News Column

UNIVERSITY GENERAL HEALTH SYSTEM, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

February 3, 2014

Forward Looking Statements This quarterly report on Form 10-Q contains "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements other than statements of historical facts included in this quarterly report including, without limitation, statements in the Management's Discussion and Analysis of Financial Condition and Results of Operations included in this quarterly report on Form 10-Q, regarding the Company's financial condition, estimated working capital, business strategy, the plans and objectives of the Company's management for future operations and those statements preceded by, followed by or that otherwise include the words "expects" or "does not expect", "is expected", "anticipates" or "does not anticipate", "plans", "estimates", "approximately", "believes", "continue", "forecast", "ongoing", "pending", "potential", "seeks", "views", or "intends", or stating that certain actions, events or results "may", "must", "could", "would", "might", "should" or "will" be taken, occur or be achieved are not statements of historical fact and may be forward-looking statements. Forward-looking statements are subject to a variety of known and unknown risks, uncertainties and other factors which could cause actual events or results to differ from those expressed or implied by the forward-looking statements, including, without limitation: risks related to environmental laws and regulations and environmental risks; risks related to changes in and the competitive nature of the healthcare industry; risks related to stock price and volume volatility; risks related to the Company's ability to access capital markets; risks related to the Company's ability to successfully implement its business and acquisition strategies; risks related to the Company's issuance of additional shares of common stock. Readers should consider the risks and uncertainties described in the Company's Annual Report on Form 10-K for the year ended December 31, 2011 ("Form 10-K"). Readers should carefully review the Form 10-K in its entirety including, but not limited to, its financial statements and the notes thereto and the risks and uncertainties described in Item 1A-"Risk Factors" of the Form 10- K. Forward -looking statements contained in this Form 10-Q are as of the date of this Form 10-Q. The Company does not undertake to update its forward-looking statements. General University General Health System, Inc. ("UGHS" or the "Company") is a diversified, integrated multi-specialty health care provider that delivers concierge physician- and patient-oriented services by providing timely, innovative health solutions that are uniquely competitive, efficient, and adaptive in today's health care delivery environment. The Company currently operates two general acute care hospitals, a 69-bed facility in Houston and a 111-bed facility in Dallas , ambulatory surgical centers ("ASC"s), hyperbaric wound care centers, diagnostic imaging centers, anesthesia and pain management institute, physical therapy centers, a sports and rehabilitation center, sleep centers, senior living facilities, three of which are owned and all of which are managed by the majority-owned management company. The Company also offers billing, coding and other revenue cycle management services as well as food, hospitality, and other services to both its facilities and outside clients. The Company plans to complete additional complementary acquisitions in future years in Texas and other markets. The Company made progress on a number of its key initiatives during the nine months ended September 30, 2013 (the "current year"). The Company completed five acquisitions during the current year, UGH Woodlands Physical Therapy, UGH Physical Therapy of Ennis , Living Well Diagnostic Imaging Center, Texas Anesthesia and Pain Management Institute and Waxahachie Diagnostic Center . In addition, the Company completed other smaller acquisitions of physician services located in Houston of Texas . These acquisitions further contribute to the expansions of the Company's regional network in the Houston and Dallas metropolitan areas. 29 -------------------------------------------------------------------------------- Table of Contents The financial information, discussion and analysis that follow should be read in conjunction with The Company's Consolidated Financial Statements as included in the Form 10-K. Results of Operations Three Months Ended September 30, 2013 Compared to Three Months Ended September 30, 2012 The following table contains the Company's consolidated and segments results of operations for the three months ended September 30, 2013 and 2012: Three Months Ended September 30, (1) 2013 2012 Amount % of Revenues Amount % of Revenues Variance Revenues Hospital $ 45,379,168 91.6 % $ 33,274,349 92.4 % $ 12,104,819 Senior living 2,077,732 4.2 2,043,499 5.7 34,233 Support services 2,094,797 4.2 702,543 2.0 1,392,254 Total Revenues 49,551,697 100.0 36,020,391 100.0 13,531,306 Operating expenses Salaries, wages and benefits 20,074,367 40.5 10,448,799 29.0 9,625,568 Medical supplies 8,183,573 16.5 4,820,777 13.4 3,362,796 General and administrative expenses (includes related party expenses of $144,600 and $372,697 , respectively) 15,775,004 31.8 7,222,741 20.1 8,552,263 Gain on extinguishment of liabilities - - (618,353 ) (1.7 ) 618,353 Depreciation and amortization (includes related party expenses of $0 and $171,290 , respectively) 2,677,210 5.4 2,443,747 6.8 233,463 Total operating expenses 46,710,154 94.3 24,317,711 67.5 22,392,443 Operating income 2,841,543 5.7 11,702,680 32.5 (8,861,137 ) Other income (expense) Interest expense, net of interest income of $21,500 and $20,000 , respectively (includes related party interest expense $29,614 and $571,394 , respectively) (1,858,474 ) (3.8 ) (1,363,821 ) (3.8 ) (494,653 ) Other income (expense) - - (252,970 ) (0.7 ) 252,970 Direct investor expense - - (857,674 ) (2.4 ) 857,674 Change in fair market value of derivatives 302,500 0.6 (5,173,513 ) (14.4 ) 5,476,013 Income before income tax 1,285,569 2.6 4,054,702 11.3 (2,769,133 ) Income tax expense 143,499 0.3 2,271,631 6.3 (2,128,132 ) Income before noncontrolling interest 1,142,070 2.3 1,783,071 5.0 (641,001 ) Net income attributable to noncontrolling interests 72,893 0.1 212,131 0.6 (139,238 ) Net income attributable to Company $ 1,214,963 2.5 % $ 1,995,202 5.5 % $ (780,239 ) Less: Cash dividend-Convertible Preferred C Stock 6,359 0.0 (53,387 ) (0.1 ) 59,746 Less: Accretion non-cash dividend-Convertible Preferred C Stock (241,023 ) (0.5 ) (145,562 ) (0.4 ) (95,461 ) Net income attributable to common shareholders $ 980,299 2.0 % $ 1,796,253 5.0 % $ (815,954 ) (1) Percentages may not foot due to rounding. Consolidated Results of Operations Revenues for the third quarter of 2013 increased $13,531,306 , or 37.6%, to $49,551,697 as compared to $36,020,391 for the third quarter of 2012. The increase in revenues was driven by the increase in surgeries 545, or 26.5%, to 2,603 for the third quarter of 2013 as compared to 2,058 for the third quarter of 2012. The acquisitions of hospital outpatient departments (HOPDs) and the UGH Dallas contributed to additional revenues of $12,253,695 for the third quarter of 2013. Salaries, wages and benefits expenses in the third quarter of 2013 increased $9,625,568 or 92.1%, to $20,074,367 from $10,448,799 for the third quarter of 2012. As a percentage of revenues, salaries, wages and benefits increased to 40.5% in the third quarter of 2013 from 29.0% in third quarter of 2012. The increase in the salaries, wages and benefits was primarily due to the acquisitions of HOPDs and the UGH Dallas hospital, coupled with compensation increases within the industry and adjustments to cost of living. Medical supplies expense in the third quarter of 2013 increased $3,362,796 , or 69.8%, to $8,183,573 from $4,820,777 in the third quarter of 2012. On an adjusted patient day ("APD") basis, medical expenses during the third quarter of 2013 increased approximately by 20.9% or $775 per APD from $641 per APD in the third quarter of 2012. As a percentage of revenues, medical supplies expense increased to 16.5% in the third quarter of 2013 as compared to 13.4% in third quarter of 2012. Medical supplies rate increased in the third quarter of 2013 due to an increase in net revenues as a result of HOPDs and the UGH Dallas hospital acquisitions, coupled with an increase in the number of surgeries performed as compared to the third quarter of 2012. 30 -------------------------------------------------------------------------------- Table of Contents General and administrative ("G&A") expenses in the third quarter of 2013 increased $8,552,263 or 118.4%, to $15,775,004 from $7,222,741 in the third quarter of 2012. The increase in G&A expenses was due to the acquisitions of HOPDs and UGH Dallas hospital. In addition, the increase was due to increases in marketing and advertising, management fees and purchased services. Marketing and advertising expenses were up as part of the Company's initiatives and strategies to increase revenues. As a percentage of revenues, G&A expenses increased to 31.8% in third quarter of 2013 from 20.1% in the third quarter of 2012. Gain on extinguishment of liabilities in the third quarter of 2012 was $618,353 . The Company recognized the gain on extinguishment in relation to accounts payable settlement. From time to time, the Company settled certain accounts payable with vendors and reduced the accounts payable owed to those vendors. In addition, in connection with the cancellation of obligations with a debt holder during the quarter ended September 30, 2012 , the Company recognized a gain of $0.1 million representing the portion of principal balance and accrued interest. Depreciation and amortization expense was $2,677,210 in the third quarter of 2013 as compared to $2,443,747 the third quarter of 2012, as a result of acquisitions of HOPDs and the UGH Dallas hospital. The increase in amortization expense primarily resulted from the amortization expense of debt issuance costs, customer relationship, tradename, software and non-compete intangibles, offset by some assets being fully depreciated in the current year as compared to prior year third quarter. Net interest expense was $1,858,474 in the third quarter of 2013 as compared to $1,363,821 in the third quarter of 2012. Interest expense is primarily comprised of interest on borrowings under the lines of credit, interest on financing lease obligations, related party notes and debt obligations. The increase in interest expense in the third quarter of 2013, as compared to the prior year third quarter, was attributable to an increase in the Company's average outstanding debt balance and debt assumed from the acquisitions. In addition, the Company's Revolving Credit Facility (see "Liquidity and Capital Resources") had an average daily borrowing balance of $349,517 in the third quarter of 2013. The Company is subject to a tax mandated by the State of Texas based on a defined calculation of gross margin (the "margin tax"). The margin tax is calculated by applying a tax rate to a base that considers both revenue and expenses and therefore has the characteristics of an income tax. As a result, the Company recorded $143,499 and $99,000 in state income tax expense in the quarters ended September 30, 2013 and 2012, respectively. As fully described in Notes 11 and 13 to the Consolidated Financial Statements, the Company issued preferred stock and the related common stock warrant in May 2012 , which do not have readily determinable fair values and therefore require significant management judgment and estimation. The Company uses the Binomial pricing model to estimate the fair value of warrant and preferred stock conversion features at the end of each applicable reporting period. Changes in the fair value of these derivatives during each reporting period are included in the statement of income. As a result, the change in fair market value of derivatives was $302,500 in the third quarter of 2013 as compared to $5,173,513 in the third quarter of 2012. The total direct investor income was nil in the third quarter of 2013 as compared to direct investor expense $857,674 in the third quarter of 2012. The change in the direct investor expense and change in fair market value of derivatives were primarily due to the amendments to C Series Preferred and warrants. In December 2012 , certain warrants shareholders agreed to waive all full ratchet price protection and in March 2013 , all C Series Preferred shareholders agreed to waive all full ratchet price protection. As of the date of the amendments, the Company reclassified the fair market value of derivatives to additional paid in capital as the derivative ceased to exist. As a result of the foregoing, the Company had net income attributable to the Company of $1,214,963 for the third quarter of 2013 as compared to a net income of $1,995,202 for the third quarter of 2012. Segment Results of Operations Hospital Revenues for the third quarter of 2013 increased by $12,104,819 , or 36.4%, to $45,379,168 as compared to $33,274,349 for the third quarter of 2012. The increase in revenues was driven by the increase in surgeries 545, or 26.5% to 2,603 for the third quarter of 2013 as compared to 2,058 for the third quarter of 2012. The acquisitions of hospital outpatient departments (HOPDs) and the UGH Dallas contributed to additional revenues of $12,253,695 for the third quarter of 2013. 31 -------------------------------------------------------------------------------- Table of Contents Provision for doubtful accounts during the third quarter of 2013 increased $12,388,062 to 26.9% of net revenue before the provision for doubtful accounts as compared to 9.9% of net revenue before the provision for doubtful accounts during the third quarter of 2012. The increase was a result of the deterioration of the accounts receivable aging. The Company adopted the provisions of Accounting Standards Update No. 2011-07, Presentation and Disclosure of Patient Service Revenue, Provision for Bad Debts, and the Allowance for Doubtful Accounts for Certain Health Care Entities ("ASU 2011-07"), during the period ended March 31, 2012 . ASU 2011-07 requires health care entities to change the presentation of the statement of operations by reclassifying the provision for doubtful accounts from an operating expense to a deduction from patient service revenues. All periods presented have been reclassified in accordance with ASU 2011-07. Day's revenues outstanding were 65 days at September 30, 2013 as compared to 73 days at December 31, 2012 . To calculate day's revenues outstanding, the Company divides its average accounts receivable net of allowance for doubtful accounts by its net revenues per day. Net revenues per day is calculated by dividing revenues for the periods by the number of calendar days in the periods. The day's revenues outstanding decrease in the third quarter of 2013 was related to the increase in the allowance due to the deterioration of the accounts receivable aging. Salaries, wages and benefits in third quarter of 2013 increased $8,351,684 , or 108.0%, to $16,081,414 from $7,729,730 in the third quarter of 2012. As a percentage of revenues, salaries, wages and benefits increased to 35.4% in the second quarter of 2013 from 23.2% in the third quarter of 2012. The increase in the salaries, wages and benefits rate was primarily due to the acquisitions of HOPDs and the UGH Dallas hospital. Medical supplies expense in the third quarter of 2013 increased $3,362,796 , or 69.8%, to $8,183,573 from $4,820,777 in the third quarter of 2012. On an adjusted patient day ("APD") basis, medical expenses during the third quarter of 2013 increased approximately by 20.9% or $775 per APD from $641 per APD in the third quarter of 2012. As a percentage of revenues, medical supplies expense increased to 18.0% in the third quarter of 2013 as compared to 14.5% in third quarter of 2012. Medical supplies rate increased in the third quarter of 2013 due to an increase in net revenues as a result of HOPDs and the UGH Dallas hospital acquisitions, coupled with an increase in the number of surgeries performed as compared to the third quarter of 2012. General and administrative expenses in the third quarter of 2013 increased $6,695,935 , or 103.7%, to $13,155,101 from $6,459,166 in the third quarter of 2012. The increase in G&A expenses was due to the acquisitions of HOPDs and UGH Dallas hospital, coupled with increases in marketing and advertising, management fees, legal fees, and purchased services. Marketing and advertising expenses were up as part of the Company's initiatives and strategies to increase revenues. Gain on extinguishment of liabilities in the third quarter of 2012 was $618,353 . The Company recognized the gain on extinguishment in relation to accounts payable settlement. From time to time, the Company settled certain accounts payable with vendors and reduced the accounts payable owed to those vendors. In addition, in connection with the cancellation of obligations with a debt holder during the quarter ended September 30, 2012 , the Company recognized a gain of $0.1 million representing the portion of principal balance and accrued interest. Depreciation and amortization expense in the third quarter of 2013 increased by $495,592 , or 31.8%, to $2,054,134 as compared to $1,558,542 in the third quarter of 2012. The increase in depreciation and amortization expense resulted from the acquisitions of HOPDs and UGH Dallas hospital. Net interest expense was $1,509,292 in current year third quarter as compared to $1,055,077 in the prior year third quarter. Interest expense is primarily comprised of interest on borrowings under the lines of credit, interest on financing lease obligations, related party notes and debt obligations. The increase in interest expense in the third quarter of 2013, as compared to the prior year second quarter, was attributable to an increase in the Company's average outstanding debt balance and debt assumed from the acquisitions. In addition, the Company's Revolving Credit Facility (see "Liquidity and Capital Resources") had an average daily borrowing balance of $349,517 in the third quarter of 2013. Operating income of the hospital segment was $5,904,946 for the third quarter of 2013 as compared to the operating income of $11,570,317 for the third quarter of 2012. In addition, the decrease in net operating income was driven by the increases in marketing and advertising, management fees, legal fees and purchased services. Marketing and advertising expenses were up as part of the Company's initiatives and strategies to increase revenues. 32 -------------------------------------------------------------------------------- Table of Contents Senior Living Senior living net revenues for the third quarter of 2013 increased 1.7% to $2,077,732 from $2,043,499 for the third quarter of 2012. This is a blended rate of assisted living dominant facilities which includes independent living and memory care units. The senior living properties reported stable occupancy, with an overall occupancy in excess of 91.5% and 94.4% for the third quarter of 2013 and 2012. Overall occupancy and revenues were not negatively impacted by the significant downturn in the macroeconomic environment, including the high unemployment levels and poor housing markets which affect private pay occupancy. Salaries, benefits and general administrative expenses remained consistent at $1,690,188 and $1,462,923 in the third quarters of 2013 and 2012, respectively. The depreciation and amortization decreased to $541,661 in the third quarter of 2013 as compared to $756,085 in the third quarter of 2012. The decrease in depreciation and amortization expense in the third quarter of 2013 over the prior year third quarter was resulted from some assets being fully depreciated in the current year as compared to prior year. Net operating income before depreciation and amortization and interest expense was $387,544 and $580,576 for the third quarters of 2013 and 2012. Support Services Revenues, net of intercompany revenues, for the third quarters of 2013 and 2012 were $2,094,797 and $702,543 . The revenues increase was due to the acquisitions of HOPDs and the UGH Dallas hospital. Salaries, benefits and general administrative expenses in the third quarter of 2013 increased $2,902,947 to $4,922,668 from $2,019,721 in the third quarter of 2012. The increase in salaries, benefits and general administrative expenses was due increases in new external clients and the acquisitions of HOPDs and the UGH Dallas hospital. The depreciation and amortization decreased to $81,415 in the third quarter of 2013 as compared to $129,120 in the third quarter of 2012. The net operating income was $195,890 for the third quarter of 2013 as compared to the net operating income $307,873 for the third quarter of 2012. 33 -------------------------------------------------------------------------------- Table of Contents Nine Months Ended September 30, 2013 Compared to Nine Months Ended September 30, 2012 The following table contains the Company's consolidated and segments results of operations for the nine months ended September 30, 2013 and 2012: Nine Months Ended September 30, (1) 2013 2012 Amount % of Revenues Amount % of Revenues Variance Revenues Hospital $ 116,004,072 91.2 % $ 76,668,851 91.1 % $ 39,335,221 Senior living 6,194,870 4.9 5,930,065 7.0 264,805 Support services 5,043,919 4.0 1,581,607 1.9 3,462,312 Total Revenues 127,242,861 100.0 84,180,523 100.0 43,062,338 Operating expenses Salaries, wages and benefits 58,204,402 45.7 27,466,450 32.6 30,737,952 Medical supplies 20,195,617 15.9 11,612,638 13.8 8,582,979 General and administrative expenses (includes related party expenses of $605,026 and $1,054,340 , respectively) 41,887,838 32.9 19,117,554 22.7 22,770,284 Gain on extinguishment of liabilities (64,517 ) (0.1 ) (3,521,879 ) (4.2 ) 3,457,362 Depreciation and amortization (includes related party expenses of $0 and $513,870 , respectively) 8,812,874 6.9 5,938,840 7.1 2,874,034 Total operating expenses 129,036,214 101.4 60,613,603 72.0 68,422,611 Operating income (loss) (1,793,353 ) (1.4 ) 23,566,920 28.0 (25,360,273 ) Other income (expense) Interest expense, net of interest income of $64,500 and $60,000 , respectively (includes related party interest expense of $104,286 and $1,734,144 , respectively) (5,494,145 ) (4.3 ) (4,187,121 ) (5.0 ) (1,307,024 ) Other income (expense) 510,707 0.4 (381,026 ) (0.5 ) 891,733 Direct investor expense (4,918,121 ) (3.9 ) (5,558,963 ) (6.6 ) 640,842 Change in fair market value of derivatives (2,067,251 ) (1.6 ) (4,256,980 ) (5.1 ) 2,189,729 Income (loss) before income tax (13,762,163 ) (10.8 ) 9,182,830 10.9 (22,944,993 ) Income tax expense 430,497 0.3 5,777,762 6.9 (5,347,265 ) Income (loss) before noncontrolling interest (14,192,660 ) (11.2 ) 3,405,068 4.0 (17,597,728 ) Net income attributable to noncontrolling interests 204,888 0.2 239,966 0.3 (35,078 ) Net income (loss) attributable to Company (13,987,772 ) (11.0 )% 3,645,034 4.3 % $ (17,632,806 ) Less: Cash dividend-Convertible Preferred C Stock (43,949 ) (0.0 ) (53,387 ) (0.1 ) 9,438 Less: Accretion non-cash dividend-Convertible Preferred C Stock (897,860 ) (0.7 ) (236,879 ) (0.3 ) (660,981 ) Net income (loss) attributable to common shareholders $ (14,929,581 ) (11.7 )% $ 3,354,768 4.0 % $ (18,284,349 ) (1) Percentages may not foot due to rounding. Consolidated Results of Operations Revenues for the first nine months of 2013 increased $43,062,338 , or 51.2%, to $127,242,861 as compared to $84,180,523 for the first nine months of 2012. The revenues increase was attributable to a 9.8% increase in the Company's average daily census. The average daily census for the nine months ended of 2013 was 43 as compared to 39 for the nine months ended of 2012. This increase in net patient revenues was also driven by the increase in surgeries 1,525, or 28.1% to 6,945 for the nine months ended of 2013 as compared to 5,420 for the nine months ended of 2012. The acquisitions of HOPDs and the UGH Dallas contributed to additional revenues of $40,903,522 for the first nine months of 2013. Salaries, wages and benefits expenses in the first nine months of 2013 increased $30,737,952 or 111.9%, to $58,204,402 from $27,466,450 in the first nine months of 2012. As a percentage of revenues, salaries, wages and benefits increased to 45.7% in the first nine months of 2013 from 32.6% in first nine months of 2012. In addition, the Company issued a total of 10,100,000 common shares to its management; as a result, the Company recorded $3,636,000 as compensation expense. The increase in the salaries, wages and benefits was primarily due to the acquisitions of HOPDs and the UGH Dallas hospital, coupled with compensation increases within the industry. Medical supplies expense in the first nine months of 2013 increased $8,582,979 , or 73.9%, to $20,195,617 from $11,612,638 in the first nine months of 2012. On an adjusted patient day ("APD") basis, medical expenses during the nine months ended of 2013 increased approximately by 12.0% or $666 per APD from $595 per APD in the nine months ended of 2012. As a percentage of revenues, medical supplies expense increased to 15.9% in the nine months ended of 2013 as compared to 13.8% in nine months ended 2012. Medical supplies rate increased in the nine months ended of 2013 due to an increase in net revenues as a result of HOPDs and the UGH Dallas hospital acquisitions, coupled with an increase in the number of surgeries performed as compared to the nine months ended of 2012. General and administrative ("G&A") expenses in the first nine months of 2013 increased $22,770,284 , or 119.1%, to $41,887,838 from $19,117,554 in the first nine months of 2012. The increase in G&A expenses was due to the acquisitions of HOPDs and the UGH Dallas hospital. In addition, the increase was due to increases in marketing and advertising, management fees and purchased services. Marketing and advertising expenses were up as part of the Company's initiatives and strategies to increase revenues. As a percentage of revenues, G&A expenses increased to 32.9% in first nine months of 2013 from 22.7% in the first nine months of 2012. 34 -------------------------------------------------------------------------------- Table of Contents Gain on extinguishment of liabilities in the first nine months ended of 2013 and 2012 was $64,517 and $3,521,879 , respectively. The Company recognized the gain on extinguishment in relation to accounts payable settlement. From time to time, the Company settled certain accounts payable with vendors and reduced the accounts payable owed to those vendors. In the first nine months of 2012, in connection with the cancellation of obligations to a debt holder, the Company recognized a gain of $2,806,787 which represents the portion of the principal balance, accrued interest, taxes and penalties due on a master equipment lease agreement and two promissory notes. Depreciation and amortization expense was $8,812,874 in the first nine months of 2013 as compared to $5,938,840 the first nine months of 2012, as a result of acquisitions of HOPDs and UGH Dallas hospital. The increase in amortization expense primarily resulted from the amortization expense of debt issuance costs, customer relationship, tradename, software and non-compete intangibles, offset by some assets being fully depreciated in the current year as compared to prior year. Net interest expense was $5,494,145 in the first nine months of 2013 as compared to $4,187,121 in the first nine months ended of 2012. Interest expense is primarily comprised of interest on borrowings under the lines of credit, interest on financing lease obligations, related party notes and debt obligations. The increase in interest expense in the first nine months of 2013, as compared to the prior year period, was attributable to an increase in the Company's average outstanding debt balance and debt assumed from the acquisitions. In addition, the Company's Revolving Credit Facility (see "Liquidity and Capital Resources") had an average daily borrowing balance of $369,611 in the first nine months of 2013. The Company is subject to a tax mandated by the State of Texas based on a defined calculation of gross margin (the "margin tax"). The margin tax is calculated by applying a tax rate to a base that considers both revenue and expenses and therefore has the characteristics of an income tax. As a result, the Company recorded $430,497 and $300,000 in state income tax expense in the first nine months of 2013 and 2012, respectively. As fully described in Notes 11 and 13 to the Consolidated Financial Statements, the Company issued preferred stock and the related common stock warrant in May 2012 , which do not have readily determinable fair values and therefore require significant management judgment and estimation. The Company uses the Binomial pricing model to estimate the fair value of warrant and preferred stock conversion features at the end of each applicable reporting period. Changes in the fair value of these derivatives during each reporting period are included in the statement of income. As a result, the total direct investor expense was $4,918,121 in the first nine months of 2013 as compared to $5,558,963 in the first nine months of 2012. The change in fair market value of derivatives was $2,067,251 in the first nine months of 2013 as compared to $4,256,980 in the first nine months of 2012. The change in the direct investor expense and change in fair market value of derivatives were primarily due to the amendments to C Series Preferred and warrants. In December 2012 , certain warrants shareholders agreed to waive all full ratchet price protection and in March 2013 , all C Series Preferred shareholders agreed to waive all full ratchet price protection. As of the date of the amendments, the Company reclassified the fair market value of derivatives to additional paid in capital as the derivative ceased to exist. As a result of the foregoing, the Company had net loss attributable to the Company of $14,929,581 for the nine months ended September 30, 2013 as compared to a net income of $3,645,034 for the nine months ended September 30, 2012 . Segment Results of Operations Hospital Revenues for the first nine months of 2013 increased by $39,335,221 or 51.3%, to $116,004,072 as compared to $76,668,851 for the first nine months of 2012. The revenues increase was attributable to a 9.8% increase in the Company's average daily census. The average daily census for the nine months ended of 2013 was 43 as compared to 39 for the nine months ended of 2012. This increase in net patient revenues was also driven by the increase in surgeries 1,525, or 28.1% to 6,945 for the nine months ended of 2013 as compared to 5,420 for the nine months ended of 2012. The acquisitions of hospital outpatient departments (HOPDs) and UGH Dallas contributed to additional revenues of $40,903,522 for the first nine months of 2013. Provision for doubtful accounts during the first nine months of 2013 increased $19,834,114 to 19.9% of net revenue before the provision for doubtful accounts as compared to 9.3% of net revenue before the provision for doubtful accounts during the first nine months of 2012. The increase was a result of the deterioration of the accounts receivable aging. 35 -------------------------------------------------------------------------------- Table of Contents The Company adopted the provisions of Accounting Standards Update No. 2011-07, Presentation and Disclosure of Patient Service Revenue, Provision for Bad Debts, and the Allowance for Doubtful Accounts for Certain Health Care Entities ("ASU 2011-07"), during the period ended March 31, 2012 . ASU 2011-07 requires health care entities to change the presentation of the statement of operations by reclassifying the provision for doubtful accounts from an operating expense to a deduction from patient service revenues. All periods presented have been reclassified in accordance with ASU 2011-07. Day's revenues outstanding were 65 days at September 30, 2013 as compared to 73 days at December 31, 2012 . To calculate day's revenues outstanding, the Company divides its average accounts receivable net of allowance for doubtful accounts by its net revenues per day. Net revenues per day is calculated by dividing revenues for the periods by the number of calendar days in the periods. The day's revenues outstanding decrease in the first nine months of 2013 was related to the increase in the allowance due to the deterioration of the accounts receivable aging. Salaries, wages and benefits in the first nine months of 2013 increased $26,770,399 , or 129.7%, to $47,409,741 from $20,639,342 in the first nine months of 2012. As a percentage of revenues, salaries, wages and benefits increased to 40.9% in the first nine months of 2013 from 26.9% in the first nine months of 2012. The increase in the salaries, wages and benefits rate was primarily due to the acquisitions of HOPDs and UGH Dallas hospital. Medical supplies expense in the first nine months of 2013 increased $8,582,979 , or 73.9%, to $20,195,617 from $11,612,638 in the first nine months of 2012. On an adjusted patient day ("APD") basis, medical expenses during the nine months ended of 2013 increased approximately by 12.0% or $666 per APD from $595 per APD in the nine months ended of 2012. As a percentage of revenues, medical supplies expense increased to 17.4% in the nine months ended of 2013 as compared to 15.1% in nine months ended 2012. Medical supplies rate increased in the nine months ended of 2013 due to an increase in net revenues as a result of HOPDs and UGH Dallas hospital acquisitions, coupled with an increase in the number of surgeries performed as compared to the nine months ended of 2012. General and administrative expenses in the first nine months of 2013 increased $19,629,352 , or 126.6%, to $35,131,657 from $15,502,305 in the first nine months of 2012. The increase in G&A expenses was due to the acquisitions of HOPDs and UGH Dallas hospital and coupled with increases in marketing and advertising, management fees, legal fees, and purchased services. Marketing and advertising expenses were up as part of the Company's initiatives and strategies to increase revenues. As a percentage of revenues, G&A expenses increased to 30.3% in first nine months of 2013 from 20.2% in the first nine months of 2012. Gain on extinguishment of liabilities in the first nine months ended of 2013 and 2012 was $64,517 and $3,521,879 , respectively. The Company recognized the gain on extinguishment in relation to accounts payable settlement. From time to time, the Company settled certain accounts payable with vendors and reduced the accounts payable owed to those vendors. In the first nine months of 2012, in connection with the cancellation of obligations to a debt holder, the Company recognized a gain of $2,806,787 which represents the portion of the principal balance, accrued interest, taxes and penalties due on a master equipment lease agreement and two promissory notes. Depreciation and amortization expense in the first nine months of 2013 increased by $1,969,560 , or 45.9%, to $6,263,009 as compared to $4,293,449 in the first nine months of 2012. The increase in depreciation and amortization expense resulted from the acquisitions of HOPDs and theUGH Dallas hospital. Net interest expense was $4,405,667 in the first nine months of 2013 as compared to $3,264,863 in the first nine months of 2012. Interest expense is primarily comprised of interest on borrowings under the lines of credit, interest on financing lease obligations, related party notes and debt obligations. The increase in interest expense in the first nine months of 2013, as compared to the prior year period, was attributable to an increase in the Company's average outstanding debt balance and debt assumed from the acquisitions. In addition, the Company's Revolving Credit Facility (see "Liquidity and Capital Resources") had an average daily borrowing balance of $369,611 in the first nine months of 2013. Operating income of the hospital segment was $7,068,565 for the first nine months of 2013 as compared to the operating income of $23,111,532 for the first nine months of 2012. In addition, the decrease in net operating income was driven by the increases in marketing and advertising, management fees legal fees and purchased services. 36 -------------------------------------------------------------------------------- Table of Contents Senior Living Senior living net revenues for the first nine months of 2013 increased 4.5% to $6,194,870 from $5,930,065 for the first nine months of 2012. The average revenue per unit occupied for the first nine months ended of 2013 and 2012 was $3,165 and $3,081 , respectively. This is a blended rate of assisted living dominant facilities which includes independent living and memory care units. The senior living properties reported continued stable occupancy, with an overall occupancy in excess of 92.8% and 94.6% for the nine months ended of 2013 and 2012. Overall occupancy and revenues were not negatively impacted by the significant downturn in the macroeconomic environment, including the high unemployment levels and poor housing markets which affect private pay occupancy. Salaries, benefits and general administrative expenses remained consistent at $4,997,915 and $4,387,044 in the first nine months of 2013 and 2012, respectively. The depreciation and amortization increased to $2,204,277 in the first nine months of 2013 as compared to $1,305,381 in the first nine months of 2012. The increase in depreciation and amortization expense in the first nine months of 2013 over the prior year period was primarily resulted from the amortization expense of customer relationship, tradename and non-compete agreement which was obtained from the final valuation report for the acquisition of TrinityCare. Net operating income before depreciation and amortization and interest expense was $1,196,955 and $1,543,021 for the nine months ended September 30, 2013 and 2012. Support Services Revenues, net of intercompany revenues, for the first nine months of 2013 and 2012 were $5,043,919 and $1,581,607 . The revenues increase was due to the acquisitions of HOPDs and the UGH Dallas. Salaries, benefits and general administrative expenses in the first nine months of 2013 increased $6,497,612 to $12,552,927 from $6,055,315 in the first nine months of 2012. The increase in salaries, benefits and general administrative expenses was due increases in the acquisitions of HOPDs and the UGH Dallas hospital. The depreciation and amortization increased to $345,588 in the first nine months of 2013 as compared to $340,010 in the first nine months of 2012. The net operating income was $573,662 for the first nine months September 30, 2013 as compared to the net operating income $217,747 for the nine months September 30, 2012 . Liquidity and Capital Resources The Company's primary cash requirements are paying its operating expenses, servicing its debt, capital expenditures on its existing properties, acquisitions and distributions to non-controlling interests. The Company's primary cash sources are cash flows from operating activities, issuances of debt and equity securities. Key components of the Company's cash flows for the current year and prior year are summarized below: Nine Months Ended September 30, 2013 2012 Net cash provided by (used in): Operating activities $ 9,491,978 $ 4,892,156 Investing activities (7,534,025 ) (2,391,953 ) Financing activities (1,674,891 ) 2,303,851 During the first nine months of 2013, the Company generated $9,491,978 in cash from operating activities. Net income, adjusted for non-cash expenses and income, provided cash of $30,040,871 . Net changes in operating assets and liabilities used net cash of $21,224,305 , which included a $35,193,471 increase in accounts receivable, offset by a $14,472,255 increase in account payable, accrued expenses and taxes payable, and a net increase of $1,649,835 in related party receivables and payables, inventories, prepaid expenses and other assets. Deferred revenues increased $1,146,746 of which $1,032,670 was deferred EHR incentive income. The deferred EHR incentive income represents initial incentive payments received for which the Company has not been recognized. 37 -------------------------------------------------------------------------------- Table of Contents During the prior year, the Company generated $4,892,156 in cash from operating activities. Net income, adjusted for non-cash expenses and income, provided cash of $23,701,473 . Net changes in operating assets and liabilities used net cash of $18,809,317 , which primarily included a $20,212,013 increase in accounts receivable and an increase of $ 2,033,897 in prepaid expenses and other assets, offset by a $321,621 decrease in related party receivable and a $415,081 decrease in inventory, a $2,750,062 increase in account payable, accrued expenses and tax payable and a decrease in deferred revenues of $50,171 . The cash used in investing activities was $7,534,025 in the first nine months of 2013, compared to $2,391,953 in the first nine months of 2012. The increase in cash used in investing activities was primarily attributable to additional purchases of property and equipment as compared to the prior year. In addition, the Company paid $1,733,562 cash for the acquisitions in the first nine months of 2013. The cash used in financing activities was $1,674,891 in the nine months ended September 30, 2013 , compared to cash provided by $2,303,851 in the nine months ended September 30, 2012 . The decrease cash in financing activities over the prior year period was primarily a result of lower borrowings and payments on notes payable. As of September 30, 2013 , the Company had a negative working capital of $38,604,549 as compared to a negative of $41,797,619 as of December 31, 2012 . The Company is a highly leveraged company with debt service requirements. The Company's short-term debt and accounts payable totaled $21,510,306 and 18,260,258 at September 30, 2013 . The negative working capital and relative low levels of cash and cash equivalents amounts, significant increase in operating expenses, and required past due payroll and income tax payments raise substantial doubt concerning the Company's ability to continue as a going concern for a reasonable period of time. On May 2, 2012 , the Company completed a securities purchase agreement (the "Securities Purchase Agreement") with institutional investors (the "Purchasers"), for the private issuance and sale to the Purchasers of 3,808 shares of the Company's Series C Variable Rate Convertible Preferred Stock (the "Preferred Shares"). In March 2013 , the total greenshoe exercises was $2,525,000 . Each Preferred Share initially convertible into approximately 4,545 shares of the Company's Common Stock (the "Conversion Shares") and each warrant initially purchase up to approximately 4,545 shares of the Company's Common Stock (the "Warrants") at $0.26 , are exercisable at any time, and expire on May 2, 2017 . The Preferred Shares were issued at an original issue discount at 12%. After deducting for fees and expenses, the aggregate net proceeds from the sale of the Preferred Shares and Warrants was approximately $3.1 million . The Company used these proceeds to pay tax payments and retired certain outstanding loan balances. At any time after the six month anniversary of the date of issuance of the Preferred Shares, the Company has the right to redeem the Preferred Shares at a premium of 115%, subject to certain conditions. Furthermore, at any time after the six month anniversary of the date of issuance of the Preferred Shares the Company has the right to require the holders to convert their Preferred Shares in the event that the Company's common stock meets certain trading premiums, and subject to other conditions. On March 25, 2013 , the Company executed an amendment (the "Amendment") to the Certificate of Designation of Preferences, Rights and Limitations of the Preferred Stock (the "Certificate of Designation"). Pursuant to the Amendment, the full ratchet price protection in the Certificate of Designation was deleted and the Company agreed, subject to certain limited exceptions, not to issue Common Stock for consideration per share less than the then existing conversion price per share under the Certificate of Designation. Each of the holders of the Preferred Stock has consented to the Amendment. Any new Preferred Shares issued on or after March 25, 2013 by the Company to the Purchasers as " Greenshoe Securities " pursuant to the Securities Purchase Agreement will be governed by the Certificate of Designation as amended by the Amendment. In the current year, the Board declared and paid cash dividend of $205,382 . At September 30, 2013 , the Company accrued $43,949 of the dividend. 38 -------------------------------------------------------------------------------- Table of Contents On September 28, 2012 , the Company entered into a Credit and Security Agreement for a $15.0 million secured revolving credit facility (the "Revolving Credit Facility") that matures on September 28, 2015 . The Revolving Credit Facility includes an additional amount of revolving loan commitment feature to increase the size of the facility to $25.0 million . In June 2013 , the secured revolving credit facility increased to $22.5 million . Borrowings under the Revolving Credit Facility are limited to the availability under a borrowing base that is determined principally on eligible account receivable as defined by the Revolving Credit Facility agreement. The daily interest rates under the Revolving Credit Facility are determined by a LIBOR rate plus an applicable margin, as set forth in the Revolving Credit Facility agreement. All of the Company's assets are pledged as collateral under the Revolving Credit Facility. The Revolving Credit Facility is used by the Company to provide financing for working capital, capital expenditures and other general corporate purposes, as well as to support its outstanding indebtedness requirements. The Revolving Credit Facility contains certain affirmative covenants, negative covenants and financial covenants including restrictions on the payment of dividends, as set forth in the Revolving Credit Facility Agreement. The Revolving Credit Facility agreement included unused line fee of 0.50% per annum. Excess borrowing availability under the Revolving Credit Facility at September 30, 2013 was $3,883,707 . At September 30, 2013 , the Company was in compliance with all of the debt covenants of the Revolving Credit Facility and expects to remain in compliance during the year 2013. The interest rate on outstanding borrowings and average daily borrowings under the Revolving Credit Facility were 4.5% and $324,885 , respectively. The Company had an outstanding balance on its Revolving Credit Facility as of September 30, 2013 of $18,613,293 . Inflation The healthcare industry is labor-intensive. Wages and other expenses increase during periods of inflation and when labor shortages in marketplaces occur. In addition, suppliers pass along rising costs to the Company in the form of higher prices. Private insurers pass along their rising costs in the form of lower reimbursement to the Company. The Company's ability to pass on these increased costs in increased rates is limited because of increasing regulatory and competitive pressures and the fact that the majority of its revenues are fee-based. Accordingly, inflationary pressures could have a material adverse effect on the Company's results of operations.


For more stories on investments and markets, please see HispanicBusiness' Finance Channel



Source: Edgar Glimpses


Story Tools