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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
| x | Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the fiscal year ended August 31, 2012
| ¨ | Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the transition period from to
Commission file number: 000-21574
DYNACQ HEALTHCARE, INC.
(Exact name of registrant as specified in its charter)
| Nevada | 76-0375477 | |||
(State or Other Jurisdiction of Incorporation or Organization) | (I.R.S. Employer Identification No.) | |||
| 4301 Vista Road, Pasadena, Texas | 77504 | |||
| (Address of Principal Executive Offices) | (Zip Code) | |||
Registrant’s telephone number, including area code: (713) 378-2000
Securities registered pursuant to Section 12(b) of the Exchange Act: None
Securities registered pursuant to Section 12(g) of the Exchange Act:
Title of each class
Common Stock, $0.001 Par Value
Indicate by check mark if the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act. Yes ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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 ¨ No x
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. (Check One):
| Large accelerated filer | ¨ | Accelerated filer | ¨ | |||
| Non-accelerated filer | ¨ | Smaller reporting company | x | |||
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
The aggregate market value of common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of February 29, 2012 was $4,840,684. As of March 19, 2013, the registrant had 14,543,626 shares of common stock outstanding.
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This annual report on Form 10-K contains forward-looking statements regarding future events and our future financial performance. Words such as “expects,” “intends,” “forecasts,” “projects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential” and similar expressions identify forward-looking statements within the meaning of the Private Securities Litigation Reform Act. All forward-looking statements are based on our current beliefs as well as assumptions made by and information currently available to us. These statements reflect our current views with respect to future events. Important factors that could cause actual results to materially differ from our current expectations include the risks and uncertainties described in Item 1A. Risk Factors below. Please read the following discussion of the results of our business and our operations and financial condition and the risk factors along with our consolidated financial statements, including the notes, included in this annual report on Form 10-K.
| Item 1. | Business. |
General
Dynacq Healthcare, Inc., a Nevada corporation (the “Company”), is a holding company that through its subsidiaries in the United States develops and manages general acute care hospitals that principally provide specialized surgeries. The Company through its subsidiaries in China and Hong Kong also (1) provided healthcare management services to a hospital in China until February 28, 2011; and (2) invests in debt and equity securities, including short-term investments in initial public offerings and pre-initial public offerings. The Company through its United States subsidiaries (1) owns and operates one general acute care hospital in Pasadena, Texas, and (2) owns one general acute care hospital in Garland, Texas, which was closed on September 30, 2011, and accordingly this business is classified as “Discontinued Operations” for the year ended August 31, 2012 and 2011 (see Discontinued Operations below). The Company is currently composed of two divisions: U.S. and Corporate.
The Company was incorporated in Nevada in February 1992. In November 2003, the Company reincorporated in Delaware and changed its name from Dynacq International, Inc. to Dynacq Healthcare, Inc. In August, 2007, the Company reincorporated back in Nevada. The terms “Company,” “Dynacq,” “our” or “we” are used herein to refer to Dynacq Healthcare, Inc. and its affiliates unless otherwise stated or indicated by context. The term “affiliates” means direct and indirect subsidiaries of Dynacq Healthcare, Inc. and partnerships and joint ventures in which subsidiaries are general or limited partners or members.
U.S. Division
The Company’s business strategy is to develop and operate general acute care hospitals designed to handle specialized surgeries such as bariatric, orthopedic and neuro-spine surgeries. The Company’s hospitals include operating rooms, pre- and post-operative space, intensive care units, nursing units and diagnostic facilities, as well as adjacent medical office buildings. These hospitals are the Surgery Specialty Hospitals of America – Southeast Houston Campus in Pasadena, Texas, near Houston (the “Pasadena facility”); and Vista Hospital of Dallas (the “Garland facility”).
Except for emergency room patients, surgeries at our facilities are typically pre-certified or pre-authorized by insurance carriers. The bulk of the surgeries are either covered by workers’ compensation insurance or by commercial insurers on an out-of-network health plan basis. The Company participates in a small number of managed care contracts.
The Company, through its affiliates, owns or leases 100% of the real estate for and equipment in its facilities. The Company maintains a majority ownership and controlling interest in all of its operating entities. As of August 31, 2012, the Company owned the following percentages of its operating entities:
Pasadena facility | 99.00 | % | ||
Garland facility | 98.25 | % |
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The Company signed a commercial contract of sale on March 7, 2013 to sell its Garland facility. The sale is expected to close in May 2013. Based on the sales price, the Company has taken an impairment charge of approximately $1.1 million as of August 31, 2012. The Company closed the Garland facility on September 30, 2011, and accordingly its operations for the year ended August 31, 2012 and 2011 are classified as “Discontinued Operations” (see Discontinued Operations below). The Company intended to sell its Pasadena facility also, and had it classified as discontinued operations, as of August 31, 2010. However, since a sale was not consummated during the 12-month period following the decision to sell, the operations of the Pasadena facility had been reclassified as continuing operations for the fiscal year ended August 31, 2011. The Pasadena facility also provides pain management services, sleep laboratory services, as well as minor emergency treatment services. In recent years, the Pasadena facility has been operating at a substantial loss. The Company is attempting to revitalize the operations of the Pasadena facility through a number of avenues, including the possibility of expanding its business in more profitable areas of operation. The Company has engaged strategic consultants to assist with this process, and intends to evaluate a number of strategic alternatives. However, there can be no assurance that we will be successful in turning the facility around.
Corporate Division
From March 1, 2009 to February 28, 2011, Dynacq Huai Bei Healthcare, Inc. (“Dynacq-Huai Bei”), a wholly owned subsidiary of the Company provided healthcare management services to the Second People’s Hospital in Rui An, China. The Company organized Dynacq-Huai Bei in April 2008 under the laws of the People’s Republic of China. Dynacq-Huai Bei was responsible for funding any operating deficits, and was entitled to any operating profits, of that hospital during the management period. Due to continued losses at the Second People’s Hospital, the Company terminated the management agreement with the Rui An City Department of Health. The Company ceased providing healthcare management services to the Second People’s Hospital as of February 28, 2011. The Company wrote off the fixed assets and inventory balances as of February 28, 2011, and does not expect any further losses due to the termination of this management agreement related to the Second People’s Hospital. We have accounted for the operations of Dynacq-Huai Bei and Second People’s Hospital in Rui An, China as discontinued operations.
Dynacq-Huai Bei and the Rui An City Department of Health had also previously entered into an agreement assigning to Dynacq-Huai Bei the right to manage the Third People’s Hospital in Rui An, which hospital is currently under construction. Dynacq-Huai Bei and the Rui An City Department of Health, in November 2010, mutually agreed to terminate this agreement due to continued delays in the construction of the Third People’s Hospital. Accordingly, Dynacq-Huai Bei will not manage the Third People’s Hospital.
The Company also organized Sino Bond Inc. Limited, a Hong Kong corporation (“Sino Bond”) to hold and manage investments in Hong Kong. Sino Bond invests in debt and equity securities in Europe and Asia, including initial public offerings and pre-initial public offerings.
The Company’s operations at Second People’s Hospital and its various proposed businesses in China, including but not limited to sandstone mining, mined coal trading, natural gas stations and sale of artifacts have been classified as discontinued operations. The Company’s foreign subsidiary, Sino Bond, is the only company classified as continuing operations in the Corporate Division, and its other foreign subsidiaries have been reclassified as discontinued operations.
During the fiscal year ended August 31, 2009, the Company invested approximately $9.1 million of its available cash in marketable securities. During the quarter ended August 31, 2011, one of these marketable securities with a book cost of $700,000 was called for a gain of $1.3 million. As of August 31, 2012, the balance of these securities is valued at approximately $16.8 million. The Company intends to hold these for a minimum period of additional 12 months, except for one particular security that was called subsequent to the year ended August 31, 2012. During the year ended August 31, 2012 and 2011, the Company also traded in initial public offerings of equity securities on the Hong Kong Stock Exchange and had losses of $318,206 and $364,721, respectively.
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RECENT DEVELOPMENTS
Internal Investigation
As previously disclosed in our Current Report on Form 8-K filed with the Securities and Exchange Commission (the “SEC”) on August 9, 2012, we announced that, at the request of our Board of Directors (the “Board”), we commenced an internal investigation of our past business practices, potentially encompassing members of the Board, management and third persons, and related accounting matters (the “Investigation”).
The Investigation, which was performed by outside legal counsel and other outside consultants at the direction of the Board, was substantially completed on December 27, 2012. The Investigation included a review of a substantial number of Company documents and emails, as well as interviews with employees, members of the Board and other persons who were familiar with the facts surrounding the Investigation. The results of the Investigation, which were reported directly to the Board, revealed that the former Chief Financial Officer of the Company did not perform a significant review or independent analysis of transactions initiated by the former Chief Executive Officer. As a result, we believe that, for the five fiscal years ending on August 31, 2012, we did not maintain effective control over financial reporting due to the existence of a material weakness related to a failure of internal controls designed to limit the ability of management to override our system of internal controls. The results of the Investigation also revealed that the former Chief Financial Officer misrepresented certain information to our independent auditor, which we have also determined to be a material weakness in our internal control over financial reporting. We also identified the existence of a significant deficiency related to a lack of objectivity by our former executive officers with respect to accounting decisions.
Based on the results of the Investigation and recommendations made by our independent auditor regarding the foregoing material weaknesses and significant deficiencies in internal control over financial reporting, we are reviewing our internal control and compliance policies and procedures. We believe that no additional remediation efforts with respect to the material weaknesses and the significant deficiency as they relate to the former Chief Executive Officer and the former Chief Financial Officer are necessary, as the executives who occupied these offices during the events in question are no longer employed by us.
We have determined that our previously reported consolidated balance sheets for periods up to and including August 31, 2012 do not require any material adjustments and/or restatements in respect of the results of the Investigation. Further, the Investigation did not result in any material change to our previously reported net income or loss or financial position for the same periods. However, the Investigation, along with subsequent analysis performed by us and our auditors, did reveal that Company expenditures in the amount of approximately $7.8 million were authorized by former officers of the Company and paid to various third parties, and the results of the Investigation and the subsequent analysis performed by us and our auditors provided no evidence of a discernible benefit to the Company resulting from these expenditures. We have determined that the questionable nature of these expenditures may result in their reclassification in our financial statements, from operating costs and expenses to other expenses, depending on determinations that the Board may make in the future. We do not expect these reclassifications, even if they are made, to result in a material restatement of our financial statements. Please see note 16 to our consolidated financial statements for additional information.
Delisting of Common Stock from NASDAQ Global Markets
As discussed in our Current Report on Form 8-K filed with the SEC on October 11, 2012, and further discussed in our Current Reports on Form 8-K filed on each of September 28, 2012 and April 13, 2012, the NASDAQ Stock Market (“NASDAQ”) announced on October 10, 2012 that the Company’s common stock would be delisted from NASDAQ. Prior to being delisted, trading in the Company’s stock was halted by NASDAQ on August 9, 2012, and NASDAQ suspended the Company’s stock from trading on October 4, 2012. As discussed in the Company’s Current Report on Form 8-K filed with the SEC on April 13, 2012, NASDAQ informed the Company that it would be subject to delisting upon a failure to regain compliance with (i) the $1.00 minimum bid price per share of its common stock pursuant to NASDAQ Listing Rule 5450(a)(1) for a period of at least ten consecutive business days ending on a date prior to October 9, 2012, and (ii) the minimum market value of its publicly held shares of at least
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$5 million pursuant to NASDAQ Listing Rule 5450(b)(1)(C) for at least ten consecutive business days prior to October 9, 2012. Further, on September 25, 2012, the Company received notification from NASDAQ stating that the Company’s common stock will be delisted from NASDAQ effective at the opening of business on October 4, 2012. The delisting of the Company’s common stock was a result of the Company’s failure to make timely payment of certain listing fees, as required by NASDAQ Listing Rule 5250(f), in the amount of $5,000. In light of the prior NASDAQ notice described in further detail above, the Company concluded that no valid business purpose would be served by making payment of these fees. The Company did not request an appeal hearing regarding the delisting. As a result of the trading halt in effect at the time of the notice for the Company’s common stock and the failure of the minimum bid price to reach $1.00 per share for 10 consecutive business days after receipt of the NASDAQ letter and prior to the commencement of the trading halt, and in light of the fact that there were fewer than ten business days remaining before October 9, 2012, the Company did not believe that it would be able to regain compliance with the NASDAQ Listing Rules discussed above prior to October 9, 2012. As a result, the Company believed that it would have become subject to delisting for failure to comply with Listing Rule 5450(a)(1) on October 9, 2012, even if it had paid the listing fees in compliance with NASDAQ Listing Rule 5250(f) on or before October 4, 2012. A Form 25 was filed with the SEC on October 11, 2012, and the Company’s stock was effectively delisted ten days following this filing.
Changes in Officers and Directors
On May 17, 2012, Chiu M. Chan, the Chairman of our Board of Directors, passed away. His seat on the Board of Directors remains vacant while the Board considers whether to appoint a new director or permanently reduce the size of the Board to five members. As previously reported in the Company’s Current Report on Form 8-K filed with the SEC on January 13, 2012, on January 10, 2012 the Board of Directors expanded the Board from five to six members and appointed Eric K. Chan, M.D. as a new member of the Board. Eric K. Chan is the son of Chiu M. Chan, who was incapacitated at the time by an unexpected illness. Eric K. Chan did not stand for election at the Annual Meeting of Shareholders held on February 15, 2012 and his term as director ended. At the conclusion of the Annual Meeting, the Board of Directors reappointed Eric K. Chan as a member of the Board. Eric K. Chan currently serves as our Chief Executive Officer and President. Dr. Chan is board certified in anesthesiology. He has been the sole owner of Redwood Health Corporation since March 2005, which furnishes physicians to provide in-house emergency medical coverage and recruits anesthesiologists and certified registered nurse anesthetists at hospitals, including the Company’s Pasadena facility. Dr. Chan has also been the sole owner of Anesthesia Associates of Houston Metroplex since August 2007, which provides anesthesiology services to hospitals, including the Company’s Pasadena facility. He was an Assistant Professor at Memorial Hermann Hospital, University of Texas at Houston from August 2007 to September 2008. Dr. Chan earned his M.B.A. in Health Organization Management and M.D. from Texas Tech University.
On August 8, 2012, the Board placed Mr. Philip Chan on paid administrative leave from his position as Chief Financial Officer of Dynacq. On November 28, 2012, Mr. Chan submitted to the Board his resignation from all positions at Dynacq and its affiliates, including his positions as Chief Financial Officer and Director of Dynacq. While Mr. Chan was on administrative leave, the Board appointed Hemant Khemka, the current Controller of Dynacq, to act as principal financial officer of Dynacq pending the results of the investigation. Mr. Khemka continues to act as principal financial officer of Dynacq.
As discussed in the Definitive Information Statement filed pursuant to Section 14(c) (the “Information Statement”) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) on October 9, 2012, pursuant to an Action by Written Consent of Stockholders in lieu of a Special Meeting, stockholders of Dynacq holding more than two-thirds of the issued and outstanding shares of our common stock as of September 24, 2012 (the “Record Date”) approved the removal of Ping S. Chu, James G. Gerace and Stephen L. Huber from their positions as members of our Board, to be effective on October 30, 2012. On October 24, 2012, James G. Gerace resigned. On October 30, 2012, the stockholder approval became effective, and Messrs. Chu and Huber were removed.
The sole remaining member of our Board is Dr. Eric K. Chan, who also serves as our Chief Executive Officer and President. As a result of the stockholder action and recent resignations, our Board has five vacancies, including the vacancy left by Mr. Chiu M. Chan’s passing. We intend to seek qualified candidates to fill these Board vacancies, including some candidates that are deemed independent based on the independence standards of NASDAQ. There can be no assurance, however, that we will be able to fill any of these vacancies with new
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directors, independent or otherwise. In the interim, the sole remaining member of our Board will continue to fulfill the Board’s responsibilities. The following holders of 9,966,482 shares of our common stock, constituting 68.5% of our outstanding common stock on the Record Date, consented to the stockholder action: Estate of Chiu M. Chan (represented by the widow of Mr. Chan, Ella Y.T.C. Chan, the sole executrix of the estate); Ella Y.T.C. Chan; Chan Chang Chin Ying (the aunt of Dr. Eric K. Chan); Philip S. Chan; Dr. Eric K. Chan; Edward K. Chiu (no relation to any other stockholder consenting to the action); and Bert Chan (brother of Eric K. Chan and son of Ella Y.T.C. Chan). Please see the Information Statement for additional information.
Discontinued Operations
On September 29, 2011, the Board of Directors of the Company approved the closure of the Garland facility, included in our U.S. division, effective September 30, 2011. Prior to that, in August 2010, the Board of Directors of the Company approved a plan to dispose of the Garland facility due to continued operating losses. The Garland facility had experienced decreases in net patient revenues and number of cases, generally attributable to the loss of physicians from our medical staff. The opening of a new hospital near our Garland facility had a direct adverse impact on our ability to retain members of the medical staff at that facility and consequently on our patient volume. The Garland facility was operating at a loss, and the Board of Directors believed that ceasing operations of the facility at that time was in the Company’s best interest. We do not expect to incur any material costs associated with termination of employment of the affected employees beyond accrued obligations for salary and benefits. The Company had estimated a closing cost of $625,000.
The Company signed a commercial contract of sale on March 7, 2013, to sell the Garland facility. The sale is expected to close in May 2013. Based on the sales price, the Company has taken an impairment charge of approximately $1.1 million as of August 31, 2012.
We have accounted for the operations of the Second People’s Hospital in Rui An, China as discontinued operations. See detailed discussion above under “Corporate Division” related to Second People’s Hospital.
Industry Background and Business Growth
U.S. Division
In the United States, the development of proprietary general acute care hospital networks occurred during the 1970’s. During the past 20 years, freestanding outpatient surgery centers were developed to compete with these general hospitals for outpatient procedures. Freestanding outpatient surgery centers have allowed physicians to perform outpatient procedures in specialized facilities designed to improve efficiency and enhance patient care. The Company believes that its operational model allows physicians to perform inpatient and outpatient procedures at facilities that provide similar efficiencies as those provided at freestanding outpatient surgery centers.
General acute care hospitals specializing in specific complex surgical procedures are designed with the goal of improving both physician and facility efficiency. The surgeries performed are primarily non-emergency procedures that are electively scheduled and, therefore, allow for efficiency available through block time/scheduling. Given the opportunity to utilize multiple operating rooms for pre-determined periods of time, the physicians are able to schedule their time more efficiently and, therefore, increase the number of procedures they can perform within a given amount of time. The facility receives the benefit of consistent staffing patterns and greater facility utilization. In addition, the Company believes that, due to the relatively small size of its facility, many physicians prefer to perform procedures in the Company’s facility because their patients prefer the comfort of a more personal atmosphere and the convenience of simplified admission and discharge procedures.
At August 31, 2012 and 2011, the Company owned, through its subsidiaries, a 99% and 100% partnership interest in the Pasadena facility operating entity, respectively. The Pasadena facility’s areas of practice include orthopedic and general surgery, such as spine and bariatric surgeries, various pain management modalities and other services. Through its affiliates, the Company owns 100% of the real estate and owns or leases 100% of the equipment.
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In recent years, the Pasadena facility has been operating at a substantial loss. The Company is attempting to revitalize the operations of the Pasadena facility through a number of avenues, including the possibility of expanding its business in more profitable areas of operation. The Company has engaged strategic consultants to assist with this process, and intends to evaluate a number of strategic alternatives. However, there can be no assurance that we will be successful in turning the facility around.
Creating and Maintaining Relationships with Quality Physicians
Since physicians provide and influence the direction of healthcare, we have developed our operating model to encourage physicians to affiliate with us and to use our facilities in accordance with their practice needs. Our strategy is to focus on the development of physician partnerships and facilities that will enhance their practices in order to provide quality healthcare in a friendly environment for the patient. We seek to attract new physicians to our facilities in order to grow or to replace physicians who retire or otherwise depart from time to time, as well as to expand the surgical case mix.
Attracting and Retaining Key Personnel
We place the utmost importance on attracting and retaining key personnel to be able to provide quality facilities to attract and retain qualified physicians. Attracting and retaining the appropriate personnel at all levels within the organization, including senior executives at the corporate level, are also important goals of management and essential in expanding our operations.
Further Refining Hospital Design
We believe we attract physicians because we design our facilities and adopt staffing, scheduling and clinical systems and protocols to increase physician productivity and promote their professional success. We focus attention on providing physicians with quality facilities designed to improve the physicians’ and their patients’ satisfaction.
Adding New Capabilities to Existing Hospitals
Our overall strategy is to develop and operate hospitals designed to handle complex surgeries. Currently, some of our more complex surgeries include spine and bariatric surgeries for which we have added more surgical equipment. The Company continues to explore the possibility of adding other types of surgical procedures that fit into our business model.
Corporate Division
Sino Bond is an investment vehicle for the Company in China, Southeast Asia and Europe. It has engaged an investment banker to recommend investment opportunities and monitor the Company’s investments. The Company anticipates making short-term investments in these entities through initial public offerings (held mostly through the Hong Kong Stock Exchange) and pre-initial public offerings.
Discontinued Operations
The Garland facility was closed effective September 30, 2011. At August 31, 2012 and 2011, the Company owned, through its subsidiaries, 98.25% of the partnership interests in the Garland facility operating entity. The areas of practice performed at this facility were orthopedic surgery, bariatric surgery, general surgery, plastic surgery, podiatry, gynecology, spine and pain management procedures. The Garland facility has been classified as discontinued operations. Through its affiliates, the Company owns 100% of the real estate and owns or leases 100% of the equipment.
From March 1, 2009 to February 28, 2011, Dynacq-Huai Bei provided healthcare management services to the Second People’s Hospital in Rui An, China. Dynacq-Huai Bei was responsible for funding any operating deficits, and was entitled to any operating profits, of that hospital during the management period. Due to continued losses at
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the Second People’s Hospital, the Company terminated the management agreement with the Rui An City Department of Health. The Company ceased providing healthcare management services to the Second People’s Hospital as of February 28, 2011. The Company wrote off the fixed assets and inventory balances as of February 28, 2011, and does not expect any further losses due to the termination of this management agreement related to the Second People’s Hospital.
Marketing
Our marketing efforts are directed primarily at physicians and other healthcare professionals who are principally responsible for referring patients to our facilities. We market our facilities to physicians by emphasizing the high level of patient satisfaction with our hospitals, the quality and responsiveness of our services and the practice efficiencies provided by our facilities. We believe that providing quality facilities creates a positive environment for patients and physicians.
The Pasadena facility is designated as a Bariatric Center of Excellence by the American Society for Bariatric Surgery (ASBS). The ASBS Center of Excellence designation recognizes surgical programs and surgeons who have demonstrated a track record of favorable short and long-term outcomes in bariatric surgery and have the resources to perform safe bariatric surgeries.
Competition
Presently, the Company operates in the greater Houston, Texas market. The Company competes with other providers, including major acute care hospitals. These entities may have various competitive advantages over the Company, including their community position, capital resources, physician partnerships and proximity to physician office buildings. The Company also encounters competition with other companies for strategic relationships with physicians.
There are several large publicly-held companies, and numerous privately-held companies, that acquire and develop freestanding private hospitals and outpatient surgery centers. Many of these competitors have greater financial and other resources than the Company. The principal competitive factors that affect the Company’s ability and the ability of its competitors to acquire or develop private hospitals are experience, reputation, relationships with physicians and other medical providers, as well as access to capital. Further, some surgeon groups develop surgical facilities without a corporate partner. The Company can provide no assurance that it will be able to compete successfully in these markets.
Government Regulation
Overview
In the United States, all participants in the healthcare industry are required to comply with extensive government regulation at the federal, state and local levels. Under these laws and regulations, hospitals must meet requirements for licensure and qualify to participate in government programs, including Medicare and Medicaid. These requirements relate to the adequacy of medical care, equipment, personnel, operating policies and procedures, maintenance of adequate records, hospital use, rate-setting, compliance with building codes and environmental protection laws, as well as patient confidentiality requirements. There are also extensive regulations governing a hospital’s participation in government programs and payment for services provided to program beneficiaries. These laws and regulations are extremely complex and, in many instances, the industry does not have the benefit of significant regulatory or judicial interpretation. Some of the laws applicable to us are subject to limited or evolving interpretations; therefore, a review of our operations by a court or law enforcement or regulatory authority may result in a determination that could have a material adverse effect on us. Providers that are found to have violated any of these laws and regulations may be excluded from participating in government healthcare programs, subjected to significant fines or penalties and/or required to repay amounts received from the government for previously billed patient services. Although we believe our policies, procedures and practices comply with governmental regulations, no assurance can be given that we will not be subjected to additional governmental inquiries or actions, or that we will not be faced with sanctions, fines or penalties if so subjected. Furthermore, the laws applicable to us may be amended or interpreted in a manner that could have a material adverse effect on us.
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Texas Workers’ Compensation Systems
A significant amount of our net revenue results from Texas workers’ compensation claims. As such, we are subject to the rules and regulations of the Texas Department of Workers’ Compensation (“TDWC”). See “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations - Revenue Recognition – Contractual Allowance” for a description of the relevant rules and regulations of the TDWC.
Licensure, Certification and Accreditation
Our hospital is subject to state and local licensing regulations ranging from the adequacy of medical care to compliance with building codes and environmental protection laws. The failure to comply with these regulations could result in the suspension or revocation of a healthcare facility’s license. To assure continued compliance with these regulations, our facility is subject to periodic inspection by governmental and other authorities. Moreover, in order to participate in the Medicare and Medicaid programs, our hospital must comply with the applicable regulations of the United States Department of Health and Human Services (“DHHS”) relating to, among other things, equipment, personnel and standards of medical care, as well as comply with all applicable state and local laws and regulations. If a hospital fails to substantially comply with the numerous conditions of participation in the Medicare and Medicaid programs or performs certain prohibited acts, the hospital’s participation in the federal or state healthcare programs may be terminated, civil or criminal penalties may be imposed under certain provisions of the Social Security Act, or both.
We believe that our hospital is in substantial compliance with current applicable federal, state and local regulations and standards. However, the requirements for licensure and certification are subject to change. Consequently, in order for our hospital to remain licensed and certified, it may be necessary from time to time for us to make material changes in our facility, equipment, personnel and/or services.
Professional Licensure
Healthcare professionals at our hospital are required to be individually and currently licensed or certified under applicable state law and may be subject to numerous Medicare and Medicaid participation and reimbursement regulations. We take steps to ensure that all independent physicians and our employees and agents have the necessary licenses and certifications with their respective licensing agency. We believe that our employees and agents as well as all independent physicians on staff comply with all applicable state licensure laws.
Corporate Practice of Medicine and Fee-splitting
Some states, such as Texas, have laws that prohibit unlicensed persons or business entities, including corporations, from employing physicians. Some states, including Texas, also have adopted laws that prohibit direct or indirect payments or fee-splitting arrangements between physicians and unlicensed persons or business entities. Possible sanctions for violations of these restrictions include loss of license, civil and criminal penalties, and rescission of the business arrangements. These laws vary from state to state, are often vague and in most states have seldom been interpreted by the courts or regulatory agencies. We have structured our arrangements with healthcare providers to avoid the exercise of any responsibility on behalf of the physicians utilizing our hospitals that could be construed as affecting the practice of medicine and to comply with all such applicable state laws. However, we cannot assure you that governmental officials charged with the responsibility for enforcing these laws will not assert that we, or the transactions in which we are involved, are in violation of these laws. These laws also may be interpreted by courts in a manner inconsistent with our interpretations.
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Federal Anti-kickback Statute
The Medicaid/Medicare Anti-kickback Statute prohibits providers and others from soliciting, receiving, offering or paying, directly or indirectly, any remuneration with the intent of generating referrals or orders for services or items covered by a federal healthcare program. Courts have interpreted this statute broadly. A violation of the Anti-kickback Statute constitutes a felony and may be punished by a criminal fine of up to $25,000 for each violation, imprisonment up to five years, or both, civil money penalties of up to $50,000 per violation and damages of up to three times the amount of the illegal kickback and/or exclusion from participation in federal healthcare programs, including Medicare and Medicaid.
The Office of Inspector General at the DHHS (the “OIG”), among other regulatory agencies, is responsible for identifying and eliminating fraud, abuse and waste in federal healthcare programs. The OIG carries out this mission through a nationwide program of audits, investigations and inspections. The OIG has published final safe harbor regulations that outline categories of activities that are deemed protected from prosecution under the Anti-kickback Statute. Currently there are statutory exceptions and safe harbors for various activities, including the following: investment interests, space rental, equipment rental, practitioner recruitment, personal services and management contracts, sale of practice, referral services, warranties, discounts, employees, group purchasing organizations, waiver of beneficiary coinsurance and deductible amounts, managed care arrangements, obstetrical malpractice insurance subsidies, investments in group practices, freestanding surgery centers and referral agreements for specialty services. Compliance with a safe harbor is not mandatory. The fact that a particular conduct or a business arrangement does not fall within a safe harbor does not automatically render the conduct or business arrangement illegal under the Anti-kickback Statute. Such conduct and business arrangements, however, may lead to increased scrutiny by government enforcement authorities. The determination as to compliance with the Anti-kickback statute outside of a safe harbor rests on the particular facts and circumstances and on the parties’ intent in entering into the transaction or arrangement.
We have a variety of financial relationships with physicians who refer patients to our hospital. Physicians may own interests in our hospital and may also own our stock. We also have medical directorship agreements with some physicians. Although we believe that our arrangements with physicians have been structured to comply with the current law and available interpretations, we cannot assure you that regulatory authorities will not determine that these arrangements violate the Anti-kickback Statute or other applicable laws. If our arrangements were found to violate the anti-kickback law, we could be subject to criminal and civil penalties and/or possible exclusion from participating in Medicare, Medicaid or other governmental healthcare programs such as workers’ compensation programs. Exclusion from these programs could result in significant reductions in revenue and could have a material adverse effect on our business.
Stark Law
The federal physician self-referral statute is commonly known as the Stark law. This law prohibits physicians from referring Medicare and Medicaid patients who need “designated health services” (“DHS”) to entities with which the physician or an immediate family member has a financial relationship and prohibits the entities from billing Medicare or Medicaid for services ordered pursuant to a prohibited referral. Stark does, however, have a number of exceptions that permit financial relationships between physicians and entities providing DHS. However, the exception allowing physicians to invest in a hospital has been severely limited. See Risk Factors for on in-depth discussion of this change. Sanctions for violating the Stark law include denial of payment, refunding amounts received for services provided pursuant to prohibited referrals, civil monetary penalties of up to $15,000 per prohibited service provided and exclusion from the Medicare and Medicaid programs. The statute also provides for a penalty of up to $100,000 for a circumvention scheme that has the principal purpose of assuring referrals and that, if directly made, would violate the Stark law.
Although we monitor all aspects of our business, due to the complexity and continuously evolving nature of the law, we cannot give assurance that federal regulatory authorities will not determine that any of our arrangements with physicians violate the Stark law. Additionally, the Stark law may be amended in ways that we cannot predict at this time, including possible changes to the current physician ownership and compensation exceptions and we cannot predict whether any other law or amendment will be enacted or the effect they might have on us.
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State Anti-kickback and Physician Self-Referral Laws
The state of Texas, in which we operate, has adopted anti-kickback laws, some of which apply more broadly to all payers, not just to federal healthcare programs. Many of these state laws do not have safe harbor regulations comparable to the federal Anti-kickback Statute and have only rarely been interpreted by the courts or other government agencies. Based on court and administrative interpretations of the federal Anti-kickback Statute, we believe that the Anti-kickback Statute prohibits payments only if they are intended to induce referrals. However, the laws in most states, including Texas, regarding kickbacks have been subjected to more limited judicial and regulatory interpretation than federal law. Therefore, we can give you no assurances that our activities will be found to be in compliance with these laws. Noncompliance with these laws could subject us to penalties and sanctions and could have a material adverse effect on us.
A number of states, including Texas, have enacted physician self-referral laws that are similar in purpose to the Stark law but which impose different restrictions. Some states, for example, only prohibit referrals when the physician’s financial relationship with a healthcare provider is based upon an investment interest. Other state laws apply only to a limited number of designated health services. Some states do not prohibit referrals, but require that a patient be informed of the financial relationship before the referral is made. We believe that our operations are in material compliance with the physician self-referral laws of the state of Texas, in which our hospital is located, however, it is possible that different interpretations or enforcement of these laws and regulations could subject our current or past practices to allegations of impropriety or illegality or could require us to make changes in our hospital, equipment, personnel, services, capital expenditure programs and operating expenses. A determination that we have violated one or more of these laws could have a material adverse effect on our business, financial condition or results of operations and our business reputation.
Other Fraud and Abuse Provisions
The Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) broadened the scope of certain federal fraud and abuse laws by adding several criminal provisions for healthcare fraud offenses that apply to all health benefit programs. HIPAA also added a prohibition against incentives intended to influence decisions by Medicare beneficiaries as to the provider from which they will receive services. In addition, HIPAA created new enforcement mechanisms to combat fraud and abuse, including the Medicare Integrity Program and an incentive program under which individuals can receive 10% of the overpayments recovered or $1,000, whichever is less, for providing information on Medicare fraud and abuse that lead to the recovery of at least $100 of Medicare funds. HIPAA was followed by The Balanced Budget Act of 1997, which created additional fraud and abuse provisions, including civil penalties for contracting with an individual or entity that the provider knows or should know is excluded from a federal healthcare program.
The Social Security Act also imposes criminal and civil penalties for making false claims and statements to Medicare and Medicaid programs. False claims include, but are not limited to, billing for services not rendered or for misrepresenting actual services rendered in order to obtain higher reimbursement, billing for unnecessary goods and services, and cost report fraud. Criminal and civil penalties may be imposed for a number of other prohibited activities, including failure to return known overpayments, certain gainsharing arrangements, and offering remuneration to influence a Medicare or Medicaid beneficiary’s selection of a healthcare provider. Like the Anti-kickback Statute, these provisions are very broad. Careful and accurate coding of claims for reimbursement, as well as accurately preparing cost reports, must be performed to avoid liability.
The Federal False Claims Act and Similar State Laws
A factor affecting the healthcare industry today is the use of the FCA and, in particular, actions brought by individuals on the government’s behalf under the FCA’s “qui tam” or whistleblower provisions. Whistleblower provisions allow private individuals to bring actions on behalf of the government alleging that the defendant has defrauded the federal government.
When a defendant is determined by a court of law to be liable under the FCA, the defendant may be required to pay three times the actual damages sustained by the government, plus mandatory civil penalties of between $5,500 and $11,000 for each false claim submitted. There are many potential bases for liability under the FCA. Liability often arises when an entity knowingly submits a false claim for reimbursement to the federal government. The FCA defines the term “knowingly” broadly. Thus, although simple negligence will not give rise to liability under the FCA, submitting a claim with reckless disregard to its truth or falsity constitutes a “knowing” submission under the FCA and, therefore, will qualify for liability. The Fraud Enforcement and Recovery Act significantly amended the
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FCA. Among the most significant changes, Congress clarified and corrected certain provisions of the FCA by legislatively overruling various court decisions that sought to interpret the scope of the FCA. Other significant changes to the FCA include an expansion of the definition of “claim,” increased liability for retaining overpayments from the government, and clarification of several provisions related to whistleblower actions. The amendments extend the FCA to instances of misuse of federal funds even when no false claim is presented to the government.
In some cases, whistleblowers and the federal government have taken the position that providers who allegedly have violated other statutes, such as the Anti-kickback Statute and the Stark law, have thereby submitted false claims under the FCA. The state of Texas, in which we operate, has adopted their own false claims provisions as well as their own whistleblower provisions whereby a private party may file a civil lawsuit in state court.
Health Information Security and Privacy Practices
The Administrative Simplification provisions of HIPAA require certain organizations, including us, to implement very significant business and operational systems designed to protect each patient’s individual healthcare information.
Pursuant to HIPAA, we are obligated to appoint or have appointed privacy and security officers, analyze our existing patient record confidentiality system, develop systems to meet the increased confidentiality requirements in the areas of both privacy and security, draft and implement policies and procedures to maintain those systems, train all relevant personnel in the policies and procedures, monitor the systems on an on-going and continuous basis, notify every new and existing patient of our confidentiality practices and contract with certain vendors to assure they adhere to the same strict confidentiality and security standards.
The imposition of HIPAA privacy, security and transactional code set standards on healthcare providers, among others, is a substantial step by the federal government toward requiring that individual health and medical records are developed, maintained and billed for in electronic format. The rules continue to be amended and, as such, we will continue to modify our systems in order to maintain compliance with the standards.
In 2009, a law known as the Health Information Technology for Economic and Clinical Health Act (“HITECH Act”) was enacted. It was aimed at increasing the use of EHRs by physicians and hospitals. Hospitals and physicians who are “meaningful users” of EHRs may receive higher reimbursement rates through the Medicare and Medicaid reimbursement systems. Other significant changes made by HITECH Act include allowing state Attorneys General to assist in the enforcement of HIPAA and imposing the full HIPAA liabilities of Covered Entities on Business Associates as well. Additionally, the HITECH Act puts in place numerous changes to patient access to their protected health information and their privacy rights. We continue to review and monitor the HIPAA policies and procedures in place at our Pasadena facility to comply with the HITECH Act changes.
The HITECH Act significantly increased penalties for violations of HIPAA. In the past, civil monetary penalties for HIPAA violations had been limited to $100 per violation, with a maximum of $25,000 for all violations of an identical requirement in a single year. With the HITECH Act, fines start at $100 per violation (maximum $25,000 per year) and go to $50,000 per violation ($1,500,000 per year). Also, the HITECH Act provides that HHS must develop a methodology by which victims of privacy violations may receive a share of penalties that are collected by the federal government. Finally, the HITECH Act provides that state attorneys general may bring a civil action to enjoin privacy or security violations or obtain damages on behalf of state residents for such violations. Violations of the HIPAA privacy standards can also result in tort liability claims, disciplinary proceedings, and even criminal prosecutions for deliberate disclosures that involve malicious intent or personal gain. Violations of a patient’s privacy may potentially result in tort liability claims.
Emergency Medical Treatment and Labor Act
Our hospital is subject to the Emergency Medical Treatment and Labor Act (“EMTALA”). This federal law requires any hospital that participates in the Medicare program to conduct an appropriate medical screening examination of every person who presents to the hospital’s dedicated emergency department for treatment and, if the patient is suffering from an emergency medical condition, either to stabilize that condition or to make an appropriate transfer of the patient to a facility that can stabilize the condition. The obligation to screen and stabilize emergency
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medical conditions exists regardless of a patient’s ability to pay for treatment. CMS has issued final regulations and interpretive guidelines clarifying various requirements under EMTALA. There are severe penalties under EMTALA if a hospital fails to screen or appropriately stabilize or transfer a patient or if the hospital delays appropriate treatment in order to first inquire about the patient’s ability to pay. Penalties for violations of EMTALA include civil monetary penalties and exclusion from participation in the Medicare program. In addition, an injured patient, the patient’s family or a medical facility that suffers a financial loss as a direct result of another hospital’s violation of the law can bring a civil suit against the hospital.
Although we believe that our emergency care practices are in compliance with EMTALA requirements, we cannot assure that CMS or others will not assert that our facility is in violation or predict any modifications that CMS will implement in the future.
Utilization Review
Federal regulations require that admissions and utilization of facilities by Medicare and Medicaid patients must be reviewed in order to ensure efficient utilization of facilities and services. The law and regulations require Quality Improvement Organizations (“QIOs”) to review the appropriateness of Medicare and Medicaid patient admissions and discharges, the quality of care provided, the validity of diagnosis related group classifications and the appropriateness of cases of extraordinary length of stay. QIOs may deny payment for services provided, assess fines and also have the authority to recommend to the Department of Health and Human Services that a provider that is in substantial non-compliance with the standards of the QIOs be excluded from participating in the Medicare program.
Audits
As with most all hospitals, we are subject to numerous types of federal and state audits to validate the accuracy of claims submitted to the Medicare and Medicaid programs. If these audits identify overpayments, we could be required to make a substantial repayment of prior years’ payments subject to various administrative appeal rights. The federal and state governments contract with third-party auditors, some on a contingency fee basis. We periodically undergo claims audits by both federal and state auditors. To date there have been no material overpayments identified. However, potential liability from future federal or state audits could potentially be substantial. Further, Medicare and Medicaid regulations also provide for withholding Medicare and Medicaid overpayments in certain circumstances, which could adversely affect our cash flow.
Certificate of Need
Some states require state approval for construction and expansion of healthcare facilities, including findings of need for additional or expanded healthcare facilities or services. Certificates of need, which are issued by governmental agencies with jurisdiction over healthcare facilities, are sometimes required for capital expenditures exceeding a prescribed amount, changes in bed capacity or services and certain other matters. Currently, we do not operate in any state that requires a certificate of need. Should we desire to expand our operations to any jurisdiction where a certificate of need will be required, we are unable to predict whether we will be able to obtain any such certificate of need.
Environmental Regulation
Our facilities’ operations generate medical waste that must be disposed of in compliance with federal, state and local environmental laws, rules and regulations. These operations also are subject to compliance with various other environmental laws, rules and regulations. We cannot predict whether the cost of such compliance will have a material effect on our future capital expenditures, earnings or competitive position.
Insurance
The Company maintains various insurance policies that cover each of its U.S. facilities including occurrence medical malpractice coverage. In addition, all physicians granted privileges at the Company’s U.S. facilities are required to maintain medical malpractice insurance coverage. The Company also maintains general liability and
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property insurance coverage for each U.S. facility, including flood coverage. The Company does not currently maintain worker’s compensation coverage in Texas. In regard to the Employee Health Insurance Plan, the Company is self-insured with specific and aggregate re-insurance with stop-loss levels appropriate for the Company’s group size. Coverage is maintained in amounts management deems adequate.
Employees
As of March 9, 2013, the Company employed approximately 85 full-time employees. In addition, the Company employed 26 part-time/flex employees, which represent approximately 7 full-time equivalent employees.
Available Information
We file proxy statements and annual, quarterly and current reports with the U.S. Securities and Exchange Commission (“SEC”). You may read and copy any document that we file at the SEC’s public reference room located at 100 F Street, N.E., Washington, D.C. 20549. You may also call the SEC at 1-800-SEC-0330 for information on the operation of the public reference room. Our SEC filings are also available to you free of charge at the SEC’s website at http://www.sec.gov. We also maintain a website at http://www.dynacq.com that includes links to our SEC filings, including our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports. These reports are available on our website without charge as soon as reasonably practicable after such reports are filed with or furnished to the SEC. Information contained on our website should not be considered part of this report.
| Item 1A. | Risk Factors. |
The value of an investment in Dynacq Healthcare, Inc. is subject to significant risks, certain of which are specific to our Company, others are inherent in our business and the industry in which we operate, and still others are market related. If any of the matters described in the risk factors listed below were to occur, our business and financial results could be materially adversely affected. The Risk Factors described below apply to the current operations and market for the common stock of the Company, and do not address risks that may arise in the future.
Risks Related to our Business
We continue to incur substantial losses, and we have no current prospect of generating operating profits.
For the fiscal years ended August 31, 2012 and 2011, our business generated a net loss of approximately $12.2 million and $21.0 million, respectively. In recent years, our net patient revenues have declined, relative to historical levels, due to declines in patient referrals. While we continue to seek out additional sources of patient referrals, we have not been able to realize the substantial increase in patient referrals we require in order to generate the revenues needed to offset our operating losses. Our industry is highly competitive, and we have not been able to identify and execute any business plan that might result in an operating profit or even in decreased losses. We are currently evaluating strategic alternatives in an attempt to reverse our historical trend of operating losses, although there can be no assurance that we will be able to reverse this trend. If we are unable to generate positive net income on a consistent basis going forward, we may not be able to continue our operations.
Our cash reserves cannot continue to support the level of losses we have incurred in recent years.
As of August 31, 2012, we had approximately $30.8 million in net assets, including approximately $10.6 million in cash and cash equivalents, available for continuing operations. These reserves are being steadily depleted by our losses, which totaled approximately $33.2 million in our last two fiscal years. If we are unsuccessful in implementing an alternative business plan to increase revenues and improve performance, or are otherwise required to continue to use a substantial portion of our current assets in order to continue our day to day operations, then our continued operations will not be sustainable.
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A significant percentage of our revenues are generated through relatively few physicians.
For the fiscal year ended August 31, 2012, approximately 90% of our gross revenues of our Pasadena facility were generated from 7 surgeons. For the fiscal year ended August 31, 2011, approximately 91% of our gross revenues of our Pasadena facility were generated from 11 surgeons. A physician from our medical staff, who accounted for 19% and 7% of gross revenues for the fiscal year ended August 31, 2012 and 2011, respectively, passed away in August 2012. The loss of this physician led to a reduction in our revenues and adversely affected our results of operations. The loss of other physicians who provide significant net patient revenues for the Company may adversely affect our results of operations.
We are subject to substantial uninsured liabilities for which we have incurred, and may continue to incur, significant expenses.
Although we maintain professional malpractice liability insurance and general liability insurance coverage for our U.S. facilities in amounts and with deductibles that we believe to be appropriate for our operations, our insurance coverage may not be sufficient or continue to be available at a cost allowing us to maintain adequate levels of insurance. Our professional malpractice liability insurance has covered the majority of malpractice and related legal claims to date; however, the cost of defending the shareholder derivative suits and any damages awarded as a result of those suits, are paid by the Company. In addition, the large monetary claims and significant defense costs involved in many of the malpractice claims may exceed the limits of our insurance coverage. If one or more successful claims against us were not covered by or exceeded the coverage of our insurance, we could be adversely affected. We do not employ any of the physicians who conduct procedures at our hospitals, and the governing documents of each of our hospitals require physicians who conduct procedures at our hospitals to maintain stated amounts of insurance.
We indemnify our directors and officers against certain liabilities and do not presently carry director and officer liability insurance.
As permitted under Nevada law and pursuant to our governing documents and indemnification agreements with certain of our officers and directors, we indemnify our directors and officers against monetary damages, including advancing expenses, to the fullest extent permitted by Nevada law. We do not carry director and officer liability insurance, so our assets are at risk in the event of successful claims against us or our officers and directors. Our assets may not be sufficient to satisfy judgments against us and our officers and directors in the event of such successful claims. In addition, our lack of director and officer liability insurance may adversely affect our ability to attract and retain highly qualified directors and officers in the future.
We are dependent on the services of our chief executive officer.
The Company’s future success will depend upon its ability to retain the services of its chief executive officer. The Company does not have a written employment agreement with our chief executive officer providing for specific terms of employment, and does not carry any key man life insurance. The Company’s loss of its chief executive officer, especially if the loss is without advance notice, could have a material adverse effect on the Company’s business, financial condition or results of operations.
We hold accounts with certain financial institutions that exceed the FDIC and SIPC insurance limits in the U.S. and with financial institutions overseas.
The Company has financial instruments that are exposed to concentrations of credit risk and consist primarily of cash investments and trade accounts receivable. The Company routinely maintains cash and temporary cash investments at certain financial institutions in amounts substantially in excess of Federal Deposit Insurance Corporation (“FDIC”) and Securities Investor Protection Corporation (“SIPC”) insurance limits in the U.S. and with financial institutions overseas. At August 31, 2012, the Company had cash balances in excess of the FDIC and SIPC limits in the U.S. and in financial institutions overseas of $8 million. Management believes that these financial institutions are of high quality and the risk of loss is minimal. However, if any of these financial institutions were to fail and we were unable to recover our cash balances, it could have a material adverse effect on the Company’s business, financial condition or results of operations.
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Our business could be adversely affected by foreign currency fluctuation.
Because we have total assets of approximately $7.8 million which are denominated in currency other than the U.S. dollar (USD), we have foreign currency exchange risk. The Chinese currency (RMB) is not freely traded and is closely controlled by the Chinese Government. The U.S. dollar (USD) has experienced volatility in world markets recently. During fiscal 2012 and 2011, fluctuation in the Euro – Hong Kong dollar and USD – RMB exchange rate resulted in exchange gains (losses) of $(309,000) and $302,000, respectively, which are included in rent and other income in our consolidated statements of operations. In fiscal year 2012, the Company also remitted funds back from China to the U.S., and reclassified foreign currency exchange gains of $1.4 million from accumulated other comprehensive income to rent and other income.
The recent economic downturn may adversely affect our revenues.
The recent weakening in the United States economy, tightening credit markets, depressed consumer spending and higher unemployment rates may result in decreased spending for healthcare services resulting in decreased revenues for our hospitals. Other risks we face from the general economic weakness include potential declines in the population covered under managed care agreements, patient decisions to postpone or cancel elective and non-emergency healthcare procedures, potential increases in the uninsured and underinsured populations and further difficulties in our collecting patient copayment and deductible receivables.
Our investments in marketable securities in foreign markets are subject to a high degree of risk and differences in market conditions than those in the U.S.
We have significant unrealized gains on our investments in available-for-sale securities. Approximately 40% of our assets as of August 31, 2012 are represented by foreign investment securities, which are generally less liquid, more volatile and harder to value than U.S. securities. These foreign investments are subject to unique risks such as currency risk, political, social and economic risk, and foreign market and trading risk. Foreign investments may be affected by political, social or economic events occurring in a country where the bonds are invested, which could cause the investments in that country to experience gains or losses. Lack of public information and uniform auditing, accounting and financial reporting standards in foreign countries make disclosure of investment information different from that available from domestic issuers. The trading markets for these investments are significantly less active than U.S. markets and may have less governmental regulation and oversight. Because of these risks, and others, there can be no assurance that the Company’s investments in securities in foreign markets will retain or increase in value or can be liquidated at a price or time favorable to the Company.
Risks Associated with our Industry
The Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act, (collectively, the “2010 Health Care Legislation”) may have a significant impact on our existing and future joint ventures.
The 2010 Health Care Legislation includes significant revisions to the portion of the Social Security Act commonly known as the “Stark law,” which generally prohibits physicians from referring Medicare and Medicaid patients to providers of enumerated “designated health services” with whom the physician or a member of the physician’s immediate family has an ownership interest or compensation arrangement. Such referrals are deemed to be “self-referrals” due to the physician’s financial relationship with the entity providing the designated health services. An exception to the general self-referral prohibition, commonly known as the “Whole Hospital Exception,” previously existed under the Stark law for physician ownership and/or investment in an entire hospital (rather than a subdivision of a hospital), provided that certain requirements were met. Under the 2010 Health Care Legislation, the availability of the Whole Hospital Exception will depend on physician ownership or investment in a new hospital entity and the existence of a provider agreement by December 31, 2010, provided certain other conditions are met. The 2010 Health Care Legislation also provides that the percentage of physician ownership or investment interests held in a new hospital entity by physician owners or investors cannot exceed the percentage that existed as of
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March 23, 2010, the date on which the legislation was enacted. Moreover, under the 2010 Health Care Legislation, except in certain circumstances, the number of operating rooms, procedure rooms and licensed beds in a hospital having physician ownership cannot be increased beyond the amount that existed on March 23, 2010. The provisions of the 2010 Health Care Legislation, that are described herein, could have a significant impact on our existing and future joint ventures.
Health care reform may have a significant effect on our existing and future operations.
The 2010 Health Care Legislation, as well as other health reform legislation, may have a significant impact on our existing and future operations and how and when such legislation will be implemented remains uncertain. The lack of consensus by legislators on how to reform the healthcare system and the emphasis on budgetary constraint and limitations on Medicare spending has created a great deal of regulatory uncertainty. Further, the development of Accountable Care Organizations may limit our ability to provide services to Medicare beneficiaries and other changes to the law implemented as part of health care reform could further restrict the care we are able to offer patients. The current economic climate as well as efforts to reduce healthcare costs could reduce the reimbursement we receive for the services we do provide and may adversely affect our business and results of operations.
If we fail to comply with the extensive laws and complex government regulations applicable to us, we could suffer penalties or be required to make significant changes to our operations.
The U.S. healthcare industry is highly regulated and must comply with extensive government regulation at the federal, state and local levels. Hospitals must meet requirements for licensure, certification to participate in government programs and accreditation. In addition, there are regulatory requirements related to areas such as adequacy and quality of medical care, relationships with physicians and other referral sources (Anti-kickback Statute and Stark law, for example), qualifications of medical and support personnel, billing for services, confidentiality of medical records, emergency care and compliance with building codes. While we believe that we are in substantial compliance with these extensive government laws and regulations, if we fail to comply with any of the laws or regulations we could be subject to criminal penalties and civil sanctions, and our facilities could lose their licenses and their ability to participate in federal and state healthcare programs. In addition, government laws and regulations, or the interpretation of such laws and regulations, may change. In that case, we may have to make changes in our facility, equipment, personnel, services or business structures so that our facility may remain licensed and qualified to participate in federal and state programs. If the rules governing reimbursement are revised or interpreted in a different manner or if a determination is made that we did not comply with these requirements, we could be subject to denials of payment or recoupment of payments already received for services provided to patients.
Specifically, the federal Anti-kickback Statute and the Stark law are very broad in scope, and many of their provisions have not been uniformly or definitively interpreted. See Business – Government Regulation for an in- depth description of those statutes. If the ownership distributions paid to physicians by our hospital is found to constitute prohibited payments made to physicians under the Anti-kickback Statute, physician self-referral or other fraud and abuse laws, our business may be adversely affected. Other companies within the healthcare industry continue to be the subject of federal and state investigations that could increase the risk that we may become subject to similar investigations in the future.
If laws governing the corporate practice of medicine change, we may be required to restructure some of our relationships.
The laws of various states in which we operate or may operate in the future do not or may not permit business corporations to practice medicine, exercise control over physicians who practice medicine or engage in various business practices, such as fee-splitting with physicians. The interpretation and enforcement of these laws vary significantly from state to state. A government agency charged with enforcement of these laws, or a private party, might assert that our arrangements with physicians and physician group practices do not comply with applicable corporate practice of medicine laws. If our arrangements with these physicians and physician group practices were deemed to violate state corporate practice of medicine, fee-splitting or similar laws, or if new laws were enacted rendering these arrangements illegal, we may be required to restructure our relationships with physicians and physician groups, which may have a material adverse effect on our business.
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Changes to the Fee Guidelines for Texas workers’ compensation cases have resulted in lower reimbursement and may result in a decrease in the number of those type of procedures performed.
The Texas Workers’ Compensation 2008 Acute Care Hospital Outpatient and Inpatient Facility Fee Guidelines which became effective March 1, 2008 establish reimbursement amounts for workers’ compensation procedures performed at our facilities. Those amounts are determined by applying the most recently adopted and effective Medicare reimbursement formula and factors as published annually in the Federal Register, including identifying the appropriate Ambulatory Payment Classification for outpatient services provided, or Diagnosis Related Group for inpatient services provided. The applicable classification or group is used to determine the maximum allowable reimbursement for the procedures performed unless not calculable using Guidelines, in which case reimbursement will be determined on a fair and reasonable basis. Based on these new Guidelines, the reimbursement due the Company for workers’ compensation cases is lower than we previously experienced. Our net patient service revenues attributable to Texas workers’ compensation cases as a percentage of gross billings have decreased and may continue to decrease as a result of lower reimbursement rates for workers’ compensation procedures still being performed.
Our revenues may be negatively affected by a reduction in payments from third-party payers, a shift in the surgical mix, government cost controls and/or other circumstances over which we have no control.
We are dependent upon private and governmental third-party sources of payment for the services provided to patients in our hospital. The amount of payment our hospital receives for its services may be adversely affected by market and cost factors as well as other factors over which we have no control, including federal and state regulations and the cost containment and utilization decisions of third-party payers. The Company’s decision to participate in certain managed care contracts may not result in an increase in patient revenues if we are unable to obtain favorable managed care contracts, we are excluded from participation in a managed care contract, or the reimbursement rate for the procedure performed is too low.
Further, complicated reimbursement rules that are subject to interpretation may subject us to denials of payment for services provided or to recoupments of payments already received. We have no control over the number of patients that are referred to our hospital annually or whether such patients will be admitted as inpatients, which typically have a higher reimbursement rate per procedure, or outpatients. Fixed fee schedules, capitation payment arrangements, exclusion from participation in managed care programs or other factors affecting payments for healthcare services over which we do not have control could also cause a reduction in our revenues.
We are dependent upon the good reputation of our physicians.
The success of our business is dependent upon quality medical services being rendered by our physicians. Any negative publicity, whether from civil litigation, allegations of criminal misconduct, or forfeiture of medical licenses, with respect to any of our physicians and/or our facilities could adversely affect our results of operations. This could occur through the loss of a physician who provides significant revenue to the Company, or decisions by patients to use different physicians or facilities with respect to their healthcare needs. Several years ago Dynacq was the subject of negative publicity in news reports focusing on its Pasadena facility, which harmed its business and reputation. As the patient-physician relationship involves inherent trust and confidence, any negative publicity adversely affecting the reputation of our physicians or our facilities would likely adversely affect our results of operations.
Our hospital faces competition for patients from other hospitals and healthcare providers.
The healthcare business is highly competitive, and competition among hospitals and other healthcare providers for patients has intensified in recent years. Generally, other hospitals in the local communities served by most U.S. hospitals provide services similar to those offered by our hospital. In addition, the number of freestanding specialty hospitals and surgery and diagnostic centers in the geographic area in which we operate has increased significantly. As a result, our hospital operates in an increasingly competitive environment. Some of the hospitals that compete with our hospital are owned by governmental agencies or not-for-profit corporations supported by endowments and charitable contributions and can finance capital expenditures and operations on a tax-exempt basis. Increasingly, we
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are facing competition by physician-owned freestanding surgery centers that compete for market share in high margin services and for quality physicians and personnel. If our competitors are better able to attract patients, recruit physicians, expand services or obtain favorable managed care contracts at their healthcare facilities, we may experience a decline in patient volume.
Our hospital faces competition for staffing, which may increase our labor costs and reduce profitability.
Our operations are dependent on the effort, abilities and experience of the management and medical support personnel, such as nurses, pharmacists and lab technicians, as well as our physicians. We compete with other healthcare providers in recruiting and retaining qualified management and medical support personnel responsible for the day-to-day operations of our hospital. In the U.S. market, the availability of nurses and other medical support personnel has become a significant operating issue to healthcare providers. This shortage may require us to continue to enhance wages and benefits to recruit and retain nurses and other medical support personnel or to hire more expensive temporary personnel. We also depend on the available labor pool of semi-skilled and unskilled employees in each of the markets in which we operate. If our labor costs increase, we may not be able to raise rates to offset these increased costs. Our failure to recruit and retain qualified management, nurses and other medical support personnel, or to control our labor costs could have a material adverse effect on our results of operations.
Market Risks Related to Our Stock
A single stockholder controls a majority of our outstanding shares, and a small group of stockholders controls a super-majority of our shares.
Mrs. Ella Chan, wife of our former chairman and chief executive officer, Mr. Chiu Chan, together with the estate of Mr. Chan, beneficially owns an aggregate of approximately 58% of our issued and outstanding common stock as of March 8, 2013. As a majority stockholder, she is able to control all matters requiring stockholder approval, including the election and removal of any directors and any merger, consolidation or sale of all or substantially all of our assets. In addition, Mrs. Chan is in a position to control the management of our business and the appointment of executive officers as well as all management personnel. As discussed in “Recent Developments – Changes in our Officers and Directors,” a group of stockholders controls approximately 68.5% of our outstanding common stock, which pursuant to the terms of our governing documents, constitutes a super-majority of our common stock, as of the date of this filing. This group has the ability to, among other things, remove members of our Board of Directors for cause or for no cause at all, as the group elected to do in October 2012. This concentration of ownership could have the effect of delaying, deferring or preventing a change of control, or impeding a merger or consolidation, takeover or other business combination or sale of all or substantially all of our assets. Mrs. Chan’s interests or the interests of this group may conflict with those of other stockholders. In the event that Mrs. Chan or members of this group elect to sell significant amounts of shares of common stock in the future, such sales could depress the market price of our common stock, further increasing the volatility of our trading market.
We have no independent directors, and no separate board committees.
As of October 30, 2012, our Chief Executive Officer, Eric Chan, is the sole member of our Board of Directors. As a result, we no longer have any independent directors to evaluate our decisions, nor do we have any committees of our Board comprised of independent directors, including audit, nominating and compensation committees. Although we are not required by rules or regulations applicable to us to have independent directors or such committees, corporate governance measures such as the presence of independent directors and the establishment of committees comprised of independent directors may be beneficial to our stockholders. For example, in the absence of audit, nominating and compensation committees comprised of at least a majority of independent directors, decisions concerning matters such as compensation packages to our senior officers and recommendations for director nominees may be made by members of the Board who have a direct interest in the outcome. Although we anticipate seeking new independent directors in the future, there can be no assurance as to whether or when we will be successful in appointing any new directors. Moreover, while the inclusion of independent directors to our Board and the adoption of certain other corporate governance measures could benefit our stockholders, there can be no assurance that these measures would be effective even if independent directors are appointed to our Board and these governance measures are implemented.
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NASDAQ delisted our common stock effective October 22, 2012, and prior to that had placed a trading halt since August 9, 2012, which is likely to affect your ability to sell shares of our common stock and the price you may receive for our common stock.
NASDAQ delisted the common stock of our Company effective October 22, 2012. Prior to that, trading in the Company’s stock was halted by NASDAQ since August 9, 2012. The Company’s common stock is eligible to trade in the “Grey Market.” Grey Market securities do not have bid or ask quotations in the OTC Link system or the OTCBB. Broker-dealers must report Grey Market trades to FINRA, so trade data is available on http://www.otcmarkets.com and other public sources. Generally, trading in the Grey Market is much more limited than trading on NASDAQ. As such, our being delisted from NASDAQ has severely decreased the liquidity of the shares of common stock that you own.
Historically, there was only limited trading activity in our securities, and we have had a relatively small public float compared to the number of our shares outstanding. Additionally, as a result of the recent delisting of our common stock from NASDAQ, the ability of stockholders to trade any shares has been severely impeded. Accordingly, we cannot predict the extent to which investors’ interest in our common stock will provide an active and liquid trading market. Due to our limited public float, we may be vulnerable to investors taking a “short position” in our common stock, which would likely have a depressing effect on the price of our common stock and add increased volatility to our trading market. Furthermore, we have been, and in the future may be subject to, class action lawsuits that further increase market volatility. The volatility of the market for our common stock could have a materially adverse effect on our business, results of operations and financial condition. Accordingly, investors must be able to bear the financial risk of losing their entire investment in our common stock.
Future issuance of additional shares of our stock could cause dilution of ownership interests and adversely affect our stock price.
In addition to approximately 85.5 million additional shares of common stock that we are authorized to issue, our board may issue up to 5 million shares of preferred stock which may have greater rights than our common stock, without seeking approval from holders of our common stock. In addition, we are obligated to issue an aggregate of approximately 2.8 million shares of common stock upon the exercise of options outstanding under our 2000 and 2011 Incentive Plan. None of these options have an exercise price which is lower than the market price at August 9, 2012, the last date of trading before trading halt by NASDAQ. The shares that could be issued upon exercise of the outstanding options represent approximately 19% of our currently outstanding shares of common stock. Additional shares are subject to options not yet granted under the Year 2011 Stock Incentive Plan, and we may grant additional options or warrants in the future to purchase shares of our common stock not under the plan. The exercise price of each option granted under our option plan is equal to the fair market value of the shares on the date of grant, although that price may be substantially less than the value per share on the date of exercise.
We have not paid cash dividends on our common stock and do not expect to do so in the foreseeable future.
It has been our policy to use all available funds from operations to improve and expand our current facilities and to acquire new facilities. For that reason, we have never paid cash dividends on our common stock and have no present intention to pay dividends in the foreseeable future. Therefore an investor in our common stock should not expect to obtain any economic benefit from owning our common stock prior to a sale of those shares, if then.
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| Item 1B. | Unresolved Staff Comments. |
None.
| Item 2. | Properties. |
The Company or its subsidiaries own or lease the following properties:
- The Pasadena facility, the office building adjacent to such facility and the land upon which the facilities are located, are owned by a wholly-owned subsidiary of the Company, and are held free and clear of any encumbrances. The hospital is approximately 45,000 square feet, and the office building is approximately 36,000 square feet. This property belongs to the U.S. Division.
- In March 2010, the Company purchased an apartment in Hong Kong as an investment for $2,014,207. The Company obtained an 18-year mortgage loan of $1,245,775 from a financial institution, with a variable interest rate at the lower of 3-month Hang Seng Interbank Offered Rates plus 0.7% or 2.9% below the Hong Kong Dollar best lending rate quoted by the financial institution. The effective interest rate at August 31, 2012 was 1.12%. This property belongs to the Corporate Division. Subsequent to the year ended August 31, 2012, this apartment was sold for a gain of approximately $480,000.
- As part of assets of discontinued operations, the Garland facility, including an approximately 90,000 square foot hospital, an approximately 27,000 square foot medical office building and approximately 22.7 acres of land in Garland, Texas, is owned by a wholly-owned subsidiary of the Company, and is held free and clear of any encumbrances. This property belongs to the U.S. Division. The Company signed a commercial contract of sale on March 7, 2013 to sell its Garland facility. The sale is expected to close in May 2013.
| Item 3. | Legal Proceedings. |
The Company is routinely involved in litigation and administrative proceedings that are incidental to its business. Specifically, all judicial review of unsatisfactory determinations of reimbursement amounts due us for our Texas facilities’ fees must be made in the district courts of Travis County, Texas in what can often be a lengthy procedure. Please refer to Management’s Discussion and Analysis of Financial Condition and Results of Operations – Revenue Recognition for a detailed description of the medical dispute resolution (“MDR”) process and our accounts receivable. The Company cannot predict whether any future litigation or administrative proceeding to which it may become a party will have a material adverse effect on the Company’s results of operations, cash flows or financial condition.
| Item 4. | Mine Safety Disclosures. |
None.
| Item 5. | Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. |
The Company’s common stock traded on the NASDAQ Global Market under the symbol “DYII” until August 8, 2012. NASDAQ delisted the common stock of our Company effective October 22, 2012. Prior to that, trading in the Company’s stock was halted by NASDAQ since August 9, 2012. The Company’s common stock is eligible to trade in the “Grey Market.” Grey Market securities do not have bid or ask quotations in the OTC Link system or the OTCBB. Broker-dealers must report Grey Market trades to FINRA, so trade data is available on http://www.otcmarkets.com and other public sources.
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The following table sets forth the high and low bid prices of the common stock for the period from September 1, 2010 to August 9, 2012. These over-the-counter prices reflect inter-dealer prices, without retail mark-ups, mark-down or commissions, and may not necessarily represent actual transactions.
| Highs | Lows | |||||||
FISCAL YEAR 2012 | ||||||||
Fourth Quarter (June 1, 2012 to August 9, 2012) | $ | 1.05 | $ | 0.43 | ||||
Third Quarter | 1.05 | 0.54 | ||||||
Second Quarter | 1.18 | 0.76 | ||||||
First Quarter | 1.75 | 0.79 | ||||||
FISCAL YEAR 2011 | ||||||||
Fourth Quarter | $ | 2.09 | $ | 1.60 | ||||
Third Quarter | 2.18 | 1.63 | ||||||
Second Quarter | 2.55 | 1.84 | ||||||
First Quarter | 2.58 | 1.90 | ||||||
As of March 19, 2013, there were approximately 382 record owners of the Company’s common stock. This number does not include stockholders who hold the Company’s securities in nominee accounts with broker-dealer firms or depository institutions.
The Company has not declared any cash dividends on its common stock for the two most recent fiscal years. The Company intends to retain all earnings for operations and expansion of its business and does not anticipate paying cash dividends in the foreseeable future. Any future determination as to the payment of cash dividends will depend upon the Company’s results of operations, financial condition and capital requirements, as well as such other factors as the Company’s Board of Directors may consider.
Securities Authorized For Issuance under Equity Compensation Plans
The following table provides information as of August 31, 2012, with respect to the Company’s equity compensation plans under which equity securities are authorized for issuance.
| Number of securities to be issued upon exercise of outstanding options, warrants and rights | Weighted average exercise price of outstanding options, warrants and rights | Number of securities remaining available for future issuance (excluding securities reflected in first column) | ||||||||||
Plan Category | ||||||||||||
Plans approved by shareholders | 2,790,566 | $ | 1.92 | 13,950,000 | ||||||||
Plans not approved by shareholders | — | — | — | |||||||||
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Total | 2,790,566 | $ | 1.92 | 13,950,000 | ||||||||
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| Item 6. | Selected Financial Data. |
Not required.
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| Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations. |
Our Management’s Discussion and Analysis includes forward-looking statements that are subject to risks and uncertainties. Actual results may differ substantially from the statements we make in this section due to a number of factors that are discussed in Item 1A – Risk Factors.
Our operating results for all periods presented reflect operations of our Garland facility in the U.S. and all of our subsidiaries in China and Hong Kong, except for Sino Bond, as discontinued operations.
RECENT DEVELOPMENTS
Internal Investigation
As previously disclosed in our Current Report on Form 8-K filed with the Securities and Exchange Commission (the “SEC”) on August 9, 2012, we announced that, at the request of our Board of Directors (the “Board”), we commenced an internal investigation of our past business practices, potentially encompassing members of the Board, management and third persons, and related accounting matters (the “Investigation”).
The Investigation, which was performed by outside legal counsel and other outside consultants at the direction of the Board, was substantially completed on December 27, 2012. The Investigation included a review of a substantial number of Company documents and emails, as well as interviews with employees, members of the Board and other persons who were familiar with the facts surrounding the Investigation. The results of the Investigation, which were reported directly to the Board, revealed that the former Chief Financial Officer of the Company did not perform a significant review or independent analysis of transactions initiated by the former Chief Executive Officer. As a result, we believe that, for the five fiscal years ending on August 31, 2012, we did not maintain effective control over financial reporting due to the existence of a material weakness related to a failure of internal controls designed to limit the ability of management to override our system of internal controls. The results of the Investigation also revealed that the former Chief Financial Officer misrepresented certain information to our independent auditor, which we have also determined to be a material weakness in our internal control over financial reporting. We also identified the existence of a significant deficiency related to a lack of objectivity by our former executive officers with respect to accounting decisions.
Based on the results of the Investigation and recommendations made by our independent auditor regarding the foregoing material weaknesses and significant deficiencies in internal control over financial reporting, we are reviewing our internal control and compliance policies and procedures. We believe that no additional remediation efforts with respect to the material weaknesses and the significant deficiency as they relate to the former Chief Executive Officer and the former Chief Financial Officer are necessary, as the executives who occupied these offices during the events in question are no longer employed by us.
We have determined that our previously reported consolidated balance sheets for periods up to and including August 31, 2012 do not require any material adjustments and/or restatements in respect of the results of the Investigation. Further, the Investigation did not result in any material change to our previously reported net income or loss or financial position for the same periods. However, the Investigation, along with subsequent analysis performed by us and our auditors, did reveal that Company expenditures in the amount of approximately $7.8 million were authorized by former officers of the Company and paid to various third parties, and the results of the Investigation and the subsequent analysis performed by us and our auditors provided no evidence of a discernible benefit to the Company resulting from these expenditures. We have determined that the questionable nature of these expenditures may result in their reclassification in our financial statements, from operating costs and expenses to other expenses, depending on determinations that the Board may make in the future. We do not expect these reclassifications, even if they are made, to result in a material restatement of our financial statements. Please see note 16 to our consolidated financial statements for additional information.
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Delisting of Common Stock from NASDAQ Global Markets
As discussed in our Current Report on Form 8-K filed with the SEC on October 11, 2012, and further discussed in our Current Reports on Form 8-K filed on each of September 28, 2012 and April 13, 2012, the NASDAQ Stock Market (“NASDAQ”) announced on October 10, 2012 that the Company’s common stock would be delisted from NASDAQ. Prior to being delisted, trading in the Company’s stock was halted by NASDAQ on August 9, 2012, and NASDAQ suspended the Company’s stock from trading on October 4, 2012. As discussed in the Company’s Current Report on Form 8-K filed with the SEC on April 13, 2012, NASDAQ informed the Company that it would be subject to delisting upon a failure to regain compliance with (i) the $1.00 minimum bid price per share of its common stock pursuant to NASDAQ Listing Rule 5450(a)(1) for a period of at least ten consecutive business days ending on a date prior to October 9, 2012, and (ii) the minimum market value of its publicly held shares of at least $5 million pursuant to NASDAQ Listing Rule 5450(b)(1)(C) for at least ten consecutive business days prior to October 9, 2012. Further, on September 25, 2012, the Company received notification from NASDAQ stating that the Company’s common stock will be delisted from NASDAQ effective at the opening of business on October 4, 2012. The delisting of the Company’s common stock was a result of the Company’s failure to make timely payment of certain listing fees, as required by NASDAQ Listing Rule 5250(f), in the amount of $5,000. In light of the prior NASDAQ notice described in further detail above, the Company concluded that no valid business purpose would be served by making payment of these fees. The Company did not request an appeal hearing regarding the delisting. As a result of the trading halt in effect at the time of the notice for the Company’s common stock and the failure of the minimum bid price to reach $1.00 per share for 10 consecutive business days after receipt of the NASDAQ letter and prior to the commencement of the trading halt, and in light of the fact that there were fewer than ten business days remaining before October 9, 2012, the Company did not believe that it would be able to regain compliance with the NASDAQ Listing Rules discussed above prior to October 9, 2012. As a result, the Company believed that it would have become subject to delisting for failure to comply with Listing Rule 5450(a)(1) on October 9, 2012, even if it had paid the listing fees in compliance with NASDAQ Listing Rule 5250(f) on or before October 4, 2012. A Form 25 was filed with the SEC on October 11, 2012, and the Company’s stock was effectively delisted ten days following this filing.
Changes in Officers and Directors
On May 17, 2012, Chiu M. Chan, the Chairman of our Board of Directors, passed away. His seat on the Board of Directors remains vacant while the Board considers whether to appoint a new director or permanently reduce the size of the Board to five members. As previously reported in the Company’s Current Report on Form 8-K filed with the SEC on January 13, 2012, on January 10, 2012 the Board of Directors expanded the Board from five to six members and appointed Eric K. Chan, M.D. as a new member of the Board. Eric K. Chan is the son of Chiu M. Chan, who was incapacitated at the time by an unexpected illness. Eric K. Chan did not stand for election at the Annual Meeting of Shareholders held on February 15, 2012 and his term as director ended. At the conclusion of the Annual Meeting, the Board of Directors reappointed Eric K. Chan as a member of the Board. Eric K. Chan currently serves as our Chief Executive Officer and President. Dr. Chan is board certified in anesthesiology. He has been the sole owner of Redwood Health Corporation since March 2005, which furnishes physicians to provide in-house emergency medical coverage and recruits anesthesiologists and certified registered nurse anesthetists at hospitals, including the Company’s Pasadena facility. Dr. Chan has also been the sole owner of Anesthesia Associates of Houston Metroplex since August 2007, which provides anesthesiology services to hospitals, including the Company’s Pasadena facility. He was an Assistant Professor at Memorial Hermann Hospital, University of Texas at Houston from August 2007 to September 2008. Dr. Chan earned his M.B.A. in Health Organization Management and M.D. from Texas Tech University.
On August 8, 2012, the Board placed Mr. Philip Chan on paid administrative leave from his position as Chief Financial Officer of Dynacq. On November 28, 2012, Mr. Chan submitted to the Board his resignation from all positions at Dynacq and its affiliates, including his positions as Chief Financial Officer and Director of Dynacq. While Mr. Chan was on administrative leave, the Board appointed Hemant Khemka, the current Controller of Dynacq, to act as principal financial officer of Dynacq pending the results of the investigation. Mr. Khemka continues to act as principal financial officer of Dynacq.
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As discussed in the Definitive Information Statement filed pursuant to Section 14(c) (the “Information Statement”) of the Securities Exchange Act of 1934, as amended (the “Exchange Act””) on October 9, 2012, pursuant to an Action by Written Consent of Stockholders in lieu of a Special Meeting, stockholders of Dynacq holding more than two-thirds of the issued and outstanding shares of our common stock as of September 24, 2012 (the “Record Date”) approved the removal of Ping S. Chu, James G. Gerace and Stephen L. Huber from their positions as members of our Board, to be effective on October 30, 2012. On October 24, 2012, James G. Gerace resigned. On October 30, 2012, the stockholder approval became effective, and Messrs. Chu and Huber were removed.
The sole remaining member of our Board is Dr. Eric K. Chan, who also serves as our Chief Executive Officer and President. As a result of the stockholder action and recent resignations, our Board has five vacancies, including the vacancy left by Mr. Chiu M. Chan’s passing. We intend to seek qualified candidates to fill these Board vacancies, including some candidates that are deemed independent based on the independence standards of NASDAQ. There can be no assurance, however, that we will be able to fill any of these vacancies with new directors, independent or otherwise. In the interim, the sole remaining member of our Board will continue to fulfill the Board’s responsibilities. The following holders of 9,966,482 shares of our common stock, constituting 68.5% of our outstanding common stock on the Record Date, consented to the stockholder action: Estate of Chiu M. Chan (represented by the widow of Mr. Chan, Ella Y.T.C. Chan, the sole executrix of the estate); Ella Y.T.C. Chan; Chan Chang Chin Ying (the aunt of Dr. Eric K. Chan); Philip S. Chan; Dr. Eric K. Chan; Edward K. Chiu (no relation to any other stockholder consenting to the action); and Bert Chan (brother of Eric K. Chan and son of Ella Y.T.C. Chan). Please see the Information Statement for additional information.
Restatement of Financial Statements for Fiscal Year 2011 Due to Change in Benefit for Income Tax Amount
We restated our financial statements for the fiscal year ended August 31, 2011, which produced adjustments to previously reported amounts. These adjustments are described in Note 15 to the consolidated financial statements included in this annual report on Form 10-K. The restatement did not change our previously reported net revenue or cash flow from operating activities. It reduced the benefit for income taxes and stockholders’ equity. Due to the restatements, investors should not rely on the Company’s previously issued financial statements for the fiscal year ended August 31, 2011.
Critical Accounting Policies and Estimates
The Consolidated Financial Statements and Notes to Consolidated Financial Statements contain information that is pertinent to the management’s discussion and analysis. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of any contingent assets and liabilities. Management believes these accounting policies involve judgment due to the significant assumptions and estimates necessary in determining the related asset and liability amounts. Management believes it has exercised proper judgment in determining these estimates based on the facts and circumstances available to it at the time the estimates were made. The significant accounting policies are described in the Company’s financial statements (see Note 1 in Notes to the Consolidated Financial Statements). Of these policies, management believes the following ones may involve a comparatively higher degree of judgment and complexity. We have discussed the development and selection of the critical accounting policies and related disclosures with the Board of Directors.
Revenue Recognition
Background
The Company’s revenue recognition policy is significant because net patient service revenue is a primary component of its results of operations. Revenue is recognized as services are delivered. The determination of the amount of revenue to be recognized in connection with the Company’s services is subject to significant judgments and estimates, which are discussed below.
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Revenue Recognition Policy
The Company has established billing rates for its medical services which it bills as gross revenue as services are delivered. Gross billed revenues are then reduced by the Company’s estimate of the discount (contractual allowance) to arrive at net patient service revenues. Net patient service revenues may not represent amounts ultimately collected. The Company adjusts current period revenue for actual differences in estimated revenue recorded in prior periods and actual cash collections.
The table below sets forth the percentage of our gross patient service revenue by financial class for our Pasadena facility for the fiscal years 2012 and 2011:
| 2012 | 2011 | |||||||
Workers’ Compensation | 11 | % | 26 | % | ||||
Commercial | 40 | % | 39 | % | ||||
Medicare | 28 | % | 17 | % | ||||
Medicaid | 1 | % | 1 | % | ||||
Self-Pay | 16 | % | 13 | % | ||||
Other | 4 | % | 4 | % | ||||
Contractual Allowance
The Company computes its contractual allowance based on the estimated collections on its gross billed charges. The Company computes its estimate by taking into account collections received, up to 30 days after the end of the period, for the services performed and also estimating amounts collectible for the services performed within the last six months. The following table shows gross revenues and contractual allowances for our Pasadena facility for fiscal years 2012 and 2011:
| 2012 | 2011 | |||||||
Gross billed charges | $ | 19,619,903 | $ | 22,138,821 | ||||
Contractual allowance(1) | 14,088,670 | 24,116,028 | ||||||
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Net revenue | $ | 5,531,233 | $ | (1,977,207 | ) | |||
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Contractual allowance percentage(1) | 72 | % | 109 | % | ||||
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| (1) | The contractual allowance percentage, excluding the stop-loss fee dispute amount booked in the quarter ended May 31, 2011, which is discussed below, would have been 63% for the year ended August 31, 2011. |
A significant amount of our net revenue results from Texas workers’ compensation claims, which are governed by the rules and regulations of the Texas Department of Workers’ Compensation (“TDWC”) and the workers’ compensation healthcare networks. If our hospital chooses to participate in a network, the amount of revenue that will be generated from workers’ compensation claims will be governed by the network contract.
For claims arising prior to the implementation of workers’ compensation networks and out of network claims, inpatient and outpatient surgical services are either reimbursed pursuant to the Acute Care In-Patient Hospital Fee Guideline or at a “fair and reasonable” rate for services in which the fee guideline is not applicable. Starting March 1, 2008, the Texas Workers’ Compensation 2008 Acute Care Hospital Outpatient and Inpatient Facility Fee Guidelines (the “Guidelines”) became effective. Under these Guidelines, the reimbursement amounts are determined by applying the most recently adopted and effective Medicare reimbursement formula and factors; however, if the maximum allowable reimbursement for the procedure performed cannot be calculated using these Guidelines, then reimbursement is determined on a fair and reasonable basis.
Based on these Guidelines, the reimbursement due the Company for workers’ compensation cases is lower than we previously experienced. The Company has continued accepting Texas workers’ compensation cases, and has not made any substantial changes in its focus towards such cases. Our net patient service revenue for Texas workers’ compensation cases as a percentage of gross billings has decreased primarily as a result of lower reimbursement rates for workers’ compensation procedures still being performed.
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Should we disagree with the amount of reimbursement provided by a third-party payer, we are required to pursue the MDR process at the TDWC to request proper reimbursement for services. From January 2007 to November 2008, the Company had been successful in its pursuit of collections regarding the stop-loss cases pending before the State Office of Administrative Hearings (“SOAH”), receiving positive rulings in over 90% of its claims presented for administrative determination. The 2007 district court decision upholding our interpretation of the statute as applied to the stop-loss claims was appealed by certain insurance carriers, and on November 13, 2008 the Third Court of Appeals determined that in order for a hospital to be reimbursed at 75% of its usual and customary audited charges for an inpatient admission, the hospital must not only bill at least $40,000, but also show that the admission involved unusually costly and unusually extensive services. Procedurally, the decision means that each case where a carrier raised an issue regarding whether the services provided were unusually costly or unusually extensive would be remanded to either SOAH or MDR for a case-by-case determination of whether the services provided meet these standards, once the definitions of those standards are determined. As a result of the Third Court of Appeals opinion, any stop-loss cases pending at SOAH have been remanded to the TDWC since these cases have not been reviewed or decided by the two-prong standard decided by the Third Court of Appeals. The SOAH Administrative Law judges determined that the most appropriate location for these cases is the TDWC, pending a final, non-appealable decision.
A petition asking the Texas Supreme Court to review the Third Court of Appeals decision has been denied. Therefore, the Company is bound by the Third Court of Appeals decision. The Texas Supreme Court’s decision has further delayed final adjudication in these pending stop-loss cases. The uncertain outcome in these cases will depend on a very lengthy process. We anticipate further, lengthy litigation at the Travis County District Courts and the Texas Courts of Appeals. Because of this lengthy process and the uncertainty of recovery in these cases, collection of a material amount of funds in these pending stop-loss cases is not anticipated during the 2013 fiscal year.
Through August 2012, insurance carriers have voluntarily paid the awards in the decisions and orders issued by SOAH, plus interest, in approximately 180 cases, involving approximately $11 million in claims. In most of these cases, the carriers have requested refunds of the payments made in the event that the SOAH decisions and orders are reversed on appeal. Our request that the TDWC Commissioner enforce the awards which were not voluntarily paid by the carriers was refused in approximately 130 cases. Motions filed seeking a refund in some cases in which the awards were voluntarily paid have been granted and the Company has been ordered to refund approximately $3.7 million, including prejudgment interest, pending remand for a case-by-case determination of whether the services provided were unusually costly and unusually extensive. In fiscal year 2011, the Company deposited these amounts as cash deposits into the registry of the court in order to stay execution of the judgments ordering refunds. Additionally, the Company has deposited $204,000 in September 2012 for another year’s interest in order to continue to stay execution of the judgments ordering refunds. We anticipate that similar motions requesting remand and a refund for awards voluntarily paid will be filed and will likely be granted by the 345th Judicial District Court of Travis County, Texas. If and when these additional motions are granted, the Company will be ordered to refund an additional $7.7 million, not including prejudgment interest. The Company has appealed the judgments requiring a refund to the carriers. The briefs of the parties have been filed with the court of appeals and the Company is now waiting for the court of appeals to act on the appeals. While the appeals are pending, the adjudication of those cases remanded for determinations of whether the services provided were unusually costly and unusually extensive will continue. Voluntary payments made pursuant to the Decisions and Orders are premature payments by the carriers and may be ordered to be refunded. Once the Company is given the opportunity to present its evidence regarding whether the services provided were unusually costly and unusually extensive, the Company anticipates that it will prevail in the underlying stop-loss fee disputes and that payments refunded to the carriers will be recaptured.
Due to the uncertainties associated with these stop-loss fee dispute cases, in fiscal year 2011, the Company recognized an increase of $10,254,990 in the contractual allowance at our Pasadena facility (and an additional $779,583 in the contractual allowance at our Garland facility, which is classified as discontinued operations), and $1,751,478 in interest expense at our Pasadena facility (and an additional interest expense of $132,339 at our Garland facility). The increase in the contractual allowance resulted in the $1,977,207 negative revenue for the Pasadena facility for the year ended August 31, 2011.
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Claims regarding payment for ambulatory surgical center and hospital outpatient services remain pending at the TDWC. It is expected that these claims will be adjudicated at SOAH and possibly in the Texas district and appellate courts. The basis for reimbursement for these services made the subject of these pending cases is the determination of “fair and reasonable” charges. In 2007, we received unfavorable rulings from SOAH in all of our appeals of unfavorable decisions related to services provided in 2001 and 2002. The 179 cases, which have been appealed to the Travis County district courts, challenge the constitutionality of the relevant statutory language. The Company received an unfavorable ruling in its lead case in March 2009, which ruling was appealed to and was upheld by the Third Court of Appeals on August 26, 2010. The Texas Supreme Court denied a petition asking for review of the Third Court of Appeals decision. The unfavorable interpretation by the Texas Courts of Appeal in our lead case negatively affects the recovery of additional reimbursement, not only in the lead case, but in the remaining 178 pending cases. Consequently, the Company is bound by the Third Court of Appeals’ ruling that interprets the applicable statute and fee guideline to require that the amount that will be paid to a provider must not only be at a “fair and reasonable rate” but also must “ensure the quality of medical care” and “achieve effective cost control” and be the same or less than that charged to others with an equivalent standard of living. This ruling will impact cases in which a fee guideline was not applicable, specifically all pending cases involving ambulatory surgical services provided from 2001 through 2004 as well as all pending cases involving hospital outpatient services provided prior to March 1, 2008, when the Guidelines took effect. Since the Third Court of Appeals’ unfavorable ruling, collection, if any, in these cases depends on the Company’s ability to establish the criteria in this ruling. The Company was given the opportunity to establish the criteria in approximately 80 cases, which were set for hearing on the merits from March through May 2012 and was unsuccessful. Additionally, the Company will have the opportunity to continue to establish the criteria in several thousand cases currently pending at SOAH during the 2013 fiscal year.
Due to the uncertainties regarding the accounts receivable in the MDR process, the 2008 and 2010 Third Court of Appeals’ opinions and our legal counsel’s advice that settlements with insurance carriers have virtually stopped, the Company had fully reserved all accounts receivable related to the MDR process as of August 31, 2008. Any monies collected for these MDR accounts receivable will be recorded as current period’s net patient service revenues.
Accounts Receivable
Accounts receivable represent net receivables for services provided by the Company. At each balance sheet date management reviews the accounts receivable for collectibility.
The contractual allowance stated as a percentage of gross receivables at the balance sheet dates is larger than the contractual allowance percentage used to reduce gross billed charges due to the application of partial cash collections to the outstanding gross receivable balances, without any adjustment being made to the contractual allowance. The contractual allowance amounts netted against gross receivables are not adjusted until such time as the final collections on an individual receivable are recognized.
Sources of Revenue and Reimbursement
The focal point of our business is providing patient care services, including complex orthopedic and bariatric procedures. The Company pursues optimal reimbursement from third-party payers for these services. We do not normally participate in managed care or other contractual reimbursement agreements, principally because they limit reimbursement for the medical services provided. This business model often results in increased amounts of reimbursement for the same or similar procedure, as compared to other healthcare providers. However, there are no contractual or administrative requirements for “prompt payment” of claims by third-party payers within a specified time frame. As a result, the Company has tended to receive higher amounts of per-procedure reimbursement than that which may be received by other healthcare providers performing similar services. Conversely, despite the increased reimbursement, we may take additional time to collect the expected reimbursement from third-party payers. The Company has been participating in managed care contracts since the first quarter of fiscal 2006 and anticipates entering into additional contracts in the future. So far these contracts have not resulted in any meaningful patient revenues. Increased participation in managed care contracts and programs may decrease the per-procedure reimbursement that the Company collects in the future for similar services.
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In addition to the fact that our collection process may be longer than other healthcare providers because of our focus on workers’ compensation and other commercial payers, the collection process can be extended due to our efforts to obtain all optimal reimbursement available to the Company. Specifically, for medical services provided to injured workers, the Company may initially receive reimbursement that may not be within the fee guidelines or regulatory guidelines mandating reimbursement. For such cases in which third-party payers did not provide appropriate reimbursement pursuant to these guidelines, the Company pursues further reimbursement. The Company reviews and pursues those particular claims that are determined to warrant additional reimbursement pursuant to the fee or regulatory guidelines. The Company’s pursuit of additional reimbursement amounts that it believes are due under fee or regulatory guidelines may be accomplished through established dispute resolution procedures with applicable regulatory authorities.
Surgeries are typically not scheduled unless they are pre-authorized by insurance carrier for medical necessity, with the exception of Medicare, Medicaid and self-pay surgeries. After the surgery, the Company’s automated computer system generates a statement of billed charges to the third-party payer. At that time, the Company also requests payment from patients for any remaining amounts that are the responsibility of the patient. In cases where a commercial insurance payers’ pre-approval is not approved subsequently, those accounts receivable may be classified to self-pay. Historically, such classifications have not been significant.
Discontinued Operations
Revenue Recognition Policy
In China, the local government Department of Health establishes billing rates for a hospital’s sale of prescription medication and medical services. A majority of the services provided by Second People’s Hospital is to cash pay patients, who pay for the services in advance. For services provided under the local government’s social healthcare insurance program, we are generally paid at approximately 95% of billed charges two to three months after the date of service. The remaining 5% of billed charges is evaluated by the local government Department of Health on a semi-annual basis and may be paid to the hospital after that evaluation is complete. As of February 28, 2011, the Company terminated the management agreement with the Rui An City Department of Health. The Company had bad debt expenses of $24,755 for the six months ended February 28, 2011, related to denials under the social healthcare insurance program. Since the amount of bad debt expense is minimal, it has been included with Other Operating Expenses in the income statement.
Accounts Receivable
Accounts receivable represent net receivables for services provided by the Company. At each balance sheet date management reviews the accounts receivable for collectibility.
Income Taxes
We provide for income taxes by taking into account the differences between the financial statement treatment and tax treatment of certain transactions. Deferred tax assets and liabilities are recognized for the anticipated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis amounts. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates is recognized as income or expense in the period that includes the enactment date. This calculation requires us to make certain estimates about our future operations and many of these estimates of future operations may be imprecise. Changes in state, federal, and foreign tax laws, as well as changes in our financial condition, could affect these estimates. In addition, we consider many factors when evaluating and estimating income tax uncertainties. These factors include an evaluation of the technical merits of the tax position as well as the amounts and probabilities of the outcomes that could be realized upon ultimate settlement. The actual resolution of those uncertainties will inevitably differ from those estimates, and such differences may be material to the financial statements. Our estimates and judgments associated with our calculations of income taxes have been reasonable in the past, however, the possibility for changes in the tax laws, as well as the current economic uncertainty, could affect the accuracy of our income tax estimates in future periods.
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Stock-Based Compensation
We account for stock-based compensation under ASC Topic 718. We estimate the fair value of stock options granted using the Black-Scholes option pricing model. The fair value for awards that are expected to vest is then amortized on a straight-line basis over the requisite service period of the award, which is generally the option vesting term. The amount of expense attributed is based on an estimated forfeiture rate, which is updated as appropriate. This option pricing model requires the input of highly subjective assumptions, including the expected volatility of our common stock, pre-vesting forfeiture rate and an option’s expected life. The financial statements include amounts that are based on our best estimates and judgments.
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Results of Operations
| Year Ended August 31, 2012 | Year Ended August 31, 2011 | |||||||||||||||||||||||
| U.S. Division | Corporate | Total | U.S. Division | Corporate | Total | |||||||||||||||||||
Net patient service revenue | $ | 5,531,233 | $ | — | $ | 5,531,233 | $ | (1,977,207 | ) | $ | — | $ | (1,977,207 | ) | ||||||||||
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Costs and expenses: | ||||||||||||||||||||||||
Compensation and benefits | 3,850,678 | 3,326,103 | 7,176,781 | 4,272,368 | 3,146,329 | 7,418,697 | ||||||||||||||||||
Medical services and supplies | 1,557,792 | — | 1,557,792 | 1,490,251 | — | 1,490,251 | ||||||||||||||||||
Other operating expenses | 3,158,835 | 1,240,448 | 4,399,283 | 3,893,930 | 4,271,391 | 8,165,321 | ||||||||||||||||||
Depreciation and amortization | 454,808 | 95,835 | 550,643 | 445,971 | 122,098 | 568,069 | ||||||||||||||||||
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Total costs and expenses | 9,022,113 | 4,662,386 | 13,684,499 | 10,102,520 | 7,539,818 | 17,642,338 | ||||||||||||||||||
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Operating loss | (3,490,880 | ) | (4,662,386 | ) | (8,153,266 | ) | (12,079,727 | ) | (7,539,818 | ) | (19,619,545 | ) | ||||||||||||
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Other income (expense): | ||||||||||||||||||||||||
Rent and other income | 28,620 | 933,161 | 961,781 | 48,107 | 1,272,185 | 1,320,292 | ||||||||||||||||||
Interest income | — | 1,225,910 | 1,225,910 | — | 1,343,091 | 1,343,091 | ||||||||||||||||||
Interest expense | (578,478 | ) | (11,917 | ) | (590,395 | ) | (1,777,649 | ) | (12,014 | ) | (1,789,663 | ) | ||||||||||||
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Total other income (expense), net | (549,858 | ) | 2,147,154 | 1,597,296 | (1,729,542 | ) | 2,603,262 | 873,720 | ||||||||||||||||
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Loss before income taxes from continuing operations | $ | (4,040,738 | ) | $ | (2,515,232 | ) | (6,555,970 | ) | $ | (13,809,269 | ) | $ | (4,936,556 | ) | (18,745,825 | ) | ||||||||
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(Provision) benefit for income taxes | (4,018,699 | ) | 1,357,468 | |||||||||||||||||||||
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Loss from continuing operations | (10,574,669 | ) | (17,388,357 | ) | ||||||||||||||||||||
Discontinued operations, net of income taxes | (1,394,984 | ) | (3,522,169 | ) | ||||||||||||||||||||
Loss on disposal of discontinued operations, net of income taxes | (229,201 | ) | (121,577 | ) | ||||||||||||||||||||
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Net loss | (12,198,854 | ) | (21,032,103 | ) | ||||||||||||||||||||
Less: Net loss attributable to noncontrolling interest | 47,358 | 15,978 | ||||||||||||||||||||||
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Net loss attributable to Dynacq Healthcare, Inc. | $ | (12,151,496 | ) | $ | (21,016,125 | ) | ||||||||||||||||||
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Operational statistics (Number of medical procedures) for Pasadena facility: | ||||||||||||||||||||||||
Inpatient: | ||||||||||||||||||||||||
Bariatric | 68 | 73 | ||||||||||||||||||||||
Orthopedic | 12 | 33 | ||||||||||||||||||||||
Other | 64 | 28 | ||||||||||||||||||||||
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Total inpatient procedures | 144 | 134 | ||||||||||||||||||||||
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Outpatient: | ||||||||||||||||||||||||
Orthopedic | 112 | 87 | ||||||||||||||||||||||
Other | 446 | 537 | ||||||||||||||||||||||
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Total outpatient procedures | 558 | 624 | ||||||||||||||||||||||
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Total procedures | 702 | 758 | ||||||||||||||||||||||
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Comparison of the Fiscal Years Ended August 31, 2012 and August 31, 2011
U.S. Division
Through August 2012, insurance carriers have voluntarily paid the awards in the decisions and orders issued by SOAH, plus interest, in approximately 180 cases, involving approximately $11 million in claims. In most of these cases, the carriers have requested refunds of the payments made in the event that the SOAH decisions and orders are reversed on appeal. Our request that the TDWC Commissioner enforce the awards which were not voluntarily paid by the carriers was refused in approximately 130 cases. Motions filed seeking a refund in some cases in which the awards were voluntarily paid have been granted and the Company has been ordered to refund approximately $3.7 million, including prejudgment interest, pending remand for a case-by-case determination of whether the services provided were unusually costly and unusually extensive. In fiscal year 2011, the Company deposited these amounts as cash deposits into the registry of the court in order to stay execution of the judgments ordering refunds. Additionally, the Company has deposited $204,000 in September 2012 for another year’s interest in order to continue to stay execution of the judgments ordering refunds. We anticipate that similar motions requesting remand and a refund for awards voluntarily paid will be filed and will likely be granted by the 345th Judicial District Court of Travis County, Texas. If and when these additional motions are granted, the Company will be ordered to refund an additional $7.7 million, not including prejudgment interest. The Company has appealed the judgments requiring a refund to the carriers. The briefs of the parties have been filed with the court of appeals and the Company is now waiting for the court of appeals to act on the appeals. While the appeals are pending, the adjudication of those cases remanded for determinations of whether the services provided were unusually costly and unusually extensive will continue. Voluntary payments made pursuant to the Decisions and Orders are premature payments by the carriers and may be ordered to be refunded. Once the Company is given the opportunity to present its evidence regarding whether the services provided were unusually costly and unusually extensive, the Company anticipates that it will prevail in the underlying stop-loss fee disputes and that payments refunded to the carriers will be recaptured.
Due to the uncertainties associated with these stop-loss fee dispute cases, in fiscal year 2011, the Company recognized an increase of $10,254,990 in the contractual allowance at our Pasadena facility (and an additional $779,583 in the contractual allowance at our Garland facility, which is classified as discontinued operations), and $1,751,478 in interest expense at our Pasadena facility (and an additional interest expense of $132,339 at our Garland facility). The increase in the contractual allowance resulted in the $1,977,207 negative revenue for the Pasadena facility for the year ended August 31, 2011.
Excluding the above mentioned stop-loss contractual allowance of $10,254,990, net patient service revenue decreased by $2,746,550, or 33%, from $8,277,783 to $5,531,233, and total surgical cases decreased by 7% from 758 cases for the year ended August 31, 2011 to 702 cases for the year ended August 31, 2012. While the number of cases decreased by 7%, net patient service revenue decreased by 33%. The change in percentage decrease in net patient service revenue compared to the decrease in the number of cases is primarily due to a change in the surgical mix of cases. Decreases in net patient revenues and number of cases are generally attributable to the loss of physicians from our medical staff. In the fourth quarter of fiscal year 2012, a physician from our medical staff, who accounted for 19% and 7% of total gross billed charges for fiscal year 2012 and 2011, respectively, passed away. The Company is making efforts to find a replacement for this physician at the present time; however, there can be no assurance given that we will succeed in this process.
Total costs and expenses decreased by $1,080,407, or 11%, from $10,102,520 for the year ended August 31, 2011 to $9,022,113 for the year ended August 31, 2012. The following discusses the various changes in costs and expenses:
| • | Compensation and benefits decreased by $421,690, or 10%, primarily associated with reduction in workforce due to lower net patient service revenues, partially offset by increase in the Company’s self-funded health care cost of its employees. |
| • | Medical services and supplies expenses increased marginally by $67,541, or 5%, while the number of surgery cases decreased 7%. The increase in medical services and supplies was due to a change in the surgical mix of cases, and also due to write-off of obsolete supplies. |
| • | Other operating expenses decreased by $735,095, or 19%, primarily associated with lower net patient service revenues. |
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Other income (expense) for the year ended August 31, 2012 and 2011 of $(549,858) and $(1,729,542) includes interest expense associated with the stop-loss cases discussed above.
Corporate Division
Compensation and benefits for the Corporate Division includes all corporate personnel compensation and benefits, and it increased by $179,774, or 6%, in 2012, compared to 2011. The increase in compensation and benefits was due to the following reasons: (1) during the current fiscal year, the Company issued 50,000 shares of its common stock to Dr. Kelly Larkin as consideration for Dr. Larkin’s employment as the Company’s marketing director, and took a compensation charge of $50,000 related to the issuance, (2) the Company retained the services of Dr. Eric Chan, as its chief executive officer starting January 10, 2012, (3) the former chief financial officer of the Company had a reduction in his compensation for part of fiscal 2011, whereas for fiscal 2012, the Compensation Committee reinstated his compensation to $200,000, effective February 1, 2012, and paid him a sum of $77,000, which equates to the prior reductions in his compensation from January 1, 2010 to January 31, 2012, and (4) the Company continues to make efforts to increase its net patient service revenues and has hired additional marketing personnel during fiscal 2012. In July 2012, the employment agreement with Dr. Larkin was terminated. Partially offsetting these increases in 2012, we had a compensation expense in 2011 of $232,500 towards stock awards made during that year.
Other operating expenses includes primarily administrative expenses for managing the various projects the Company is undertaking in China and Hong Kong, related marketing expenses and rent for an apartment for our former chief executive officer in Hong Kong. The Company has made the decision to not pursue any new line of business and/or projects, and has also terminated the apartment lease. Other operating expenses also include all the corporate general and administrative expenses in the U.S. including other professional fees such as legal expenses and audit expenses. Other operating expenses decreased by $3,030,943, from $4,271,391 for the year ended August 31, 2011 to $1,240,448 for the year ended August 31, 2012. The Company incurred the following costs in fiscal 2011, with no corresponding expenses in fiscal 2012: (1) marketing cost in Hong Kong of $1,650,000, which included $1,050,000 for estimated marketing expenses that were supposed to be incurred in fiscal years 2012 and 2013 based on a contract with Kenkon Limited, which expires in May 2013 (The Company believed that the proposed businesses being pursued in China and Hong Kong would eventually be beneficial; however, due to no immediate project in an advanced stage, the Company had expensed the contractual obligation through the entire term of the contract as of August 31, 2011); (2) rental expense of $292,967 for the apartment in Hong Kong for its former chief executive officer, and (3) $476,000 in administrative support services fees. In fiscal year 2012, the Company reversed $870,000 of marketing costs and $88,000 of administrative support service fees that were expensed and accrued for in fiscal year 2011, since the amounts were determined to be not payable. The Company had incurred lower other operating expenses through the third quarter of fiscal year 2012, compared to same period in fiscal 2011, primarily associated with lower net revenues. However, due to the internal investigation discussed above, the Company has incurred legal, accounting and other professional fees associated with this review of approximately $560,000 through August 31, 2012. The Company continues to incur significant amounts of fees related to this investigation in the first two quarters of fiscal 2013, and may continue to do so for the remainder of fiscal year 2013.
Rent and other income decreased by $339,024, from $1,272,185 for the year ended August 31, 2011 to $933,161 for the year ended August 31, 2012. Rent and other income for the year ended August 31, 2012 includes (1) a foreign currency gain of $1,422,590 realized due to the monies invested in China coming back to the U.S. (The Company had invested in its foreign subsidiaries in China during the last few years, and due to a favorable change in exchange rates between the U.S. Dollar and the Chinese Yuan Renminbi, the Company had accumulated other comprehensive income of $1,422,590. This amount was realized as a gain during fiscal year 2012 upon the return of investments from the Company’s foreign subsidiaries in China); (2) a loss of $318,206 on trading securities, including losses due to fair valuation of trading securities as of August 31, 2012, and (3) foreign currency exchange losses of $337,953, primarily on investments in Euro bonds. Rent and other income for the year ended August 31, 2011 includes (1) a gain of $1.3 million on call of a bond which was part of its available-for-sale securities’ holdings with a book cost of $700,000, (2) foreign currency exchange gains of $302,000 primarily on investments in Euro bonds, and (3) a loss of $365,000 on short-term investments in the equity securities in Hong Kong.
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Interest income of $1,225,910 and $1,343,091 for the year ended August 31, 2012 and 2011, respectively, are primarily related to the Company’s investments in bonds.
Investments in securities
During the fiscal year ended August 31, 2009, the Company invested approximately $9.1 million of its available cash in marketable securities. During the quarter ended August 31, 2011, one of these marketable securities with a book cost of $700,000 was called for a gain of $1.3 million. As of August 31, 2012, the balance of these securities is valued at approximately $16.8 million. Unrealized gains in these investments of $5.5 million are included in accumulated other comprehensive income in the Consolidated Balance Sheet as at August 31, 2012, net of taxes of $2.9 million. The Company intends to hold these for a minimum period of an additional 12 months, except for one particular security that was called subsequent to the year ended August 31, 2012. During the year ended August 31, 2012 and 2011, the Company also traded in initial public offerings of equity securities on the Hong Kong Stock Exchange and had losses of $318,000 and $365,000, respectively.
Discontinued Operations
Garland Facility (discontinued operations)
Due to the uncertainties associated with the stop-loss fee dispute cases discussed above, in fiscal year 2011, the Company recognized an increase of $779,583 in the contractual allowance, and an additional interest expense of $132,339, at our Garland facility.
The Company closed the Garland facility on September 30, 2011, and accordingly its operations for the fiscal years 2011 and 2012 continue to be classified as discontinued operations. The Company signed a commercial contract of sale on March 7, 2013 to sell its Garland facility. The sale is expected to close in May 2013. Net patient service revenue for the year ended August 31, 2012 was $397,278, primarily due to receipts on old accounts receivable that were written off earlier per the Company’s revenue recognition policy. Excluding the above mentioned stop-loss contractual allowance of $779,583, net patient service revenue for the year ended August 31, 2011 was $1,866,038.
Total costs and expenses decreased from $6,254,270 for the year ended August 31, 2011 to $2,432,816 for the year ended August 31, 2012, due to the closure of the facility on September 30, 2011. The Company has taken an impairment charge of $1,058,056 as of August 31, 2012 based on the contract sales price of the facility.
Corporate (discontinued operations)
The Corporate Division revenue includes net patient service revenues from Second People’s Hospital in Rui An, China. Due to continued losses at the Second People’s Hospital, the Company terminated the management agreement as of February 28, 2011 with the Rui An City Department of Health. The loss before income taxes at the Second People’s Hospital for the six months ended February 28, 2011, which is the termination date of the management agreement, was $375,890. This loss amount of $375,890 includes a $187,041 loss before taxes on disposition of the Second People’s Hospital.
The Corporate Division also includes other operating expenses the Company incurred at certain of its subsidiaries in China while pursuing various projects. All of the Company’s foreign subsidiaries, except for Sino Bond, have been reclassified as discontinued operations. The Company incurred $(258,151) and $881,637 in total costs and expenses at these subsidiaries during the fiscal year ended August 31, 2012 and 2011, respectively. The negative expense in 2012 is the result of reversal of expenses accrued in prior years. The expenses in fiscal year 2011 include $260,000 write-down of inventory of artifacts, and various other set up costs and operating costs of these subsidiaries. Other income in fiscal year 2011 includes a $720,696 refund received from the Rui An City
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Department of Health as part of the negotiation of termination of the assignment agreement to manage the Third People’s Hospital, and write-off of associated liabilities of $43,840 (the decision to terminate the agreement was based on the continued delays in the construction of the hospital). Income before income taxes in these subsidiaries was $106,680 and $83,193 for the fiscal year ended August 31, 2012 and 2011, respectively.
The Company had a provision for income taxes in fiscal year 2012, and the benefit for income taxes for fiscal year 2011 was lower than the statutory federal rate, due to the uncertainty of the Company’s ability to recognize the benefit from the net operating losses. The Company has recorded a full valuation allowance against the deferred tax asset. The estimated income tax refund as at August 31, 2011 was overstated by $1,794,294. The restated income tax receivable as of August 31, 2011 is $569,430.
Liquidity and Capital Resources
The Company maintained sufficient liquidity to meet its business needs in fiscal 2012. As of August 31, 2012, its principal source of liquidity was $11.4 million in cash and net accounts receivable, and $18.1 million in investments in trading securities and available-for-sale securities. The Company has approximately $10.6 million in cash as of August 31, 2012, the majority of which is deposited in national and international banks. The amounts at these financial institutions overseas do not have insurance protection and in the U.S. are substantially in excess of FDIC and Securities Investor Protection Corporation insurance limits; however, management believes that these financial institutions are of high quality and the risk of loss is minimal.
Cash flows from operating activities
Cash flow used in operating activities for continuing activities was $12,947,715 during fiscal year 2012, primarily due to a net loss before discontinued operations of $10,527,311 and decreases in accounts payable and accrued liabilities of $6,709,647, of which a decrease of $3,703,252 was due to cash deposits made by the Company into the registry of the court in order to stay execution of the judgments ordering refunds in the stop-loss fee dispute cases. These decreases were partially offset by changes in income tax related accounts of $2,358,623, decreases in accounts receivable of $394,315, and depreciation and amortization expenses of $550,643.
In addition, cash flow used in operating activities for discontinued operations was $748,076 during fiscal year 2012, primarily due to a net loss from discontinued operations of $1,624,185, partially offset by an impairment charge of $1,058,056 for the Garland facility.
Total cash flow used in operating activities for continuing and discontinued operations combined was $13,695,791 during fiscal year 2012.
Cash flows from investing activities
Cash flow used in investing activities for continuing activities was $225,173, primarily due to purchase of equipment of $159,919, purchase of trading securities of $211,248, offset by related sales on part of these securities of $94,669. Subsequent to the year ended August 31, 2012, one of the available-for-sale securities the Company was holding was called. The sales proceeds of this security was $2.7 million, with a gain of $2.2 million. Additionally, the Company sold the apartment in Hong Kong subsequent to the year ended August 31, 2012, for net proceeds, after paying off the related $1.1 million note payable, of $1.3 million. The gain on the sale of this apartment was approximately $480,000.
In addition, cash flow provided by investing activities for discontinued operations was $14,000 towards sale of equipment.
Total cash flow used in investing activities for continuing and discontinued operations combined was $211,173 during fiscal year 2012.
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Cash flows from financing activities
Cash flow used in financing activities for continuing activities was $6,001. In November 2011, the Company borrowed $116,339 as note payable from a financial institution at an interest rate of 4.5%. This note payable is to be repaid in 36 monthly installments and is secured by specific equipment purchased at our Pasadena facility. The Company has paid $64,182 during the fiscal year ended August 31, 2012 towards notes payable for equipment purchased. In addition, the Company paid $64,114 towards a mortgage loan for the purchase of an apartment in Hong Kong. The Company also made payments of $94,044 on equipment purchased on capital leases for its Pasadena facility. During the fiscal year ended August 31, 2012, the Company received contributions of $100,000 for sale of non-controlling interests in our Pasadena facility’s operations. Subsequent to the year ended August 31, 2012, the Company sold the apartment in Hong Kong, and as mentioned above, paid off the related note payable of $1.1 million.
Total cash flow used in financing activities was $6,001 during fiscal year 2012.
The Company had working capital of $5,444,841 as of August 31, 2012, and maintained a liquid position by a current ratio of approximately 1.4 to 1.
We believe we will be able to meet our ongoing liquidity and cash needs for fiscal year 2013 through the combination of available cash and cash flow from operations.
Off-Balance Sheet Arrangements
We are not a party to any off-balance sheet arrangements that have, or are reasonably likely to have, a material effect on us.
Contractual Obligations and Commitments
Due to the uncertainties associated with the stop-loss fee dispute cases, the Company has booked, in fiscal year 2011, an increase of $12.9 million in the contractual allowance and related interest expense at our Pasadena and Garland facilities. For a detailed discussion of this, see Revenue Recognition Policy under Note 1 to the Consolidated Financial Statements. Motions filed seeking a refund in some cases in which the awards were voluntarily paid have been granted and the Company has been ordered to refund approximately $3.7 million, including prejudgment interest, pending remand for a case-by-case determination of whether the services provided were unusually costly and unusually extensive. In fiscal year 2011, the Company deposited these amounts as cash deposits into the registry of the court in order to stay execution of the judgments ordering refunds. Additionally, the Company has deposited $204,000 in September 2012 for another year’s interest in order to continue to stay execution of the judgments ordering refunds. We anticipate that similar motions requesting remand and a refund for awards voluntarily paid will be filed and will likely be granted by the 345th Judicial District Court of Travis County, Texas. If and when these additional motions are granted, the Company will be ordered to refund an additional $7.7 million, not including prejudgment interest. The Company has appealed the judgments requiring a refund to the carriers. The briefs of the parties have been filed with the court of appeals and the Company is now waiting for the court of appeals to act on the appeals. While the appeals are pending, the adjudication of those cases remanded for determinations of whether the services provided were unusually costly and unusually extensive will continue. Voluntary payments made pursuant to the Decisions and Orders are premature payments by the carriers and may be ordered to be refunded. Once the Company is given the opportunity to present its evidence regarding whether the services provided were unusually costly and unusually extensive, the Company anticipates that it will prevail in the underlying stop-loss fee disputes and that payments refunded to the carriers will be recaptured.
Total rent and lease expenses paid by the Company for the fiscal years 2012 and 2011 were approximately $127,000 and $470,000, respectively. The Company’s total minimum rental commitments under noncancellable operating leases are approximately $63,000 in the next five fiscal years.
The Company has contracts with doctors to manage various areas of the Company’s hospital and other service agreements. Payments made under these agreements for the fiscal years ending August 31, 2012 and 2011 were $1,190,000 and $1,296,000, respectively. The Company’s minimum commitments under these contracts are approximately $712,000, all of which is payable in fiscal year 2013.
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The Company has administrative support services agreements with outside organizations for administrative support services. Payments made related to these agreements for fiscal years 2012 and 2011 were $266,000 and $433,000, respectively. The Company has a total commitment of approximately $259,000, all of which is to be incurred in fiscal year 2013 related to these administrative support services agreements.
The Company, through its subsidiary, also had agreements with outside organizations that offer marketing, pre-authorization and follow up support services to prospective bariatric and orthopedic patients in areas serviced by the Pasadena facility. The facility received bariatric and orthopedic referrals from other sources, and the organizations referred clients to other area hospitals. The Company had cancelled these agreements in the first quarter of fiscal year 2011, and does not have a commitment related to these agreements anymore, and markets on a month-to-month basis. These marketing expenses for the fiscal years 2012 and 2011 were $162,000 and $762,000, respectively.
The Company has a note payable commitment for purchase of equipment for the Pasadena facility at an interest rate of 4.5% and 6%, secured by the said equipment of approximately $88,000, of which $41,000 is payable in 2013, $40,000 in 2014 and $7,000 in 2015.
The Company has a note payable commitment of $75,000 per year for the next 15.5 years related to an apartment purchased in Hong Kong as an investment. The Company obtained an 18-year mortgage loan of $1,245,775 from a financial institution, with a variable interest rate at the lower of 3-month Hang Seng Interbank Offered Rates plus 0.7% or 2.9% below the Hong Kong Dollar best lending rate quoted by the financial institution. The effective interest rate at August 31, 2011 was 1.12%. The total amount payable in fiscal years 2013, 2014, 2015, 2016, 2017 and thereafter are $65,000, $65,000, $66,000, $67,000, $67,000 and $762,000, respectively. Subsequent to the year ended August 31, 2012, the Company sold the apartment in Hong Kong, as well as paid off the related note payable.
The Company has purchased some equipment under capital leases, and has a total commitment to pay $203,000 under these leases, of which $113,000 is payable in fiscal year 2013 and $90,000 in 2014.
These commitments mentioned above total $12.4 million, of which $11.1 million is payable in fiscal year 2013, $219,000 in 2014, $91,000 in 2015, $82,000 in 2016, $76,000 in 2017, and approximately $807,000 is payable after five years.
Discontinued Operations
Total rent and lease expenses paid by the Company for its discontinued operations for the fiscal years 2012 and 2011 were approximately $117,000 and $225,000, respectively. The Company’s total minimum rental commitments under noncancellable operating leases are approximately $139,000.
The Company had contracts with doctors to manage various areas of the Company’s hospital and other service agreements. Payments made under these agreements for the fiscal years ended August 31, 2012 and 2011 were $-0- and $668,000, respectively.
The Company had administrative support services agreements with outside organizations for administrative support services. Payments made related to these agreements for fiscal years 2012 and 2011 were $110,000 and $210,000, respectively. The Company has a total commitment of approximately $64,000, all of which is to be incurred in fiscal year 2013, related to these administrative support services agreements.
The Company, through its subsidiary, also had agreements with outside organizations that offer marketing, pre-authorization and follow up support services to prospective bariatric and orthopedic patients in areas serviced by the Garland facility, before its closure in September 2011. The facility received bariatric and orthopedic referrals from other sources, and the organizations referred clients to other area hospitals. The Company had since cancelled these agreements in the first quarter of fiscal year 2011, and does not have a commitment related to these agreements anymore. These marketing expenses for the fiscal years 2012 and 2011 were $-0- and $124,500, respectively.
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These commitments mentioned above for discontinued operations total $203,000.
Recent Accounting Pronouncements
See Note 1 to the Consolidated Financial Statements - Recent Accounting Pronouncements, which is incorporated here by reference.
Inflation
Inflation has not significantly impacted the Company’s financial position or operations.
| Item 7A. | Quantitative and Qualitative Disclosures About Market Risk. |
Not required.
| Item 8. | Financial Statements and Supplementary Data. |
Below is an index to the consolidated financial statements and notes thereto contained in Item 8, Financial Statements and Supplementary Data.
| PAGE | ||||
| 38 | ||||
| 39 | ||||
| 41 | ||||
| 42 | ||||
| 43 | ||||
| 45 | ||||
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Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors
Dynacq Healthcare, Inc.
Houston, Texas
We have audited the accompanying consolidated balance sheets of Dynacq Healthcare, Inc. (the “Company”), as of August 31, 2012 and 2011, and the related consolidated statements of operations, stockholders’ equity, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 15 to the consolidated financial statements, certain errors in the estimated income tax receivable and benefit for income taxes as of August 31, 2011, were discovered by management of the Company during the current year. Accordingly, amounts reported for income tax receivable and benefit for income taxes have been restated in the August 31, 2011 consolidated financial statements now presented, and an adjustment has been made to retained earnings as of August 31, 2011, to correct the errors. Our opinion is not modified with respect to that matter.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Dynacq Healthcare, Inc. at August 31, 2012 and 2011, and the consolidated results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States.
/s/ KWCO, PC
KWCO, PC
Houston, Texas
March 22, 2013
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Dynacq Healthcare, Inc.
| August 31, | ||||||||
| 2012 | 2011 | |||||||
| (Restated) | ||||||||
Assets | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 10,638,217 | $ | 24,315,160 | ||||
Accounts receivable, net of contractual allowances of approximately $187,478,000 and $188,513,000 at August 31, 2012 and 2011, respectively | 797,964 | 1,192,279 | ||||||
Inventories | 408,961 | 550,441 | ||||||
Trading securities | 1,280,518 | 1,471,644 | ||||||
Interest receivable | 167,229 | 192,366 | ||||||
Prepaid expenses | 423,659 | 272,414 | ||||||
Income tax receivable | 569,430 | 569,430 | ||||||
Assets of discontinued operations | 5,401,092 | 6,909,527 | ||||||
|
|
|
| |||||
Total current assets | 19,687,070 | 35,473,261 | ||||||
Investments available-for-sale | 16,828,886 | 18,722,274 | ||||||
Investment in real estate, net | 1,889,395 | 1,941,041 | ||||||
Property and equipment, net | 6,655,820 | 7,168,864 | ||||||
Income tax receivable | 868,249 | 868,249 | ||||||
Other assets | 255,876 | 255,517 | ||||||
|
|
|
| |||||
Total assets | $ | 46,185,296 | $ | 64,429,206 | ||||
|
|
|
| |||||
The accompanying notes are an integral part of these consolidated financial statements.
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Dynacq Healthcare, Inc.
Consolidated Balance Sheets (continued)
| August 31, | ||||||||
| 2012 | 2011 | |||||||
| (Restated) | ||||||||
Liabilities and stockholders’ equity | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 2,271,436 | $ | 2,346,720 | ||||
Accrued liabilities | 11,763,362 | 18,430,553 | ||||||
Current portion of notes payable | 105,735 | 97,918 | ||||||
Current portion of capital lease obligations | 101,696 | 94,044 | ||||||
Liabilities of discontinued operations | — | 604,302 | ||||||
|
|
|
| |||||
Total current liabilities | 14,242,229 | 21,573,537 | ||||||
Non-current liabilities: | ||||||||
Long-term portion of notes payable | 1,074,187 | 1,093,961 | ||||||
Long-term portion of capital lease obligations | 87,465 | 189,161 | ||||||
|
|
|
| |||||
Total liabilities | 15,403,881 | 22,856,659 | ||||||
|
|
|
| |||||
Commitments and contingencies | ||||||||
Equity: | ||||||||
Dynacq stockholders’ equity: | ||||||||
Preferred stock, $.01 par value; 5,000,000 shares authorized, none issued or outstanding | — | — | ||||||
Common stock, $.001 par value; 100,000,000 shares authorized, 14,543,626 and 14,426,960 shares issued at August 31, 2012 and 2011, respectively | 14,544 | 14,427 | ||||||
Additional paid-in capital | 10,172,794 | 9,780,837 | ||||||
Accumulated other comprehensive income | 8,419,324 | 7,453,676 | ||||||
Retained earnings | 12,108,494 | 24,259,990 | ||||||
|
|
|
| |||||
Total Dynacq stockholders’ equity | 30,715,156 | 41,508,930 | ||||||
|
|
|
| |||||
Non-controlling interest | 66,259 | 63,617 | ||||||
|
|
|
| |||||
Total equity | 30,781,415 | 41,572,547 | ||||||
|
|
|
| |||||
Total liabilities and equity | $ | 46,185,296 | $ | 64,429,206 | ||||
|
|
|
| |||||
The accompanying notes are an integral part of these consolidated financial statements.
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Dynacq Healthcare, Inc.
Consolidated Statements of Operations
| Year Ended August 31, | ||||||||
| 2012 | 2011 | |||||||
| (Restated) | ||||||||
Net patient service revenue | $ | 5,531,233 | $ | (1,977,207 | ) | |||
|
|
|
| |||||
Costs and expenses: | ||||||||
Compensation and benefits | 7,176,781 | 7,418,697 | ||||||
Medical services and supplies | 1,557,792 | 1,490,251 | ||||||
Other operating expenses | 4,399,283 | 8,165,321 | ||||||
Depreciation and amortization | 550,643 | 568,069 | ||||||
|
|
|
| |||||
Total costs and expenses | 13,684,499 | 17,642,338 | ||||||
|
|
|
| |||||
Operating loss | (8,153,266 | ) | (19,619,545 | ) | ||||
|
|
|
| |||||
Other income (expense): | ||||||||
Rent and other income | 961,781 | 1,320,292 | ||||||
Interest income | 1,225,910 | 1,343,091 | ||||||
Interest expense | (590,395 | ) | (1,789,663 | ) | ||||
|
|
|
| |||||
Total other income, net | 1,597,296 | 873,720 | ||||||
|
|
|
| |||||
Loss before income taxes from continuing operations | (6,555,970 | ) | (18,745,825 | ) | ||||
(Provision) benefit for income taxes | (4,018,699 | ) | 1,357,468 | |||||
|
|
|
| |||||
Loss from continuing operations | (10,574,669 | ) | (17,388,357 | ) | ||||
Discontinued operations, net of income taxes | (1,394,984 | ) | (3,522,169 | ) | ||||
Loss on disposal of discontinued operations, net of income taxes | (229,201 | ) | (121,577 | ) | ||||
|
|
|
| |||||
Net loss | (12,198,854 | ) | (21,032,103 | ) | ||||
Less: Net loss attributable to noncontrolling interest | 47,358 | 15,978 | ||||||
|
|
|
| |||||
Net loss attributable to Dynacq Healthcare, Inc. | $ | (12,151,496 | ) | $ | (21,016,125 | ) | ||
|
|
|
| |||||
Basic and diluted loss per common share: | ||||||||
Loss from continuing operations attributable to Dynacq Healthcare, Inc. | $ | (0.73 | ) | $ | (1.22 | ) | ||
Discontinued operations, net of income taxes | (0.10 | ) | (0.25 | ) | ||||
Loss on disposal of discontinued operations, net of income taxes | (0.02 | ) | (0.01 | ) | ||||
|
|
|
| |||||
Net loss attributable to Dynacq Healthcare, Inc. | $ | (0.85 | ) | $ | (1.48 | ) | ||
|
|
|
| |||||
Basic and diluted average common shares outstanding | 14,489,780 | 14,196,191 | ||||||
|
|
|
| |||||
Amounts attributable to Dynacq Healthcare, Inc.: | ||||||||
Loss from continuing operations | $ | (10,527,311 | ) | $ | (17,372,379 | ) | ||
Discontinued operations, net of income taxes | (1,394,984 | ) | (3,522,169 | ) | ||||
Loss on disposal of discontinued operations, net of income taxes | (229,201 | ) | (121,577 | ) | ||||
|
|
|
| |||||
Net loss attributable to Dynacq Healthcare, Inc. | $ | (12,151,496 | ) | $ | (21,016,125 | ) | ||
|
|
|
| |||||
The accompanying notes are an integral part of these consolidated financial statements.
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Dynacq Healthcare, Inc.
Consolidated Statements of Stockholders’ Equity
| Common Stock | Accumulated Other Comprehensive Income (Loss) | |||||||||||||||||||||||||||
| Shares | Amount | Additional Paid-In Capital | Foreign currency translation | Unrealized gains (losses) on securities | Retained Earnings | Total | ||||||||||||||||||||||
Balance, August 31, 2010 | 14,176,960 | $ | 14,177 | $ | 9,039,624 | $ | 366,918 | $ | 8,306,657 | $ | 45,276,115 | $ | 63,003,491 | |||||||||||||||
Stock issued on acquisition and employee compensation | 250,000 | 250 | 464,750 | — | — | — | 465,000 | |||||||||||||||||||||
Charge for granting stock options to employees | — | — | 276,463 | — | — | — | 276,463 | |||||||||||||||||||||
Foreign currency translation adjustment, net of taxes of $315,465 | — | — | — | 585,864 | — | — | 585,864 | |||||||||||||||||||||
Unrealized losses on securities available-for-sale, net of taxes of $(972,334) | — | — | — | — | (1,805,763 | ) | — | (1,805,763 | ) | |||||||||||||||||||
Net loss (Restated) | — | — | — | — | — | (21,016,125 | ) | (21,016,125 | ) | |||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||
Balance, August 31, 2011 (Restated) | 14,426,960 | 14,427 | 9,780,837 | 952,782 | 6,500,894 | 24,259,990 | 41,508,930 | |||||||||||||||||||||
Stock issued for non-controlling interest sale and employee compensation | 116,666 | 117 | 116,549 | — | — | — | 116,666 | |||||||||||||||||||||
Charge for granting stock options to employees | — | — | 275,408 | — | — | — | 275,408 | |||||||||||||||||||||
Reclassification adjustment for foreign currency gains included in net income, net of taxes of $(501,273) | (921,318 | ) | (921,318 | ) | ||||||||||||||||||||||||
Foreign currency translation adjustment, net of taxes of $(12,530) | — | — | — | (23,268 | ) | — | — | (23,268 | ) | |||||||||||||||||||
Unrealized gains on securities available-for-sale, net of taxes of $($3,500,481) | — | — | — | — | 1,910,234 | — | 1,910,234 | |||||||||||||||||||||
Net loss | — | — | — | — | — | (12,151,496 | ) | (12,151,496 | ) | |||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||
Balance, August 31, 2012 | 14,543,626 | $ | 14,544 | $ | 10,172,794 | $ | 8,196 | $ | 8,411,128 | $ | 12,108,494 | $ | 30,715,156 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
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Dynacq Healthcare, Inc.
Consolidated Statements of Cash Flows
| Year Ended August 31, | ||||||||
| 2012 | 2011 | |||||||
| (Restated) | ||||||||
Cash flows from operating activities | ||||||||
Net loss | $ | (12,151,496 | ) | $ | (21,016,125 | ) | ||
Less loss from discontinued operations, net of income taxes | 1,624,185 | 3,643,746 | ||||||
|
|
|
| |||||
Net loss before discontinued operations | (10,527,311 | ) | (17,372,379 | ) | ||||
Adjustments to reconcile net loss before discontinued operations to net cash used in operating activities: | ||||||||
Depreciation and amortization | 550,643 | 568,069 | ||||||
(Gain) loss on disposal of assets | (34,392 | ) | 172,174 | |||||
Loss (gain) on call/sale of investments in bonds and securities | 317,206 | (935,279 | ) | |||||
Deferred income taxes | 2,358,623 | (2,690,894 | ) | |||||
Noncontrolling interest | (47,358 | ) | (15,978 | ) | ||||
Loss on buy back of noncontrolling interest | — | 98,350 | ||||||
Charge for stock options to employees | 275,408 | 276,463 | ||||||
Charge for non-controlling interest sale and issuance of stock awards | 166,666 | 232,500 | ||||||
Write-off of investment in affiliates | — | 232,500 | ||||||
Foreign currency exchange (gains) losses | 293,640 | (268,656 | ) | |||||
Changes in operating assets and liabilities: | ||||||||
Accounts receivable | 394,315 | 1,106,783 | ||||||
Inventories | 141,480 | 20,438 | ||||||
Prepaid expenses | (151,245 | ) | 179,873 | |||||
Interest receivable | 25,137 | 162,095 | ||||||
Income taxes receivable | — | 3,457,353 | ||||||
Other assets | (880 | ) | 5,221 | |||||
Accounts payable | (75,284 | ) | (500,576 | ) | ||||
Accrued liabilities | (6,634,363 | ) | 13,921,368 | |||||
|
|
|
| |||||
Cash used in continuing activities | (12,947,715 | ) | (1,350,575 | ) | ||||
Cash used in discontinued activities | (748,076 | ) | (2,718,020 | ) | ||||
|
|
|
| |||||
Net cash used in operating activities | (13,695,791 | ) | (4,068,595 | ) | ||||
|
|
|
| |||||
Cash flows from investing activities | ||||||||
Purchase of trading securities | (211,248 | ) | (6,304,748 | ) | ||||
Sale/call proceeds of trading and investment in available-for-sale securities | 94,669 | 6,460,659 | ||||||
Sale of equipment | 51,325 | — | ||||||
Purchase of equipment | (159,919 | ) | (7,532 | ) | ||||
|
|
|
| |||||
Cash provided by (used in) continuing activities | (225,173 | ) | 148,379 | |||||
Cash provided by (used in) discontinued activities | 14,000 | (104,385 | ) | |||||
|
|
|
| |||||
Net cash provided by (used in) investing activities | $ | (211,173 | ) | $ | 43,994 | |||
|
|
|
| |||||
Continued.
43
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Dynacq Healthcare, Inc.
Consolidated Statements of Cash Flows (continued)
| Year Ended August 31, | ||||||||
| 2012 | 2011 | |||||||
| (Restated) | ||||||||
Cash flows from financing activities | ||||||||
Principal payments on notes payable | $ | (128,296 | ) | $ | (92,559 | ) | ||
Proceeds from notes payable | 116,339 | 65,000 | ||||||
Payments on capital lease | (94,044 | ) | (86,969 | ) | ||||
Contributions from, purchases of and distributions to noncontrolling interest holders, net | 100,000 | (98,350 | ) | |||||
|
|
|
| |||||
Cash used in continuing activities | (6,001 | ) | (212,878 | ) | ||||
Cash used in discontinued activities | — | (43,112 | ) | |||||
|
|
|
| |||||
Net cash used in financing activities | (6,001 | ) | (255,990 | ) | ||||
|
|
|
| |||||
Effect of exchange rate changes on cash | 236,022 | 929,806 | ||||||
|
|
|
| |||||
Net decrease in cash and cash equivalents | (13,676,943 | ) | (3,350,785 | ) | ||||
Cash and cash equivalents at beginning of year | 24,315,160 | 27,665,945 | ||||||
|
|
|
| |||||
Cash and cash equivalents at end of year | $ | 10,638,217 | $ | 24,315,160 | ||||
|
|
|
| |||||
Supplemental cash flow disclosures | ||||||||
Cash paid during year for: | ||||||||
Interest | $ | 751,082 | $ | 42,375 | ||||
|
|
|
| |||||
Income taxes | $ | — | $ | — | ||||
|
|
|
| |||||
Non-cash investing and financing activities: | ||||||||
Investments in bonds | $ | (1,590,247 | ) | $ | (2,778,096 | ) | ||
Accumulated other comprehensive income | (1,910,234 | ) | 1,805,762 | |||||
Deferred tax liabilities | 3,500,481 | 972,334 | ||||||
Equipment from capital lease | — | 34,592 | ||||||
Capital lease obligation | — | (34,592 | ) | |||||
|
|
|
| |||||
| $ | — | $ | — | |||||
|
|
|
| |||||
The accompanying notes are an integral part of these consolidated financial statements.
44
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Dynacq Healthcare, Inc.
Notes to Consolidated Financial Statements
August 31, 2012
1. Significant Accounting Policies
Business and Organization
Dynacq Healthcare, Inc., a Nevada corporation (the “Company”), is a holding company that through its subsidiaries in the United States develops and manages general acute care hospitals that principally provide specialized surgeries. The Company through its subsidiaries in China and Hong Kong also (1) provided healthcare management services to a hospital in China until February 28, 2011; and (2) invests in debt and equity securities, including short-term investments in initial public offerings and pre-initial public offerings. The Company through its United States subsidiaries (1) owns and operates one general acute care hospital in Pasadena, Texas and (2) owns one general acute care hospital in Garland, Texas, which was closed on September 30, 2011, and accordingly this business is classified as “Discontinued Operations” for the year ended August 31, 2012 and 2011 (see Note 3 — Discontinued Operations below). The Company is currently composed of two divisions: U.S. and Corporate.
The Company was incorporated under the laws of the State of Nevada in 1992. The Company was reincorporated in Delaware in November 2003 and reincorporated back in Nevada in August 2007.
U.S. Division
In the United States, the Company manages and operates one general acute care hospital that principally provides specialized surgeries such as bariatric, orthopedic and neuro-spine surgeries.
In May 1998, Vista Community Medical Center, L.L.C., a Texas limited liability company, was organized for the purpose of operating a hospital (the “Pasadena facility”). In June 2003, the Pasadena facility was converted to a limited liability partnership. As of August 31, 2012 and 2011, the Company through its subsidiaries had a 99% and 100%, respectively, ownership interest in the Pasadena facility.
In July 2003, Vista Hospital of Dallas, LLP was organized for the purposes of acquiring and operating a surgical hospital in Garland, Texas (the “Garland facility”). As of August 31, 2012 and 2011, the Company had a 98.25% membership interest in the Garland facility. In August 2010, the Board of Directors of the Company approved a plan to dispose of the Garland facility. The Company closed the Garland facility on September 30, 2011, and accordingly, its operations for the year ended August 31, 2012 and 2011 continue to be classified as discontinued operations.
Corporate Division
From March 1, 2009 to February 28, 2011, Dynacq Huai Bei Healthcare, Inc. (“Dynacq-Huai Bei”), a wholly owned subsidiary of the Company provided healthcare management services to the Second People’s Hospital in Rui An, China. The Company organized Dynacq-Huai Bei in April 2008 under the laws of the People’s Republic of China. Dynacq-Huai Bei was responsible for funding any operating deficits, and is to be rewarded with any operating profits, of that hospital during the management period. Due to continued losses at the Second People’s Hospital, the Company terminated the management agreement with the Rui An City Department of Health. The Company ceased providing healthcare management services to the Second People’s Hospital as of February 28, 2011. The Company wrote off the fixed assets and inventory balances as of February 28, 2011, and does not expect any further losses due to the termination of this management agreement related to the Second People’s Hospital. We have accounted for the operations of Dynacq-Huai Bei and Second People’s Hospital in Rui An, China as discontinued operations.
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Dynacq-Huai Bei and the Rui An City Department of Health had also previously entered into an agreement assigning to Dynacq-Huai Bei the right to manage the Third People’s Hospital in Rui An, which hospital is currently under construction. Dynacq-Huai Bei and the Rui An City Department of Health, in November 2010, mutually agreed to terminate this agreement due to continued delays in the construction of the Third People’s Hospital. Accordingly, Dynacq-Huai Bei will not manage the Third People’s Hospital.
The Company also organized Sino Bond Inc. Limited, a Hong Kong corporation (“Sino Bond”) to hold and manage investments in Hong Kong. Sino Bond invests in debt and equity securities in Europe and Asia, including initial public offerings and pre-initial public offerings.
During the fiscal year ended August 31, 2009, the Company invested approximately $9.1 million of its available cash in marketable securities. During the quarter ended August 31, 2011, one of these marketable securities with a book cost of $700,000 was called for a gain of $1.3 million. As of August 31, 2012, the balance of these securities is valued at approximately $16.8 million. The Company intends to hold these for a minimum period of an additional 12 months, except for one particular security that was called subsequent to the year ended August 31, 2012. During the year ended August 31, 2012 and 2011, the Company also traded in initial public offerings of equity securities on the Hong Kong Stock Exchange and had losses of $318,206 and $364,721, respectively.
Reclassification
Certain previously reported financial information has been reclassified to conform to the current year’s presentation. The impact of such reclassification was not significant to the prior year’s overall presentation.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly and majority owned subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation.
Basis of Presentation
The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for annual financial information and with the instructions to Form 10-K and Article 3 and 3-A of Regulation S-X. The majority of the Company’s expenses are “cost of revenue” items. Costs that could be classified as general and administrative by the Company would include the corporate office costs, which were approximately $5.9 million and $8.3 million for the fiscal years 2012 and 2011, respectively.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. The most significant of the Company’s estimates is the determination of revenue to recognize for the services the Company provides and the determination of the contractual allowance. See “Revenue Recognition” below for further discussion. Actual results could differ materially from those estimates used in preparation of these financial statements.
Cash and Cash Equivalents
The Company considers all highly liquid investments with maturities of three months or less on the date of purchase to be cash equivalents. Cash equivalents are carried at cost, which approximates fair value.
Investments in Available-for-Sale and Trading Securities
The Company has invested in various bonds. These investments are classified as available-for-sale securities, and are carried at fair value as of August 31, 2012 and 2011, based on the quoted market prices as of that date. These investments are subject to default risk. The Company intends to hold these for a minimum period of an additional 12 months. Unrealized gains in the fair value are reported in accumulated other comprehensive income, net of related income tax effect. The Company regularly monitors its investment portfolio for any decline in fair value that is other than temporary and records any such impairment as an impairment loss. The determination on the gain or loss on the sale of any security is specific identification method.
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The Company also invests in initial public offerings of equity securities on the Hong Kong Stock Exchange. These investments are classified as trading securities, and are carried at fair value as of August 31, 2012. These investments are subject to fluctuations in the market price. During the year ended August 31, 2012 and 2011, the Company had a net loss of $318,206 and $364,721 in trading of these securities, respectively.
Investment in Real Estate and Note Payable
In March 2010, the Company purchased an apartment in Hong Kong as an investment for $2,014,207. This apartment was used as a security to obtain an 18-year mortgage loan of $1,245,775 from a financial institution, with a variable interest rate at the lower of 3-month Hang Seng Interbank Offered Rates plus 0.7% or 2.9% below the Hong Kong Dollar best lending rate quoted by the financial institution. The effective interest rate at August 31, 2012 was 1.12%. The Company has paid down $64,114 and $63,709 during the fiscal year ended August 31, 2012 and 2011, respectively, and the current and long-term portions of the note payable as of August 31, 2012 are $64,558 and $1,027,057, respectively. For the fiscal year ended August 31, 2012 and 2011, depreciation expense associated with the apartment was $51,646 in each year. Subsequent to the year ended August 31, 2012, this apartment was sold for a gain of approximately $480,000.
In November 2011 and September 2010, the Company borrowed $116,339 and $65,000 as notes payable from a financial institution at an interest rate of 4.5% and 6%, which notes are to be repaid in 36 and 24 monthly installments, respectively, and are secured by specific equipments purchased at our Pasadena facility. The Company has paid down $64,182 and $28,850 during the year ended August 31, 2012 and 2011, respectively, and the current and long-term portions of the notes payable as of August 31, 2012 are $47,129 and $41,178, respectively.
Inventories
Inventories, consisting primarily of medical supplies, are stated at the lower of cost or market, with cost determined by use of the average cost method.
Property and Equipment
Property and equipment are stated at cost. Maintenance and repairs are charged to expense as incurred. Expenditures which extend the physical or economic life of the assets are capitalized and depreciated.
Depreciation is computed using the straight-line method over the estimated useful lives of the assets ranging from five to 39 years. The Company has classified its assets into three categories. The categories are listed below, along with the useful life and the weighted average useful life for each category.
| Useful Life | ||||
Land | N/A | |||
Buildings and improvements | 39 years | |||
Equipment, furniture and fixtures | 5 years | |||
The Company also leases equipment under capital leases. Such assets are amortized on a straight-line basis over the lesser of the term of the lease or the remaining useful life of the assets.
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Impairment of Long-lived Assets
In accordance with ASC Topic 360-10-05, “Impairment or Disposal of Long-Lived Assets”, the Company evaluates the carrying value of property, plant and equipment and definite-lived assets whenever a change in circumstances indicates that the carrying value may not be recoverable from the undiscounted future cash flows from operations. If an impairment exists, the net book values are reduced to fair values as warranted.
In August 2010, the Board of Directors of the Company approved a plan to dispose of the Pasadena and Garland facilities due to continued operating losses. Both facilities have experienced decreases in net patient revenues and number of cases, generally attributable to the loss of physicians from our medical staffs resulting in fewer elective surgeries. The opening of a new hospital near our Garland facility had a direct adverse impact on our ability to retain members of the medical staff at that facility and consequently on our patient volume. Neither of these facilities is currently profitable, and the Board of Directors believed this plan of disposal was in the Company’s best interest.
The Company closed the Garland facility on September 30, 2011. The Company signed a commercial contract of sale on March 7, 2013 to sell its Garland facility. The sale is expected to close in May 2013. Based on the sales price, the Company has taken an impairment charge of approximately $1.1 million as of August 31, 2012. This facility belongs to the U.S. Division.
The Company obtained an independent appraisal for the Pasadena facility in October 2012, and based on the hospital’s valuation, expected sale proceeds, and expected cash flows, has determined that there is no impairment charge required in connection with the foregoing operating and/or disposal activities.
Fair Value of Financial Instruments
On September 1, 2008, the Company adopted ASC Topic 825-10-25, “Financial Instruments” (formerly referred to as SFAS No. 159, The Fair Value Option for Financial Assets and Liabilities (“SFAS 159”)), which permits entities to choose to measure certain financial assets and liabilities at fair value. The adoption of ASC Topic 825-10-25 had no impact on the consolidated financial statements because the Company did not elect the fair value option for any financial assets or financial liabilities that were not already recorded at fair value.
On September 1, 2008, the Company adopted ASC Topic 820, “Fair Value Measurements and Disclosures” (formerly referred to as SFAS 157) for our financial assets and liabilities. Management uses the fair value hierarchy of ASC Topic 820, which gives the highest priority to quoted prices in active markets. The fair value of financial instruments is estimated based on market trading information, where available. Absent published market values for an instrument or other assets, management uses observable market data to arrive at its estimates of fair value. Management believes that the carrying amount of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate fair value. ASC Topic 820 defines fair value as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, ASC Topic 820 establishes a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. The three levels of inputs used to measure fair value are as follows:
| Level 1 | Quoted prices in active markets for identical assets or liabilities. |
| Level 2 | Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted price for identical or similar assets and liabilities in markets that are not active; or other input that are observable or can be corroborated by observable market data. |
| Level 3 | Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs. |
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In January 2010, the Financial Accounting Standards Board (“FASB”) issued guidance related to fair value disclosure requirements. The new guidance resulted in a change in the Company’s accounting policy effective March 1, 2010. Under this guidance, companies will be required to make additional disclosures concerning significant transfers of amounts between the Level 1 and Level 2 fair value disclosures, as well as further disaggregation of the types of activity that were previously disclosed in the rollforward of Level 3 fair value disclosures. Further, the guidance clarifies the level of aggregation of assets and liabilities within the fair value hierarchy that may be presented. The adoption of this guidance did not have an impact on the Company’s consolidated financial statements.
The following table summarizes our financial assets and liabilities measured at fair value on a recurring basis as of August 31, 2012, segregated among the appropriate levels within the fair value hierarchy:
| Quoted prices in active markets for identical | Significant other observable inputs | Significant unobservable | ||||||||||
| (Level 1) | (Level 2) | (Level 3) | ||||||||||
Assets | ||||||||||||
Investments available-for-sale | $ | — | $ | 16,828,886 | $ | — | ||||||
Trading securities | 1,280,518 | — | — | |||||||||
The Company’s investments in Level 1 are in equity stocks at a cost of $2,047,390. The Company’s investments in Level 2 are in perpetual bonds traded on the European markets, at a cost of $8,435,146.
Revenue Recognition
Background
The Company’s revenue recognition policy is significant because net patient service revenue is a primary component of its results of operations. Revenue is recognized as services are delivered. The determination of the amount of revenue to be recognized in connection with the Company’s services is subject to significant judgments and estimates, which are discussed below.
Revenue Recognition Policy
The Company has established billing rates for its medical services which it bills as gross revenue as services are delivered. Gross billed revenues are then reduced by the Company’s estimate of the discount (contractual allowance) to arrive at net patient service revenues. Net patient service revenues may not represent amounts ultimately collected. The Company adjusts current period revenue for actual differences in estimated revenue recorded in prior periods and actual cash collections.
The table below sets forth the percentage of our gross patient service revenue by financial class for our Pasadena facility for the fiscal years 2012 and 2011:
| 2012 | 2011 | |||||||
Workers’ Compensation | 11 | % | 26 | % | ||||
Commercial | 40 | % | 39 | % | ||||
Medicare | 28 | % | 17 | % | ||||
Medicaid | 1 | % | 1 | % | ||||
Self-Pay | 16 | % | 13 | % | ||||
Other | 4 | % | 4 | % | ||||
Contractual Allowance
The Company computes its contractual allowance based on the estimated collections on its gross billed charges. The Company computes its estimate by taking into account collections received, up to 30 days after the end of the period, for the services performed and also estimating amounts collectible for the services performed within the last six months. The following table shows gross revenues and contractual allowances for our Pasadena facility for fiscal years 2012 and 2011:
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| 2012 | 2011 | |||||||
Gross billed charges | $ | 19,619,903 | $ | 22,138,821 | ||||
Contractual allowance(1) | 14,088,670 | 24,116,028 | ||||||
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| |||||
Net revenue | $ | 5,531,233 | $ | (1,977,207 | ) | |||
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Contractual allowance percentage(1) | 72 | % | 109 | % | ||||
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| (1) | The contractual allowance percentage, excluding the stop-loss fee dispute amount booked in the quarter ended May 31, 2011, which is discussed below, would have been 63% for the year ended August 31, 2011. |
A significant amount of our net revenue results from Texas workers’ compensation claims, which are governed by the rules and regulations of the Texas Department of Workers’ Compensation (“TDWC”) and the workers’ compensation healthcare networks. If our hospital chooses to participate in a network, the amount of revenue that will be generated from workers’ compensation claims will be governed by the network contract.
For claims arising prior to the implementation of workers’ compensation networks and out of network claims, inpatient and outpatient surgical services are either reimbursed pursuant to the Acute Care In-Patient Hospital Fee Guideline or at a “fair and reasonable” rate for services in which the fee guideline is not applicable. Starting March 1, 2008, the Texas Workers’ Compensation 2008 Acute Care Hospital Outpatient and Inpatient Facility Fee Guidelines (the “Guidelines”) became effective. Under these Guidelines, the reimbursement amounts are determined by applying the most recently adopted and effective Medicare reimbursement formula and factors; however, if the maximum allowable reimbursement for the procedure performed cannot be calculated using these Guidelines, then reimbursement is determined on a fair and reasonable basis.
Based on these Guidelines, the reimbursement due the Company for workers’ compensation cases is lower than we previously experienced. The Company has continued accepting Texas workers’ compensation cases, and has not made any substantial changes in its focus towards such cases. Our net patient service revenue for Texas workers’ compensation cases as a percentage of gross billings has decreased primarily as a result of lower reimbursement rates for workers’ compensation procedures still being performed.
Should we disagree with the amount of reimbursement provided by a third-party payer, we are required to pursue the MDR process at the TDWC to request proper reimbursement for services. From January 2007 to November 2008, the Company had been successful in its pursuit of collections regarding the stop-loss cases pending before the State Office of Administrative Hearings (“SOAH”), receiving positive rulings in over 90% of its claims presented for administrative determination. The 2007 district court decision upholding our interpretation of the statute as applied to the stop-loss claims was appealed by certain insurance carriers, and on November 13, 2008 the Third Court of Appeals determined that in order for a hospital to be reimbursed at 75% of its usual and customary audited charges for an inpatient admission, the hospital must not only bill at least $40,000, but also show that the admission involved unusually costly and unusually extensive services. Procedurally, the decision means that each case where a carrier raised an issue regarding whether the services provided were unusually costly or unusually extensive would be remanded to either SOAH or MDR for a case-by-case determination of whether the services provided meet these standards, once the definitions of those standards are determined. As a result of the Third Court of Appeals opinion, any stop-loss cases pending at SOAH have been remanded to the TDWC since these cases have not been reviewed or decided by the two-prong standard decided by the Third Court of Appeals. The SOAH Administrative Law judges determined that the most appropriate location for these cases is the TDWC, pending a final, non-appealable decision.
A petition asking the Texas Supreme Court to review the Third Court of Appeals decision has been denied. Therefore, the Company is bound by the Third Court of Appeals decision. The Texas Supreme Court’s decision has further delayed final adjudication in these pending stop-loss cases. The uncertain outcome in these cases will depend on a very lengthy process. We anticipate further, lengthy litigation at the Travis County District Courts and the Texas Courts of Appeals. Because of this lengthy process and the uncertainty of recovery in these cases, collection of a material amount of funds in these pending stop-loss cases is not anticipated during the 2013 fiscal year.
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Through August 2012, insurance carriers have voluntarily paid the awards in the decisions and orders issued by SOAH, plus interest, in approximately 180 cases, involving approximately $11 million in claims. In most of these cases, the carriers have requested refunds of the payments made in the event that the SOAH decisions and orders are reversed on appeal. Our request that the TDWC Commissioner enforce the awards which were not voluntarily paid by the carriers was refused in approximately 130 cases. Motions filed seeking a refund in some cases in which the awards were voluntarily paid have been granted and the Company has been ordered to refund approximately $3.7 million, including prejudgment interest, pending remand for a case-by-case determination of whether the services provided were unusually costly and unusually extensive. In fiscal year 2011, the Company deposited these amounts as cash deposits into the registry of the court in order to stay execution of the judgments ordering refunds. Additionally, the Company has deposited $204,000 in September 2012 for another year’s interest in order to continue to stay execution of the judgments ordering refunds. We anticipate that similar motions requesting remand and a refund for awards voluntarily paid will be filed and will likely be granted by the 345th Judicial District Court of Travis County, Texas. If and when these additional motions are granted, the Company will be ordered to refund an additional $7.7 million, not including prejudgment interest. The Company has appealed the judgments requiring a refund to the carriers. The briefs of the parties have been filed with the court of appeals and the Company is now waiting for the court of appeals to act on the appeals. While the appeals are pending, the adjudication of those cases remanded for determinations of whether the services provided were unusually costly and unusually extensive will continue. Voluntary payments made pursuant to the Decisions and Orders are premature payments by the carriers and may be ordered to be refunded. Once the Company is given the opportunity to present its evidence regarding whether the services provided were unusually costly and unusually extensive, the Company anticipates that it will prevail in the underlying stop-loss fee disputes and that payments refunded to the carriers will be recaptured.
Due to the uncertainties associated with these stop-loss fee dispute cases, in fiscal year 2011, the Company recognized an increase of $10,254,990 in the contractual allowance at our Pasadena facility (and an additional loss of $779,583 in the contractual allowance at our Garland facility, which is classified as discontinued operations), and $1,751,478 in interest expense at our Pasadena facility (and an additional interest expense of $132,339 at our Garland facility). The increase in the contractual allowance resulted in the $1,977,207 negative revenue for the Pasadena facility for the year ended August 31, 2011.
Claims regarding payment for ambulatory surgical center and hospital outpatient services remain pending at the TDWC. It is expected that these claims will be adjudicated at SOAH and possibly in the Texas district and appellate courts. The basis for reimbursement for these services made the subject of these pending cases is the determination of “fair and reasonable” charges. In 2007, we received unfavorable rulings from SOAH in all of our appeals of unfavorable decisions related to services provided in 2001 and 2002. The 179 cases, which have been appealed to the Travis County district courts, challenge the constitutionality of the relevant statutory language. The Company received an unfavorable ruling in its lead case in March 2009, which ruling was appealed to and was upheld by the Third Court of Appeals on August 26, 2010. The Texas Supreme Court denied a petition asking for review of the Third Court of Appeals decision. The unfavorable interpretation by the Texas Courts of Appeal in our lead case negatively affects the recovery of additional reimbursement, not only in the lead case, but in the remaining 178 pending cases. Consequently, the Company is bound by the Third Court of Appeals’ ruling that interprets the applicable statute and fee guideline to require that the amount that will be paid to a provider must not only be at a “fair and reasonable rate” but also must “ensure the quality of medical care” and “achieve effective cost control” and be the same or less than that charged to others with an equivalent standard of living. This ruling will impact cases in which a fee guideline was not applicable, specifically all pending cases involving ambulatory surgical services provided from 2001 through 2004 as well as all pending cases involving hospital outpatient services provided prior to March 1, 2008, when the Guidelines took effect. Since the Third Court of Appeals’ unfavorable ruling, collection, if any, in these cases depends on the Company’s ability to establish the criteria in this ruling. The Company was given the opportunity to establish the criteria in approximately 80 cases, which were set for hearing on the merits from March through May 2012 and was unsuccessful. Additionally, the Company will have the opportunity to continue to establish the criteria in several thousand cases currently pending at SOAH during the 2013 fiscal year.
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Due to the uncertainties regarding the accounts receivable in the MDR process, the 2008 and 2010 Third Court of Appeals’ opinions and our legal counsel’s advice that settlements with insurance carriers have virtually stopped, the Company had fully reserved all accounts receivable related to the MDR process as of August 31, 2008. Any monies collected for these MDR accounts receivable will be recorded as current period’s net patient service revenues.
Accounts Receivable
Accounts receivable represent net receivables for services provided by the Company. At each balance sheet date management reviews the accounts receivable for collectibility.
The contractual allowance stated as a percentage of gross receivables at the balance sheet dates is larger than the contractual allowance percentage used to reduce gross billed charges due to the application of partial cash collections to the outstanding gross receivable balances, without any adjustment being made to the contractual allowance. The contractual allowance amounts netted against gross receivables are not adjusted until such time as the final collections on an individual receivable are recognized.
Sources of Revenue and Reimbursement
The focal point of our business is providing patient care services, including complex orthopedic and bariatric procedures. The Company pursues optimal reimbursement from third-party payers for these services. We do not normally participate in managed care or other contractual reimbursement agreements, principally because they limit reimbursement for the medical services provided. This business model often results in increased amounts of reimbursement for the same or similar procedure, as compared to other healthcare providers. However, there are no contractual or administrative requirements for “prompt payment” of claims by third-party payers within a specified time frame. As a result, the Company has tended to receive higher amounts of per-procedure reimbursement than that which may be received by other healthcare providers performing similar services. Conversely, despite the increased reimbursement, we may take additional time to collect the expected reimbursement from third-party payers. The Company has been participating in managed care contracts since the first quarter of fiscal 2006 and anticipates entering into additional contracts in the future. So far these contracts have not resulted in any meaningful patient revenues. Increased participation in managed care contracts and programs may decrease the per-procedure reimbursement that the Company collects in the future for similar services.
In addition to the fact that our collection process may be longer than other healthcare providers because of our focus on workers’ compensation and other commercial payers, the collection process can be extended due to our efforts to obtain all optimal reimbursement available to the Company. Specifically, for medical services provided to injured workers, the Company may initially receive reimbursement that may not be within the fee guidelines or regulatory guidelines mandating reimbursement. For such cases in which third-party payers did not provide appropriate reimbursement pursuant to these guidelines, the Company pursues further reimbursement. The Company reviews and pursues those particular claims that are determined to warrant additional reimbursement pursuant to the fee or regulatory guidelines. The Company’s pursuit of additional reimbursement amounts that it believes are due under fee or regulatory guidelines may be accomplished through established dispute resolution procedures with applicable regulatory authorities.
Surgeries are typically not scheduled unless they are pre-authorized by insurance carrier for medical necessity, with the exception of Medicare, Medicaid and self-pay surgeries. After the surgery, the Company’s automated computer system generates a statement of billed charges to the third-party payer. At that time, the Company also requests payment from patients for any remaining amounts that are the responsibility of the patient. In cases where a commercial insurance payers’ pre-approval is not approved subsequently, those accounts receivable may be classified to self-pay. Historically, such classifications have not been significant.
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Discontinued Operations
Revenue Recognition Policy
In China, the local government Department of Health establishes billing rates for a hospital’s sale of prescription medication and medical services. A majority of the services provided by Second People’s Hospital is to cash pay patients, who pay for the services in advance. For services provided under the local government’s social healthcare insurance program, we are generally paid at approximately 95% of billed charges two to three months after the date of service. The remaining 5% of billed charges is evaluated by the local government Department of Health on a semi-annual basis and may be paid to the hospital after that evaluation is complete. As of February 28, 2011, the Company terminated the management agreement with the Rui An City Department of Health. The Company had bad debt expenses of $24,755 for the six months ended February 28, 2011, related to denials under the social healthcare insurance program. Since the amount of bad debt expense is minimal, it has been included with Other Operating Expenses in the income statement.
Accounts Receivable
Accounts receivable represent net receivables for services provided by the Company. At each balance sheet date management reviews the accounts receivable for collectibility.
Stock Based Compensation
Under ASC Topic 718, Stock Compensation, the Company estimates the fair value of stock options granted using the Black-Scholes option pricing model. The fair value for awards that are expected to vest is then amortized on a straight-line basis over the requisite service period of the award, which is generally the option vesting term. The amount of expense attributed is based on estimated forfeiture rate, which is updated based on actual forfeitures as appropriate. This option pricing model requires the input of highly subjective assumptions, including the expected volatility of our common stock, pre-vesting forfeiture rate and an option’s expected life. The financial statements include amounts that are based on the Company’s best estimates and judgments.
Advertising Costs
Advertising and marketing costs in the amounts of $162,000 and $2,412,000 for the years ending August 31, 2012 and 2011, respectively, were expensed as incurred. The marketing cost for the year ended August 31, 2011 included $1,050,000 for estimated marketing expenses that were supposed to be incurred in fiscal years 2012 and 2013 based on a contract with Kenkon Limited, which expires in May 2013 (The Company believed that the proposed businesses being pursued in China and Hong Kong would eventually be beneficial; however, due to no immediate project in an advanced stage, the Company had expensed the contractual obligation through the entire term of the contract as of August 31, 2011). In fiscal year 2012, the Company reversed $870,000 of marketing costs that were expensed and accrued for in fiscal year 2011, since the amounts were determined to be not payable. In addition, the Company had advertising and marketing costs in the amounts of $-0- and $125,000 for the years ending August 31, 2012 and 2011, respectively, for its discontinued operations, which were also expensed as incurred.
Income Taxes
The Company uses the liability method in accounting for income taxes. Under this method, deferred tax liabilities or assets are determined based on differences between the income tax basis and the financial reporting basis of assets and liabilities and are measured using the enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. If the Company is uncertain about its ability to recognize benefit from net operating losses, it records a valuation allowance against deferred tax assets.
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Noncontrolling Interest
The equity of minority investors (minority investors are generally physician groups and other healthcare providers that perform surgeries at the Company’s facilities) in certain subsidiaries of the Company is reported on the consolidated balance sheets as noncontrolling interest. Noncontrolling interest reported in the consolidated income statements reflect the respective interests in the income or loss of the limited partnerships or limited liability companies attributable to the minority investors (equity interests ranged from 1% to 1.75% during the fiscal year ended August 31, 2012). During 2011, the Company purchased noncontrolling interests at an amount that was $98,350 more than the net book value of the noncontrolling interest liability on the date of purchase. The $98,350 loss has been included in Rent and Other Income in the accompanying consolidated statement of operations for the year ended August 31, 2011.
The following table sets forth the activity in the noncontrolling interest liability account for the fiscal years ending August 31, 2012 and 2011:
Balance August 31, 2010 | $ | 79,595 | ||
Loss allocated to noncontrolling interest holders | (15,978 | ) | ||
Distribution to noncontrolling interest holders | (98,350 | ) | ||
Loss on purchase of noncontrolling interest | 98,350 | |||
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Balance August 31, 2011 | 63,617 | |||
Loss allocated to noncontrolling interest holders | (47,358 | ) | ||
Capital contributions from / distributions to new noncontrolling interest holders, net | 50,000 | |||
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Balance August 31, 2012 | $ | 66,259 | ||
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Net Income (Loss) per Share
Basic net income (loss) per share has been computed using the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share has been calculated to give effect to the dilutive effect of common stock equivalents consisting of stock options and warrants in years in which the Company has income.
Foreign Currency Translation
The functional currency of the Company as a whole is the U.S. Dollar. The Company has designated the Chinese Yuan Renminbi as the functional currency for Dynacq-Huai Bei in mainland China, and the U.S. Dollar for Sino Bond in Hong Kong. Assets and liabilities are translated into U.S. dollars using current exchange rates as of the balance sheet date. Income and expense are translated at average exchange rates prevailing during the period. The effects of foreign currency translation adjustments are included as a component of Accumulated Other Comprehensive Income within stockholders’ equity.
Recent Accounting Pronouncements
Presentation of Comprehensive Income: In June 2011, the FASB amended its guidance governing the presentation of comprehensive income. The amended guidance eliminates the option to report other comprehensive income and its components in the statement of changes in equity. Under the new guidance, an entity can elect to present items of net income and other comprehensive income in one continuous statement referred to as the statement of comprehensive income or in two separate, but consecutive, statements. While the options for presenting other comprehensive income change under the guidance, other portions of the current guidance will not change. For public entities, these changes are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The adoption of this standard is not expected to have a material impact on our consolidated financial position or results of operation.
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2. Property and Equipment
At August 31, property and equipment consisted of the following:
| 2012 | 2011 | |||||||
Land | $ | 497,110 | $ | 497,110 | ||||
Buildings and improvements | 8,989,115 | 9,281,245 | ||||||
Equipment, furniture and fixtures | 10,058,232 | 10,518,364 | ||||||
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| 19,544,457 | 20,296,719 | |||||||
Less accumulated depreciation and amortization | (12,888,637 | ) | (13,127,855 | ) | ||||
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Net property and equipment | $ | 6,655,820 | $ | 7,168,864 | ||||
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For the years ended August 31, 2012 and 2011, depreciation expense was $550,643 and $568,069, respectively.
3. Discontinued Operations
Under ASC Topic 360-10-35, Property, Plant, and Equipment – Subsequent Measurement (formerly referred to as SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets), we classify assets to be disposed of as held for sale or, if appropriate, discontinued operations when they have received appropriate approvals to be disposed of by our management or Board of Directors. Cash flows from our discontinued businesses are reflected as discontinued operating, investing, and financing activities in our statement of cash flows. We had $5,401,092 of assets of discontinued operations and $-0- of liabilities of discontinued operations as of August 31, 2012.
U.S. Division
The Company had made the decision to sell its Garland facility as of August 31, 2010, and its operation was classified as discontinued operations for the year ended August 31, 2010. However, the Company closed the Garland facility on September 30, 2011, and accordingly its operations for the years ended August 31, 2012 and 2011 continue to be classified as discontinued operations. The Company signed a commercial contract of sale on March 7, 2013 to sell its Garland facility. The sale is expected to close in May 2013. Based on the sales price, the Company has taken an impairment charge of approximately $1.1 million as of August 31, 2012.
The Company obtained an independent appraisal for both the hospitals in October 2012, and based on each hospital’s valuation, expected sale proceeds, and expected cash flows, has determined that there is no impairment charge required in connection with the foregoing disposal activities. Because we do not intend to sell the accounts receivable of hospitals in discontinued operations, the receivables are included in our accounts receivable in the accompanying Consolidated Balance Sheets.
Corporate Division
The Company’s operations at Second People’s Hospital and its various proposed businesses in China, including but not limited to sandstone mining, mined coal trading, natural gas stations and sale of artifacts have been classified as discontinued operations. The Company’s foreign subsidiary, Sino Bond, is the only company classified as continuing operations in the Corporate Division, and its other foreign subsidiaries have been reclassified as discontinued operations.
The following is a summary of financial information related to our discontinued operations for the years ended August 31, 2012 and 2011.
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Discontinued Operations
| Year Ended August 31, 2012 | Year Ended August 31, 2011 | |||||||||||||||||||||||
| U.S. Division | Corporate Division | Total | U.S. Division | Corporate Division | Total | |||||||||||||||||||
Net patient service revenue | $ | 397,278 | $ | — | $ | 397,278 | $ | 1,086,455 | $ | 831,232 | $ | 1,917,687 | ||||||||||||
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Costs and expenses: | ||||||||||||||||||||||||
Compensation and benefits | 181,693 | 22,644 | 204,337 | 2,473,738 | 610,399 | 3,084,137 | ||||||||||||||||||
Medical services and supplies | 235,977 | — | 235,977 | 773,448 | 406,452 | 1,179,900 | ||||||||||||||||||
Other operating expenses | 957,090 | (363,148 | ) | 593,942 | 3,007,084 | 890,222 | 3,897,306 | |||||||||||||||||
Asset impairment charge | 1,058,056 | — | 1,058,056 | — | — | — | ||||||||||||||||||
Depreciation and amortization | — | 82,353 | 82,353 | — | 90,734 | 90,734 | ||||||||||||||||||
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Total costs and expenses | 2,432,816 | (258,151 | ) | 2,174,665 | 6,254,270 | 1,997,807 | 8,252,077 | |||||||||||||||||
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Operating income (loss) | (2,035,538 | ) | 258,151 | (1,777,387 | ) | (5,167,815 | ) | (1,166,575 | ) | (6,334,390 | ) | |||||||||||||
Other income (expense), net | 304,673 | 77,730 | 382,403 | (129,505 | ) | 1,060,920 | 931,415 | |||||||||||||||||
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Income (loss) before income taxes | (1,730,865 | ) | 335,881 | (1,394,984 | ) | (5,297,320 | ) | (105,655 | ) | (5,402,975 | ) | |||||||||||||
Benefit for income taxes | — | — | — | 1,850,654 | 30,152 | 1,880,806 | ||||||||||||||||||
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Income (loss) on discontinued operations, net of taxes | (1,730,865 | ) | 335,881 | (1,394,984 | ) | (3,446,666 | ) | (75,503 | ) | (3,522,169 | ) | |||||||||||||
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Loss on disposal of discontinued assets | — | (229,201 | ) | (229,201 | ) | — | (187,041 | ) | (187,041 | ) | ||||||||||||||
Benefit for income taxes | — | — | — | — | 65,464 | 65,464 | ||||||||||||||||||
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Loss on disposal of discontinued operations, net of taxes | — | (229,201 | ) | (229,201 | ) | — | (121,577 | ) | (121,577 | ) | ||||||||||||||
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Total income (loss) on discontinued operations, net of taxes | $ | (1,730,865 | ) | $ | 106,680 | $ | (1,624,185 | ) | $ | (3,446,666 | ) | $ | (197,080 | ) | $ | (3,643,746 | ) | |||||||
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| August 31, 2012 | August 31, 2011 | |||||||||||||||||||||||
| U.S. Division | Corporate Division | Total | U.S. Division | Corporate Division | Total | |||||||||||||||||||
Current assets | $ | — | $ | — | $ | — | $ | 260,020 | $ | 118,734 | $ | 378,754 | ||||||||||||
Property and equipment, net | 5,401,092 | — | 5,401,092 | 6,530,773 | — | 6,530,773 | ||||||||||||||||||
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Total assets | $ | 5,401,092 | $ | — | $ | 5,401,092 | $ | 6,790,793 | $ | 118,734 | $ | 6,909,527 | ||||||||||||
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Current liabilities: | ||||||||||||||||||||||||
Accounts payable and accrued liabilities | $ | — | $ | — | $ | — | $ | — | $ | 604,302 | $ | 604,302 | ||||||||||||
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Total liabilities | $ | — | $ | — | $ | — | $ | — | $ | 604,302 | $ | 604,302 | ||||||||||||
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4. Notes payable
At August 31, notes payable consisted of the following:
| 2012 | 2011 | |||||||
Note payable secured by the apartment purchased in Hong Kong as an investment for $2,014,207. The Company obtained an 18-year mortgage loan of $1,245,775 from a financial institution, with a variable interest rate at the lower of 3-month Hang Seng Interbank Offered Rates plus 0.7% or 2.9% below the Hong Kong Dollar best lending rate quoted by the financial institution. The effective interest rate at August 31, 2012 was 1.12%. Subsequent to the year ended August 31, 2012, the apartment was sold, and the related note payable was also paid off. | $ | 1,091,615 | $ | 1,155,729 | ||||
Notes payable for $116,339 and $65,000 for purchases of equipment for the Pasadena facility at an interest rate of 4.5% and 6%, secured by the said equipment. | 88,307 | 36,150 | ||||||
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Total | 1,179,922 | 1,191,879 | ||||||
Less: Current portion | (105,735 | ) | (97,918 | ) | ||||
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Long-term portion | $ | 1,074,187 | $ | 1,093,961 | ||||
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Principal payments due on the note payable in fiscal years 2013, 2014, 2015, 2016, 2017 and thereafter are $105,735, $105,529, $72,872, $66,729, $67,470 and $761,587, respectively.
5. Income Taxes
The provision (benefit) for income taxes consisted of the following:
| Year Ended August 31, | ||||||||
| 2012 | 2011 | |||||||
| (Restated) | ||||||||
Current tax (benefit) expense: | ||||||||
Federal | $ | — | $ | (569,430 | ) | |||
State | — | (3,000 | ) | |||||
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Total current | — | (572,430 | ) | |||||
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Deferred tax (benefit) expense: | ||||||||
Federal | 4,018,699 | (785,038 | ) | |||||
State | — | — | ||||||
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Total deferred | 4,018,699 | (785,038 | ) | |||||
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Total income tax (benefit) expense | $ | 4,018,699 | $ | (1,357,468 | ) | |||
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As of August 31, 2012 there was an income tax expense of $4,018,699. The Company had anticipated collecting significant amounts of money from the MDR cases, which were fully reserved, to offset some of the prior years’ losses but has not been successful as yet. In addition, the Company in fiscal year 2012 continued to have operating losses. The Company believes that the likelihood of realizing future tax benefit for the deferred tax assets is low, and hence increased the valuation allowance to write-off the deferred tax assets. As of August 31, 2011, the Company had an income tax benefit of $1,146,766. Please refer to note 15 of these Consolidated Financial Statements for a discussion of the restated income tax receivable as at August 31, 2011.
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The components of the provision (benefit) for deferred income taxes at August 31 were as follows:
| 2012 | 2011 | |||||||
| Restated | ||||||||
Applicable to: | ||||||||
Net operating loss carryforward | $ | (4,941,754 | ) | $ | (5,466,384 | ) | ||
Differences between revenues and expenses recognized for federal income tax and financial reporting purposes | 2,172,058 | (341,188 | ) | |||||
Difference in method of computing depreciation for tax and financial reporting purposes | 49,061 | (42,535 | ) | |||||
Valuation allowance | 6,739,334 | 5,065,069 | ||||||
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Deferred income tax expense (benefit) | $ | 4,018,699 | $ | (785,038 | ) | |||
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Significant components of the Company’s deferred tax liabilities and assets were as follows at August 31, 2012:
| Current | Noncurrent | |||||||
Deferred tax liabilities: | ||||||||
Depreciation | $ | — | $ | (180,415 | ) | |||
Deferred tax assets: | ||||||||
Net operating loss carryforward | — | 7,827,575 | ||||||
Revenue and expense differences | 54,664 | 3,342,010 | ||||||
Allowance for uncollectible accounts | 513,456 | — | ||||||
Asset impairment | 370,320 | — | ||||||
Other | (166,758 | ) | 43,551 | |||||
Valuation allowance | (771,682 | ) | (11,032,721 | ) | ||||
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Net deferred tax asset (liability) | $ | — | $ | — | ||||
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Significant components of the Company’s deferred tax liabilities and assets were as follows at August 31, 2011:
| Current | Noncurrent | |||||||
| (Restated) | ||||||||
Deferred tax liabilities: | ||||||||
Depreciation | $ | — | $ | (131,353 | ) | |||
Exchange gains provision | — | (518,217 | ) | |||||
Investment valuation | — | (3,500,481 | ) | |||||
Deferred tax assets: | ||||||||
Net operating loss carryforward | 2,885,821 | |||||||
Revenue and expense differences | 350,986 | 4,521,437 | ||||||
Allowance for uncollectible accounts | 656,884 | — | ||||||
Asset impairment | 79,239 | 633,915 | ||||||
Other | — | 86,838 | ||||||
Valuation allowance | (1,087,109 | ) | (3,977,960 | ) | ||||
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Net deferred tax asset (liability) | $ | — | $ | — | ||||
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In assessing the ability to realize deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Due to the uncertainty of the Company’s ability to recognize the benefit from the net operating losses, the Company has recorded a full valuation allowance against the deferred tax assets as at August 31, 2012.
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The Company recognizes tax benefits only for tax positions that are more likely than not to be sustained upon examination by tax authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50% likely to be realized upon settlement. Unrecognized tax benefits are tax benefits claimed in the Company’s tax returns that do not meet these recognition and measurement standards.
A reconciliation of the benefit for income taxes with amounts determined by applying the statutory federal income tax rate to income before income taxes and noncontrolling interests is as follows:
| Year Ended August 31, | ||||||||
| 2012 | 2011 | |||||||
| (Restated) | ||||||||
Benefit for income taxes computed using the statutory rate of 35% | $ | (2,294,590 | ) | $ | (6,561,039 | ) | ||
State income taxes, net of federal benefit | — | (1,950 | ) | |||||
Noncontrolling interest in loss of consolidated subsidiaries | 16,575 | 5,592 | ||||||
Non-deductible expenses | (442,620 | ) | 134,860 | |||||
Changes in valuation allowance | 6,739,334 | 5,065,069 | ||||||
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Expense (benefit) for income taxes | $ | 4,018,699 | $ | (1,357,468 | ) | |||
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The Company files income tax returns in the U.S. federal and foreign jurisdictions. The U.S. Internal Revenue Service has closed examination of the Company’s income tax returns through fiscal year 2007. With regard to foreign tax jurisdictions, the Company has not been subjected to examination by tax authorities since it started its foreign operations.
6. Related Party Transactions
The Company has retained Redwood Health Corporation (“Redwood”), to furnish physicians to provide in-house emergency medical coverage for its Pasadena facility during the weekend hours and weekday nights at an hourly rate of $75. The Company’s chief executive officer is a physician and an affiliate of Redwood. The Company paid $421,725 and $434,100 for emergency room physician services to Redwood in fiscal 2012 and 2011, respectively. Management, as well as the Audit Committee that approved the agreement, believes that the hourly rate being paid is consistent with comparable in-house emergency medical coverage rates available in the area.
Dr. Ping Chu, a director of the Company until October 30, 2012, has paid the Company $14,938 and $16,163 during fiscal years ended August 31, 2012 and 2011, respectively for rent and management fees. As of August 31, 2012 and 2011, the Company had accounts receivable from Dr. Chu of $46,848 and $46,381, respectively. Included in the accounts receivable balance were amounts applicable to Dr. Chu’s staffs’ payroll for which he reimburses the Company in the ordinary course of business.
During the fiscal year 2009, the Company retained Anesthesia Associates of Houston Metroplex to provide exclusive, continuous and uninterrupted anesthesiology services, including physicians and CRNAs, to the Pasadena facility for a monthly compensation of $5,000. The Company’s chief executive officer is a physician and an affiliate of Anesthesia Associates of Houston Metroplex. The Company paid $60,000 for anesthesiology services to said organization in each of the fiscal years 2012 and 2011. Management, as well as the Board of Directors that approved the agreement, believes that the rate being paid is consistent with comparable in-house anesthesiology services rates available in the area. During the fiscal year 2009, the Company also retained Redwood to locate and recruit additional skilled anesthesiologists and CRNAs for its Pasadena facility for a monthly compensation of $20,000. The Company paid $240,000 for said recruitment services to Redwood in each of the fiscal years 2012 and 2011. Management, as well as the Board of Directors that approved the agreement, believes that the rate being paid is consistent with comparable rates for recruitment available in the area. The Company entered into these two agreements in order to replace the previous anesthesiology group, whose contract terminated at the end of fiscal 2009. The compensation which was being paid to the previous group was substantially the same as that being paid under the new contracts.
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Discontinued Operations
The Company purchased $92,180 worth of artifacts as inventory for re-sale in China during fiscal year 2011. The purchase amount was paid by Mr. Chiu Chan, the Company’s former chief executive officer. The amount payable to his estate of $270,468 and $242,301, as of August 31, 2012 and 2011, respectively, is included in Accrued Liabilities in the Consolidated Balance Sheet. The Audit Committee had since approved the purchases by Mr. Chan on behalf of the Company, and believed that these purchases have been made at the prevailing market rates.
7. Stockholders’ Equity and Stock Option Plan
Preferred Stock
In January 1992, the board of directors approved an amendment to the Company’s Articles of Incorporation to authorize 5,000,000 shares of undesignated preferred stock, for which the board of directors is authorized to fix the designation, powers, preferences and rights. There are no shares of preferred stock issued or outstanding as of August 31, 2012.
Treasury Stock
The Company did not purchase any treasury shares in fiscal years 2012 and 2011.
Stock Option Plans
Year 2011 Stock Incentive Plan
In August 2011, we mailed an Information Statement to all of our stockholders of record as of July 29, 2011. The Information Statement disclosed that our Board of Directors had approved, and the holders of a majority of the outstanding shares of our common stock had executed an Action by Written Consent of Stockholders in Lieu of a Special Meeting (the “Written Consent”), approving the adoption of the Year 2011 Stock Incentive Plan (“2011 Plan”).
The purpose of the 2011 Plan is to strengthen the Company by providing an incentive to its employees, officers, consultants and directors and thereby encouraging them to devote their abilities and industry to the success of the Company’s business enterprise. It is intended that this purpose be achieved by extending to employees, officers, consultants and directors of the Company and its subsidiaries an added long-term incentive for high levels of performance and unusual efforts through the grant of incentive stock options, non-qualified stock options, stock appreciation rights, dividend equivalent rights, performance awards and restricted stock. The Company has reserved 15,000,000 shares of common stock for future issuance under the 2011 Plan.
On November 14, 2011, the Compensation Committee granted stock options to purchase an aggregate of 200,000 shares under the 2011 Plan, with a weighted average exercise price of $1.07 to two employees. These stock options will vest based on certain operating performance criteria, and expire after five years. The shares underlying these stock options are registered under the Securities Act of 1933 (the “Securities Act”).
On January 12, 2012, the Compensation Committee granted stock options to purchase 250,000 shares under the 2011 Plan, with an exercise price of $1.10 to the Company’s chief executive officer, Eric K. Chan. These stock options will vest in annual installments of 25 percent beginning on the first anniversary date, and expire after ten years. The shares underlying these stock options are registered under the Securities Act.
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On February 6, 2012, the Compensation Committee granted stock options to purchase an aggregate of one million shares under the 2011 Plan, with a weighted average exercise price of $1.00 to various employees. These stock options will vest based on certain operating performance criteria, and expire after five years. The shares underlying these stock options are registered under the Securities Act.
As of August 31, 2012, there remain 1,050,000 shares to be issued upon exercise of outstanding options, and 13,950,000 shares which can be issued under the 2011 Plan after giving effect to shares issued and canceled.
2000 Incentive Plan
The Company’s 2000 Incentive Plan (“2000 Plan”) provides for options and other stock-based awards that may be granted to eligible employees, officers, consultants and non-employee directors of the Company or its subsidiaries. The Company had reserved 5,000,000 shares of common stock for future issuance under the 2000 Plan. The 2000 Plan does not have a fixed termination date, provided that no incentive stock option can be granted subsequent to August 29, 2011. As of August 31, 2012, there remain 1,740,566 shares to be issued upon exercise of outstanding options, and no new stock option awards will be issued under the 2000 Plan.
On July 7, 2011, the Compensation Committee granted stock options to purchase an aggregate of 1.4 million shares under the 2000 Plan, with a weighted average exercise price of $1.89 to all full time employees with a minimum of one year of employment with the Company. These stock options will vest in annual installments of 25 percent beginning on the first anniversary date, and expire after ten years. Generally, options granted become exercisable in annual installments of 25% beginning on the first anniversary date, and expire after five to ten years.
The 2011 Plan and the 2000 Plan (the “Plans”) are administered by the Compensation Committee of the board of directors. The Compensation Committee has the power to determine which eligible employees will receive awards, the timing and manner of the grant of such awards, the exercise price of stock options (which may not be less than market value on the date of grant), the number of shares, and all of the terms of the awards. Currently, however, we do not have a Compensation Committee, and accordingly, the Board of Directors, of which our chief executive officer is the sole member, will administer the Plans until such time as a Compensation Committee is established. The Company may at any time amend or terminate the 2011 Plan. However, no amendment that would impair the rights of any participant with respect to outstanding grants can be made without the participant’s prior consent. Stockholder approval of an amendment to the Plans is necessary only when required by applicable law or stock exchange rules.
The following table summarizes the stock option activities for the year ended August 31, 2012 (share amounts in thousands):
| Shares | Weighted Average Option Exercise Price Per Share | Weighted Average Grant Date Fair Value Per Share | Aggregate Intrinsic Value(1) | |||||||||||||
Outstanding, August 31, 2011 | 2,206 | $ | 2.41 | $ | — | $ | — | |||||||||
Granted | 1,450 | 1.03 | 0.52 | — | ||||||||||||
Exercised | — | — | — | — | ||||||||||||
Expired or canceled | (865 | ) | 1.68 | — | — | |||||||||||
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Outstanding, August 31, 2012 | 2,791 | $ | 1.92 | — | $ | — | ||||||||||
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| (1) | These amounts represent the difference between the exercise price and the closing price of Dynacq common stock on August 9, 2012 and August 31, 2011, as reported on the NASDAQ stock market, for all in-the-money options outstanding. For exercised options, intrinsic value represents the difference between the exercise price and the closing price of Dynacq common stock on the date of exercise. |
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For the years ended August 31, 2012 and 2011, the Company did not have any stock options exercised.
For the years ended August 31, 2012 and 2011, stock-based compensation expense associated with the Company’s stock options and stock grants was $325,408 and $276,463, respectively. The total unrecognized compensation expense for outstanding stock options as of August 31, 2012 was approximately $1,043,000, and will be recognized, in general, over 3.2 years. The weighted average number of years to recognize the compensation expense is 1.7 years.
The following summarizes information related to stock options outstanding at August 31, 2012 and related weighted average price and life information:
| Options Outstanding | Options Exercisable | |||||||||||||||||||
Range of Exercise Prices | Shares | Weighted Average Remaining Contractual Life (Years) | Weighted Average Exercise Price | Shares | Weighted Average Exercise Price | |||||||||||||||
| (Share Amounts In Thousands) | ||||||||||||||||||||
$1.00 – 1.10 | 1,050 | 5.8 | $ | 1.03 | — | $ | — | |||||||||||||
$1.86 | 957 | 8.9 | 1.86 | 239 | 1.86 | |||||||||||||||
$2.50 – 2.75 | 569 | 0.8 | 2.54 | 569 | 2.54 | |||||||||||||||
$4.90 | 215 | 2.3 | 4.90 | 215 | 4.90 | |||||||||||||||
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Total | 2,791 | 5.6 | $ | 1.92 | 1,023 | $ | 2.88 | |||||||||||||
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The fair value of the stock-based awards was estimated using the Black-Scholes model with the following weighted average assumptions for two fiscal years ended August 31, 2012:
| Year Ended August 31, | ||||||||
| 2012 | 2011 | |||||||
Estimated fair value | $ | 0.52 | $ | 1.12 | ||||
Expected life (years) | 4.1 | 4.1 | ||||||
Risk free interest rate | 0.79 | % | 1.55 | % | ||||
Volatility | 78 | % | 81 | % | ||||
Dividend yield | — | — | ||||||
On July 7, 2011, a performance share award was granted by the Compensation Committee to an employee whereby the employee could have earned up to 1.5 million shares of the Company’s common stock if certain operating performance criteria were met. Due to termination of employment before any of the shares vested, this performance award was cancelled effective as of August 31, 2011. Such shares are not reflected in the above tables for stock option activities and stock options outstanding.
8. Employee Benefit Plan
The Company sponsors a 401(k) defined contribution plan covering substantially all employees of the Company and provides for voluntary contributions by these employees, subject to certain limits. The plan was effective June 1, 2001. The Company makes discretionary contributions to the plan. The Company’s contributions for fiscal years 2012 and 2011 were $32,322 and $29,083, respectively. In addition, for its employees at its discontinued operations, the company contributed $1,821 and $11,981 for fiscal years 2012 and 2011, respectively.
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9. Net Income (Loss) Per Share
The following table presents the computation of basic and diluted loss per common share attributable to the Company:
| Year Ended August 31, | ||||||||
| 2012 | 2011 | |||||||
| (Restated) | ||||||||
Basic and diluted loss per common share: | ||||||||
Numerator: | ||||||||
Loss from continuing operations | $ | (10,574,669 | ) | $ | (17,388,357 | ) | ||
Less: Net loss attributable to noncontrolling interest | 47,358 | 15,978 | ||||||
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Loss from continuing operations attributable to Dynacq Healthcare, Inc. | (10,527,311 | ) | (17,372,379 | ) | ||||
Discontinued operations, net of income taxes | (1,394,984 | ) | (3,522,169 | ) | ||||
Loss on disposal of discontinued operations, net of income taxes | (229,201 | ) | (121,577 | ) | ||||
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Net loss attributable to Dynacq Healthcare, Inc. | $ | (12,151,496 | ) | $ | (21,016,125 | ) | ||
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Denominator: | ||||||||
Basic and diluted average common shares outstanding | 14,489,780 | 14,196,191 | ||||||
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Basic and diluted loss per common share: | ||||||||
Loss from continuing operations attributable to Dynacq Healthcare, Inc. | $ | (0.73 | ) | $ | (1.22 | ) | ||
Discontinued operations, net of income taxes | (0.10 | ) | (0.25 | ) | ||||
Loss on disposal of discontinued operations, net of income taxes | (0.02 | ) | (0.01 | ) | ||||
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Net loss attributable to Dynacq Healthcare, Inc. | $ | (0.85 | ) | $ | (1.48 | ) | ||
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Basic net income (loss) per share is computed by dividing net income (loss) available to common shareholders by the weighted average number of common shares outstanding for the reporting period. Diluted net income (loss) per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. For the calculation of diluted net income (loss) per share, the basic weighted average number of shares is increased by the dilutive effect of stock options determined using the treasury stock method. However, if it is anti-dilutive, the dilutive effect of the stock options is not included in the calculation of diluted net income (loss) per share. Stock options with exercise prices exceeding current market prices that were excluded from the computation of net income (loss) per share amounted to approximately 2,653,000 shares and 1,232,000 shares for the fiscal year ended August 31, 2012 and 2011, respectively.
10. Comprehensive Loss and Accumulated Other Comprehensive Income
Comprehensive income (loss) consists of net income (loss) and other comprehensive income (loss). Other comprehensive income (loss) represents certain components of revenues, expenses, gains and losses that are included in comprehensive income (loss), but are excluded from net income (loss). Other comprehensive income (loss) amounts are recorded directly as an adjustment to stockholders’ equity, net of tax, and for the years ended August 31, 2012 and 2011 were as follows:
| 2012 | 2011 | |||||||
| (Restated) | ||||||||
Net loss | $ | (12,151,496 | ) | $ | (21,016,125 | ) | ||
Other comprehensive income (loss), net of taxes: | ||||||||
Foreign currency translation adjustment, net of taxes of $(12,530) and $315,465, respectively | (23,268 | ) | 585,864 | |||||
Reclassification adjustment for foreign currency gains included in net income, net of taxes of $(501,273) and $-0-, respectively | (921,318 | ) | — | |||||
Change in valuation of investment available-for-sale, net of taxes of $(3,500,481) and $(1,427,334), respectively | 1,910,234 | (2,650,763 | ) | |||||
Reclassification adjustment for gains on call of investment available-for-sale included in net income, net of taxes of $-0- and $455,000, respectively | — | 845,000 | ||||||
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Total other comprehensive loss, net of taxes | (11,185,848 | ) | (22,236,024 | ) | ||||
Comprehensive loss attributable to the noncontrolling interest | — | — | ||||||
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Comprehensive loss attributable to Dynacq Healthcare, Inc. | $ | (11,185,848 | ) | $ | (22,236,024 | ) | ||
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The components of accumulated other comprehensive income were as follows:
| August 31, 2012 | August 31, 2011 | |||||||
Foreign currency translation adjustment, net of taxes of $4,414 and $518,217, respectively | $ | 8,196 | $ | 952,782 | ||||
Change in valuation of investment available-for-sale, net of taxes of $-0- and $3,500,481, respectively | 8,411,128 | 6,500,894 | ||||||
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| |||||
Total accumulated other comprehensive income, net of taxes of $4,414 and $4,018,698, respectively | $ | 8,419,324 | $ | 7,453,676 | ||||
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11. Accrued Liabilities
Accrued liabilities at August 31 is as follows:
| 2012 | 2011 | |||||||
MDR stop-loss cases accrual, including accrued interest | $ | 9,548,602 | $ | 12,918,370 | ||||
Marketing fees liability | 300,000 | 2,381,565 | ||||||
Payroll and related taxes | 389,713 | 703,398 | ||||||
Noncontrolling interest in consolidated subsidiary buy-out liability | 106,937 | 156,737 | ||||||
Property taxes | 339,527 | 364,308 | ||||||
Medicare liability | — | 400,000 | ||||||
Year-end accruals of expenses and other | 1,078,583 | 1,506,175 | ||||||
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Total accrued liabilities | $ | 11,763,362 | $ | 18,430,553 | ||||
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12. Commitments and Contingencies
Due to the uncertainties associated with the stop-loss fee dispute cases, the Company has recognized, in fiscal year 2011, an increase of $12.9 million in the contractual allowance and related interest expense at our Pasadena and Garland facilities. For a detailed discussion of this, see Revenue Recognition Policy under Note 1 to the Consolidated Financial Statements. Motions filed seeking a refund in some cases in which the awards were voluntarily paid have been granted and the Company has been ordered to refund approximately $3.7 million, including prejudgment interest, pending remand for a case-by-case determination of whether the services provided were unusually costly and unusually extensive. In fiscal year 2011, the Company deposited these amounts as cash deposits into the registry of the court in order to stay execution of the judgments ordering refunds. Additionally, the Company has deposited $204,000 in September 2012 for another year’s interest in order to continue to stay execution of the judgments ordering refunds. We anticipate that similar motions requesting remand and a refund for awards voluntarily paid will be filed and will likely be granted by the 345th Judicial District Court of Travis County, Texas. If and when these additional motions are granted, the Company will be ordered to refund an additional $7.7 million, not including prejudgment interest. The Company has appealed the judgments requiring a refund to the carriers. The briefs of the parties have been filed with the court of appeals and the Company is now waiting for the court of appeals to act on the appeals. While the appeals are pending, the adjudication of those cases remanded for determinations of whether the services provided were unusually costly and unusually extensive will continue. Voluntary payments made pursuant to the Decisions and Orders are premature payments by the carriers and may be ordered to be refunded. Once the Company is given the opportunity to present its evidence regarding whether the services provided were unusually costly and unusually extensive, the Company anticipates that it will prevail in the underlying stop-loss fee disputes and that payments refunded to the carriers will be recaptured.
Total rent and lease expenses paid by the Company for the fiscal years 2012 and 2011 were approximately $127,000 and $470,000, respectively. The Company’s total minimum rental commitments under noncancellable operating leases are approximately $63,000 in the next five fiscal years.
The Company has contracts with doctors to manage various areas of the Company’s hospital and other service agreements. Payments made under these agreements for the fiscal years ending August 31, 2012 and 2011 were $1,190,000 and $1,296,000, respectively. The Company’s minimum commitments under these contracts are approximately $712,000, all of which is payable in fiscal year 2013.
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The Company has administrative support services agreements with outside organizations for administrative support services. Payments made related to these agreements for fiscal years 2012 and 2011 were $266,000 and $433,000, respectively. The Company has a total commitment of approximately $259,000, all of which is to be incurred in fiscal year 2013 related to these administrative support services agreements.
The Company, through its subsidiary, also had agreements with outside organizations that offer marketing, pre-authorization and follow up support services to prospective bariatric and orthopedic patients in areas serviced by the Pasadena facility. The facility received bariatric and orthopedic referrals from other sources, and the organizations referred clients to other area hospitals. The Company had cancelled these agreements in the first quarter of fiscal year 2011, and does not have a commitment related to these agreements anymore, and markets on a month-to-month basis. These marketing expenses for the fiscal years 2012 and 2011 were $162,000 and $762,000, respectively.
The Company has notes payable commitment for purchases of equipment for the Pasadena facility at an interest rate of 4.5% and 6%, secured by the said equipment of approximately $88,000, of which $41,000 is payable in 2013, $40,000 in 2014 and $7,000 in 2015.
The Company has a note payable related to an apartment purchased in Hong Kong as an investment. The Company obtained an 18-year mortgage loan of $1,245,775 from a financial institution, with a variable interest rate at the lower of 3-month Hang Seng Interbank Offered Rates plus 0.7% or 2.9% below the Hong Kong Dollar best lending rate quoted by the financial institution. The effective interest rate at August 31, 2012 was 1.12%. The total amount payable in fiscal years 2013, 2014, 2015, 2016, 2017 and thereafter are $65,000, $65,000, $66,000, $67,000, $67,000 and $762,000, respectively. Subsequent to the year ended August 31, 2012, the Company sold the apartment in Hong Kong, as well as paid off the related note payable.
The Company has purchased some equipment under capital leases, and has a total commitment to pay $203,000 under these leases, of which $113,000 is payable in fiscal year 2013, and $90,000 in 2014.
These commitments mentioned above total $12.4 million, of which $11.1 million is payable in fiscal year 2013, $219,000 in 2014, $91,000 in 2015, $82,000 in 2016, $76,000 in 2017, and approximately $807,000 is payable after five years.
Discontinued Operations
Total rent and lease expenses paid by the Company for its discontinued operations for the fiscal years 2012 and 2011 were approximately $117,000 and $225,000, respectively. The Company’s total minimum rental commitments under noncancellable operating leases are approximately $139,000.
The Company had contracts with doctors to manage various areas of the Company’s hospital and other service agreements. Payments made under these agreements for the fiscal years ended August 31, 2012 and 2011 were $-0-and $668,000, respectively.
The Company had administrative support services agreements with outside organizations for administrative support services. Payments made related to these agreements for fiscal years 2012 and 2011 were $110,000 and $210,000, respectively. The Company has a total commitment of approximately $64,000, all of which is to be incurred in fiscal year 2013, related to these administrative support services agreements.
The Company, through its subsidiary, also had agreements with outside organizations that offer marketing, pre-authorization and follow up support services to prospective bariatric and orthopedic patients in areas serviced by the Garland facility, before its closure in September 2011. The facility received bariatric and orthopedic referrals from other sources, and the organizations referred clients to other area hospitals. The Company had since cancelled these agreements in the first quarter of fiscal year 2011, and does not have a commitment related to these agreements anymore. These marketing expenses for the fiscal years 2012 and 2011 were $-0- and $124,500, respectively.
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These commitments mentioned above for discontinued operations total $203,000.
Risks and Uncertainties
The Company maintains various insurance policies that cover each of its U.S. facilities; including occurrence medical malpractice coverage. In addition, all physicians granted privileges at the Company’s U.S. facilities are required to maintain medical malpractice insurance coverage. The Company also maintains general liability and property insurance coverage for each U.S. facility, including flood coverage. The Company does not currently maintain workers’ compensation coverage in Texas. In regard to the Employee Health Insurance Plan, the Company is self-insured with specific and aggregate re-insurance with stop-loss levels appropriate for the Company’s group size. Coverage is maintained in amounts management deems adequate.
The Company is routinely involved in litigation and administrative proceedings that are incidental to its business. Specifically, all judicial review of unsatisfactory determinations of reimbursement amounts due us for our Texas facilities’ fees must be made in the district courts of Travis County, Texas in what can often be a lengthy procedure.
13. Concentrations of Credit Risk and Fair Value of Financial Instruments
The Company has financial instruments that are exposed to concentrations of credit risk and consist primarily of cash investments and trade accounts receivable. The Company routinely maintains cash and temporary cash investments at certain financial institutions in amounts substantially in excess of Federal Deposit Insurance Corporation (“FDIC”) and Securities Investor Protection Corporation (“SIPC”) insurance limits in the U.S. and in financial institutions overseas. The management believes that these financial institutions are of high quality and the risk of loss is minimal. At August 31, 2012, the Company had cash balances in excess of the FDIC and SIPC limits in the U.S. and in financial institutions overseas of $8 million.
As is customary in the healthcare business, the Company has accounts receivable from various third-party payers. The Company does not request collateral from its customers and continually monitors its exposure for credit losses and maintains allowances for anticipated losses. Gross receivables from third-party payers are normally in excess of 90% of the total receivables at any point in time. The mix of gross receivables from our facilities in the United States from self-pay patients and third-party payers at August 31, 2012 and 2011 is as follows:
| 2012 | 2011 | |||||||
Workers’ compensation | 1 | % | 1 | % | ||||
Workers’ compensation subject to Medical Dispute Resolution process | 84 | % | 85 | % | ||||
Commercial | 9 | % | 8 | % | ||||
Medicare / Government | 1 | % | — | % | ||||
Self-pay | 4 | % | 4 | % | ||||
Other | 1 | % | 2 | % | ||||
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| |||||
| 100 | % | 100 | % | |||||
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We had one third-party payer (customer) who represented 14% of our gross receivables as of August 31, 2012 and 2011. We had one third-party payers (customers) representing 10% of the Company’s gross revenue for the year ended August 31, 2012. We had two third-party payers (customers) representing 17% and 10% of the Company’s gross revenue for the year ended August 31, 2011.
With respect to our discontinued operations in the U.S., we had one third-party payer (customer) representing 31% of the Company’s gross revenue for the year ended August 31, 2011.
With respect to our discontinued operations in China, the majority of our gross receivables as at August 31, 2012 and 2011 are from the local government Department of Health. We had 10% of our gross revenues in China from the local government Department of revenue for the fiscal year ended August 31, 2011.
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The carrying amounts of cash and cash equivalents, current receivables, accounts payable and accrued liabilities approximate fair value due to the short-term nature of these instruments. The carrying amounts of the Company’s short-term borrowings at August 31, 2012 and 2011 approximate their fair value.
14. Industry Segments and Geographic Information
The Industry Segment “U.S. Division” comprises of the Company’s Pasadena facility. The Company at the present time has the U.S. Division and the Corporate Division.
Certain previously reported financial information has been reclassified to conform to the current year’s presentation.
Corporate Division
The Company signed a commercial contract of sale on March 7, 2013 to sell its Garland facility. The sale is expected to close in May 2013. Based on the sales price, the Company has taken an impairment charge of approximately $1.1 million as of August 31, 2012. The Company closed the Garland facility on September 30, 2011, and accordingly its operations for the year ended August 31, 2012 and 2011 are classified as “Discontinued Operations” (see Discontinued Operations below).
From March 1, 2009 to February 28, 2011, Dynacq Huai Bei Healthcare, Inc. (“Dynacq-Huai Bei”), a wholly owned subsidiary of the Company provided healthcare management services to the Second People’s Hospital in Rui An, China. The Company organized Dynacq-Huai Bei in April 2008 under the laws of the People’s Republic of China. Dynacq-Huai Bei was responsible for funding any operating deficits, and was entitled to any operating profits, of that hospital during the management period. Due to continued losses at the Second People’s Hospital, the Company terminated the management agreement with the Rui An City Department of Health. The Company ceased providing healthcare management services to the Second People’s Hospital as of February 28, 2011. The Company wrote off the fixed assets and inventory balances as of February 28, 2011, and does not expect any further losses due to the termination of this management agreement related to the Second People’s Hospital. We have accounted for the operations of Dynacq-Huai Bei and Second People’s Hospital in Rui An, China as discontinued operations, and have reclassified prior period financial statements to exclude them from continuing operations.
Dynacq-Huai Bei and the Rui An City Department of Health had also previously entered into an agreement assigning to Dynacq-Huai Bei the right to manage the Third People’s Hospital in Rui An, which hospital is currently under construction. Dynacq-Huai Bei and the Rui An City Department of Health, in November 2010, mutually agreed to terminate this agreement due to continued delays in the construction of the Third People’s Hospital. Accordingly, Dynacq-Huai Bei will not manage the Third People’s Hospital.
The Company also organized Sino Bond Inc. Limited, a Hong Kong corporation (“Sino Bond”) to hold and manage investments in Hong Kong. Sino Bond invests in debt and equity securities in Europe and Asia, including initial public offerings and pre-initial public offerings.
During the fiscal year ended August 31, 2009, the Company invested approximately $9.1 million of its available cash in marketable securities. During the quarter ended August 31, 2011, one of these marketable securities with a book cost of $700,000 was called for a gain of $1.3 million. As of August 31, 2012, the balance of these securities is valued at approximately $16.8 million, except for one particular security that was called subsequent to the year ended August 31, 2012. The Company intends to hold these for a minimum period of an additional 12 months. During the year ended August 31, 2012 and 2011, the Company also traded in initial public offerings of equity securities on the Hong Kong Stock Exchange and had losses of $318,206 and $364,721, respectively.
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Discontinued Operations
On September 29, 2011, the Board of Directors of the Company approved the closure of the Garland facility, included in our U.S. division, effective September 30, 2011. Prior to that, in August 2010, the Board of Directors of the Company approved a plan to dispose of the Garland facility due to continued operating losses. The Garland facility had experienced decreases in net patient revenues and number of cases, generally attributable to the loss of physicians from our medical staff. The opening of a new hospital near our Garland facility had a direct adverse impact on our ability to retain members of the medical staff at that facility and consequently on our patient volume. The Garland facility was operating at a loss, and the Board of Directors believed that ceasing operations of the facility at that time was in the Company’s best interest. We do not expect to incur any material costs associated with termination of employment of the affected employees beyond accrued obligations for salary and benefits. The Company has estimated a closing cost of $625,000. The Company signed a commercial contract of sale on March 7, 2013 to sell its Garland facility. The sale is expected to close in May 2013. Based on the sales price, the Company has taken an impairment charge of approximately $1.1 million as of August 31, 2012.
The Company obtained an independent appraisal for the Pasadena facility in October 2012, and based on the hospital’s valuation, expected sale proceeds, and expected cash flows, has determined that there is no impairment charge required in connection with the foregoing operating and/or disposal activities.
The Corporate Division includes interest and other income related to these investments in available-for-sale securities, corporate personnel compensation expenses, and general and administrative expenses. Such expenses and income are not allocated to our operating division, as they relate to our general corporate activities.
We generally evaluate performance based on profit or loss from operations before income taxes and non-recurring charges and other criteria. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies. There are no transfers between segments.
Summarized financial information concerning the business segments from continuing operations is as follows:
| Year Ended August 31, | ||||||||
| 2012 | 2011 | |||||||
Revenues from external customers | ||||||||
Net patient service revenues | ||||||||
U.S. Division | $ | 5,531,233 | $ | (1,977,207 | ) | |||
Corporate | — | — | ||||||
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Consolidated | $ | 5,531,233 | $ | (1,977,207 | ) | |||
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Loss before taxes and discontinued operations | ||||||||
U.S. Division | $ | (4,040,738 | ) | $ | (13,809,269 | ) | ||
Corporate | (2,515,232 | ) | (4,936,556 | ) | ||||
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Consolidated | $ | (6,555,970 | ) | $ | (18,745,825 | ) | ||
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| August 31, | ||||||||
| 2012 | 2011 | |||||||
| (Restated) | ||||||||
Total Assets | ||||||||
U.S. Division | $ | 8,072,893 | $ | 8,763,015 | ||||
Corporate | 32,711,311 | 48,756,664 | ||||||
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Assets of continuing operations | 40,784,204 | 57,519,679 | ||||||
Assets of discontinued operations | 5,401,092 | 6,909,527 | ||||||
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Consolidated | $ | 46,185,296 | $ | 64,429,206 | ||||
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15. Restatement
The estimated income tax refund for the year ended August 31, 2011 was overstated by $1,794,294. The following summarizes the restated amounts:
| As Reported(1) | Difference | As Restated | ||||||||||
Balance Sheet | ||||||||||||
Income tax receivable | $ | 2,363,724 | $ | (1,794,294 | ) | $ | 569,430 | |||||
Total current assets | 37,267,555 | (1,794,294 | ) | 35,473,261 | ||||||||
Total assets | 66,223,500 | (1,794,294 | ) | 64,429,206 | ||||||||
Retained earnings | 26,054,284 | (1,794,294 | ) | 24,259,990 | ||||||||
Total Dynacq stockholders’ equity | 43,303,224 | (1,794,294 | ) | 41,508,930 | ||||||||
Total equity | 43,366,841 | (1,794,294 | ) | 41,572,547 | ||||||||
Total liabilities and equity | 66,223,500 | (1,794,294 | ) | 64,429,206 | ||||||||
Statement of Operations | ||||||||||||
Benefit for income taxes | 3,151,762 | (1,794,294 | ) | 1,357,468 | ||||||||
Loss from continuing operation | (15,594,063 | ) | (1,794,294 | ) | (17,388,357 | ) | ||||||
Net loss | (19,237,809 | ) | (1,794,294 | ) | (21,032,103 | ) | ||||||
Net loss attributable to Dynacq Healthcare, Inc. | (19,221,831 | ) | (1,794,294 | ) | (21,016,125 | ) | ||||||
Basic and diluted loss per common share: | ||||||||||||
Loss from continuing operations attributable to Dynacq Healthcare, Inc. | (1.10 | ) | (0.13 | ) | (1.22 | ) | ||||||
Net loss attributable to Dynacq Healthcare, Inc. | (1.36 | ) | (0.13 | ) | (1.48 | ) | ||||||
Statement of Cash Flows | ||||||||||||
Net loss | (19,221,831 | ) | (1,794,294 | ) | (21,016,125 | ) | ||||||
Income tax receivable | 1,663,059 | 1,794,294 | 3,457,353 | |||||||||
| (1) | The amounts are stated after reclassification of certain discontinued operations. |
16. Subsequent Events
Internal Investigation
As previously disclosed in our Current Report on Form 8-K filed with the Securities and Exchange Commission (the “SEC”) on August 9, 2012, we announced that, at the request of our Board of Directors (the “Board”), we had commenced an internal investigation of our past business practices, potentially encompassing members of the Board, management and third persons, and related accounting matters (the “Investigation”).
The Investigation, which was performed by outside legal counsel and other outside consultants at the direction of the Board, was substantially completed on December 27, 2012 at a cost of approximately $2 million. The Investigation included a review of a substantial number of Company documents and emails, as well as interviews with employees, members of the Board and other persons who were familiar with the facts surrounding the Investigation. The results of the Investigation, which were reported directly to the Board, revealed that the former Chief Financial Officer of the Company did not perform a significant review or independent analysis of transactions initiated by the former Chief Executive Officer. As a result, we believe that, for the five fiscal years ending on August 31, 2012, we did not maintain effective control over financial reporting due to the existence of a material weakness related to a failure of internal controls designed to limit the ability of management to override our system of internal controls. The results of the Investigation also revealed that the former Chief Financial Officer misrepresented certain information to our independent auditor, which we have also determined to be a material weakness in our internal control over financial reporting. We also identified the existence of a significant deficiency related to a lack of objectivity by our former executive officers with respect to accounting decisions.
Based on the results of the Investigation and recommendations made by our independent auditor regarding the foregoing material weaknesses and significant deficiencies in internal control over financial reporting, we are reviewing our internal control and compliance policies and procedures. We believe that no additional remediation efforts with respect to the material weaknesses and the significant deficiency as they relate to the former Chief Executive Officer and the former Chief Financial Officer are necessary, as the executives who occupied these offices during the events in question are no longer employed by us.
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We have determined that our previously reported consolidated balance sheets for periods up to and including August 31, 2012 do not require any material adjustments and/or restatements in respect of the results of the Investigation. Further, the Investigation did not result in any material change to our previously reported net income or loss or financial position for the same periods. However, the Investigation, along with subsequent analysis performed by us and our auditors did reveal that Company expenditures in the amount of approximately $7.8 million were authorized by former officers of the Company and paid to various third parties, and the results of the Investigation and the subsequent analysis performed by us and our auditors provided no evidence of a discernible benefit to the Company resulting from these expenditures. The following table summarizes the statement of operations classification of these amounts for each of the years ended August 31, 2012 and 2011 and in aggregate for the years ended August 31, 2001 to 2010:
| Years Ended August 31, | Aggregate For Years Ended August 31, 2001 | |||||||||||||||
| 2012 | 2011 | to 2010 | Total | |||||||||||||
Compensation and benefits | ||||||||||||||||
Non-executive employee salaries | $ | 3,526 | $ | 45,838 | $ | 1,097,894 | $ | 1,147,258 | ||||||||
Other operating expenses | ||||||||||||||||
Professional fees | (56,000 | )(1) | 380,000 | 1,324,000 | 1,648,000 | |||||||||||
Marketing expenses | (820,000 | )(1) | 1,700,000 | 2,575,000 | 3,455,000 | |||||||||||
Rent expenses | — | 292,967 | 939,512 | 1,232,479 | ||||||||||||
Abandoned cash | 267,729 | — | — | 267,729 | ||||||||||||
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Total | $ | (604,745 | )(1) | $ | 2,418,805 | $ | 5,936,406 | $ | 7,750,466 | |||||||
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| (1) | The negative expense in 2012 is the result of the reversal of expenses accrued in 2011. |
We have determined that the questionable nature of these expenditures may result in their reclassification in our financial statements, from operating costs and expenses to other expenses, depending on determinations that the Board may make in the future. We do not expect these reclassifications, even if they are made, to result in a material restatement of our financial statements.
| Item 9. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. |
None.
| Item 9A. | Controls and Procedures. |
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation to assess the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report, pursuant to Exchange Act Rule 13a-15(e). Based on that evaluation, our principal executive officer and principal financial officer concluded that, as of August 31, 2012, our disclosure controls and procedures were not effective. This conclusion is based on the material weaknesses and significant deficiencies in internal control over financial reporting described below, which may compromise our ability to ensure that information required to be disclosed in reports we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms.
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Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal controls over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of management, including our principal executive officer and principal financial officer, an evaluation of the effectiveness of our internal control over financial reporting was conducted based on the framework in Internal Controls – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on that evaluation under the framework in Internal Controls – Integrated Framework issued by the COSO, our management concluded that our internal control over financial reporting was not effective.
As previously disclosed in our Current Report on Form 8-K dated August 8, 2012, we announced that, at the request of our Board of Directors (the “Board”), we commenced an internal investigation of our past business practices, potentially encompassing members of the Board, management and third persons, and related accounting matters (the “Investigation”).
The Investigation, which was performed by outside legal counsel and other outside consultants at the direction of the Board, was substantially completed on December 27, 2012. The Investigation included a review of a substantial number of Company documents and emails, as well as interviews with employees, members of the Board and other persons who were familiar with the facts surrounding the Investigation. The results of the Investigation, which were reported directly to the Board, revealed that the former Chief Financial Officer of the Company did not perform a significant review or independent analysis of transactions initiated by the former Chief Executive Officer. As a result, we believe that, for the five fiscal years ending on August 31, 2012, we did not maintain effective control over financial reporting due to the existence of a material weakness related to a failure of internal controls designed to limit the ability of management to override our system of internal controls. The results of the Investigation also revealed that the former Chief Financial Officer misrepresented certain information to our independent auditor, which we have also determined to be a material weakness in our internal control over financial reporting. We also identified the existence of a significant deficiency related to a lack of objectivity by our former executive officers with respect to accounting decisions.
Based on the results of the Investigation and recommendations made by our independent auditor regarding the foregoing material weaknesses and significant deficiencies in internal control over financial reporting, we are reviewing our internal control and compliance policies and procedures. We believe that no additional remediation efforts with respect to the material weaknesses and the significant deficiency as they relate to the former Chief Executive Officer and the former Chief Financial Officer are necessary, as the executives who occupied these offices during the events in question are no longer employed by us.
We have determined that our previously reported consolidated balance sheets for periods up to and including August 31, 2012 do not require any material adjustments and/or restatements in respect of the results of the Investigation. Further, the Investigation did not result in any material change to our previously reported net income or loss or financial position for the same periods. However, the Investigation, along with subsequent analysis performed by us and our auditors, did reveal that Company expenditures in the amount of approximately $7.8 million were authorized by former officers of the Company and paid to various third parties, and the results of the Investigation and the subsequent analysis performed by us and our auditors provided no evidence of a discernible benefit to the Company resulting from these expenditures. We have determined that the questionable nature of these expenditures may result in their reclassification in our financial statements, from operating costs and expenses to other expenses, depending on determinations that the Board may make in the future. We do not expect these reclassifications, even if they are made, to result in a material restatement of our financial statements. Please see note 16 to our consolidated financial statements for more information about the expenditures.
Changes in Internal Control over Financial Reporting
As described above, based on the results of the Investigation and recommendations made by our independent auditor regarding the foregoing material weaknesses and significant deficiencies in internal control over financial reporting, we are reviewing our internal control and compliance policies and procedures. As of the date of this report, the review process is not complete. During November and December of 2012, we implemented two changes
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to our internal control and compliance policies and procedures; specifically, for all accounts payable disbursements, both our Chief Executive Officer and Corporate Controller sign all check requests, and for all payroll changes (including new hires, terminations and pay rate changes), both our Chief Executive Officer and Corporate Controller sign the approval form for such payroll changes. We believe these two changes to our internal control and compliance policies and procedures are reasonably likely to materially affect our internal control over financial reporting. Our purpose in implementing these changes is to improve the effectiveness of our internal control over financial reporting, and we will continue to monitor the effects of these two changes to determine if this result is achieved.
Additionally, we believe that the departure of our former Chief Financial Officer on August 8, 2012 (the Board placed Philip Chan on paid administrative leave from his position as Chief Financial Officer on August 8, 2012, and on November 28, 2012, he submitted his resignation) and the departure of our former Chief Executive Officer (Chiu M. Chan became incapacitated by an unexpected illness in January 2012 and subsequently passed away in May 2012) may be deemed a change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Our management, including our principal executive officer and principal financial officer, does not expect that our disclosure controls or internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. In addition, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of error of fraud, if any, within a company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management’s override of the control. The design of any systems of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of these inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
| Item 9B. | Other Information. |
None.
| Item 10. | Directors, Executive Officers and Corporate Governance. |
Our directors and/or executive officers and their ages as of March 22, 2013, are shown below.
Name | Age | Position | ||
| Eric K. Chan | 34 | Director, Chief Executive Officer and President | ||
| Hemant Khemka | 47 | Interim Principal Financial Officer |
Eric K. Chan has served as a board member, Chief Executive Officer and President since January 2012. Dr. Chan is board certified in anesthesiology. He has been the sole owner of Redwood Health Corporation since March 2005, which furnishes physicians to provide in-house emergency medical coverage and recruits anesthesiologists and certified registered nurse anesthetists at hospitals, including the Company’s Pasadena facility. Dr. Chan has also been the sole owner of Anesthesia Associates of Houston Metroplex since August 2007, which provides anesthesiology services to hospitals, including the Company’s Pasadena facility. He was an Assistant Professor at Memorial Hermann Hospital, University of Texas at Houston from August 2007 to September 2008. Dr. Chan earned his M.B.A. in Health Organization Management and M.D. from Texas Tech University.
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Hemant Khemka has served as interim principal financial officer since August 2012, as Corporate Controller since July 2004 and was our assistant controller since April 2003. Mr. Khemka earned advanced accounting degrees from the University of Calcutta, a Masters degree in Business Administration and is a Certified Public Accountant in the state of Texas. Prior to his employment with Dynacq, Mr. Khemka had previous corporate and outside accounting experience with Ernst & Young LLP and El Paso Corporation.
Independence and “Controlled Company” Disclosure
Mrs. Ella Chan, wife of our former chairman and chief executive officer, Mr. Chiu Chan, together with the estate of Mr. Chan, beneficially owns an aggregate of approximately 58% of our issued and outstanding common stock as of August 31, 2012. As a majority stockholder, she is able to control all matters requiring stockholder approval, including the election and removal of any directors and any merger, consolidation or sale of all or substantially all of our assets. In addition, Mrs. Chan is in a position to control the management of our business and the appointment of executive officers as well as all management personnel. As discussed in the Information Statement filed on October 9, 2012 with the SEC, a group of stockholders controls approximately 68.5% of our outstanding common stock, which pursuant to the terms of our governing documents, constitutes a super-majority of our common stock, as of the date of this filing. This group has the ability to, among other things, remove members of our Board of Directors for cause or for no cause at all, as the group elected to do in October 2012.
The Board of Directors has thus determined that the Company is a “controlled company” within the meaning of Listing Rule 5615(c)(1) for the NASDAQ Stock Market. As a “controlled company,” the Company is exempt from certain listing standards of NASDAQ and is thus not required to have (i) a board of directors comprised of a majority of independent directors; (ii) compensation of the executive officers determined by a majority of the independent directors or a compensation committee composed solely of independent directors; and (iii) director nominees selected, or recommended for the Board’s selection, either by a majority of the independent directors or a nominating committee composed solely of independent directors. The Company’s stock was delisted from NASDAQ in October 2012.
The sole remaining member of our Board is Dr. Eric K. Chan, who also serves as our Chief Executive Officer and President. Our Board currently has five vacancies. We intend to seek qualified candidates to fill these vacancies, including some candidates that are deemed independent based on the independence standards of NASDAQ. There can be no assurance, however, that we will be able to fill any of these vacancies with new directors, independent or otherwise. In the interim, the sole remaining member of our Board will continue to fulfill the Board’s responsibilities.
Audit Committee and Audit Committee Financial Expert
The Company at present does not have an audit committee, however, for certain purposes of the rules and regulations of the SEC and in accordance with the Sarbanes-Oxley Act of 2002, the Company’s Board of Directors is deemed to be its audit committee and as such functions as an audit committee and performs some of the same functions as an audit committee including: (1) selection and oversight of our independent accountant; (2) establishing procedures for the receipt, retention and treatment of complaints regarding accounting, internal controls and auditing matters; and (3) engaging outside advisors. The Board of Directors has determined that its sole member, Dr. Eric Chan, is able to read and understand fundamental financial statements and has substantial business experience that results in that member’s financial sophistication. Accordingly, the Board of Directors believes that its member has the sufficient knowledge and experience necessary to fulfill the duties and obligations that an audit committee would have. The Board has not, however, determined that Dr. Chan should be deemed a financial expert. The absence of a financial expert on the Board is attributable to the recent removals and resignations of certain Board members, as described under the “Recent Developments” subsection of Item 1 of this report. We anticipate seeking qualified candidates to fill the vacancies in the Board, including a financial expert. There can be no assurance, however, that we will be able to fill any of the Board vacancies with new directors, including a financial expert.
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Procedures for Contacting Directors
Shareholders who wish to communicate with the Board of Directors, or with any individual director, may send such communication in writing addressed to the Board of Directors, or to an individual director, at 4301 Vista Road, Pasadena, Texas 77504. All communications received from shareholders are sent directly to Board members.
Indemnification of our Directors and Officers against Certain Liabilities and Director and Officer Liability Insurance
As permitted under Nevada law and pursuant to our governing documents and indemnification agreements with certain of our officers and directors, we indemnify our directors and officers against monetary damages, including advancing expenses, to the fullest extent permitted by Nevada law.
We do not carry director and officer liability insurance.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires our directors and executive officers, and persons who own beneficially more than ten percent of our common stock, to file reports of ownership and changes of ownership with the Securities and Exchange Commission. Based solely upon a review of Forms 3, 4 and 5 furnished to us during the fiscal year ended August 31, 2012, we believe that the directors, executive officers, and greater than ten percent beneficial owners have complied with all applicable filing requirements during the fiscal year ended August 31, 2012, with the exception of Ella Y.T.C. Chan, who was late in filing a Form 3.
Code of Conduct
The Company has adopted a Code of Conduct that applies to all of its directors, officers and employees. The Code of Conduct is reasonably designed to deter wrongdoing and to promote (i) honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships, (ii) full, fair, accurate, timely and understandable disclosure in reports and documents filed with, or submitted to, the SEC and in other communications made by the Company, (iii) compliance with applicable governmental laws, rules and regulations, (iv) the prompt internal reporting of violations of the Code of Conduct to appropriate persons identified in the Code of Conduct, and (v) accountability for adherence to the Code of Conduct. The Code of Conduct is available on the Company’s website atwww.dynacq.com. Amendments to the Code of Conduct and any grant of a waiver from a provision of the Code of Conduct requiring disclosure under applicable SEC rules will be disclosed on the Company’s website atwww.dynacq.com.
Code of Ethics
The Company has adopted a Code of Ethics that applies to its principal executive officer, principal financial officers, principal accounting officer or controller, and persons performing similar functions. The Code of Ethics is reasonably designed to help maintain the Company’s standards of business conduct and ensure compliance with legal requirements, specifically, but not limited to, Section 406 of the Sarbanes-Oxley Act of 2002 and SEC rules promulgated thereunder. The Code is also designed to deter wrongdoing and promote ethical conduct, and full, fair, accurate, timely, and understandable disclosure of financial information in the periodic reports of the Company. The Code of Ethics is available on the Company’s website atwww.dynacq.com. Amendments to the Code of Ethics and any grant of a waiver from a provision of the Code of Ethics requiring disclosure under applicable SEC rules will be disclosed on the Company’s website atwww.dynacq.com.
| Item 11. | Executive Compensation. |
Named Executive Officers
The Company’s executive officers are Eric K. Chan, Chief Executive Officer, President, and the sole board member, and Hemant Khemka, interim principal financial officer and Corporate Controller. Throughout this report, these individuals are sometimes referred to collectively as the “Named Executive Officers.”
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EXECUTIVE COMPENSATION
Summary Compensation Table
The following table summarizes the compensation of the Named Executive Officers, including former executive officers, for the past two fiscal years:
Name and Principal Position | Year | Salary ($) | Bonus ($) | Option Awards(1) ($) | All Other Compensation(2) ($) | Total ($) | ||||||||||||||||||
Eric K. Chan, (3) | 2012 | 224,861 | — | 22,162 | 3,829 | 250,852 | ||||||||||||||||||
Chief Executive Officer | ||||||||||||||||||||||||
Hemant Khemka, | 2012 | 161,510 | — | 16,228 | 4,590 | 182,328 | ||||||||||||||||||
Corporate Controller | 2011 | 156,751 | — | 9,062 | 4,018 | 169,831 | ||||||||||||||||||
Chiu M. Chan,(4) | 2012 | 367,493 | — | — | 8,463 | 375,956 | ||||||||||||||||||
Chief Executive Officer | 2011 | 630,000 | — | 39,237 | 17,197 | 686,434 | ||||||||||||||||||
Philip S. Chan,(5) | 2012 | 189,996 | — | (6) | 49,875 | 7,388 | 247,259 | |||||||||||||||||
Chief Financial Officer | 2011 | 160,000 | — | 40,189 | 6,427 | 206,616 | ||||||||||||||||||
| (1) | Represents the dollar amount recognized for financial statement reporting purposes for the fiscal years ended August 31, 2012 and 2011, in accordance with ASC Topic 718, without taking into account an estimate of forfeitures of stock option grants. These stock options were awarded to the Named Executive Officers in fiscal years 2007, 2011 and 2012. |
| (2) | Represents amounts paid by the Company for life insurance premium, employer’s contribution to the Company’s 401(k) plan and club membership fees. |
| (3) | Eric K. Chan joined the Company in January 2012 as its Chief Executive Officer. |
| (4) | Chiu M. Chan passed away in May 2012. |
| (5) | Philip S. Chan resigned in November 2012. Mr. Chan had a reduction in his compensation for part of fiscal 2011, whereas for fiscal 2012, the Compensation Committee reinstated his compensation to $200,000, effective February 1, 2012, and paid him a sum of $77,000, which equates to the prior reductions in his compensation from January 1, 2010 to January 31, 2012. |
| (6) | The Compensation Committee previously approved a bonus of $450,000 payable to Mr. Philip Chan, of which $300,000 would have been payable during the year ended August 31, 2012 and $150,000 would have been payable subsequent to the fiscal year. Prior to any payment, the Board determined that a bonus to Mr. Chan was not warranted based on additional information it obtained, and thus the Company has not paid or accrued the bonus amounts. |
The Company provides competitive base salaries and bonuses to its executives. The Company does not target any specific proportion of total compensation in setting base salary and bonus compensation.
Grants of Plan Based Awards
There were no non-equity incentive plan awards to the Named Executive Officers in fiscal year 2012. The following table sets forth certain information concerning grants of awards to the Named Executive Officers pursuant to the Company’s equity incentive plans in the fiscal year ended August 31, 2012.
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| All Other Stock Awards: Number | All Other Stock Awards: | Exercise or Base | Grant Date | |||||||||||||||||||||||||||||
| Grant | Estimated Future Payouts Under Equity Incentive Plan Awards | of of Stock | Number of Underlying | Price of Awards | Fair Value of Stock Option | |||||||||||||||||||||||||||
Name | date | Threshold | Target | Maximum | or units | Options(1) | ($/share) | Awards(2) | ||||||||||||||||||||||||
Eric K. Chan | 01/12/12 | — | — | — | — | 250,000 | $ | 1.10 | $ | 132,970 | ||||||||||||||||||||||
| (1) | All options to purchase shares of Dynacq’s common stock granted under Dynacq’s 2011 Stock Incentive Plan. Each grant vests 25% over the first four years from the date of grant. |
| (2) | Represents the grant date fair value computed in accordance with ASC Topic 718. |
Outstanding Equity Awards at Fiscal Year-End
The following table sets forth certain information regarding equity-based awards held by the Named Executive Officers as of August 31, 2012.
| Option Awards | ||||||||||||||||||||
| Number of Securities Underlying Unexercised Options | Equity Incentive Plan Awards: Number of Securities Underlying Unexercised Unearned | Option Exercise | Option Expiration | |||||||||||||||||
Name | Exercisable | Unexercisable | Options | Price | Date | |||||||||||||||
Eric K. Chan | 62,500 | 187,500 | (1) | — | $ | 1.10 | 01/12/22 | |||||||||||||
Hemant Khemka | 50,000 | — | — | $ | 4.90 | 12/16/14 | ||||||||||||||
| 40,000 | — | — | $ | 2.50 | 06/22/13 | |||||||||||||||
| 24,625 | 73,875 | (2) | — | $ | 1.86 | 07/07/21 | ||||||||||||||
| (1) | Of the 187,500 stock options granted to Mr. Eric K. Chan, 62,500 stock options will vest on each of January 12, 2014, 2015 and 2016. |
| (2) | Of the 73,875 stock options granted to Mr. Hemant Khemka, 24,625 stock options will vest on each of July 7, 2013, 2014 and 2015. |
Option Exercises
No stock options were exercised by any of the Named Executive Officers in the fiscal year ended August 31, 2012.
Potential Payments upon Termination or Change-in-Control
The Named Executive Officers do not have employment agreements with the Company and both are employed on an “at will” basis. The Company does not have arrangements with any of its Named Executive Officers providing for additional benefits or payments in connection with a termination of employment, change in job responsibility or change-in-control. Grants of stock options to all employees eligible to receive such grants under the Company’s
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2000 Incentive Plan vest immediately in the event of a change in control; therefore, no separate disclosure is presented herein with respect to the acceleration of stock options held by the Named Executive Officers upon a change of control under the terms of this stock option plan. Grants of stock options to all employees eligible to receive grants under the Company’s Year 2011 Stock Incentive Plan do not have a provision for immediate vesting in the event of a change in control.
Risk Assessment of the Company’s Compensation Policies
The Company’s compensation programs are discretionary, balanced and focused on the long term. Goals and objectives of the Company’s compensation programs reflect a balanced mix of quantitative and qualitative performance measures to avoid excessive weight on a single performance measure. The Company’s approach to compensation practices and policies applicable to employees throughout the Company is consistent with that followed for its executives and, accordingly, the Company believes that its compensation policies and practices do not create risks that are reasonably likely to have a material adverse effect on the Company.
Pension Benefits
There were no pension benefit plans in effect in fiscal year 2012.
Frequency of Say-on-Pay Advisory Vote
As reported in our current report on Form 8-K filed with the SEC on February 17, 2011, at the Annual Meeting of the Shareholders of Dynacq Healthcare, Inc. held on February 15, 2011, we allowed shareholders to vote, on an advisory basis, whether advisory votes on executive compensation should occur every one, two or three years. The greatest number of votes cast (9,351,823) by shareholders were voted in favor of holding future advisory votes on executive officer compensation every three years. In light of this result, our Board of Directors has decided that future advisory votes on named executive officer compensation will be held every three years until the next shareholder advisory vote on the frequency of such votes, which in accordance with applicable regulations, will occur no later than our Annual Meeting in 2017.
Compensation of Directors
The following table sets forth certain information regarding the compensation paid to the Company’s non-employee directors for their service during the fiscal year ended August 31, 2012. The non-employee directors were paid a monthly fee for their position as directors. Mr. James G. Gerace was paid a higher monthly fee than the other directors due to his position as the chairman of the audit committee. As discussed in the Information Statement filed with the SEC on October 9, 2012, pursuant to an Action by Written Consent of Stockholders in lieu of a Special Meeting, stockholders of Dynacq holding more than two-thirds of the issued and outstanding shares of our common stock as of September 24, 2012 approved the removal of Ping S. Chu, James G. Gerace and Stephen L. Huber from their positions as members of our Board. The stockholder action took effect on October 30, 2012.
Name | Fees Earned or Paid in Cash | All Other Compensation | Total | |||||||||
Ping S. Chu | $ | 49,000 | — | $ | 49,000 | |||||||
James G. Gerace | $ | 67,000 | — | $ | 67,000 | |||||||
Stephen L. Huber | $ | 49,000 | — | $ | 49,000 | |||||||
| Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. |
The following table sets forth, as of March 19, 2013, information with respect to shares beneficially owned by: (a) each person who is known by us to be the beneficial owner of more than 5% of our outstanding shares of common stock, (b) each of our directors and the named executive officers named in the Summary Compensation Table above, and (c) all current directors and executive officers as a group.
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Beneficial ownership is determined in accordance with Rule 13d-3 under the Exchange Act. Under this rule, some shares may be deemed to be beneficially owned by more than one person (if, for example, persons share the power to vote or the power to dispose of the shares). In addition, shares are deemed to be beneficially owned by a person if the person has the right to acquire shares (for example, upon exercise of an option) within sixty days of the date as of which the information is provided. In computing the percentage ownership of any person, the amount of shares is deemed to include the amount of shares beneficially owned by such person by reason of such acquisition rights. As a result, the percentage of outstanding shares of any person as shown in the following table does not necessarily reflect the person’s actual voting power at any particular date.
To our knowledge, except as indicated in the footnotes to this table and pursuant to applicable community property laws, the persons named in the table have sole voting and investing power with respect to all shares of common stock shown as beneficially owned by them.
Beneficial Owner(1) | Number Of Shares | Percent Of Class(2) | ||||||
Ella Y.T.C. Chan(3) | 8,498,320 | (4) | 58.03 | % | ||||
Estate of Chiu M. Chan(3) | 6,888,115 | (5) | 47.04 | % | ||||
Eric K. Chan | 262,311 | (6) | 1.80 | % | ||||
Hemant Khemka | 114,625 | (7) | * | |||||
All directors and executive officers as a group (2 persons) | 376,936 | (8) | 2.56 | % | ||||
| (1) | The address for each named person is 4301 Vista Road, Pasadena, Texas 77504. |
| (2) | Based on 14,543,626 shares outstanding as of March 19, 2013. |
| (3) | The estate of Chiu M. Chan is represented by his widow, Ella Y.T.C. Chan, the sole executrix of the estate. Since Mrs. Chan has voting power with respect to 58% of the Company’s outstanding common stock, either as an individual or as the sole executrix of the estate of Chiu M. Chan, she controls the outcome of any matter requiring the vote of a majority of the outstanding shares to approve. |
| (4) | Includes 1,610,205 shares Ella Y.T.C. Chan owns directly and 6,888,115 shares (including 100,000 shares underlying options, which are currently exercisable) she beneficially owns indirectly through the estate of Chiu M. Chan. |
| (5) | Includes 100,000 shares underlying options, which are currently exercisable. |
| (6) | Includes 62,500 shares underlying options, which are currently exercisable. |
| (7) | Includes 114,625 shares underlying options, which are currently exercisable. |
| (8) | Includes 177,125 shares underlying options, which are currently exercisable. |
| * | Indicates ownership of less than 1%. |
Securities Authorized For Issuance under Equity Compensation Plans
The following table provides information as of March 8, 2013, with respect to the Company’s equity compensation plans under which equity securities are authorized for issuance.
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| Number of securities to be issued upon exercise of outstanding options, warrants and rights | Weighted average exercise price of outstanding options, warrants and rights | Number of securities remaining available for future issuance (excluding securities reflected in first column) | ||||||||||
Plan Category | ||||||||||||
Plans approved by shareholders | 1,656,566 | $ | 2.32 | 14,750,000 | ||||||||
Plans not approved by shareholders | — | — | — | |||||||||
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Total | 1,656,566 | $ | 2.32 | 14,750,000 | ||||||||
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| Item 13. | Certain Relationships and Related Transactions, and Director Independence. |
Six immediate family members (four uncles and two aunts) of the Company’s chief executive officer, Mr. Eric Chan, received an aggregate of $363,369 and $377,872 in compensation as employees of the Company or its subsidiaries in fiscal years 2012 and 2011, respectively. These family members were also related to Mr. Chiu Chan, the Company’s former chief executive officer.
Two immediate family members (a sister and a sister-in-law) of the Company’s former chief financial officer, Mr. Philip Chan, received an aggregate of $133,288 in compensation as employees of the Company or its subsidiaries in each of the fiscal years 2012 and 2011.
The Company has retained Redwood Health Corporation (“Redwood”), to furnish physicians to provide in-house emergency medical coverage for its Pasadena facility during the weekend hours and weekday nights at an hourly rate of $75. The Company’s chief executive officer is a physician and an affiliate of Redwood. The Company paid $421,725 and $434,100 for emergency room physician services to Redwood in fiscal 2012 and 2011, respectively. Management, as well as the Audit Committee that approved the agreement, believes that the hourly rate being paid is consistent with comparable in-house emergency medical coverage rates available in the area.
Dr. Ping Chu, a director of the Company until October 30, 2012, has paid the Company $14,938 and $16,163 during fiscal years ended August 31, 2012 and 2011, respectively for rent and management fees. As of August 31, 2012 and 2011, the Company had accounts receivable from Dr. Chu of $46,848 and $46,381, respectively. Included in the accounts receivable balance were amounts applicable to Dr. Chu’s staffs’ payroll for which he reimburses the Company in the ordinary course of business.
During the fiscal year 2009, the Company retained Anesthesia Associates of Houston Metroplex to provide exclusive, continuous and uninterrupted anesthesiology services, including physicians and CRNAs, to the Pasadena facility for a monthly compensation of $5,000. The Company’s chief executive officer is a physician and an affiliate of Anesthesia Associates of Houston Metroplex. The Company paid $60,000 for anesthesiology services to said organization in each of the fiscal years 2012 and 2011. Management, as well as the Board of Directors that approved the agreement, believes that the rate being paid is consistent with comparable in-house anesthesiology services rates available in the area. During the fiscal year 2009, the Company also retained Redwood to locate and recruit additional skilled anesthesiologists and CRNAs for its Pasadena facility for a monthly compensation of $20,000. The Company paid $240,000 for said recruitment services to Redwood in each of the fiscal years 2012 and 2011. Management, as well as the Board of Directors that approved the agreement, believes that the rate being paid is consistent with comparable rates for recruitment available in the area. The Company entered into these two agreements in order to replace the previous anesthesiology group, whose contract terminated at the end of fiscal 2009. The compensation which was being paid to the previous group was substantially the same as that being paid under the new contracts.
The Company purchased $92,180 worth of artifacts as inventory for re-sale in China during fiscal year 2011. The purchase amount was paid by Mr. Chiu Chan, the Company’s former chief executive officer. The amount payable to his estate of $270,468 and $242,301, as of August 31, 2012 and 2011, respectively, is included in Accrued Liabilities in the Consolidated Balance Sheet. The Audit Committee had since approved the purchases by Mr. Chan on behalf of the Company, and believed that these purchases have been made at the prevailing market rates.
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Director Independence
The sole remaining member of our Board is Dr. Eric K. Chan, who also serves as our Chief Executive Officer and President, and is not independent. Our Board currently has five vacancies. We intend to seek qualified candidates to fill these vacancies, including some candidates that are deemed independent based on the independence standards of NASDAQ. There can be no assurance, however, that we will be able to fill any of these vacancies with new directors, independent or otherwise. In the interim, the sole remaining member of our Board will continue to fulfill the Board’s responsibilities.
| Item 14. | Principal Accounting Fees and Services. |
General
The following table presents fees for professional services rendered by KWCO, PC (“KWCO”), independent registered public accounting firm for the audit of the Company’s annual financial statements, fees for audit-related services, tax services and all other services.
| 2012 | 2011 | |||||||
Audit Fees | $ | 376,435 | $ | 342,650 | ||||
Audit Related Fees | 28,814 | 14,000 | ||||||
Tax–Related Fees | 25,300 | 21,070 | ||||||
All Other Fees | — | — | ||||||
Audit Fees
Audit Feesrepresents the aggregate fees billed for professional services rendered by KWCO for the audit of our annual financial statements and review of financial statements included in our quarterly reports or services that are normally provided in connection with statutory and regulatory filings or engagements for those fiscal years.
Audit-Related Fees
Audit Related Fees represents the aggregate fees billed for professional services rendered by KWCO for the audit of the Company’s 401(k) plan.
Tax-Related Fees
Tax-Related Fees represents the aggregate fees billed for professional services rendered by KWCO for income tax return preparation and tax compliance.
All Other Fees
All Other Fees represents the aggregate fees billed for professional services other than the services reported above.
Audit Committee Pre-Approval Policies and Procedures
All audit and non-audit services performed by the independent certified public accountants are pre-approved by the Audit Committee, which considers, among other things, the possible effect of the performance of such services on the auditors’ independence. The Audit Committee’s charter provides that the Audit Committee may delegate to any of its members the authority to pre-approve any services performed by the independent certified public
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accountants, provided that such approval is presented to the Audit Committee at its next scheduled meeting. All of the audit-related, tax and all other services described above were pre-approved by the full Audit Committee, before the removal of its members from the Board in October 2012.
| Item 15. | Exhibits, Financial Statement Schedules. |
(a)(1) Financial Statements: See Index to Consolidated Financial Statements under Item 8 on Page 37 of this Report.
(a)(2) Financial Statement Schedule: Not required.
(b) Exhibits. The following exhibits are to be filed as part of the annual report:
EXHIBIT NO. | IDENTIFICATION OF EXHIBIT | |
| Exhibit 3.1 | Certificate of Incorporation incorporated by reference to Exhibit 3.1 to the Form 10-K filed November 13, 2007. | |
| Exhibit 3.2 | Bylaws incorporated by reference to Exhibit 3.2 to the Form 10-K filed November 13, 2007. | |
| +Exhibit 10.1 | The Company’s Year 2000 Incentive Plan adopted on August 29, 2000, and incorporated by reference as Appendix B from the Company’s Definitive Proxy Statement on Schedule 14A filed August 9, 2000. | |
| +Exhibit 10.2 | The Company’s Year 2011 Stock Incentive Plan adopted on September 2, 2011, and incorporated by reference as Exhibit A from the Company’s Definitive Information Statement on Schedule 14C filed August 11, 2011. | |
| Exhibit 10.3 | Form of Indemnification Agreement with various officers and directors of the Company, incorporated by reference to Exhibit 10.11 to the Form 10-K for the fiscal year ended August 31, 2004. | |
| Exhibit 10.4 | Commercial Contract of Sale dated March 7, 2013 for the sale of the Garland facility, incorporated by reference to Exhibit 10.1 to the Form 8-K/A filed March 15, 2013. | |
| Exhibit 14.1 | Code of Ethics for Principal Executive and Senior Financial Officers, incorporated by reference to Exhibit 14.1 to the Company’s Annual Report on Form 10-K for the fiscal year ended August 31, 2003. | |
| Exhibit 21.1 | Listing of subsidiaries. | |
| Exhibit 23.1 | Consent of KWCO, PC. | |
| Exhibit 31.1 | Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| Exhibit 31.2 | Certification of Corporate Controller Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| Exhibit 32.1 | Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
| Exhibit 32.2 | Certification of Corporate Controller Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
| + | Management contract or compensatory plan or arrangement. |
The Company is in the process of preparing the Interactive Data Files required to be submitted with this report pursuant to Rule 405 of Registration ST. The Company anticipates filing the Interactive Data Files by amendment to this report upon their completion.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| Dynacq Healthcare, Inc. | ||||||
| Date: March 22, 2013 | By: | /s/ Eric K. Chan | ||||
| Eric K. Chan, Chief Executive Officer | ||||||
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature | Title | Date | ||
/s/ Eric K. Chan Eric K. Chan (Principal Executive Officer) | Director, CEO and President | March 22, 2013 | ||
/s/ Hemant Khemka Hemant Khemka (Interim Principal Financial and Accounting Officer) | Corporate Controller | March 22, 2013 | ||
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EXHIBIT INDEX
EXHIBIT NO. | IDENTIFICATION OF EXHIBIT | |
| Exhibit 3.1 | Certificate of Incorporation incorporated by reference to Exhibit 3.1 to the Form 10-K filed November 13, 2007. | |
| Exhibit 3.2 | Bylaws incorporated by reference to Exhibit 3.2 to the Form 10-K filed November 13, 2007. | |
| +Exhibit 10.1 | The Company’s Year 2000 Incentive Plan adopted on August 29, 2000, and incorporated by reference as Appendix B from the Company’s Definitive Proxy Statement on Schedule 14A filed August 9, 2000. | |
| +Exhibit 10.2 | The Company’s Year 2011 Stock Incentive Plan adopted on September 2, 2011, and incorporated by reference as Exhibit A from the Company’s Definitive Information Statement on Schedule 14C filed August 11, 2011. | |
| Exhibit 10.3 | Form of Indemnification Agreement with various officers and directors of the Company, incorporated by reference to Exhibit 10.11 to the Form 10-K for the fiscal year ended August 31, 2004. | |
| Exhibit 10.4 | Commercial Contract of Sale dated March 7, 2013 for the sale of the Garland facility, incorporated by reference to Exhibit 10.1 to the Form 8-K/A filed March 15, 2013. | |
| Exhibit 14.1 | Code of Ethics for Principal Executive and Senior Financial Officers, incorporated by reference to Exhibit 14.1 to the Company’s Annual Report on Form 10-K for the fiscal year ended August 31, 2003. | |
| Exhibit 21.1 | Listing of subsidiaries. | |
| Exhibit 23.1 | Consent of KWCO, PC. | |
| Exhibit 31.1 | Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| Exhibit 31.2 | Certification of Corporate Controller Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| Exhibit 32.1 | Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
| Exhibit 32.2 | Certification of Corporate Controller Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
| + | Management contract or compensatory plan or arrangement. |
The Company is in the process of preparing the Interactive Data Files required to be submitted with this report pursuant to Rule 405 of Registration ST. The Company anticipates filing the Interactive Data Files by amendment to this report upon their completion.
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