA also has a group of contract transcriptionists who work out of
their homes and OLA offers these services to clients as well.
OLP provides payroll processing services to small businesses, a few of
which are also customers of OLA. OLP provides payroll services including direct
deposit, time clock interface and tax reporting to clients in Alabama, Florida,
Georgia, Louisiana, Mississippi, Tennessee and Texas.
On September 8, 2006 the Company entered into a Stock Purchase
Agreement (the "Online Stock Purchase Agreement") with OLA, OLP and the
stockholders of each of OLA and OLP to purchase all of the issued and
outstanding capital stock of both OLA and OLP for an aggregate purchase price of
$3,310,924, subject to adjustments conditioned upon future revenue results. The
purchase price is payable in a combination of cash and the issuance of unsecured
subordinated promissory notes. At the closing of the On Line acquisition,
$2,476,943 of the purchase price will be paid in cash and the remainder through
the issuance of an unsecured subordinated promissory note in the original
principal amount of $833,981. The Company also has an option to pay up to
$75,000 of the purchase price in the form of an additional unsecured promissory
note in lieu of cash at the closing. The Online Stock Purchase Agreement is
incorporated by reference to Exhibit 10.2 of the Company's Current Report on
Form 8-K filed on September 11, 2006.
Both the Rand Stock Purchase Agreement and the Online Stock Purchase
Agreement contain customary representations and warranties and terms and
conditions to closing.
In addition to the Rand Stock Purchase Agreement and the Online Stock
Purchase Agreement, the Company also entered into a Stock Purchase Agreement on
September 8, 2006 with Phoenix Life Insurance Company ("Phoenix") and Brantley
Partners IV, L.P. ("Brantley IV") (the "Stock Purchase Agreement"). Pursuant to
the terms of the Stock Purchase Agreement, Phoenix and Brantley IV will
purchase, for an aggregate purchase price of $4,650,000, shares of the Company's
Class D Common Stock representing upon conversion 19.375% of the Company's
outstanding Class A Common Stock as of the date of issuance of the Class D
Common Stock, on a fully-diluted basis taking into account the issuance of the
shares of Class D Common Stock but excluding certain of the Company's
outstanding options, warrants and convertible securities and certain shares of
Class B Common Stock to be purchased by the Company from Brantley Capital
Corporation. Since the Company's charter documents do not currently authorize
the issuance of the Company's Class D Common Stock, the Company will amend and
restate its Certificate of Incorporation to provide for such shares upon
shareholder approval. The Stock Purchase Agreement is incorporated by reference
to Exhibit 10.3 of the Company's Current Report on Form 8-K filed on September
11, 2006.
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As of September 30, 2006, Brantley IV owns 7,863,996 shares of the
Company's Class B Common Stock, warrants to purchase 20,455 shares of the
Company's Class A Common Stock and notes which are currently convertible into
1,358,054 shares of the Company's Class A Common Stock. As of September 30,
2006, this represents 35.4% of the Company's voting power and 51.7% of the
Company's voting power on an as converted basis. As of September 30, 2006,
Brantley IV and its affiliates own 44.8% of the Company's voting power and 59.5%
of the Company's voting power on an as converted basis.
Phoenix is a limited partner in Brantley IV and Brantley Partners V,
L.P and has also co-invested with Brantley IV and its affiliates in a number of
transactions. Phoenix does not currently own, of record, any shares of the
Company's capital stock. Two of the Company's directors, Paul H. Cascio and
Michael J. Finn, are affiliated with Brantley IV and its related entities. Paul
Cascio and Michael J. Finn serve as general partners of the general partner of
Brantley Venture Partners III, L.P. ("Brantley III") and Brantley IV and are
limited partners in these funds. Neither Phoenix, Brantley IV nor Messrs. Cascio
or Finn is affiliated with Brantley Capital Corporation. The advisor to Brantley
III is Brantley Venture Management III, L.P. and the advisor to Brantley IV is
Brantley Management IV, L.P.
Brantley IV will purchase, for an aggregate purchase price of
$1,650,000, such number of shares of Class D Common Stock representing upon
conversion 6.875% of the Company's outstanding Class A Common Stock as of the
date of issuance of the Class D Common Stock, on a fully-diluted basis taking
into account the issuance of the shares of Class D Common Stock but excluding
certain of the Company's outstanding options, warrants and convertible
securities and certain shares of Class B Common Stock to be purchased by the
Company from Brantley Capital Corporation.
Phoenix will purchase, for an aggregate purchase price of $3,000,000,
such number of shares of Class D Common Stock, representing upon conversion
12.5% of the Company's outstanding Class A Common Stock as of the date of
issuance of the Class D Common Stock, on a fully-diluted basis taking into
account the issuance of the shares of Class D Common Stock but excluding certain
of the Company's outstanding options, warrants and convertible securities and
certain shares of Class B Common Stock to be purchased by the Company from
Brantley Capital Corporation.
The Class D Common Stock, upon stockholder approval, will have the
following rights and preferences:
o The holders of the Class D Common Stock will have priority in
certain distributions made to the other holders of Common Stock.
The holders of the shares of Class D Common Stock (other than
shares concurrently being converted into Class A Common Stock), as
a single and separate class, will be entitled to receive all
distributions until there has been paid with respect to each such
share from amounts then and previously distributed an amount equal
to 9% per annum on the Class D issuance amount, without
compounding, from the date the Class D Common Stock is first
issued.
o In addition to receiving any accrued but unpaid distributions
described above, the holders of the Class D Common Stock will have
the right to receive distributions pari passu with the holders of
the shares of the Class A Common Stock, assuming for purposes of
such calculation that each share of Class D Common Stock
represented one share of Class A Common Stock (subject to
adjustment to such conversion ratio for subsequent issuances by
the Company of shares of the Company's capital stock, or rights to
acquire such shares, for less than the price the holders of the
Class D Common Stock paid for their shares and for stock splits,
combinations, stock dividends and certain other actions as more
fully specified in the Company's certificate of incorporation).
o The holders of a majority of the Class D Common Stock have the
ability to authorize any payment that might otherwise be
considered a distribution for purposes of the Company's amended
and restated certificate of incorporation to be excluded from the
distribution priority provisions described above.
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o Each share of Class D Common Stock will be entitled to one vote.
The Class D Common Stock will vote together with all other classes
of the Company's Common Stock and not as a separate class, except
as otherwise required by law or in the event of certain actions
adversely affecting the rights and preferences of the Class D
Common Stock as more fully specified in the Company's certificate
of incorporation.
o At the option of each holder of Class D Common Stock, exercisable
at any time and from time to time by notice to the Company, each
outstanding share of Class D Common Stock held by such investor
will convert into a number of shares of Class A Common Stock equal
to the "Class D Conversion Factor" in effect at the time such
notice is given. The Class D Conversion Factor will initially be
one share of Class A Common Stock for each share of Class D Common
Stock, subject to adjustment to such conversion ratio for
subsequent issuances by the Company of shares of the Company's
capital stock, or rights to acquire such shares, for less than the
price the holders of the Class D Common Stock paid for their
shares and for stock splits, combinations, stock dividends and
certain other actions as more fully specified in the Company's
certificate of incorporation.
On September 8, 2006 the Company also entered into a Note Purchase
Agreement with Phoenix (the "Note Purchase Agreement," and together with the
Stock Purchase Agreement, the "Private Placement Agreements"). Pursuant to the
terms of the Note Purchase Agreement, Phoenix will purchase, for an aggregate
purchase price of $3,350,000, (i) the Company's senior unsecured subordinated
promissory notes, due 2011, in the original principal amount of $3,350,000 and
(ii) warrants to purchase shares of the Company's Class A Common Stock equal to
1.117% of the Company's outstanding Class A Common Stock on the date of issuance
of the warrants, on a fully-diluted basis taking into account the issuance of
the shares of Class D Common Stock described above and the shares of Class A
Common Stock covered by the warrants but excluding certain of the Company's
outstanding options, warrants and convertible securities and certain shares of
Class B Common Stock to be purchased by the Company from Brantley Capital
Corporation. The Note Purchase Agreement is incorporated by reference to Exhibit
10.4 of the Company's Current Report on Form 8-K filed on September 11, 2006.
The Company's senior unsecured subordinated promissory notes will bear
interest at the combined rate of (i) 12% per annum payable in cash on a
quarterly basis and (ii) 2% per annum payable in kind (meaning that the accrued
interest will be capitalized as principal) on a quarterly basis, subject to the
Company's right to pay such amount in cash. The notes will be unsecured and
subordinated to all of the Company's other senior debt. Upon the occurrence and
during the continuance of an event of default the interest rate on the cash
portion of the interest shall increase from 12% per annum to 14% per annum, for
a combined rate of default interest of 16% per annum. The Company may prepay
outstanding principal (together with accrued interest) on the note subject to
certain prepayment penalties and the Company is required to prepay outstanding
principal (together with accrued interest) on the note upon certain specified
circumstances.
The warrants provide the holder with the right to purchase shares of
the Company's Class A Common Stock equal to 1.117% of the Company's outstanding
Class A Common Stock on the date of issuance of the warrants, on a fully-diluted
basis taking into account the issuance of the shares of Class D Common Stock
described above and the shares of Class A Common Stock covered by the warrants
but excluding certain of the Company's outstanding options and warrants and
certain shares of Class B Common Stock to be purchased by the Company from
Brantley Capital Corporation. The warrants will be exercisable for five years
from the date of issuance of the warrants at $0.01 per share.
Some or all of the proceeds the Company receives upon consummation of
the sale of the Class D Common Stock, senior unsecured subordinated promissory
notes and warrants in the private placement, along with proceeds from senior
bank financing and other funds available to the Company, will be used to finance
a portion of the acquisitions of the Rand and On Line businesses, the Company's
purchase of certain shares of the Company's Class B Common Stock from Brantley
Capital Corporation, to repay certain outstanding senior indebtedness and for
general working capital purposes.
The obligations of Phoenix and Brantley IV to close under the Private
Placement Agreements are subject to the satisfaction or waiver of many
conditions in accordance with each of the Stock Purchase Agreement and Note
Purchase Agreement, including:
o receipt of approval from the Company's stockholders of the
amendments to the Company's certificate of incorporation and
issuance of the Company's shares of Class D Common Stock and Class
A Common Stock;
o the absence of any material adverse change in the Company's
business and operations, and the business and operations of the
Rand and On Line businesses, since June 30, 2006;
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o in the case of the Stock Purchase Agreement, the filing of the
Company's Second Amended and Restated Certificate of Incorporation
with the Secretary of State of Delaware and its acceptance thereof
and the Company's reservation of a sufficient number of shares of
Class A common Stock for issuance on conversion of the Class D
Common Stock;
o the conversion to Class A Common Stock by Brantley IV of the
entire unpaid principal amount of, including accrued but unpaid
interest on, the Company's convertible subordinated promissory
notes in the aggregate original principal amount of $1,250,000;
o consummation, in the case of the Stock Purchase Agreement, of the
transactions contemplated by the Note Purchase Agreement and, in
the case of the Note Purchase Agreement, of the transactions
contemplated by the Stock Purchase Agreement;
o in the case of the Stock Purchase Agreement, consummation by each
of Phoenix and Brantley IV of their respective obligations under
the Stock Purchase Agreement;
o consummation of the acquisitions of the Rand and On Line
businesses;
o the accuracy of the Company's representations and warranties in
the Private Placement Agreements as of the closing date taking
into account in certain instances the inclusion of the Rand and On
Line businesses as part of the Company's business;
o delivery of pro forma financial statements giving effect to the
acquisitions of the Rand and On Line businesses, the consummation
of the private placement, the conversion of the Brantley IV notes
and the consummation of senior financing that are satisfactory to
Phoenix and Brantley IV;
o the performance and compliance with all of the covenants made, and
obligations to be performed, by the other parties in the Private
Placement Agreements prior to the closing;
o the receipt of all requisite third-party consents;
o consummation with one or more senior lenders for the provision of
not less than $6,500,000 of senior secured financing and, in the
case of the Note Purchase Agreement, execution of mutually
acceptable intercreditor and subordination agreement(s) among
Phoenix, the Company's senior lender and certain of the Company's
existing debt holders; and
o conversion of all shares of Class B Common Stock and Class C
Common Stock by the holders thereof into shares of Class A Common
Stock or the Company's acquisition and retirement of all such
shares, including the Company's purchase and retiring of the
1,722,983 shares of Class B Common Stock held by Brantley Capital
Corporation.
In connection with the private placement, the parties will enter into a
registration rights agreement, pursuant to which the holders of a majority of
the shares of Class A Common Stock issuable upon either conversion of the Class
D Common Stock or the exercise of the warrants will have the right to require
the Company to register their shares of Class A Common Stock under the
Securities Act. The agreement allows them one right to demand that the Company
register their shares of Class A Common Stock under the Securities Act on a
registration statement filed with the SEC and unlimited rights to include (or
"piggy-back") the registration of their shares of Class A Common Stock on
certain registration statements that the Company may file with the SEC for other
purposes.
On September 8, 2006 the Company also entered into a Purchase Agreement
(the "Purchase Agreement") with Brantley Capital Corporation to purchase all
1,722,983 shares of the Company's Class B Common Stock owned by Brantley Capital
Corporation at any time between now and December 31, 2006 for an aggregate
purchase price of $482,435. Upon the Company's acquisition of these shares of
Class B Common Stock they will be retired in accordance with the terms of the
Company's certificate of incorporation. The Company plans to consummate this
purchase simultaneous with the closing of the private placement. The Company
anticipates using a portion of the proceeds from the private placement, along
with proceeds from senior bank financing and other funds available to the
Company, to fund the purchase price for the Company's purchase of the shares of
Class B Common Stock owned by Brantley Capital Corporation. The Purchase
Agreement is incorporated by reference to Exhibit 10.5 of the Company's Current
Report on Form 8-K filed on September 11, 2006.
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These shares represent about 16.5% of the Company's outstanding shares
of Class B Common Stock (and about 11.5% of the Company's outstanding shares of
Class A Common Stock on a fully-diluted basis assuming conversion as of
September 30, 2006) and the Company's acquisition of these shares will assist
the Company in satisfying the closing condition to the private placement that
requires all holders of shares of the Company's Class B Common Stock and Class C
Common Stock to have converted or been acquired by the Company. Brantley Capital
Corporation had previously informed the Company that they would not convert
their shares as required in connection with the consummation of the private
placement and the Company's board of directors determined that the terms of this
acquisition were in the best interests of the Company's stockholders and the
Company's ability to consummate the private placement.
The transactions contemplated by the foregoing agreements are all
expected to close simultaneously, if stockholder approval is obtained as
required under the Private Placement Agreements and upon satisfaction of the
other relevant closing conditions. On November 9, 2006, the Company filed a
definitive proxy statement with the SEC on Form DEF14A with respect to the
transactions contemplated by the Rand Stock Purchase Agreement, the Online Stock
Purchase Agreement, the Private Placement Agreements and the Purchase Agreement,
which are described above, and set a special shareholder meeting date of
November 27, 2006 for approval of the aforementioned transactions.
This description of the material terms of each of the agreements
referenced above is qualified by reference to the complete text of the
agreements.
FINANCIAL OVERVIEW
As more fully described below, the Company's results of operations for
the three months and nine months ended September 30, 2006 as compared to the
same periods 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 in the first quarter of 2006;
o The Company sold substantially all of the assets of San Jacinto
and recorded a gain on disposition of discontinued components of
$94,066 in the first quarter of 2006; and
o The Company paid $112,500 in satisfaction of a $778,000 debt and
recognized a gain on forgiveness of debt totaling $665,463 in the
first quarter of 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-7 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:
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(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;
(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 and nine months ended
September 30, 2006 and 2005, respectively.
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 and
nine months ended September 30, 2006 or 2005, respectively.
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 September 30, 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".)
-7-
The general partnership interest was accounted for as an investment in
limited partnership due to the interpretation of Statement of Financial
Accounting Standards ("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 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 intangible assets in the fourth quarter of each fiscal year, unless
circumstances require testing at other times. (See "Results of Operations -
Discontinued Operations" for additional discussion regarding the impairment
testing of identifiable intangible assets.)
RECENT ACCOUNTING PRONOUNCEMENTS
In September 2006, the SEC issued Staff Accounting Bulletin No. 108,
"Considering the Effects of Prior Year Misstatements When Quantifying
Misstatements in Current Year Financial Statements," ("SAB 108") which provides
interpretive guidance on how the effects of the carryover or reversal of prior
year misstatements should be considered in quantifying a current year
misstatement. SAB 108 is effective for fiscal years ending after November 15,
2006. The Company will adopt the provisions of SAB 108 for its fiscal year ended
December 31, 2006 and does not expect the impact of SAB 108 to be material to
its consolidated financial statements.
In September 2006, the FASB issued SFAS No. 157, "Fair Value
Measurements," ("SFAS 157") which defines fair value, establishes a framework
for measuring fair value in generally accepted accounting principles and expands
disclosures about fair value measurements. SFAS 157 is effective for financial
statements issued for fiscal years beginning after November 15, 2007 and interim
periods within those fiscal years. Earlier application is encouraged provided
that the reporting entity has not yet issued financial statements for that
fiscal year, including financial statements for an interim period within that
fiscal year. The Company does not expect the impact of SFAS 157 to be material
to its consolidated financial statements.
In June 2006, the FASN issued Financial Interpretation No. 48,
"Accounting for Uncertainty in Income Taxes," ("FIN 48") which clarifies the
accounting for uncertainty in income taxes recognized in the financial
statements in accordance with SFAS No. 109, "Accounting for Income Taxes." FIN
48 provides that a tax benefit from an uncertain tax position may be recognized
when it is more likely than not that the position will be sustained upon
examination, based on the technical merits. This interpretation also provides
guidance on measurement, de-recognition, classification, interest and penalties,
accounting in interim periods, disclosure and transition. FIN 48 will become
effective for fiscal years beginning after December 15, 2006. The Company does
not expect the impact of FIN 48 to be material to its consolidated financial
statements.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and
Error Corrections" ("SFAS 154"). SFAS 154 replaces Auditing Practices Board
("APB") Opinion NO. 20, "Accounting Changes" ("APB 20") and SFAS No. 3,
"Reporting Accounting Changes in Interim Financial Statements," and changes the
requirements for the accounting and reporting of a change in accounting
principle. SFAS 154 applies to all voluntary changes in accounting principle as
well as to changes required by an accounting pronouncement that does not include
specific transition provisions. Previously, most changes in accounting
principles were required to be recognized by way of including the cumulative
effect of the changes in accounting principle in the income statement of the
period of change. SFAS 154 requires that such changes in accounting principle be
retrospectively applied as of the beginning of the first period presented as if
that accounting principle had always been used, unless it is impracticable to
determine either the period-specific effects or the cumulative effect of the
change. SFAS 154 is effective for accounting changes and corrections of errors
made in fiscal years beginning after December 15, 2005. However, SFAS 154 does
not change the transition provisions of any existing accounting pronouncements.
The adoption of SFAS 154 was not material to the Company's consolidated
financial statements.
-8-
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 APB 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 begin 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 and nine months ended September 30, 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 and nine months
ended September 30, 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 and nine months ended September 30, 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 and nine months ended September 30, 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.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2006 2005 2006 2005
------------------------ ---------------------
Net operating revenues 100.0% 100.0% 100.0% 100.0%
Total operating expenses 104.8% 124.1% 104.9% 119.6%
----- ----- ----- -----
Loss from continuing operations before other income (expenses) (4.8%) (24.1%) (4.9%) (19.6%)
Total other income (expenses), net (1.7%) (1.4%) 1.3% (1.2%)
----- ----- ----- -----
Loss from continuing operations (6.5%) (25.5%) (3.6%) (20.8%)
Discontinued operations
Income (loss) from operations of
discontinued components, including net gain on disposal 0.0% (58.3%) 2.7% (50.6%)
----- ----- ----- -----
Net loss (6.5%) (83.8%) (0.9%) (71.4%)
===== ===== ===== =====
-9-
THREE MONTHS ENDED SEPTEMBER 30, 2006 AS COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 2005
The following table sets forth, for the periods indicated, the
consolidated statements of operations of the Company.
FOR THE THREE MONTHS ENDED
SEPTEMBER 30,
2006 2005
----------- ------------
(Unaudited) (Unaudited)
Net operating revenues $ 7,474,193 $ 7,255,542
Operating expenses
Salaries and benefits 2,782,117 3,572,503
Physician group distribution 2,112,603 2,003,996
Facility rent and related costs 455,403 433,303
Depreciation and amortization 407,964 608,544
Professional and consulting fees 393,774 566,923
Insurance 163,139 238,315
Provision for doubtful accounts 146,895 278,184
Other expenses 1,373,470 1,305,359
----------- -----------
Total operating expenses 7,835,365 9,007,127
----------- -----------
Loss from continuing operations before other income (expenses) (361,172) (1,751,585)
----------- -----------
Other income (expenses)
Interest expense (122,169) (97,178)
Other expense, net (4,365) (5,121)
----------- -----------
Total other income (expenses), net (126,534) (102,299)
----------- -----------
Loss from continuing operations (487,706) (1,853,884)
Discontinued operations
Income (loss) from operations of discontinued components -- (4,228,403)
----------- -----------
Net loss $ (487,706) $(6,082,287)
=========== ===========
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 September 30, 2006,
consolidated net operating revenues increased $218,651, or 3.0%, to $7,474,193,
as compared with $7,255,542 for the three months ended September 30, 2005.
MBS's net operating revenues totaled $2,451,464 for the three months
ended September 30, 2006 as compared to net operating revenues totaling
$2,491,109 for the same period in 2005, a decrease of $39,645, or 1.6%. The
decrease in net operating revenues for MBS was primarily the result of the loss
of two customers in the third quarter of 2005, one of which retired from medical
practice and one group which decided to bring their billing in-house, which
accounted for approximately $120,000 in net operating revenues in the third
quarter of 2005. This decrease was partially offset in the third quarter of 2006
by the addition of two new customers accounting for approximately $104,000 in
net operating revenues.
IPS's net patient service revenue increased $257,982, or 5.4%, from
$4,764,747 for the three months ended September 30, 2005 to $5,022,729 for the
three months ended September 30, 2006. The increase in net patient service
revenue for IPS's affiliated medical groups was primarily the result of
increases in immunizations administered and office procedures related to
well-child visits and back to school check-ups in the third quarter of 2006 as
compared to the same period in 2005. Three of IPS's four clinic-based affiliated
pediatric groups experienced increases in procedures and immunizations
administered in the third quarter of 2006, with total procedures and
immunizations for all clinic-based facilities increasing 534 and 619,
respectively, to 101,346 and 19,711 for the three months ended September 30,
2006.
Other revenue, which represents revenue from the Company's vaccine
program, a group purchasing alliance for vaccines and medical supplies, totaled
$44,626 for the third quarter of 2005, increasing $34,515, or 77.3%, to $79,141
for the three months ended September 30, 2006. The vaccine program had a total
of 485 enrolled participants at September 30, 2006.
OPERATING EXPENSES
SALARIES AND BENEFITS. Consolidated salaries and benefits decreased
$790,386 to $2,782,117 for the three months ended September 30, 2006, as
compared to $3,572,503 for the same period in 2005.
MBS's salaries and benefits totaled $1,440,599 for the three months
ended September 30, 2006 as compared to $1,537,438 for the three months ended
September 30, 2005, a decrease of $96,839. This decrease is primarily the 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 fluctuate indirectly to increases and decreases in productivity and patient
volume. Clinical salaries, bonuses, overtime and health insurance collectively
totaled $440,999 for the three months ended September 30, 2006, an increase of
$18,037 from the same period in 2005. These expenses represented approximately
8.9% and 9.0% of net operating revenues for the three months ended September 30,
2006 and 2005, respectively. The fact that these expenses, as a percentage of
net operating revenues, remained virtually flat is related to the fixed nature
of salaries and benefits needed to maintain minimum staffing levels.
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 $181,568 for the three months ended September 30, 2005.
Additionally, salaries and benefits for the third quarter of 2005 included
accruals of $484,520 for separation benefits for Orion's former president, Keith
LeBlanc, who resigned from the Company on November 8, 2005, and $69,750 for
retention costs and accrued vacation related to the aforementioned staff
reductions.
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 $25,374, or 3.0%, from $843,841 for the three months ended September
30, 2005 to $869,215 for the same period in 2006. These expenses include the
adoption of SFAS 123(R), beginning in the first quarter of 2006, which resulted
in stock option compensation expense totaling $49,642. The costs associated with
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 were offset by staffing adjustments at the Company's
corporate office.
-10-
PHYSICIAN GROUP DISTRIBUTION. Physician group distribution increased
$108,607, or 5.4%, for the three months ended September 30, 2006 to $2,112,603,
as compared with $2,003,996 for the three months ended September 30, 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 September
30, 2006, management fee revenue totaled $359,071 and represented approximately
14.5% of net operating income as compared to management fee revenue totaling
$359,802 and representing approximately 15.2% of net operating income for the
same period in 2005. Physician group distribution represented 42.1% of net
operating revenues for the three months ended September 30, 2006 and 2005. The
increase in physician group distribution for the three months ended September
30, 2006 was directly related to the increase in net patient service revenue,
which was primarily the result of increased procedure volume during the third
quarter of 2006.
FACILITY RENT AND RELATED COSTS. Facility rent and related costs
increased $22,099, or 5.1%, from $433,303 for the three months ended September
30, 2005 to $455,403 for the three months ended September 30, 2006.
MBS's facility rent and related costs totaled $135,380 for the three
months ended September 30, 2006 as compared to $127,199 for the same period in
2005. This increase can be explained generally by increases in utilities and
off-site storage costs for the third quarter of 2006.
Facility rent and related costs associated with IPS's affiliated
medical groups and Orion's corporate office totaled $320,023 for the three
months ended September 30, 2006 compared to $280,539 for the same period in
2005. The sublease between eClinicalWeb and the Company as a result of the
IntegriMED Agreement in June 2005 ended as of June 30, 2006, resulting in the
loss of $27,000 in rent expense offsets for the Company's corporate office in
Roswell, Georgia. Additionally, one of the Company's affiliated medical groups
moved to a new office location in the third quarter of 2006, which resulted in
an increase of approximately $8,700 in facility related costs as compared to the
third quarter of 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 approximately $25,000 for the three
months ended September 30, 2005.
DEPRECIATION AND AMORTIZATION. Consolidated depreciation and
amortization expense totaled $407,964 for the three months ended September 30,
2006, a decrease of $200,581 from the three months ended September 30, 2005.
For the three months ended September 30, 2006, depreciation expense
related to the fixed assets of MBS totaled $16,986 as compared to $19,657 for
the same period in 2005. Deprecation expense related to the fixed assets of IPS
and Orion totaled $39,243 and $28,024 for the three months ended September 30,
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 $11,843 for the three months ended September 30, 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 September 30, 2006 and 2005, respectively.
Amortization expense related to the MSAs for IPS's affiliated medical
groups totaled $86,211 and $88,392 for the three months ended September 30, 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.
-11-
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
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 third quarter of 2006. Amortization
expense for the intangible assets recorded as a result of the IPS Merger totaled
$195,105 for the three months ended September 30, 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 September
30, 2006, professional and consulting fees totaled $393,774, a decrease of
$173,149, or 30.5%, from the same period in 2005.
For the three months ended September 30, 2006, MBS recorded
professional and consulting expenses totaling $43,980 as compared with $79,257
for the same period in 2005, a decrease of $35,277. MBS utilized contract labor
in the third quarter of 2005 as a result of staffing shortages. This contract
labor was not utilized in the third 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 $487,666 for the three months ended September 30, 2005 to
$349,794 for the three months ended September 30, 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, including
an accrual of $90,000 related to a legal settlement recorded in the third
quarter of 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 $238,315 for the three months ended September 30, 2005 to
$163,139 for the three months ended September 30, 2006. The decrease can be
explained generally by the following: (i) insurance expense related to the
directors and officers' liability policies in the third quarter of 2005 included
approximately $40,000 of premiums for run-off policies related to SurgiCare and
IPS; (ii) general liability insurance premiums related to the Company's former
Houston, Texas office, which was closed in August 2005, totaled approximately
$15,000 in the third quarter of 2005; and (iii) professional liability insurance
premiums for the Company's affiliated medical groups decreased approximately
$15,000 in the third quarter of 2006 when compared with the same period in 2005.
PROVISION FOR DOUBTFUL ACCOUNTS. The Company's consolidated provision
for doubtful accounts, or bad debt expense, decreased $131,289, or 47.2%, for
the three months ended September 30, 2006 to $146,895. The entire provision for
doubtful accounts for the quarter ended September 30, 2006 related to IPS's
affiliated medical groups and accounted for 2.9% of IPS's net operating revenues
as compared to 5.3% 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 71.2% for the three months ended September 30, 2006, compared
to 70.3% for the same period in 2005.
OTHER EXPENSES. Consolidated other expenses totaled $1,373,470 for the
three months ended September 30, 2006, an increase of $68,110, or 5.2%, 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 $303,678 for the three months ended
September 30, 2006 as compared to $305,813 for the three months ended September
30, 2005. Cost savings of approximately $27,000 as a result of renegotiated long
distance rates were offset by an increase of approximately $29,000 in courier
expenses in the third quarter of 2006. Courier expenses fluctuate as a result of
increases or decreases in net operating revenues.
For the three months ended September 30, 2006, IPS's direct clinical
expenses, other than salaries and benefits, totaled $736,581, an increase of
$99,747 over direct clinical expenses in the third quarter of 2005, which
totaled $636,834. Vaccine expenses increased approximately $101,000 in the third
quarter of 2006 when compared to the same period in 2005, and accounted for
12.8% and 11.3% of net operating revenues for the three months ended September
30, 2006 and 2005, respectively. 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.
-12-
The Company's and IPS's general and administrative expenses totaled
$186,124 for the three months ended September 30, 2006, a decrease of $55,639
from the same period in 2005. There were approximately $43,000 of expense
decreases related 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.
OTHER INCOME AND EXPENSES.
INTEREST EXPENSE. Consolidated interest expense totaled $122,169 for
the three months ended September 30, 2006, an increase of $24,992 from the same
period in 2005. Interest expense activity in the third quarter of 2006,
including increases from the third quarter of 2005, can be explained generally
by the following:
o MBS NOTES. On April 19, 2006, the Company executed subordinated
promissory notes with the former equity owners of MBS and DCPS for
an aggregate of $714,336. This represented the retroactive
purchase price increase due to the former equity owners of MBS and
DCPS based on the financial results of the newly formed MBS,
required by the merger agreement governing the DCPS/MBS Merger.
The notes bear interest at the rate of 8% per annum, payable
monthly beginning on April 30, 2006, and will mature on December
15, 2007. Interest expense related to these notes totaled
approximately $14,287 for the three months ended September 30,
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 $49,351 for the three months ended September 30,
2006, compared to $48,359 for the three months ended September 30,
2005.
-13-
DISCONTINUED OPERATIONS.
TASC AND TOM. On June 13, 2005, the Company announced that it had
accepted an offer to purchase its interests in Tuscarawas Ambulatory Surgery
Center, LLC ("TASC") and Tuscarawas Open MRI, L.P. ("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 determined that the joint venture interests
associated with TASC and TOM were impaired and recorded a charge for impairment
of intangible assets related to TASC and TOM of $2,122,445 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. In early
2006, the Company was notified by Union that it was exercising its option to
terminate the management services agreements of TOM and TASC as of March 12,
2006 and April 3, 2006, respectively. As a result, the Company recorded a charge
for impairment of intangible assets of $1,021,457 for the three months ended
December 31, 2005 related to the TASC and TOM management services agreements.
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 September 30, 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 September 30, 2005:
SEPTEMBER 30, 2005
------------------
Income statement data:
Net operating revenues $ 737,355
Operating expenses 827,429
-------------------
Net loss $ (90,074)
-------------------
Balance sheet data:
Current assets $ 641,172
Other assets 1,398,449
-------------------
Total assets $ 2,039,621
-------------------
Current liabilities $ 617,186
Other liabilities 828,312
-------------------
Total liabilities $ 1,445,498
-------------------
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 $38,440 recorded in the
fourth quarter of 2005) 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 September 30, 2005. There were no
operations for this component in the Company's financial statements after
October 31, 2005.
-14-
The following table contains selected financial statement data related
to Sutter as of and for the three months ended September 30, 2005:
SEPTEMBER 30, 2005
----------------------
Income statement data:
Net operating revenues $ 106,151
Operating expenses 103,440
----------------------
Net income $ 2,711
----------------------
Balance sheet data:
Current assets $ 102,924
Other assets 14,066
----------------------
Total assets $ 116,990
----------------------
Current liabilities $ 21,778
Other liabilities --
----------------------
Total liabilities $ 21,778
----------------------
MEMORIAL VILLAGE. As a result of the uncertainty of future cash flows
related to our surgery center business as well as the transactions related to
TASC and TOM, the Company determined that the joint venture interest associated
with Memorial Village was impaired and recorded a charge for impairment of
intangible assets related to Memorial Village of $3,229,462 for the three months
ended June 30, 2005. 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 an additional charge for
impairment of intangible assets of $1,348,085 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 September 30, 2005. There were no operations for this
component in the Company's financial statements after March 31, 2006.
The following table contains selected financial statement data related
to Memorial Village as of and for the three months ended September 30, 2005:
SEPTEMBER 30, 2005
---------------------
Income statement data:
Net operating revenues $ 61,046
Operating expenses 817,575
---------------------
Net loss $ (756,529)
---------------------
Balance sheet data:
Current assets $ 414,255
Other assets 552,107
---------------------
Total assets $ 966,362
---------------------
Current liabilities $ 940,149
Other liabilities 52,546
---------------------
Total liabilities $ 992,695
---------------------
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., the Company's
wholly owned subsidiary, and is not consolidated in our 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. As a
result of the uncertainty of future cash flows related to the surgery center
business, and in conjunction with the transactions related to TASC and TOM, the
Company determined that the joint venture interest associated with San Jacinto
was impaired and recorded a charge for impairment of intangible assets related
to San Jacinto of $734,522 for the three months ended June 30, 2005. The Company
also recorded an additional $2,113,262 charge for impairment of intangible
assets for the three months ended September 30, 2005 related to the management
contracts with San Jacinto. 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. There were no operations for this component
in our financial statements after March 31, 2006.
-15-
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. There was no
management fee revenue associated with the discontinued operations in the
surgery center business for the three months ended September 30, 2006. For the
three months ended September 30, 2005, the Company generated management fee
revenue of $101,662 and net minority interest losses totaling $24,823. For the
quarters ended June 30, 2005 and December 31, 2005, the Company recorded a
charge for impairment of intangible assets of $276,420 and $142,377,
respectively, related to trained work force and non-compete agreements affected
by the surgery center operations the Company discontinued in 2005 and early
2006.
The following table summarizes the components of income (loss) from
operations of discontinued components:
THREE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, 2006 SEPTEMBER 30, 2005
------------------ ------------------
TASC and TOM
Net loss $ -- $ (90,074)
Sutter
Net income -- 2,711
Memorial Village
Net loss -- (756,529)
Loss on disposal -- (1,348,085)
San Jacinto
Loss on disposal -- (2,113,262)
Orion
Net income -- 76,836
---------------------------------------
Total income (loss) from operations of discontinued components,
including net gain (loss) on disposal $ -- $ (4,228,403)
=======================================
-16-
NINE MONTHS ENDED SEPTEMBER 30, 2006 AS COMPARED TO
NINE MONTHS ENDED SEPTEMBER 30, 2005
The following table sets forth, for the periods indicated, the
consolidated statements of operations of the Company.
FOR THE NINE MONTHS ENDED
SEPTEMBER 30,
2006 2005
------------ -------------
(Unaudited) (Unaudited)
Net operating revenues $ 21,559,921 $ 22,536,655
Operating expenses
Salaries and benefits 8,317,365 9,778,358
Physician group distribution 6,135,949 6,607,754
Facility rent and related costs 1,247,678 1,291,402
Depreciation and amortization 1,226,791 2,335,745
Professional and consulting fees 1,100,885 1,498,563
Insurance 502,499 679,588
Provision for doubtful accounts 446,041 915,019
Other expenses 3,646,413 3,855,454
------------ ------------
Total operating expenses 22,623,622 26,961,884
------------ ------------
Loss from continuing operations before other income (expenses) (1,063,701) (4,425,229)
------------ ------------
Other income (expenses)
Interest expense (356,313) (247,569)
Gain on forgiveness of debt 665,463 --
Other expense, net (18,517) (24,098)
------------ ------------
Total other income (expenses), net 290,633 (271,667)
------------ ------------
Minority interest earnings in partnership -- (1,660)
------------ ------------
Loss from continuing operations (773,068) (4,698,556)
Discontinued operations
Income (loss) from operations of discontinued components 576,390 (11,412,149)
------------ ------------
Net loss $ (196,678) $(16,110,705)
============ ============
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 nine months ended September 30, 2006,
consolidated net operating revenues decreased $976,734, or 4.3%, to $21,559,921,
as compared to consolidated net operating revenues of $22,536,655 for the nine
months ended September 30, 2005.
MBS's net operating revenues totaled $7,207,517 for the nine months
ended September 30, 2006 as compared to net operating revenues totaling
$7,684,641 for the same period in 2005, a decrease of $477,124, or 6.2%. The
decrease in net operating revenues for MBS was primarily the result of the loss
of two customers in the third quarter of 2005, one of which retired from medical
practice and one group which decided to bring their billing in-house, which
accounted for approximately $606,000 in net operating revenues in the first nine
months of 2005. This decrease was partially offset in the first nine months of
2006 by the addition of three new customers accounting for approximately
$248,000 in net operating revenues in the first nine months of 2006.
IPS's net patient service revenue decreased $499,924, or 3.4%, from
$14,852,328 for the nine months ended September 30, 2005 to $14,352,404 for the
nine months ended September 30, 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 half of 2006 as compared with the same period in 2005. These
patient volume decreases were partially offset by the third quarter 2006
increases in immunizations and procedures associated with well-child and back to
school visits at the Company's affiliated medical groups. Three of IPS's four
clinic-based affiliated pediatric groups experienced decreases in patient volume
in the first nine months of 2006, with total procedures and office visits for
all clinic-based facilities decreasing 12,888 and 12,193, respectively, to
292,470 and 114,335 for the nine months ended September 30, 2006.
Other revenue, which represents revenue from the Company's vaccine
program, a group purchasing alliance for vaccines and medical supplies, totaled
$86,215 for the first nine months of 2005, increasing $173,563, or 201.3%, to
$259,778 for the nine months ended September 30, 2006. The vaccine program,
which had a total of 428 enrolled participants at December 31, 2005, added
approximately 57 members during the first nine months of 2006.
OPERATING EXPENSES
SALARIES AND BENEFITS. Consolidated salaries and benefits decreased
$1,460,994 to $8,317,365 for the nine months ended September 30, 2006, as
compared to $9,778,358 for the same period in 2005.
MBS's salaries and benefits totaled $4,362,967 for the nine months
ended September 30, 2006 as compared to $4,638,394 for the nine months ended
September 30, 2005, a decrease of $275,427. This decrease is primarily the
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 fluctuate indirectly to increases and decreases in productivity and patient
volume. Clinical salaries, bonuses, overtime and health insurance collectively
totaled $1,306,669 for the first nine months of 2006, an increase of $27,371
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 nine months of
2006 as compared to the staffing levels for the first nine months of 2005. These
expenses represented approximately 9.3% and 8.7% of net operating revenues for
the nine months ended September 30, 2006 and 2005, respectively. The increase,
as a percentage of net operating revenues, is related to the fixed nature of
salaries and benefits needed to maintain minimum staffing levels.
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 $746,594 for the nine months ended September 30, 2005.
Additionally, salaries and benefits for the third quarter of 2005 included
accruals of $484,520 for separation benefits for Orion's former president, Keith
LeBlanc, who resigned from the Company on November 8, 2005, and $69,750 for
retention costs and accrued vacation related to the aforementioned staff
reductions.
-17-
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 $92,503, or 3.8%, from $2,449,147 for the nine months ended September
30, 2005 to $2,541,650 for the same period in 2006. The additional expense can
be attributed primarily to the adoption of SFAS 123(R) in the first quarter of
2006, which resulted in stock option compensation expense totaling approximately
$147,000 for the first nine months of 2006.
PHYSICIAN GROUP DISTRIBUTION. Physician group distribution decreased
$471,805, or 7.1%, for the nine months ended September 30, 2006 to $6,135,949,
as compared with $6,607,754 for the nine months ended September 30, 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 nine months ended September 30,
2006, management fee revenue totaled $1,019,585 and represented approximately
14.2% of net operating income as compared to management fee revenue totaling
$1,111,655 and representing approximately 14.4% of net operating income for the
same period in 2005. Physician group distribution represented 42.8% of net
operating revenues in the first nine months of 2006, compared to 44.5% of net
operating revenues for the nine months ended September 30, 2005. The decrease in
physician group distribution for the nine months ended September 30, 2006 was
directly related to the decrease in net patient service revenue, which was
primarily the result of decreased patient volume during the first nine months of
2006.
FACILITY RENT AND RELATED COSTS. Facility rent and related costs
decreased $43,724, or 3.4%, from $1,291,402 for the nine months ended September
30, 2005 to $1,247,678 for the nine months ended September 30, 2006.
MBS's facility rent and related costs totaled $392,274 for the nine
months ended September 30, 2006 as compared to $369,976 for the same period in
2005. This increase can be explained generally by increases in utilities and
off-site storage costs for the first nine months of 2006.
Facility rent and related costs associated with IPS's affiliated
medical groups and Orion's corporate office totaled $812,986 for the nine months
ended September 30, 2006 compared to $819,945 for the same period in 2005. Rent
expense related to the Company's corporate office in Roswell, Georgia decreased
for the first six months of 2006 due to approximately $54,000 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 approximately $101,000 for the nine
months ended September 30, 2005.
DEPRECIATION AND AMORTIZATION. Consolidated depreciation and
amortization expense totaled $1,226,791 for the nine months ended September 30,
2006, a decrease of $1,108,954 from the nine months ended September 30, 2005.
For the nine months ended September 30, 2006, depreciation expense
related to the fixed assets of MBS totaled $51,823 as compared to $61,492 for
the same period in 2005. Deprecation expense related to the fixed assets of IPS
and Orion totaled $119,766 and $86,840 for the nine months ended September 30,
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 $34,611 for the nine months ended September 30, 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 $796,570 for the nine months
ended September 30, 2006 and 2005, respectively.
Amortization expense related to the MSAs for IPS's affiliated medical
groups totaled $258,633 and $297,733 for the nine months ended September 30,
2006 and 2005, respectively. The decrease is directly related to the Sutter
Settlement and the CARDC Settlement.
-18-
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. Amortization expense for the intangible
assets recorded as a result of the IPS Merger totaled $1,058,499 for the nine
months ended September 30, 2005. As a result of the dispositions related to 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 nine months of 2006. (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 nine months ended September
30, 2006, professional and consulting fees totaled $1,100,885, a decrease of
$397,677, or 26.5%, from the same period in 2005.
For the first nine months of 2006, MBS recorded professional and
consulting expenses totaling $132,455 as compared with $221,518 for the first
nine months of 2005, a decrease of $89,063. This change is primarily the result
of a decrease in contract labor used in 2005 as a result of staffing shortages.
This contract labor was not utilized in the first nine months 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 $1,277,044 for the nine months ended September 30, 2005 to
$968,430 for the nine months ended September 30, 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, including an accrual of
$90,000 related to a legal settlement recorded in the third quarter of 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 $679,588 for the nine months ended September 30, 2005 to $502,499
for the nine months ended September 30, 2006. The decrease can be explained
generally by the following: (i) insurance expense related to the directors and
officers' liability policies for the first nine months of 2005 included
approximately $115,000 of premiums for run-off policies related to SurgiCare and
IPS; (ii) general liability insurance premiums related to the Company's former
Houston, Texas office, which was closed in August 2005, totaled approximately
$54,000 for the nine months ended September 30, 2005; and (iii) professional
liability insurance premiums for the Company's affiliated medical groups
decreased approximately $6,500 for the nine months ended September 30, 2006 when
compared with the same period in 2005.
PROVISION FOR DOUBTFUL ACCOUNTS. The Company's consolidated provision
for doubtful accounts, or bad debt expense, decreased $468,978, or 51.3%, for
the nine months ended September 30, 2006 to $446,041. The entire provision for
doubtful accounts for the nine months ended September 30, 2006 related to IPS's
affiliated medical groups and accounted for 3.1% of IPS's net operating revenues
as compared to 6.0% 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 70.8% for the nine months ended September 30, 2006, compared
to 66.0% for the same period in 2005.
OTHER EXPENSES. Consolidated other expenses totaled $3,646,414 for the
nine months ended September 30, 2006, a decrease of $209,041 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 $860,298 for the nine months ended
September 30, 2006 as compared to $968,769 for the nine months ended September
30, 2005. Of the total decrease, approximately $116,000 related to decreases in
office supplies in the first nine 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 nine months of 2006. Additionally, MBS
renegotiated its long distance rates in the fall of 2005, which resulted in
approximately $53,000 in cost savings in the first nine months of 2006 as
compared to the same period in 2005.
For the nine months ended September 30, 2006, IPS's direct clinical
expenses, other than salaries and benefits, totaled $1,883,398, an increase of
$134,539 over direct clinical expenses in the first nine months of 2005, which
totaled $1,748,962. Vaccine expenses accounted for approximately $144,000 of the
total increase in direct clinical expenses in the first nine 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.
-19-
The Company's and IPS's general and administrative expenses totaled
$520,902 for the nine months ended September 30, 2006, a decrease of $256,111
from the same period in 2005. Of the total decrease, approximately $240,000
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.
OTHER INCOME AND EXPENSES.
INTEREST EXPENSE. Consolidated interest expense totaled $356,313 for
the nine months ended September 30, 2006, an increase of $108,744 from the same
period in 2005. Interest expense activity in the nine months ended September 30,
2006, including increases from the first nine 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 $85,313 for the nine
months ended September 30, 2006 as compared to $59,963 for the
same period in 2005.
o MBS NOTES. On April 19, 2006, the Company executed subordinated
promissory notes with the former equity owners of MBS and DCPS for
an aggregate of $714,336. This represented the retroactive
purchase price increase due to the former equity owners of MBS and
DCPS based on the financial results of the newly formed MBS, as
required by the merger agreement governing the DCPS/MBS Merger.
The notes bear interest at the rate of 8% per annum, payable
monthly beginning on April 30, 2006, and will mature on December
15, 2007. Interest expense related to these notes totaled
approximately $85,828 for the nine months ended September 30,
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 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 $164,158 for the nine
months ended September 30, 2006, compared to $158,777 for the nine
months ended September 30, 2005. The increase in interest expense
on the line of credit facility was a direct result of interest
rate increases for the first nine 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 $1,008,282 and
$2,260,601 at September 30, 2006 and 2005, respectively.
Additionally, the average prime rate for the first nine months of
2006 was 7.86% as compared to 5.89% for the same nine-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 in the first quarter of 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. There were no
operations for this component after March 31, 2005.
-20-
The following table contains selected financial statement data related
to Bellaire SurgiCare as of and for the nine months ended September 30, 2005:
SEPTEMBER 30, 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. 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 nine months ended September 30, 2005:
SEPTEMBER 30, 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 $ --
----------------------
-21-
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 nine months ended September 30, 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 nine months ended September 30, 2005:
SEPTEMBER 30, 2005
----------------------
Income statement data:
Net operating revenues $ 191,771
Operating expenses 899,667
----------------------
Net loss $ (707,896)
----------------------
Balance sheet data:
Current assets $ --
Other assets --
----------------------
Total assets $ --
----------------------
Current liabilities $ --
Other liabilities --
----------------------
Total liabilities $ --
----------------------
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.
Additionally, as part of the transactions, TASC, as the sole member of 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 determined that the joint
venture interests associated with TASC and TOM were impaired and recorded a
charge for impairment of intangible assets related to TASC and TOM of $2,122,445
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. In early 2006, the Company was notified by Union
that it was exercising its option to terminate the management services
agreements of TOM and TASC as of March 12, 2006 and April 3, 2006, respectively.
As a result, the Company recorded a charge for impairment of intangible assets
of $1,021,457 for the three months ended December 31, 2005 related to the TASC
and TOM management services agreements. 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 nine months ended
September 30, 2005. There were no operations for this component in the Company's
financial statements after September 30, 2005.
-22-
The following table contains selected financial statement data related
to TASC and TOM as of and for the nine months ended September 30, 2005:
SEPTEMBER 30, 2005
----------------------
Income statement data:
Net operating revenues $ 2,408,156
Operating expenses 2,467,110
----------------------
Net loss $ (58,956)
----------------------
Balance sheet data:
Current assets $ 641,172
Other assets 1,398,449
----------------------
Total assets $ 2,039,621
----------------------
Current liabilities $ 617,186
Other liabilities 828,312
----------------------
Total liabilities $ 1,445,498
----------------------
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 $38,440 recorded in the
fourth quarter of 2005) 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 nine months ended September 30, 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 nine months ended September 30, 2005:
SEPTEMBER 30, 2005
----------------------
Income statement data:
Net operating revenues $ 322,470
Operating expenses 314,049
----------------------
Net income $ 8,421
----------------------
Balance sheet data:
Current assets $ 102,924
Other assets 14,066
----------------------
Total assets $ 116,990
----------------------
Current liabilities $ 21,778
Other liabilities --
----------------------
Total liabilities $ 21,778
----------------------
MEMORIAL VILLAGE. As a result of the uncertainty of future cash flows
related to our surgery center business as well as the transactions related to
TASC and TOM, the Company determined that the joint venture interest associated
with Memorial Village was impaired and recorded a charge for impairment of
intangible assets related to Memorial Village of $3,229,462 for the three months
ended June 30, 2005. 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 an additional charge for
impairment of intangible assets of $1,348,085 for the three months ended
September 30, 2005. On February 8, 2006, Memorial Village executed 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 nine
months ended September 30, 2006 and 2005, respectively. There were no operations
for this component in the Company's financial statements after March 31, 2006.
-23-
The following table contains selected financial statement data related
to Memorial Village as of and for the nine months ended September 30, 2006 and
2005, respectively:
SEPTEMBER 30, 2006 SEPTEMBER 30, 2005
-------------------- --------------------
Income statement data:
Net operating revenues $ 17,249 $ 1,329,899
Operating expenses 170,285 2,320,322
--------------------- ---------------------
Net loss $ (153,036) $ (990,423)
--------------------- ---------------------
Balance sheet data:
Current assets $ -- $ 414,255
Other assets -- 552,107
--------------------- ---------------------
Total assets $ -- $ 966,362
--------------------- ---------------------
Current liabilities $ -- $ 940,149
Other liabilities 52,546
--------------------- ---------------------
Total liabilities $ -- $ 992,695
--------------------- ---------------------
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
disposal of this discontinued operation of $94,066 for the quarter ended March
31, 2006. As a result of the uncertainty of future cash flows related to the
surgery center business, and in conjunction with the transactions related to
TASC and TOM, the Company determined that the joint venture interest associated
with San Jacinto was impaired and recorded a charge for impairment of intangible
assets related to San Jacinto of $734,522 for the three months ended June 30,
2005. The Company also recorded an additional $2,113,262 charge for impairment
of intangible assets for the three months ended September 30, 2005 related to
the management contracts with San Jacinto. 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. There were no
operations for this component in the Company's financial statements after March
31, 2006.
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 $61,039 for the nine months ended September 30, 2006. For the
nine months ended September 30, 2005, the Company generated management fee
revenue of $320,069 and net minority interest losses totaling $67,588. For the
quarters ended June 30, 2005 and December 31, 2005, the Company recorded a
charge for impairment of intangible assets of $276,420 and $142,377,
respectively, related to trained work force and non-compete agreements affected
by the surgery center operations the Company discontinued in 2005 and early
2006.
The following table summarizes the components of income (loss) from
operations of discontinued components:
NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2006 SEPTEMBER 30, 2005
------------------ ------------------
Bellaire SurgiCare
Net loss $ -- $ (188,418)
Loss on disposal -- (163,049)
CARDC
Net income -- 38,700
Gain on disposal -- 268,292
IntegriMED
Net loss -- (707,896)
Loss on disposal -- (47,101)
TASC and TOM
Net loss -- (58,956)
Loss on disposal -- (2,122,445)
Sutter
Net income -- 8,421
Memorial Village
Net loss (153,036) (990,423)
Gain (loss) on disposal 574,321 (4,577,547)
San Jacinto
Gain (loss) on disposal 94,066 (2,847,784)
Orion
Net income (loss) 61,039 (23,943)
---------------------------------------------
Total income (loss) from operations of discontinued components,
including net gain (loss) on disposal $ 576,390 $ (11,412,149)
=============================================
-24-
LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operating activities totaled $220,919 for the three
months ended September 30, 2006 as compared to cash used in operating activities
of $122,402 for the three months ended September 30, 2005. For the nine months
ended September 30, 2006, net cash used in operating activities totaled $359,403
as compared to net cash used in operating activities totaling $2,151,458 for the
same period in 2005. The net impact of discontinued operations on net cash
provided by operating activities in the first nine months of 2006 totaled
$230,743.
For the three months ended September 30, 2006, net cash used in
investing activities totaled $36,785 compared to $93,929 in net cash provided by
investing activities for the same period in 2005. For the nine months ended
September 30, 2006, net cash provided by investing activities totaled $380,446
as compared to $349,949 in net cash provided by investing activities in the nine
months ended September 30, 2005. The net impact of discontinued operations on
net cash provided by investing activities totaled $430,244 in the first nine
months of 2006.
Net cash used in financing activities totaled $219,058 for the nine
months ended September 30, 2006 as compared to $1,870,761 in net cash provided
by financing activities for the nine months ended September 30, 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
$708,607 in the first nine months of 2006, including approximately
$300,000 in repayments related to discontinued operations;
o As discussed below, in March and April of 2005, the Company
borrowed an aggregate of $1,250,000 from Brantley IV. o The
Company made aggregate payments in the amount of $112,500 in the
first quarter of 2006 in satisfaction of a $778,000 debt, and
recognized a gain on forgiveness of debt totaling $665,463 for the
nine months ended September 30, 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 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.
-25-
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
September 30, 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 September 30, 2006, if Brantley IV were to convert
the First Note, the Company would have to issue 1,121,251 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 August 8, 2006, Brantley IV and the
Company executed a second amendment to the First Note (the "First and Second
Note Second Amendment") extending the First Note Maturity Date to October 15,
2006, and as of October 15, 2006, Brantley IV and the Company executed a third
amendment to the First Note (the "First and Second Note Third Amendment")
further extending the First Note Maturity Date to November 30, 2006. A copy of
the First and Second Note Third Amendment is incorporated by reference to
Exhibit 10.1 on the Company's Current Report on Form 8-K filed on October 19,
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 September 30, 2006, if
Brantley IV were to convert the Second Note, the Company would have to issue
244,294 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. On August 8, 2006, Brantley IV and the Company
executed the First and Second Note Second Amendment extending the Second Note
Maturity Date to October 15, 2006, and as of October 15, 2006, Brantley IV and
the Company executed the First and Second Note Third Amendment further extending
the Second Note Maturity Date to November 30, 2006.
-26-
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
and nine months ended September 30, 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 September 30, 2006, the outstanding principal under the revolving
credit facility was $1,008,282. The full amount of the loan as of September 30,
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. The
Company is currently negotiating the terms of a new senior secured credit
facility in the aggregate principal amount of $16,500,000, consisting of a
$2,000,000 revolving loan commitment, a $4,500,000 term loan and a $10,000,000
acquisition facility commitment available for future acquisitions. The proceeds
from the new facility would be used to repay the Company's current credit
facility with CIT and provide capital to enable the Company to execute
components of its strategic plan, including the acquisitions of Rand and Online,
which are described in greater detail under the caption "Strategic Focus." If
the Company is unable to reach an agreement on a credit facility with this
lender, then we will seek to find another institutional lender to provide a
credit facility on similar terms, but there is no guarantee that we will be able
to find such a lender or be able to negotiate similar terms to such credit
facility.
As of September 30, 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, primarily by focusing on the Company's strengths,
which include providing billing, collections and complementary business
management services to physician practices. In 2005 and early 2006, the Company
ceased investment in business lines that did not complement the Company's
strategic plans. Additionally, the Company redirected financial resources and
company personnel to areas that management believes enhance long-term growth
potential. A key component of our long-term strategic plan was the
identification of potential acquisition targets that would increase the
Company's presence in the markets it serves and enhance stockholder value. The
Company has identified several acquisition opportunities to expand its business
that are consistent with its strategic plan. The Company signed definitive
agreements in September 2006 for the acquisition of two of these targets, Rand
and Online. In addition to the Rand Stock Purchase Agreement and the Online
Stock Purchase Agreement, in September 2006 the Company also executed the
Private Placement Agreements and the Purchase Agreement. The Rand Stock Purchase
Agreement, the Online Stock Purchase Agreement, the Private Placement Agreements
and the Purchase Agreement are all described in greater detail under the caption
"Strategic Focus."
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.
-27-
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
On July 12, 2005, the Company was named as a defendant in a suit
entitled American International Industries, Inc. ("AII") vs. Orion HealthCorp,
Inc. (previously known as SurgiCare, Inc.), Keith G. LeBlanc, Paul Cascio,
Brantley Capital Corporation, Brantley Venture Partners III, L.P., Brantley
Partners IV, L.P. (collectively, "the Named Defendants") and UHY Mann Frankfort
Stein & Lipp CPAs, LLP ("UHY Mann") in the 80th Judicial District Court of
Harris County, Texas, Cause No. 2005-44326. The case involved 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 AII to
convert its SurgiCare Class AA convertible preferred stock into shares of the
Company's Class A Common Stock. AII asserted that the value of its Class A
Common Stock of Orion had fallen as a direct result of the alleged material
misrepresentations by the Company. AII was seeking an aggregate of $7,600,000 in
damages (actual damages of $3,800,000 and punitive damages of $3,800,000), and
rescission of the agreement to convert the SurgiCare Class AA convertible
preferred stock into Class A Common Stock. On September 8, 2006, the Company
entered into a Settlement Agreement with a Joint and Mutual Release and
Indemnity Agreement (the "AII Settlement Agreement") in which the claims by AII
against the Named Defendants were fully settled as to all claims, with complete
mutual releases for all of the Named Defendants and AII. Under the terms of the
AII Settlement Agreement, AII will receive $750,000, paid primarily by various
insurance carriers of the Named Defendants, on or before 45 days from the
execution of the AII Settlement Agreement. As part of the AII Settlement
Agreement, the Named Defendants vigorously denied any liability and AII
acknowledged the highly disputed nature of its claims against the Named
Defendants. Both the Named Defendants and AII acknowledged that the AII
Settlement Agreement was made as a compromise to avoid further expense and to
terminate for all time the controversy underlying the lawsuit. A copy of the AII
Settlement Agreement is incorporated by reference to Exhibit 10.1 on the
Company's Current Report on Form 8-K filed on September 14, 2006.
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.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
On November 1, 2006, the Company issued 125,000 shares of Class A
Common Stock to Keith LeBlanc, former president of the Company, in connection
with restricted stock units that were granted to him on August 31, 2005. Per the
terms of Mr. LeBlanc's separation agreement, 125,000 of the 250,000 restricted
stock units vested on January 1, 2006 and the remaining 125,000 units will vest
on January 1, 2007. In the separation agreement, Mr. LeBlanc agreed to refrain
from trading any of the restricted stock units for a period of one year
commencing on November 1, 2005.
There was no placement agent or underwriter for the stock issuance. The
Company processed the stock issuance internally. The shares were not sold for
cash. The Company did not receive any consideration in connection with the stock
issuance. 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 4(2) of the Securities Act.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
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
and nine months ended September 30, 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 September 30, 2006, the outstanding principal under the revolving
credit facility was $1,008,282. The full amount of the loan as of September 30,
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.
-28-
ITEM 6. EXHIBITS
EXHIBIT NO. DESCRIPTION
----------- -----------
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
-29-
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: November 13, 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 November 13, 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 Chairman of the Board Director
By: /s/ David Crane By: /s/ Stephen H. Murdock
------------------------------------------------- -------------------------------
David Crane Stephen H. Murdock
Director Chief Financial Officer (Principal Accounting
and Financial Officer)
-30-
ORION HEALTHCORP, INC.
INDEX TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
Page Number
-----------
Consolidated Condensed Balance Sheets as of September 30, 2006 (unaudited) and December 31, 2005 F-2
Consolidated Condensed Statements of Operations for the Three Months Ended September 30, 2006 and 2005 (unaudited) F-3
Consolidated Condensed Statements of Operations for the Nine Months Ended September 30, 2006 and 2005 (unaudited) F-4
Consolidated Condensed Statements of Cash Flows for the Three Months Ended September 30, 2006 and 2005 (unaudited) F-5
Consolidated Condensed Statements of Cash Flows for the Nine Months Ended September 30, 2006 and 2005 (unaudited) F-6
Notes to Unaudited Consolidated Condensed Financial Statements F-7
F-1
Orion HealthCorp, Inc.
Consolidated Condensed Balance Sheets
September 30, December 31,
2006 2005
------------ ------------
(Unaudited)
Current assets
Cash and cash equivalents $ 100,795 $ 298,807
Accounts receivable, net 2,745,039 2,798,304
Inventory 282,202 206,342
Prepaid expenses and other current assets 732,970 715,671
Assets held for sale -- 975,839
------------ ------------
Total current assets 3,861,006 4,994,963
------------ ------------
Property and equipment, net 620,173 741,966
------------ ------------
Other long-term assets
Intangible assets, excluding goodwill, net 12,742,510 13,797,714
Goodwill 2,490,695 2,490,695
Other assets, net 62,643 92,432
------------ ------------
Total other long-term assets 15,295,848 16,380,841
------------ ------------
Total assets $ 19,777,027 $ 22,117,770
============ ============
Current liabilities
Accounts payable and accrued expenses $ 5,843,410 $ 6,738,278
Other current liabilities -- 25,000
Current portion of capital lease obligations 92,397 92,334
Current portion of long-term debt 3,491,527 4,231,674
Liabilities held for sale -- 452,027
------------ ------------
Total current liabilities 9,427,334 11,539,313
------------ ------------
Long-term liabilities
Capital lease obligations, net of current portion 145,374 213,599
Long-term debt, net of current portion 3,795,381 3,871,593
Minority interest in partnership -- 35,000
------------ ------------
Total long-term liabilities 3,940,755 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, 12,788,776
and 12,428,042 shares issued and outstanding at
September 30, 2006 and December 31, 2005, respectively 12,788 12,428
Common Stock, Class B, par value $0.001;
25,000,000 shares authorized, 10,448,470
shares issued and outstanding at September 30, 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 September 30, 2006
and December 31, 2005, respectively 1,438 1,438
Additional paid-in capital 57,075,010 56,928,016
Accumulated deficit (50,652,428) (50,455,748)
Treasury stock - at cost; 9,140 shares (38,318) (38,318)
------------ ------------
Total stockholders' equity 6,408,938 6,458,264
------------ ------------
Total liabilities and stockholders' equity $ 19,777,027 $ 22,117,770
============ ============
The accompanying notes are an integral part of these consolidated condensed
financial statements.
F-2
Orion HealthCorp, Inc.
Consolidated Condensed Statements of Operations
For the Three Months Ended September 30,
2006 2005
------------ ---------------
(Unaudited) (Unaudited)
Net operating revenues $ 7,474,193 $ 7,255,542
Operating expenses
Salaries and benefits 2,782,117 3,572,503
Physician group distribution 2,112,603 2,003,996
Facility rent and related costs 455,403 433,303
Depreciation and amortization 407,964 608,544
Professional and consulting fees 393,774 566,923
Insurance 163,139 238,315
Provision for doubtful accounts 146,895 278,184
Other expenses 1,373,470 1,305,359
------------ ------------
Total operating expenses 7,835,365 9,007,127
------------ ------------
Loss from continuing operations before other income (expenses) (361,172) (1,751,585)
------------ ------------
Other income (expenses)
Interest expense (122,169) (97,178)
Other expense, net (4,365) (5,121)
------------ ------------
Total other income (expenses), net (126,534) (102,299)
------------ ------------
Loss from continuing operations (487,706) (1,853,884)
Discontinued operations
Income (loss) from operations of discontinued components -- (4,228,403)
------------ ------------
Income (loss) before provision for income taxes (487,706) (6,082,287)
Provision for income taxes -- --
------------ ------------
Net loss $ (487,706) $ (6,082,287)
============ ============
Weighted average common shares outstanding
Basic 12,777,363 11,344,066
Diluted 12,777,363 11,344,066
Income (loss) per share
Basic
Net loss per share from continuing operations $ (0.04) $ (0.16)
Net income (loss) per share from discontinued operations $ -- $ (0.37)
------------ ------------
Net loss per share $ (0.04) $ (0.53)
============ ============
Diluted
Net loss per share from continuing operations $ (0.04) $ (0.16)
Net income (loss) per share from discontinued operations $ -- $ (0.37)
------------ ------------
Net loss per share $ (0.04) $ (0.53)
============ ============
The accompanying notes are an integral part of these consolidated condensed
financial statements.
F-3
Orion HealthCorp, Inc.
Consolidated Condensed Statements of Operations
For the Nine Months Ended September 30,
2006 2005
---------------- -----------------
(Unaudited) (Unaudited)
Net operating revenues $ 21,559,921 $ 22,536,655
Operating expenses
Salaries and benefits 8,317,365 9,778,358
Physician group distribution 6,135,949 6,607,754
Facility rent and related costs 1,247,678 1,291,402
Depreciation and amortization 1,226,791 2,335,745
Professional and consulting fees 1,100,885 1,498,563
Insurance 502,499 679,588
Provision for doubtful accounts 446,041 915,019
Other expenses 3,646,413 3,855,454
------------ ------------
Total operating expenses 22,623,622 26,961,884
------------ ------------
Loss from continuing operations before other income (expenses) (1,063,701) (4,425,229)
------------ ------------
Other income (expenses)
Interest expense (356,313) (247,569)
Gain on forgiveness of debt 665,463 --
Other expense, net (18,517) (24,098)
------------ ------------
Total other income (expenses), net 290,633 (271,667)
------------ ------------
Minority interest earnings in partnership -- (1,660)
------------ ------------
Loss from continuing operations (773,068) (4,698,556)
Discontinued operations
Income (loss) from operations of discontinued components 576,390 (11,412,149)
------------ ------------
Net loss $ (196,678) $(16,110,705)
============ ============
Weighted average common shares outstanding
Basic 12,600,820 9,766,413
Diluted 12,600,820 9,766,413
Income (loss) per share
Basic
Net loss per share from continuing operations $ (0.06) $ (0.48)
Net income (loss) per share from discontinued operations $ 0.05 $ (1.17)
------------ ------------
Net loss per share $ (0.01) $ (1.65)
============ ============
Diluted
Net loss per share from continuing operations $ (0.06) $ (0.48)
Net income (loss) per share from discontinued operations $ 0.05 $ (1.17)
------------ ------------
Net loss per share $ (0.01) $ (1.65)
============ ============
The accompanying notes are an integral part of these consolidated condensed
financial statements.
F-4
Orion HealthCorp, Inc.
Consolidated Statements of Cash Flows
For the Three Months Ended September 30,
2006 2005
---------------------------------------------
"Revised"
Operating activities
Net loss $ (487,706) $ (6,082,287)
Adjustments to reconcile net loss to net
cash provided by (used in) operating activities:
Provision for doubtful accounts 146,895 278,184
Depreciation and amortization 407,964 608,544
Stock option compensation expense 49,642 -
Impact of discontinued operations - 4,761,898
Changes in operating assets and liabilities:
Accounts receivable (562,070) 592,069
Inventory (111,817) 14,496
Prepaid expenses and other assets (113,116) (72,158)
Other assets 1,400 21,453
Accounts payable and accrued expenses 447,891 (289,615)
Deferred revenues and other liabilities - 45,014
---------------------------------------------
Net cash used in operating activities (220,919) (122,402)
---------------------------------------------
Investing activities
Sale (purchase) of property and equipment (36,785) 12,051
Impact of discontinued operations - 81,878
---------------------------------------------
Net cash provided by (used in) investing activities (36,785) 93,929
---------------------------------------------
Financing activities
Net repayments of capital lease obligations (22,463) (39,186)
Net borrowings on line of credit 9,614 579,151
Net repayments of notes payable 409 (12,235)
Net borrowings (repayments) of other obligations 42,016 (39,243)
---------------------------------------------
Net cash provided by financing activities 29,576 488,487
---------------------------------------------
Net increase (decrease) in cash and cash equivalents (228,128) 460,014
Cash and cash equivalents, beginning of quarter 328,923 311,084
---------------------------------------------
Cash and cash equivalents, end of quarter $ 100,795 $ 771,098
=============================================
Supplemental cash flow information
Cash paid during the quarter for
Income taxes $ - $ -
Interest $ 93,419 $ 68,428
The accompanying notes are an integral part of these consolidated condensed
financial statements.
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.
F-5
Orion HealthCorp, Inc.
Consolidated Statements of Cash Flows
For the Nine Months Ended September 30,
2006 2005
-------------------------------------------
"Revised"
Operating activities
Net loss $ (196,678) $(16,110,705)
Adjustments to reconcile net loss to net
cash provided by (used in) operating activities:
Minority interest in earnings of partnerships - 1,660
Provision for doubtful accounts 446,041 915,019
Depreciation and amortization 1,226,791 2,335,745
Gain on forgiveness of debt (665,463) -
Stock option compensation expense 147,354 -
Conversion of notes payable to common stock - 57,886
Impact of discontinued operations 230,743 11,141,434
Changes in operating assets and liabilities:
Accounts receivable (392,776) (229,122)
Inventory (75,860) (10,742)
Prepaid expenses and other assets (199,028) (154,849)
Other assets 14,342 12,859
Accounts payable and accrued expenses (894,869) (139,662)
Deferred revenues and other liabilities - 29,018
-------------------------------------------
Net cash used in operating activities (359,403) (2,151,458)
-------------------------------------------
Investing activities
Sale (purchase) of property and equipment (49,796) 32,195
Impact of discontinued operations 430,244 317,754
-------------------------------------------
Net cash provided by investing activities 380,448 349,949
-------------------------------------------
Financing activities
Net repayments of capital lease obligations (68,162) (164,835)
Net borrowings (repayments) on line of credit (408,607) 943,664
Net borrowings of notes payable - 1,140,360
Net repayments of notes payable 389,556
Net borrowings (repayments) of other obligations 168,156 (48,428)
Impact of discontinued operations (300,000) -
-------------------------------------------
Net cash provided by (used in) financing activities (219,058) 1,870,761
-------------------------------------------
Net increase (decrease) in cash and cash equivalents (198,012) 69,252
Cash and cash equivalents, beginning of period 298,807 701,846
-------------------------------------------
Cash and cash equivalents, end of period $ 100,795 $ 771,098
===========================================
Supplemental cash flow information
Cash paid during the period for
Income taxes $ - $ -
Interest $ 271,000 $ 187,606
The accompanying notes are an integral part of these consolidated condensed
financial statements.
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.
F-6
ORION HEALTHCORP, INC.
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
SEPTEMBER 30, 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 and nine months ended September 30, 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.
These financial statements have been prepared in accordance
with GAAP for interim financial reporting and in accordance with the
instructions to Form 10-QSB and Item 310-(b) of Regulation S-B. Accordingly,
they do not contain all of the information and footnotes required by GAAP for
complete financial statements. In the opinion of management, the accompanying
unaudited consolidated condensed financial statements include adjustments
consisting of only normal recurring adjustments necessary for a fair
presentation of the Company's financial position and results of operations and
cash flows of the interim periods presented. The results of operations for any
interim period are not necessarily indicative of results for the full year.
The accompanying unaudited consolidated condensed financial
statements should be read in conjunction with the financial statements and
related notes therein included in the Company's Annual Report on Form 10-KSB/A
for the year ended December 31, 2005.
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.
F-7
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 59 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
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 September 30, 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 September 30, 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").
F-8
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.
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 $0 and $14,669 for the three months
ended September 30, 2006 and 2005, respectively. For the nine months ended
September 30, 2006 and 2005, management fee revenue related to TOM was $7,217
and $32,020, 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 $0 and $20,135 for the three months
ended September 30, 2006 and 2005, respectively. For the nine months ended
September 30, 2006 and 2005, management fee revenue related to TASC was $22,525
and $72,173, 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.
F-9
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.
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 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 September 30, 2006.
F-10
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 September 30, 2006, if Brantley IV were to convert
the First Note, the Company would have to issue 1,121,251 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 August 8, 2006, Brantley IV and the
Company executed a second amendment to the First Note (the "First and Second
Note Second Amendment") extending the First Note Maturity Date to October 15,
2006, and as of October 15, 2006, Brantley IV and the Company executed a third
amendment to the First Note (the "First and Second Note Third Amendment")
further extending the First Note Maturity Date to November 30, 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 September 30, 2006, if
Brantley IV were to convert the Second Note, the Company would have to issue
244,294 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. On August 8, 2006, Brantley IV and the Company
executed the First and Second Note Second Amendment extending the Second Note
Maturity Date to October 15, 2006, and as of October 15, 2006, Brantley IV and
the Company executed the First and Second Note Third Amendment further extending
the Second Note Maturity Date to November 30, 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.
F-11
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 and nine months ended September 30, 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 September 30, 2006, the outstanding principal
under the revolving credit facility was $1,008,282. The full amount of the loan
as of September 30, 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. The Company is currently negotiating the terms of a new
senior secured credit facility in the aggregate principal amount of $16,500,000,
consisting of a $2,000,000 revolving loan commitment, a $4,500,000 term loan and
a $10,000,000 acquisition facility commitment available for future acquisitions.
The proceeds from the new facility would be used to repay the Company's current
credit facility with CIT and provide capital to enable the Company to execute
components of its strategic plan, including acquisition opportunities, two of
which are described in greater detail below. If the Company is unable to reach
an agreement on a credit facility with this lender, then we will seek to find
another institutional lender to provide a credit facility on similar terms, but
there is no guarantee that we will be able to find such a lender or be able to
negotiate similar terms to such credit facility.
As of September 30, 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. In 2005 and early 2006, the
Company ceased investment in business lines that did not complement the
Company's strategic plans. 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).
Additionally, the Company redirected financial resources and
company personnel to areas that management believes enhance long-term growth
potential. A key component of the Company's long-term strategic plan was the
identification of potential acquisition targets that would increase the
Company's presence in the markets it serves and enhance stockholder value.
The Company has identified several acquisition opportunities
to expand its business that are consistent with its strategic plan. The Company
signed definitive agreements in September 2006 for the acquisition of two of
these targets and plans to consummate the transactions in the fourth quarter of
2006. The Company also entered into definitive agreements for additional equity
and mezzanine debt financing in September 2006, which it expects to consummate
simultaneously with the two acquisitions. On November 9, 2006, the Company filed
a definitive proxy statement with the Securities and Exchange Commission (the
"SEC") on Form DEF14A with respect to the transactions contemplated by the
definitive agreements, which are described in greater detail below, and set a
special stockholders meeting date of November 27, 2006 for approval of certain
changes in corporate structure which will enable the Company to consummate the
transactions.
The first acquisition involves the purchase of all of the
issued and outstanding capital stock of Rand Medical Billing, Inc. ("Rand").
Rand is a full service billing agency, providing medical billing exclusively for
anatomic and clinical pathology practices located in Simi Valley, California.
On September 8, 2006 the Company entered into a stock purchase
agreement with Rand Medical Billing, Inc. and the stockholder of Rand to
purchase all of the issued and outstanding capital stock of Rand for an
aggregate purchase price of $9,365,333, subject to adjustments conditioned upon
future revenue results. A portion of the purchase price is payable by the
issuance of such number of shares of the Company's Class A Common Stock having a
value of $600,000 based on the average closing price per share of the Company's
Class A Common Stock for the twenty day period prior to the closing of the Rand
acquisition. The remainder of the purchase price is payable in a combination of
cash and the issuance of an unsecured subordinated promissory note in the
original principal amount of $1,365,333. At the closing of the Rand acquisition,
$6,800,000 of the purchase price will be paid in cash and the balance will be
placed in escrow (including the shares of the Company's Class A Common Stock)
pending resolution of the purchase price adjustments and subject to claims, if
any, for indemnification.
F-12
The second acquisition involves the purchase of all the issued
and outstanding capital stock of two related companies, On Line Alternatives,
Inc. ("OLA") and On Line Payroll Services, Inc. ("OLP") (collectively,
"Online").
OLA is an outsourcing company providing data entry, insurance
filing, patient statements, payment posting, collection follow-up and patient
refund processing to medical practices. Most of OLA's customers are
hospital-based physician practices including radiology, neurology and emergency
medicine. Customers also include some other specialties as plastic surgery,
family practice, internal medicine and orthopedics. All billing functions are
the responsibility of OLA, and include credentialing and accounts payable
processing. OLA also has a group of contract transcriptionists who work out of
their homes and OLA offers these services to clients as well.
OLP provides payroll processing services to small businesses,
a few of which are also customers of OLA. OLP provides payroll services
including direct deposit, time clock interface and tax reporting to clients in
Alabama, Florida, Georgia, Louisiana, Mississippi, Tennessee and Texas.
On September 8, 2006 the Company entered into a stock purchase
agreement with OLA, OLP and the stockholders of each of OLA and OLP to purchase
all of the issued and outstanding capital stock of both OLA and OLP for an
aggregate purchase price of $3,310,924, subject to adjustments conditioned upon
future revenue results. The purchase price is payable in a combination of cash
and the issuance of unsecured subordinated promissory notes. At the closing of
the On Line acquisition, $2,476,943 of the purchase price will be paid in cash
and the remainder through the issuance of an unsecured subordinated promissory
note in the original principal amount of $833,981. The Company also has an
option to pay up to $75,000 of the purchase price in the form of an additional
unsecured promissory note in lieu of cash at the closing.
Each of the stock purchase agreements with Rand and On Line
contains customary representations and warranties and terms and conditions to
closing.
In addition to the Rand and On Line agreements, the Company
also entered into a Stock Purchase Agreement on September 8, 2006 with Phoenix
Life Insurance Company ("Phoenix") and Brantley IV (the "Stock Purchase
Agreement"). Pursuant to the terms of the Stock Purchase Agreement, Phoenix and
Brantley IV will purchase, for an aggregate purchase price of $4,650,000, shares
of the Company's Class D Common Stock representing upon conversion 19.375% of
the Company's outstanding Class A Common Stock as of the date of issuance of the
Class D Common Stock, on a fully-diluted basis taking into account the issuance
of the shares of Class D Common Stock but excluding certain of the Company's
outstanding options, warrants and convertible securities and certain shares of
Class B Common Stock to be purchased by the Company from Brantley Capital
Corporation. Since the Company's charter documents do not currently authorize
the issuance of the Company's Class D Common Stock, the Company will amend and
restate its Certificate of Incorporation to provide for such shares upon
shareholder approval.
As of September 30, 2006, Brantley IV owns 7,863,996 shares of
the Company's Class B Common Stock, warrants to purchase 20,455 shares of the
Company's Class A Common Stock and notes which are currently convertible into
1,358,054 shares of the Company's Class A Common Stock. As of September 30,
2006, this represents 31.9% of the Company's voting power and 52.4% of the
Company's voting power on an as converted basis (at the closing price of the
Company's Class A Common Stock on the record date of $0.25 per share). As of
September 30, 2006, Brantley IV and its affiliates own 44.8% of the Company's
voting power and 60.5% of the Company's voting power on an as converted basis
(at the closing price of the Company's Class A Common Stock on the record date
of $0.25 per share).
Phoenix is a limited partner in Brantley IV and Brantley
Partners V, L.P and has also co-invested with Brantley IV and its affiliates in
a number of transactions. Phoenix does not currently own, of record, any shares
of the Company's capital stock. Two of the Company's directors, Paul H. Cascio
and Michael J. Finn, are affiliated with Brantley IV and its related entities.
Paul Cascio and Michael J. Finn serve as general partners of the general partner
of Brantley Venture Partners III, L.P. ("Brantley III") and Brantley IV and are
limited partners in these funds. Neither Phoenix, Brantley IV nor Messrs. Cascio
or Finn is affiliated with Brantley Capital Corporation. The advisor to Brantley
III is Brantley Venture Management III, L.P. and the advisor to Brantley IV is
Brantley Management IV, L.P.
Brantley IV will purchase, for an aggregate purchase price of
$1,650,000, such number of shares of Class D Common Stock representing upon
conversion 6.875% of the Company's outstanding Class A Common Stock as of the
date of issuance of the Class D Common Stock, on a fully-diluted basis taking
into account the issuance of the shares of Class D Common Stock but excluding
certain of the Company's outstanding options, warrants and convertible
securities and certain shares of Class B Common Stock to be purchased by the
Company from Brantley Capital Corporation.
F-13
Phoenix will purchase, for an aggregate purchase price of
$3,000,000, such number of shares of Class D Common Stock, representing upon
conversion 12.5% of the Company's outstanding Class A Common Stock as of the
date of issuance of the Class D Common Stock, on a fully-diluted basis taking
into account the issuance of the shares of Class D Common Stock but excluding
certain of the Company's outstanding options, warrants and convertible
securities and certain shares of Class B Common Stock to be purchased by the
Company from Brantley Capital Corporation.
The Class D Common Stock, upon stockholder approval, will have
the following rights and preferences:
o The holders of the Class D Common Stock will have priority in certain
distributions made to the other holders of Common Stock. The holders
of the shares of Class D Common Stock (other than shares concurrently
being converted into Class A Common Stock), as a single and separate
class, will be entitled to receive all distributions until there has
been paid with respect to each such share from amounts then and
previously distributed an amount equal to 9% per annum on the Class D
issuance amount, without compounding, from the date the Class D Common
Stock is first issued.
o In addition to receiving any accrued but unpaid distributions
described above, the holders of the Class D Common Stock will have the
right to receive distributions pari passu with the holders of the
shares of the Class A Common Stock, assuming for purposes of such
calculation that each share of Class D Common Stock represented one
share of Class A Common Stock (subject to adjustment to such
conversion ratio for subsequent issuances by the Company of shares of
the Company's capital stock, or rights to acquire such shares, for
less than the price the holders of the Class D Common Stock paid for
their shares and for stock splits, combinations, stock dividends and
certain other actions as more fully specified in the Company's
certificate of incorporation).
o The holders of a majority of the Class D Common Stock have the ability
to authorize any payment that might otherwise be considered a
distribution for purposes of the Company's amended and restated
certificate of incorporation to be excluded from the distribution
priority provisions described above.
o Each share of Class D Common Stock will be entitled to one vote. The
Class D Common Stock will vote together with all other classes of the
Company's Common Stock and not as a separate class, except as
otherwise required by law or in the event of certain actions adversely
affecting the rights and preferences of the Class D Common Stock as
more fully specified in the Company's certificate of incorporation.
o At the option of each holder of Class D Common Stock, exercisable at
any time and from time to time by notice to the Company, each
outstanding share of Class D Common Stock held by such investor will
convert into a number of shares of Class A Common Stock equal to the
"Class D Conversion Factor" in effect at the time such notice is
given. The Class D Conversion Factor will initially be one share of
Class A Common Stock for each share of Class D Common Stock, subject
to adjustment to such conversion ratio for subsequent issuances by the
Company of shares of the Company's capital stock, or rights to acquire
such shares, for less than the price the holders of the Class D Common
Stock paid for their shares and for stock splits, combinations, stock
dividends and certain other actions as more fully specified in the
Company's certificate of incorporation.
On September 8, 2006 the Company also entered into a Note
Purchase Agreement with Phoenix (the "Note Purchase Agreement," and together
with the Stock Purchase Agreement, the "Private Placement Agreements"). Pursuant
to the terms of the Note Purchase Agreement, Phoenix will purchase, for an
aggregate purchase price of $3,350,000, (i) the Company's senior unsecured
subordinated promissory notes, due 2011, in the original principal amount of
$3,350,000 and (ii) warrants to purchase shares of the Company's Class A Common
Stock equal to 1.117% of the Company's outstanding Class A Common Stock on the
date of issuance of the warrants, on a fully-diluted basis taking into account
the issuance of the shares of Class D Common Stock described above and the
shares of Class A Common Stock covered by the warrants but excluding certain of
the Company's outstanding options, warrants and convertible securities and
certain shares of Class B Common Stock to be purchased by the Company from
Brantley Capital Corporation.
The Company's senior unsecured subordinated promissory notes
will bear interest at the combined rate of (i) 12% per annum payable in cash on
a quarterly basis and (ii) 2% per annum payable in kind (meaning that the
accrued interest will be capitalized as principal) on a quarterly basis, subject
to the Company's right to pay such amount in cash. The notes will be unsecured
and subordinated to all of the Company's other senior debt. Upon the occurrence
and during the continuance of an event of default the interest rate on the cash
portion of the interest shall increase from 12% per annum to 14% per annum, for
a combined rate of default interest of 16% per annum. The Company may prepay
outstanding principal (together with accrued interest) on the note subject to
certain prepayment penalties and the Company is required to prepay outstanding
principal (together with accrued interest) on the note upon certain specified
circumstances.
F-14
The warrants provide the holder with the right to purchase
shares of the Company's Class A Common Stock equal to 1.117% of the Company's
outstanding Class A Common Stock on the date of issuance of the warrants, on a
fully-diluted basis taking into account the issuance of the shares of Class D
Common Stock described above and the shares of Class A Common Stock covered by
the warrants but excluding certain of the Company's outstanding options and
warrants and certain shares of Class B Common Stock to be purchased by the
Company from Brantley Capital Corporation. The warrants will be exercisable for
five years from the date of issuance of the warrants at $0.01 per share.
Some or all of the proceeds the Company receives upon
consummation of the sale of the Class D Common Stock, senior unsecured
subordinated promissory notes and warrants in the private placement, along with
proceeds from senior bank financing and other funds available to the Company,
will be used to finance a portion of the acquisitions of the Rand and On Line
businesses, the Company's purchase of certain shares of the Company's Class B
Common Stock from Brantley Capital Corporation, to repay certain outstanding
senior indebtedness and for general working capital purposes.
The obligations of Phoenix and Brantley IV to close under the
Private Placement Agreements are subject to the satisfaction or waiver of many
conditions in accordance with each of the Stock Purchase Agreement and Note
Purchase Agreement, including:
o receipt of approval from the Company's stockholders of the amendments
to the Company's certificate of incorporation and issuance of the
Company's shares of Class D Common Stock and Class A Common Stock;
o the absence of any material adverse change in the Company's business
and operations, and the business and operations of the Rand and On
Line businesses, since June 30, 2006;
o in the case of the Stock Purchase Agreement, the filing of the
Company's Second Amended and Restated Certificate of Incorporation
with the Secretary of State of Delaware and its acceptance thereof and
the Company's reservation of a sufficient number of shares of Class A
common Stock for issuance on conversion of the Class D Common Stock;
o the conversion to Class A Common Stock by Brantley IV of the entire
unpaid principal amount of, including accrued but unpaid interest on,
the Company's convertible subordinated promissory notes in the
aggregate original principal amount of $1,250,000;
o consummation, in the case of the Stock Purchase Agreement, of the
transactions contemplated by the Note Purchase Agreement and, in the
case of the Note Purchase Agreement, of the transactions contemplated
by the Stock Purchase Agreement;
o in the case of the Stock Purchase Agreement, consummation by each of
Phoenix and Brantley IV of their respective obligations under the
Stock Purchase Agreement;
o consummation of the acquisitions of the Rand and On Line businesses;
o the accuracy of the Company's representations and warranties in the
Private Placement Agreements as of the closing date taking into
account in certain instances the inclusion of the Rand and On Line
businesses as part of the Company's business;
o delivery of pro forma financial statements giving effect to the
acquisitions of the Rand and On Line businesses, the consummation of
the private placement, the conversion of the Brantley IV notes and the
consummation of senior financing that are satisfactory to Phoenix and
Brantley IV;
o the performance and compliance with all of the covenants made, and
obligations to be performed, by the other parties in the Private
Placement Agreements prior to the closing;
F-15
o the receipt of all requisite third-party consents;
o consummation with one or more senior lenders for the provision of not
less than $6,500,000 of senior secured financing and, in the case of
the Note Purchase Agreement, execution of mutually acceptable
intercreditor and subordination agreement(s) among Phoenix, the
Company's senior lender and certain of the Company's existing debt
holders; and
o conversion of all shares of Class B Common Stock and Class C Common
Stock by the holders thereof into shares of Class A Common Stock or
the Company's acquisition and retirement of all such shares, including
the Company's purchase and retiring of the 1,722,983 shares of Class B
Common Stock held by Brantley Capital Corporation.
In connection with the private placement, the parties will
enter into a registration rights agreement, pursuant to which the holders of a
majority of the shares of Class A Common Stock issuable upon either conversion
of the Class D Common Stock or the exercise of the warrants will have the right
to require the Company to register their shares of Class A Common Stock under
the Securities Act. The agreement allows them one right to demand that the
Company register their shares of Class A Common Stock under the Securities Act
on a registration statement filed with the SEC and unlimited rights to include
(or "piggy-back") the registration of their shares of Class A Common Stock on
certain registration statements that the Company may file with the SEC for other
purposes.
On September 8, 2006 the Company also entered into a purchase
agreement with Brantley Capital Corporation to purchase all 1,722,983 shares of
the Company's Class B Common Stock owned by Brantley Capital Corporation at any
time between now and December 31, 2006 for an aggregate purchase price of
$482,435. Upon the Company's acquisition of these shares of Class B Common Stock
they will be retired in accordance with the terms of the Company's certificate
of incorporation. The Company plans to consummate this purchase simultaneous
with the closing of the private placement. The Company anticipates using a
portion of the proceeds from the private placement, along with proceeds from
senior bank financing and other funds available to the Company, to fund the
purchase price for the Company's purchase of the shares of Class B Common Stock
owned by Brantley Capital Corporation.
These shares represent about 16.5% of the Company's
outstanding shares of Class B Common Stock (and about 11.5% of the Company's
outstanding shares of Class A Common Stock on a fully-diluted basis assuming
conversion as of September 30, 2006) and the Company's acquisition of these
shares will assist the Company in satisfying the closing condition to the
private placement that requires all holders of shares of the Company's Class B
Common Stock and Class C Common Stock to have converted or been acquired by the
Company. Brantley Capital Corporation had previously informed the Company that
they would not convert their shares as required in connection with the
consummation of the private placement and the Company's board of directors
determined that the terms of this acquisition were in the best interests of the
Company's stockholders and the Company's ability to consummate the private
placement.
The transactions contemplated by the foregoing agreements are
all expected to close simultaneously, if stockholder approval is obtained as
required under the Private Placement Agreements and upon satisfaction of the
other relevant closing conditions.
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.
F-16
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 September 30, 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 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
September 30, 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 Statement of Financial Accounting Standards
("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.
F-17
The following table summarizes key financial information, by
reportable segment, as of and for the three months and nine months ended
September 30, 2006 and 2005, respectively:
For the Three Months Ended September 30, For the Nine Months Ended September 30,
2006 2006
------------------------------------------------------------------------------------
IPS MBS Total IPS MBS Total
------------- ------------- ------------- ------------- ------------- --------------
Net operating revenues $ 4,943,588 $ 2,451,464 $ 7,395,052 $ 14,092,619 $ 7,207,517 $ 21,300,136
Income from continuing operations 272,860 230,982 503,842 760,952 569,872 1,330,824
Depreciation and amortization 107,266 282,510 389,776 323,754 848,392 1,172,146
Total assets 8,458,400 9,677,957 18,136,357 8,458,400 9,677,957 18,136,357
For the Three Months Ended September 30, For the Nine Months Ended September 30,
2005 2005
------------------------------------------------------------------------------------
IPS MBS Total IPS MBS Total
------------- ------------- ------------- ------------- ------------- --------------
Net operating revenues $ 4,720,121 $ 2,491,109 $ 7,211,230 $ 14,766,113 $ 7,684,641 $ 22,450,754
Income from continuing operations 271,410 150,838 422,248 813,922 613,737 1,427,659
Depreciation and amortization 107,748 285,180 392,928 352,758 858,062 1,210,820
Total assets 9,792,125 9,930,670 19,722,795 9,792,125 9,930,670 19,722,795
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 three months and nine months ended September 30, 2006 and 2005,
respectively:
Three Months Ended Nine Months Ended
September 30, September 30,
2006 2005 2006 2005
------------ ------------ ------------ ------------
Net operating revenues:
Total net operating revenues for reportable
segments $ 7,395,052 $ 7,211,230 $21,300,136 $22,450,754
Corporate revenue 79,141 44,312 259,785 85,901
------------ ------------ ------------ ------------
Total consolidated net operating revenues $ 7,474,193 $ 7,255,542 $21,559,921 $22,536,655
============ ============ ============ ============
Income (loss) from continuing operations:
Total income from continuing operations for
reportable segments $ 503,842 $ 422,248 $ 1,330,824 $ 1,427,659
Extraordinary gain - - 665,463 -
Corporate overhead (991,547) (2,276,132) (2,769,355) (6,126,215)
------------ ------------ ------------ ------------
Total consolidated income (loss) from
continuing operations $ (487,705) $(1,853,884) $ (773,068) $(4,698,556)
============ ============ ============ ============
Depreciation and amortization:
Total depreciation and amortization for reportable
segments $ 389,776 $ 392,928 $ 1,172,146 $ 1,210,820
Corporate depreciation and amortization 18,188 215,616 54,645 1,124,925
------------ ------------ ------------ ------------
Total consolidated depreciation and
amortization $ 407,964 $ 608,544 $ 1,226,791 $ 2,335,745
============ ============ ============ ============
Total assets:
Total assets for reportable segments $18,136,357 $19,722,795 $18,136,357 $19,722,795
Corporate assets 1,640,670 1,870,063 1,640,670 1,870,063
Assets held for sale or related to discontinued
operations (1) - 8,595,427 - 8,595,427
------------ ------------ ------------ ------------
Total consolidated assets $19,777,027 $30,188,285 $19,777,027 $30,188,285
============ ============ ============ ============
(1) The balance at September 30, 2005 includes $5,522,881 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 Financial Accounting
Standards Board ("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.
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.
F-18
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.
All of the charges for impairment of intangible assets are
included in discontinued operations.
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.
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
2006 2005 2006 2005
-------------- -------------- -------------- ---------------
Net loss $ (487,706) $ (6,082,287) $ (196,678) $ (16,110,705)
Weighted average number of shares of
Class A Common Stock outstanding
for basic net loss per share
12,777,363 11,344,066 12,600,820 9,766,413
Dilutive stock options, warrants
and restricted stock units (a) (a) (a) (a)
Convertible notes payable (b) (b) (b) (b)
Class B Common Stock (c) (c) (c) (c)
Class C Common Stock (d) (d) (d) (d)
Weighted average number of shares of
Class A Common Stock outstanding for
diluted net loss per share
12,777,363 11,344,066 12,600,820 9,766,413
Net loss per share - Basic $ (0.04) $ (0.53) $ (0.01) $ (1.65)
Net loss per share - Diluted $ (0.04) $ (0.53) $ (0.01) $ (1.65)
F-19
The following potentially dilutive securities are not included
in the calculation of weighted average number of shares of Class A Common Stock
outstanding for diluted net loss per share for the three months and nine months
ended September 30, 2006 and 2005, respectively, because the effect would be
anti-dilutive due to the net loss for the periods:
(1) 2,612,347 and 1,786,841 options, warrants and restricted stock units
were outstanding as of September 30, 2006 and 2005, respectively.
(2) $1,300,000 of notes was convertible into Class A Common Stock at
September 30, 2006 and 2005, respectively. Of the total, $50,000 was
convertible into 391,832 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 September 30, 2006. The remaining
$1,250,000 was convertible into 1,365,546 and shares of Class A Common
Stock at September 30, 2006.
(3) 10,448,470 and 10,642,306 shares of Class B Common Stock were
outstanding at September 30, 2006 and 2005, respectively. 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 September 30, 2006 and 2005,
respectively, each share of Class B Common Stock was convertible into
6.564372146119 and 4.158844397612 shares of Class A Common Stock.
(4) 1,437,572 and 1,462,121 shares of Class C Common Stock were
outstanding at September 30, 2006 and 2005, respectively. 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. As
of September 30, 2006 and 2005, respectively, each share of Class C
Common Stock was convertible into 13.7500000 and 8.4615384 shares of
Class A Common Stock under the anti-dilution provision.
Subject to the terms of any preferred stock or any other class
of stock having any preference or priority over the Class A Common Stock, Class
B Common Stock and Class C Common Stock that the Company may issue in the
future, all dividends and other distributions will be made to the holders of
Class A Common Stock, Class B Common Stock and Class C Common Stock in the
following order of priority:
o First, the holders of the shares of Class B Common Stock (other than
shares concurrently being converted into Class A Common Stock), as a
single and separate class, are entitled to receive all distributions
until there has been paid with respect to each such share from amounts
then and previously distributed an amount equal to $1.15 plus an
amount equal to nine percent (9%) per annum on such amount, without
compounding, from the date the Class B Common Stock was first issued.
o Second, the holders of the shares of Class C Common Stock (other than
shares concurrently being converted into Class A Common Stock), as a
single and separate class, are entitled to receive all distributions
until there has been paid with respect to each such share from amounts
then and previously distributed an amount equal to $3.30. After the
full required distributions have been made to the holders of shares of
Class C Common Stock (other than shares concurrently being converted
into Class A Common Stock) as described in the previous sentence, each
share of Class C Common Stock then outstanding will be retired and
will not be reissued.
F-20
o Third, after the full distributions have been made to the holders of
the shares of Class B Common Stock and Class C Common Stock as
described above, all holders of the shares of Class A Common Stock and
Class B Common Stock, as a single class, shall thereafter be entitled
to receive all remaining distributions pro rata based on the number of
outstanding shares of Class A Common Stock or Class B Common Stock
held by each holder, provided that for purposes of such remaining
distributions, each share of Class B Common Stock will be deemed to
have been converted into one share of Class A Common Stock (subject to
adjustment to account for stock splits, stock dividends, combinations
or other similar events affecting the Class A Common Stock).
NOTE 8. EMPLOYEE STOCK-BASED COMPENSATION
At September 30, 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. On
May 12, 2006, the Company granted 102,000 stock options to certain employees and
directors of the Company under the Company's 2004 Incentive Plan, as amended.
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 and nine months ended September 30, 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
$49,642 and $97,713, respectively, with a corresponding decrease in the
Company's income from continuing operations, income before provision for income
taxes and net income resulting from the 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.
F-21
The following table illustrates the pro forma net income and
earnings per share that would have resulted in the three months and nine months
ended September 30, 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 forma net income and earnings per share for the
three months and nine months ended September 30, 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 SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
2006 2005 2006 2005
-------------- -------------- -------------- --------------
Net income (loss) - as reported $ (487,706) $ (6,082,287) $ (196,678) $ (16,110,705)
Add: Stock-based employee
compensation included in net income (loss)
49,642 -- 147,354 --
Deduct: Total stock-based employee
compensation (expense determined under the fair
value-based method for all awards),
net of tax effect
(49,642) (45,831) (147,354) (109,589)
----------------------------------------------------------------------------
Net loss - pro forma $ (487,705) $ (6,128,118) $ (196,678) $ (16,220,294)
============================================================================
Net loss per share:
Basic - as reported $ (0.04) $ (0.53) $ (0.01) $ (1.65)
Basic - pro forma $ (0.04) $ (0.53) $ (0.01) $ (1.66)
Diluted - as reported $ (0.04) $ (0.53) $ (0.01) $ (1.65)
Diluted - pro forma $ (0.04) $ (0.53) $ (0.01) $ (1.66)
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 and nine months
ended September 30, 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 and nine months
ended September 30, 2005:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2005 SEPTEMBER 30, 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 $ -- $ --
------------------- -------------
F-22
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
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 and nine
months ended September 30, 2005. There were no operations for this component in
the Company's financial statements after March 31, 2005.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2005 SEPTEMBER 30, 2005
------------------ ------------------
Income statement data:
Net operating revenues $ -- $ 848,373
Operating expenses -- 809,673
------------------- -------------
Net loss $ -- $ 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 and nine months ended September
30, 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 and nine months ended
September 30, 2005:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2005 SEPTEMBER 30, 2005
------------------ ------------------
Income statement data:
Net operating revenues $ -- $ 191,771
Operating expenses -- 899,667
------------------- -------------
Net loss $ -- $ (707,896)
------------------- -------------
Balance sheet data:
Current assets $ -- $ --
Other assets -- --
------------------- -------------
Total assets $ -- $ --
------------------- -------------
Current liabilities $ -- $ --
Other liabilities -- --
------------------- -------------
Total liabilities $ -- $ --
------------------- -------------
F-23
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 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 determined that
the joint venture interests associated with TASC and TOM were impaired and
recorded a charge for impairment of intangible assets related to TASC and TOM of
$2,122,445 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 and nine months
ended September 30, 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 and nine months ended
September 30 2005:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2005 SEPTEMBER 30, 2005
------------------ ------------------
Income statement data:
Net operating revenues $ 737,355 $ 2,408,156
Operating expenses 827,429 2,467,111
----------- -----------
Net loss $ (90,074) $ (58,956)
----------- -----------
Balance sheet data:
Current assets $ 641,172 $ 641,172
Other assets 1,398,449 1,398,449
----------- -----------
Total assets $ 2,039,621 $ 2,039,621
----------- -----------
Current liabilities $ 617,186 $ 617,186
Other liabilities 828,312 828,312
----------- -----------
Total liabilities $ 1,445,498 $ 1,445,498
----------- -----------
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 $38,440 recorded in the fourth quarter of
2005) 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 and nine months ended September 30, 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 and nine months ended September
30, 2005:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2005 SEPTEMBER 30, 2005
------------------ ------------------
Income statement data:
Net operating revenues $106,151 $322,470
Operating expenses 103,440 314,049
-------- --------
Net income $ 2,711 $ 8,421
-------- --------
Balance sheet data:
Current assets $102,924 $102,924
Other assets 14,066 14,066
-------- --------
Total assets $116,990 $116,990
-------- --------
Current liabilities $ 21,778 $ 21,778
Other liabilities -- --
-------- --------
Total liabilities $ 21,778 $ 21,778
-------- --------
F-24
MEMORIAL VILLAGE. As a result of the uncertainty of future
cash flows related to our surgery center business as well as the transactions
related to TASC and TOM, the Company determined that the joint venture interest
associated with Memorial Village was impaired and recorded a charge for
impairment of intangible assets related to Memorial Village of $3,229,462 for
the three months ended June 30, 2005. 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 an
additional charge for impairment of intangible assets of $1,348,085 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 and nine months ended September 30, 2006 and 2005, respectively.
The following table contains selected financial statement data
related to Memorial Village as of and for the three months and nine months ended
September 30, 2006 and 2005, respectively:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2006 SEPTEMBER 30, 2005 SEPTEMBER 30, 2006 SEPTEMBER 30, 2005
------------------ ------------------ ------------------ ------------------
Income statement data:
Net operating revenues $ -- $ 61,046 $ 17,249 $ 1,329,899
Operating expenses -- 817,575 170,285 2,320,322
------- --------- --------- -----------
Net loss $ -- $(756,529) $(153,036) $ (990,423)
------- --------- --------- -----------
Balance sheet data:
Current assets $ -- $ 414,255 $ -- $ 414,255
Other assets -- 552,107 -- 552,107
------- --------- --------- -----------
Total assets $ -- $ 966,362 $ -- $ 966,362
------- --------- --------- -----------
Current liabilities $ -- $ 940,149 $ -- $ 940,149
Other liabilities 52,546 52,546
------- --------- --------- -----------
Total liabilities $ -- $ 992,695 $ -- $ 992,695
------- --------- --------- -----------
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. As a result of the uncertainty of future cash flows related to the
surgery center business, and in conjunction with the transactions related to
TASC and TOM, the Company determined that the joint venture interest associated
with San Jacinto was impaired and recorded a charge for impairment of intangible
assets related to San Jacinto of $734,522 for the three months ended June 30,
2005. The Company also recorded an additional $2,113,262 charge for impairment
of intangible assets for the three months ended September 30, 2005 related to
the management contracts with San Jacinto. 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. There were no
operations for this component in our financial statements after March 31, 2006.
F-25
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 $0 and
$61,039, respectively, for the three months and nine months ended September 30,
2006. For the three months and nine months ended September 30, 2005, the Company
generated management fee revenue of $101,662 and $320,069, respectively, and net
minority interest losses totaling $24,823 and $67,588, respectively. For the
quarters ended June 30, 2005 and December 31, 2005, the Company recorded a
charge for impairment of intangible assets of $276,420 and $142,377,
respectively, related to trained work force and non-compete agreements affected
by the surgery center operations the Company discontinued in 2005 and early
2006.
The following table summarizes the components of income (loss) from
operations of discontinued components:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2006 SEPTEMBER 30, 2005 SEPTEMBER 30, 2006 SEPTEMBER 30, 2005
------------------ --------------------------------------------------------
Bellaire SurgiCare
Net loss $-- $ -- $ -- $ (188,418)
Loss on disposal -- -- -- (163,049)
CARDC
Net income -- -- -- 38,700
Gain on disposal -- -- -- 268,292
IntegriMED
Net loss -- -- -- (707,896)
Loss on disposal -- -- -- (47,101)
TASC and TOM
Net loss -- (90,074) -- (58,956)
Loss on disposal -- -- -- (2,122,445)
Sutter
Net income -- 2,711 -- 8,421
Memorial Village
Net loss -- (756,529) (153,036) (990,423)
Gain (loss) on disposal -- (1,348,085) 574,321 (4,577,547)
San Jacinto
Gain (loss) on disposal -- (2,113,262) 94,066 (2,847,784)
Orion
Net income -- 76,835 61,039 (23,943)
----------------------------------------------------------------------------
Total income (loss) from operations
of discontinued components, including
net gain (loss) on disposal $-- $(4,228,403) $ 576,390 $(11,412,149)
============================================================================
F-26
NOTE 10. LONG-TERM DEBT
Long-term debt is as follows:
SEPTEMBER 30, 2006 DECEMBER 31, 2005
------------------ -----------------
Promissory note due to sellers of MBS, bearing interest at 8%,
interest payable monthly or on demand, matures December 15, 2007 $ 1,714,336 $ 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 $654,010 and $641,467, respectively 3,096,134 3,108,677
Revolving line of credit with a financial institution,
bearing interest at 6.5%, interest payable monthly or on demand (1) -- 778,006
$2,300,000 revolving line of credit, bearing interest at prime
(8.25% at September 30, 2006) plus 6%, interest payable
monthly, matures December 14, 2006 (2) 1,008,282 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 168,156 --
Convertible promissory notes due to a related party,
bearing interest at 9%, mature November 30, 2006 1,250,000 1,250,000
----------- -----------
Total long-term debt 7,286,908 8,103,268
Less: current portion of long-term debt (3,491,527) (4,231,675)
----------- -----------
Long-term debt, net of current portion $ 3,795,381 $ 3,871,593
=========== ===========
(1) As of March 13, 2006, the Company had retired approximately $778,000 of
debt at a discounted price of $112,500.
(2) 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 September 30,
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 September 30, 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.
F-27
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 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, the Company was named as a defendant in a
suit entitled American International Industries, Inc. ("AII") vs. Orion
HealthCorp, Inc. (previously known as SurgiCare, Inc.), Keith G. LeBlanc, Paul
Cascio, Brantley Capital Corporation, Brantley Venture Partners III, L.P.,
Brantley Partners IV, L.P. (collectively, "the Named Defendants") and UHY Mann
Frankfort Stein & Lipp CPAs, LLP ("UHY Mann") in the 80th Judicial District
Court of Harris County, Texas, Cause No. 2005-44326. The case involved
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 AII to convert its SurgiCare Class AA convertible preferred stock into
shares of the Company's Class A Common Stock. AII asserted that the value of its
Class A Common Stock of Orion had fallen as a direct result of the alleged
material misrepresentations by the Company. AII was seeking an aggregate of
$7,600,000 in damages (actual damages of $3,800,000 and punitive damages of
$3,800,000), and rescission of the agreement to convert the SurgiCare Class AA
convertible preferred stock into Class A Common Stock. On September 8, 2006, the
Company entered into a Settlement Agreement with a Joint and Mutual Release and
Indemnity Agreement (the "AII Settlement Agreement") in which the claims by AII
against the Named Defendants were fully settled as to all claims, with complete
mutual releases for all of the Named Defendants and AII. Under the terms of the
AII Settlement Agreement, AII will receive $750,000, paid primarily by various
insurance carriers of the Named Defendants, on or before 45 days from the
execution of the AII Settlement Agreement. As part of the AII Settlement
Agreement, the Named Defendants vigorously denied any liability and AII
acknowledged the highly disputed nature of its claims against the Named
Defendants. Both the Named Defendants and AII acknowledged that the AII
Settlement Agreement was made as a compromise to avoid further expense and to
terminate for all time the controversy underlying the lawsuit.
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 October 15, 2006, Brantley IV and the Company executed
the First and Second Note Third Amendment, which extends the First Note Maturity
Date and Second Note Maturity Date to November 30, 2006. (See Note 2. Going
Concern).
On November 1, 2006, the Company issued 125,000 shares of
Class A Common Stock to Keith LeBlanc, former president of the Company, in
connection with restricted stock units that were granted to him on August 31,
2005. Per the terms of Mr. LeBlanc's separation agreement, 125,000 of the
250,000 restricted stock units vested on January 1, 2006 and the remaining
125,000 units will vest on January 1, 2007. In the separation agreement, Mr.
LeBlanc agreed to refrain from trading any of the restricted stock units for a
period of one year commencing on November 1, 2005.
F-28
On November 9, 2006, the Company filed a definitive proxy
statement with the SEC on Form DEF14A with respect to the transactions
contemplated by the Rand Stock Purchase Agreement, the Online Stock Purchase
Agreement, the Private Placement Agreements and the Purchase Agreement, which
are described in Note 2. Going Concern, and set a special stockholders meeting
date of November 27, 2006 for approval of certain changes in corporate structure
which will enable the Company to consummate the aforementioned transactions.
F-29
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
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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