UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED - MARCH 31, 2008
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
Commission file number: 0-52197
HC INNOVATIONS, INC.
(Exact name of registrant as specified in its charter)
Delaware 04-3570877
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
10 Progress Drive, Suite 200 Shelton, CT 06484
(Address of principal executive office)
(203) 925-9600
(Registrant's telephone number including area code)
Indicate by check mark whether the registrant: (1) filed all reports
required to be filed by Section 13 or 15(d) of the Exchange Act 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 [X] NO [ ]
Indicate by check mark whether registrant is a large accelerated filer,
an accelerated filer, a non-accelerated filer, or a smaller reporting company.
See definitions of "large accelerated filer", " accelerated filer", and "smaller
reporting company" in Rule 12b-2 of the Exchange Act.
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 Exchange Act) ___Yes X No
Number of shares outstanding of each of the issuer's classes of common
equity, as of May 6, 2008, 38,615,363.
HC INNOVATIONS, INC.
AND SUBSIDIARIES
FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2008
TABLE OF CONTENTS
Page
PART I - Financial Information
Item 1. FINANCIAL STATEMENTS 1
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION 18
Item 3. Quantitative and Qualitative Disclosures About Market Risk 26
Item 4T. Controls and Procedures 26
PART II - Other Information
Item 1. Legal Proceedings. 27
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS 27
Item 3. DEFAULTS UPON SENIOR SECURITIES. 28
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. 28
Item 5. OTHER INFORMATION. 28
Item 6. EXHIBITS. 28
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HC INNOVATIONS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
- --------------------------------------------------------------------------------
MARCH 31, 2008 DECEMBER 31, 2007
(UNAUDITED) (AUDITED)
Assets
Current assets:
Cash and cash equivalents $ 945,696 $ 3,442,290
Accounts receivable, net of contractual allowances 3,621,767 2,216,059
Prepaid expenses 489,478 546,027
------------ ------------
Total current assets 5,056,941 6,204,376
Fixed assets, net 990,237 1,030,920
Capitalized software development costs, net 2,367,711 2,217,975
Deferred issuance costs, net 493,166 648,485
Other assets 91,308 80,782
------------ ------------
Total assets $ 8,999,363 $ 10,182,538
============ ============
Liabilities and Stockholders' Equity (Deficit)
Current liabilities:
Lines of credit $ 200,000 $ 200,000
Current portion of notes payable 379,934 388,414
Current portion of capital lease obligations 282,418 284,943
Convertible debentures, net of discounts 5,033,274 4,069,140
Accounts payable 2,019,427 1,770,358
Accrued liabilities 1,637,883 1,196,882
Other current liabilities 531,600 317,128
------------ ------------
Total current liabilities 10,084,536 8,226,865
Capital lease obligations, net of current portion 462,326 530,717
Total liabilities 10,546,862 8,757,582
Stockholders' equity (deficit):
Preferred stock, $.001 par value, 5,000,000 shares authorized - -
Common stock, $.001 par value, 100,000,000 shares authorized 38,616 38,601
Stock subscriptions receivable (21,671) (21,671)
Additional paid-in capital 17,709,536 17,377,800
Deficit (19,273,980) (15,969,774)
------------ ------------
Total stockholders' equity (deficit) (1,547,499) 1,424,956
------------ ------------
Total liabilities and stockholders' equity (deficit) $ 8,999,363 $ 10,182,538
============ ============
THE ACCOMPANY NOTES ARE AN INTEGRAL PART OF THESE CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS
1
HC INNOVATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Operations (Unaudited)
THREE MONTHS ENDED
------------------
MARCH 31, 2008 MARCH 31, 2007
-------------- -------------
Net revenues $ 5,318,350 $ 2,197,971
Cost of services 4,114,730 1,738,709
Selling, general and administrative expenses 3,167,414 1,634,250
Depreciation and amortization 298,341 122,884
------------ ------------
7,580,485 3,495,843
------------ ------------
Loss from operations (2,262,135) (1,297,872)
Other income (expense):
Interest income 14,181 3,223
Other expense (7,369) (506)
Interest expense (1,048,883) (166,846)
------------ ------------
(1,042,071) (164,129)
------------ ------------
Loss before provision for income taxes (3,304,206) (1,462,001)
Provision for income taxes - -
------------ ------------
Net loss $ (3,304,206) $ (1,462,001)
============ ============
Basic and diluted net loss per share $ (0.09) $ (0.04)
============ ============
Weighted average common shares outstanding 38,607,825 33,919,840
============ ============
THE ACCOMPANY NOTES ARE AN INTEGRAL PART OF THESE CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS
2
HC INNOVATIONS, INC. AND SUBSIDIARIES
Consolidated Statement of Changes in Stockholders' Equity (Deficit) (Unaudited)
- --------------------------------------------------------------------------------
Common Stock
---------------------------- Total
Paid-In Subscriptions Stockholders'
Shares Issued Amount Capital Receivable Deficit Equity (Deficit)
------------- ------------ ------------ ------------ ------------ ---------------
Balance, January 1, 2008 38,600,407 $ 38,601 $ 17,377,800 $ (21,671) $(15,969,774) $ 1,424,956
Beneficial conversion discount (Note 4) - - 210,000 - - 210,000
Issuance of warrants to advisor in
connection with convertible
debentures (Note 4) - - 56,973 - - 56,973
Issuance of common stock in connection
with satisfaction of accounts
payable (Note 5) 15,000 15 18,735 - - 18,750
Issuance of warrants for consulting
services (Note 6) - - 46,028 - - 46,028
Net loss - - - - (3,304,206) (3,304,206)
------------ ------------ ------------ ------------ ------------ ------------
Balance, March 31, 2008 38,615,407 $ 38,616 $ 17,709,536 $ (21,671) $(19,273,980) $ (1,547,499)
============ ============ ============ ============ ============ ============
THE ACCOMPANY NOTES ARE AN INTEGRAL PART OF THESE CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS
3
HC INNOVATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Unaudited)
- --------------------------------------------------------------------------------
THREE MONTHS ENDED
------------------
MARCH 31, 2008 MARCH 31, 2007
-------------- --------------
Cash flows from operating activities:
Net loss $(3,304,206) $(1,462,001)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 298,341 122,884
Amortization of discount - convertible debentures 252,538 137,044
Amortization of beneficial conversion discount 568,333 -
Consulting services expense - warrants 46,028 52,120
Consulting services expense - common stock 3,750 -
Changes in operating assets and liabilities:
(Increase) decrease in:
Accounts receivable (1,405,708) (406,515)
Prepaid expenses 56,549 (64,268)
Other assets (10,718) (4,647)
Increase (decrease) in:
Accounts payable 264,070 226,077
Accrued liabilities 426,235 142,259
Other current liabilities 214,473 144,087
----------- -----------
Net cash used in operating activities (2,590,315) (1,112,960)
----------- -----------
Cash flow from investing activities:
Purchases of fixed assets, net (4,535) (19,357)
Expenditures for capitalized software development costs (234,848) (262,588)
----------- -----------
Net cash used in investing activities (239,383) (281,945)
----------- -----------
Cash flows from financing activities:
Proceeds from issuance of convertible debentures 425,000 -
Proceeds from issuance of common stock, net - 2,227,593
Proceeds from notes payable 50,000 -
Payments on line of credit - -
Payments on convertible debentures - -
Payments on notes payable (58,480) (7,865)
Payments on capital lease obligations (70,916) (28,273)
Deferred issuance costs paid (12,500) -
----------- -----------
Net cash provided by financing activities 333,104 2,191,455
----------- -----------
Net (decrease) increase in cash and cash equivalents (2,496,594) 796,550
Cash and cash equivalents - beginning of period 3,442,290 151,534
----------- -----------
Cash and cash equivalents - end of period $ 945,696 $ 948,084
=========== ===========
Supplemental cash flow information: Cash paid during the year for:
Interest $ 31,822 $ 37,831
=========== ===========
Noncash investing and financing activities:
Common stock issued for prepaid consulting services $ - $ 156,360
=========== ===========
Common stock issued for prepaid consulting services
and satisfaction of accounts payable $ 18,750 $ -
=========== ===========
Beneficial conversion discount on convertible debentures $ 210,000 $ -
=========== ===========
Discount on convertible debentures - common stock and warrants $ 56,973 $ -
=========== ===========
Computer equipment acquired through capital lease $ - $ 55,807
=========== ===========
THE ACCOMPANY NOTES ARE AN INTEGRAL PART OF THESE CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS
4
HC INNOVATIONS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles
for interim financial information and in accordance with the instructions
to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not
include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals and
adjustments to previously established loss provisions) considered necessary
for a fair presentation have been included. Operating results for the three
months ended March 31, 2008 are not necessarily indicative of the results
that may be expected for the year ending December 31, 2008. For further
information, refer to the consolidated financial statements and footnotes
thereto included in the Company's annual report on Form 10-KSB for the
fiscal year ended December 31, 2007.
1. NATURE OF OPERATIONS
HC Innovations, Inc. ("HCI") and subsidiaries (the "Company") is a
specialty care management company comprised of separate divisions each with
a specific focus and intervention. The Company's mission is to identify
subgroups of people with high costs and disability and create and implement
programs and interventions that improve their health, resulting in dramatic
reductions in the cost of their care. The Company also develops and
implements medical management systems for the long term care industry.
Enhanced Care Initiatives, Inc. ("ECI"), a wholly owned subsidiary of HCI
was founded in 2002 and is the management company for all HCI entities. ECI
has five wholly owned subsidiaries operating in Tennessee, Texas,
Massachusetts, Alabama, and New York. ECI markets its proprietary specialty
care management programs for the medically frail and other costly
sub-populations to Health Maintenance Organizations ("HMOs") and other
managed care organizations as well as state Medicaid departments.
NP Care, LLCs ("LLCs") are nursing home medical management systems. The
LLCs care program provides onsite medical care by Physicians ("MD's") and
Advanced Practice Registered Nurse ("APRN") under the oversight of the
patients' individual physician to residents in nursing homes and assisted
living facilities. The LLCs operate in the states of Connecticut, Florida,
New Jersey, Ohio, Illinois, Tennessee and Massachusetts and are managed
exclusively by ECI.
5
HC INNOVATIONS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
GOING CONCERN / MANAGEMENT'S PLAN
As shown in the accompanying condensed consolidated financial statements,
the Company has sustained a consolidated net loss for the three-month
period ended March 31, 2008 of approximately $3.3 million. The table below
sets forth, in millions, the balances of working capital (deficit),
accumulated deficits and stockholders' equity (deficit) at March 31, 2008
and December 31, 2007 respectively.
March 31, 2008 December 31, 2007
Working capital deficit $ (5.0) $ (2.0)
Accumulated deficit $ (19.3) $ (16.0)
Stockholders' (deficit) equity $ (1.5) $ 1.4
The report of our independent registered accounting firm as of and for the
year ended December 31, 2007 contains an explanatory paragraph raising
substantial doubt about the Company's ability to continue as a going
concern. The condensed consolidated financial statements do not include
adjustments that might result from the outcome of this uncertainty.
Management believes that the Company will be successful in its efforts to
adequately meet its capital needs and continue to grow its businesses.
During the first quarter of 2008, the Company raised $425,000 through the
issuance of convertible notes. These notes mature in January and February
2009 and carry interest rates of 10% with interest accruing monthly.
$250,000 of the convertible notes were issued to our non executive
Chairman. During April 2008 the Company raised an additional $125,000
through the issuance of convertible notes. These notes mature in April 2009
and carry interest rates of 10% with interest accruing monthly.
The cumulative losses to date are largely a result of business development
and start up costs associated with expanding the Company's operations to
ten states, largely driven by new contracts as well as significant
investment in building our corporate infrastructure to support the
Company's expansion. During 2007, the Company was successful in securing
new contracts with McKesson Corporation (McKesson) and with Health
Insurance Plan of Greater New York. Combined these contracts provide the
Company with the opportunity to enroll up to 18,000 members generating
revenue on a per member per month basis over a three year period.
6
HC INNOVATIONS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The condensed consolidated financial statements include the accounts of HCI
and its wholly-owned, majority-owned and controlled subsidiaries (which are
referred to as the Company, unless the context otherwise requires), as well
as certain affiliated limited liability companies, which are variable
interest entities required to be consolidated. The Company consolidates all
controlled subsidiaries, in which control is effectuated through ownership
of voting common stock or by other means. All significant intercompany
transactions have been eliminated in consolidation.
In states where ECI is not permitted to directly own a medical operation
due to corporate practice of medicine laws in those states, it performs
only non-medical administrative and support services, does not represent to
the public or its clients that it offers medical services and does not
exercise influence or control over the practice of medicine. In those
states, ECI conducts business through limited liability companies (LLCs)
that it controls, and it is these affiliated LLCs that employ Advanced
Practice Nurse Practitioners ("APNPs") who practice medicine. In such
states, ECI generally enters into exclusive long-term management services
agreements with the LLCs that operate the medical operations that restricts
the member(s) of the affiliated LLCs from transferring their ownership
interests in the affiliated LLCs and otherwise provides ECI or its designee
with a controlling voting or financial interest in the affiliated LLCs and
their operations.
The LLCs, which are required to be consolidated under Financial Accounting
Standards Board ("FASB") Interpretation No. 46, as revised ("FIN 46(R)"),
"CONSOLIDATION OF VARIABLE INTEREST ENTITIES", would also be consolidated
under the provisions of Emerging Issues Task Force ("EITF") No. 97-2,
"APPLICATION OF FASB STATEMENT NO. 94 AND APB OPINION NO. 16 TO PHYSICIAN
PRACTICE MANAGEMENT ENTITIES AND CERTAIN OTHER ENTITIES WITH CONTRACTUAL
MANAGEMENT ARRANGEMENTS." The LLCs have been determined to be variable
interest entities due to the existence of a call option under which ECI has
the ability to require the member(s) holding all of the voting equity
interests of the underlying LLCs to transfer their equity interests at any
time to any person specified by ECI and vote the member(s) interests as ECI
instructs. This call option agreement represents rights provided through a
variable interest other than the equity interest itself that caps the
returns that could be earned by the equity holders.
7
HC INNOVATIONS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
BASIS OF PRESENTATION (CONTINUED)
In addition the Company has an exclusive long-term management services
agreement with each of the LLC's and the member(s) of the LLCs which allows
the Company to direct all of the non-clinical activities of the LLCs,
retain all of the economic benefits, and assume all of the risks associated
with ownership of the LLCs. Due to these agreements, the Company has all of
the economic benefits and risks associated with the LLCs and the Company is
considered to be the primary beneficiary of the activities of the LLCs and
is required to consolidate the LLCs under FIN 46(R).
REVENUE RECOGNITION
The Company's revenue includes fees for service revenue and revenue from
capitated contracts. Net revenue consists of the following components for
the three-months ended March 31, 2007 and 2008:
March 31, 2008 March 31, 2007
Gross patient service
revenue $ 3,863,478 $ 2,000,753
Less: provision for
contractual
allowances (1,356,280) (575,792)
----------------------------------------
Net patient service revenue 2,507,198 1,424,961
Capitated contract revenue 2,811,152 773,010
----------------------------------------
Total revenue $ 5,318,350 $ 2,197,971
========================================
Revenue from APRN and MD services are generated from billings to a
patient's respective insurance carrier, health maintenance organization,
Medicare and Medicaid. Payments from these sources are generally based on
prospectively determined rates that vary according to a classification
system based on clinical, diagnostic and other factors and are
substantially below established rates. The Company monitors its revenues
and receivables from these reimbursement sources, as well as other
third-party insurance payors, and records an estimated contractual
allowance for certain service revenues and receivable balances in the month
service is
8
HC INNOVATIONS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
REVENUE RECOGNITION (CONTINUED)
provided and revenue is recognized, to properly account for anticipated
differences between billed and reimbursed amounts. Accordingly, a
substantial portion of the Company's total net revenues and receivables
reported in the accompanying condensed consolidated financial statements
are recorded at the amount ultimately expected to be received from these
payors. Net revenues from fee for service patients are recorded in the
month service is provided by credentialed practitioners.
A significant portion of the Company's fee for service revenues have been
reimbursed by federal Medicare and, to a lesser extent, state Medicaid
programs.
The Company evaluates several criteria in developing the estimated
contractual allowances for unbilled and/or initially rejected claims on a
monthly basis, including historical trends based on actual claims paid,
current contract and reimbursement terms, and changes in patient base and
payor/service mix. Contractual allowance estimates are adjusted to actual
amounts as cash is received and claims are settled and the aggregate impact
of these resulting adjustments were not significant to the Company's
operations for the three months ended March 31, 2008. Further, the Company
does not expect the reasonably possible effects of a change in estimates
related to unsettled March 31, 2008 contractual allowance amounts from
Medicare, Medicaid and other third-party payors to be significant to its
future operating results and consolidated financial position. Revenue from
capitated contracts is recorded monthly based on the number of members
covered under each capitated contract per month.
INCOME TAXES
The Company adopted the provisions of FASB Interpretation No. 48,
"Accounting for Uncertainty in Income Taxes - an interpretation of FASB
Statement No. 9" ("FIN No. 48"), on January 1, 2007. FIN No. 48 requires
that the impact of tax positions be recognized in the financial statements
if they are more likely than not of being sustained upon examination, based
on the technical merits of the position. As discussed in the consolidated
financial statements in the 2007 Form 10-KSB, the Company has a valuation
allowance against the full amount of its net deferred tax assets. The
Company currently provides a valuation allowance against deferred tax
assets when it is more likely than not that some portion, or all of its
deferred tax assets, will not be realized. There was no significant impact
to the Company as a
9
HC INNOVATIONS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INCOME TAXES (CONTINUED)
result of adopting FIN No. 48 and there is no interest or penalties accrued
as management believes the Company has no uncertain tax positions at March
31, 2008.
The Company is subject to U.S. federal income tax as well as income tax of
certain state jurisdictions. The Company has not been audited by the I.R.S.
or any states in connection with income taxes. The periods from 2003-2007
remain open to examination by the I.R.S. and state authorities.
EARNINGS PER SHARE
Basic earnings (loss) per share ("EPS") is computed dividing the net income
(loss) attributable to the common stockholders (the numerator) by the
weighted average number of shares of common stock outstanding (the
denominator) during the reporting periods. Diluted income (loss) per share
is computed by increasing the denominator by the weighted average number of
additional shares that could have been outstanding from securities
convertible into common stock, such as stock options and warrants (using
the "treasury stock" method), and convertible preferred stock and debt
(using the "if-converted" method), unless their effect on net income (loss)
per share is antidilutive. Under the "if-converted" method, convertible
instruments are assumed to have been converted as of the beginning of the
period or when issued, if later. The effect of computing the diluted income
(loss) per share is antidilutive and, as such, basic and diluted earnings
(loss) per share are the same for the three months ended March 31, 2008 and
2007.
NEWLY ADOPTED ACCOUNTING STANDARDS
In September 2006, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 157, "Fair Value Measurements," which defines fair value,
establishes a framework in generally accepted accounting principles for
measuring fair value and expands disclosures about fair value measurements.
This standard only applies when other standards require or permit the fair
value measurement of assets and liabilities. It does not increase the use
of fair value measurement. SFAS No. 157 is effective for fiscal years
beginning after November 15, 2007, except as it relates to nonrecurring
fair value measurements of nonfinancial assets and liabilities for which
the standard is effective for fiscal years beginning after November 15,
2008. The adoption of SFAS No. 157 with respect to financial assets and
liabilities in the first quarter of 2008 did not have a significant effect
on the Company's condensed consolidated results of
10
HC INNOVATIONS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
NEWLY ADOPTED ACCOUNTING STANDARDS (CONTINUED)
operations or financial position. In addition, the Company is evaluating
the impact of SFAS No. 157 for measuring nonfinancial assets and
liabilities on future results of operations and financial position.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities - Including an Amendment of FASB
Statement No. 115." SFAS No. 159 permits entities to choose to measure
eligible items at fair value at specified election dates and report
unrealized gains and losses on items, for which the fair value option has
been elected, in earnings at each subsequent reporting date. SFAS No. 159
is effective for fiscal years beginning after November 15, 2007. The
adoption of SFAS No. 159 in the first quarter of 2008 did not have an
impact on the Company's condensed consolidated results of operations or
financial position.
RECENTLY ISSUED ACCOUNTING STANDARDS
There are no new accounting standards that are expected to have a
significant impact on the Company.
11
HC INNOVATIONS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
3. CAPITALIZED SOFTWARE DEVELOPMENT COSTS
Capitalized software development costs as of March 31, 2008 and December 31,
2007 are summarized as follows:
March 31, 2008 December 31, 2007
Capitalized software
development costs $2,830,347 $ 2,613,092
Less: accumulated
amortization (462,636) (395,117)
-------------------- -------------------
Net $ 2,367,711 $2,217,975
==================== ===================
Amortization expense related to capitalized software development costs for the
three months ended March 31, 2008 and 2007 totaled approximately $67,500 and
$47,400, respectively.
4. CONVERTIBLE NOTES
The Company issued approximately $6.4 million and $425,000 in twelve month, 10%
interest, senior secured convertible notes to nine private investors during the
fourth quarter of 2007 and the first quarter of 2008, respectively. $1.4 million
of the $6.4 million convertible notes issued during the fourth quarter of 2007
were issued as a result of four of the investors converting previously
outstanding promissory notes. $250,000 of the $425,000 convertible notes issued
during the first quarter of 2008 were issued to the Company's non-executive
Chairman. Each of the investors have represented in writing that they are
accredited investors and acquired the securities for their own accounts. The
notes are convertible into common stock at any time prior to maturity at an
amount equal to 70% (75% for $3 million worth of the notes) of the average low
bid price for the twenty day period prior to the conversion date subject to a
floor price of $1.00. Additionally, if there is a Qualified Financing (As
defined below) the debenture holders are entitled to, but not required to,
convert at a rate equal to a 30% discount of the price paid per share in the
Qualified Financing with the same limitation of a floor of $1.00. In connection
with the fourth quarter 2007 and first quarter 2008 convertible note sales, the
Company issued 600,000 and 42,500 warrants, respectively, which are exercisable
at any time prior to expiration at a strike price equal to the strike price per
share for warrants granted under a Qualified Financing or if no Qualified
Financing takes place at the average of the lowest bid price for the 20 trading
days prior to the expire date per share. The Warrants have a five year maturity
date from the date of the debenture issuance. The term "Qualified Financing" is
defined as the sale for cash by the Company in a transaction or series of
related transactions of debt, equity, equity-linked securities or any
combination thereof (the "SECURITIES") generating gross proceeds to the Company
(excluding the principal amount of any notes tendered in connection therewith)
of at least $10,000,000.
12
HC INNOVATIONS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
4. CONVERTIBLE DEBENTURES (CONTINUED)
The convertible notes issued during the fourth quarter of 2007 and the first
quarter of 2008 contained beneficial conversion discounts totaling $1,779,000
and $210,000, respectively, because the value allocated to the notes on a
relative basis were less than the fair value of the Company's common stock. The
Company valued the warrants issued during the fourth quarter of 2007 and the
first quarter of 2008 at $979,147 and $56,973 and allocated $5,385,618 and
$368,027 to the notes, respectively. The fair value of the warrants were
determined by using the Black-Scholes model assuming an exercise price of $0.85,
risk free interest rate of 5%, volatility ranging from 152% and 168% and a term
equal to the contractual life of the warrants. The discount related to the fair
value of the warrants and the beneficial conversion discounts are being
amortized over the term of the notes through a charge to interest expense. The
convertible notes totaling $6,789,765 are reflected in the condensed
consolidated balance sheets net of the unamortized portion of the discounts and
warrants of the beneficial conversion discount. For the three months ended March
31, 2008 the Company recorded interest expense of $568,334 related to the
beneficial conversion discount and $252,538 related to the warrants.
The features of the convertible notes and terms of the warrants were evaluated
under applicable accounting literature, including SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities," and EITF 00-19, "Accounting for
Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company's Own Stock,". The conclusion was that none of the features of the
convertible notes should be separately accounted for as derivatives and that the
warrants meet the tests for equity classification.
The Company incurred approximately $671,000 in deferred issuance costs relating
to the issuance of the convertible notes. Amortization expense associated with
the deferred issuance costs totaled approximately $160,000 for the three month
period ended March 31, 2008.
At March 31, 2008 the unamortized balance of the beneficial conversion features
were approximately $1,684,000, the unamortized balance of the warrant discount
were approximately $666,000, and the unamortized balance of deferred issuance
costs were approximately $448,000.
13
HC INNOVATIONS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
5. STOCKHOLDERS' EQUITY (DEFICIT)
During the first quarter of 2008, the Company issued to four (4) private
investors $425,000 in twelve month, 10% interest, senior secured convertible
notes, and of this amount $250,000 was issued to the Company's non-executive
Chairman. The convertible notes issued contained beneficial conversion discounts
totaling $210,000 because the value allocated to the notes were less than the
fair value of the Company's common stock. In addition the Company issued 42,500
warrants as more fully described in note 4. The Company valued the warrants
using the Black-Scholes model at $56,973. These transactions resulted in charges
to additional paid in capital during the three month period ended March 31 2008.
During the first quarter of 2008 the company issued 15,000 shares in
satisfaction of accounts payable to one vendor. The share value on the date of
issuance was $1.25, the dollar amount of accounts payable satisfaction was
$15,000 which resulted in a noncash charge to expense in the amount of $3,750.
WARRANTS
A summary of warrant activity is as follows:
Weighted
Weighted Average Life
Warrants Price Average Price (Years)
------------- ---------------- ----------------
Balance January 1, 2008 5,068,210 1.88 3.01
================ ================
Issued 42,500 .85 .85 5.0
Issued 20,000 1.10 1.10 5.0
Issued 20,000 1.35 1.35 5.0
------------- ---------------- ----------------
Balance March 31, 2008 5,150,710 1.87 3.05
------------- ---------------- ----------------
Exercisable March 31, 2008 4,279,733 2.08 2.64
============= ================ ================
14
HC INNOVATIONS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
6. COMMITMENTS
CONSULTING AGREEMENTS
In December 2007, the Company entered into a consulting agreement with its non
executive Chairman whereby the non-executive Chairman would provide management
consulting services to the Company. The consulting agreement has a six month
term. During the first quarter of 2008 the Company incurred expenses of $15,000
related to this consulting agreement.
6. COMMITMENTS
CONSULTING AGREEMENTS (CONTINUED)
In February of 2008 the Company entered into a consulting agreement with an
investment advisor whereby the investment advisor would provide management
consulting services in addition to investment advisory services. The consulting
agreement has an initial six month term with terms requiring monthly cash
payments of $15,000 and monthly awards of 20,000 warrants to purchase the
Company's common stock. This agreement may be terminated at any time thereafter
upon 30 days notice. During the first quarter of 2008 the Company incurred
expenses of $30,000 related to this consulting agreement.
During the first quarter of 2008 the Company issued 40,000 common stock warrants
to this financial advisor in exchange for consulting services rendered during
the quarter. The Company valued the commitment to issue warrants using the
Black-Scholes model at $46,028 assuming exercise prices of $1.10 and $1.35 in
February and March 2008, respectively, a risk free interest rate of 5%,
volatility ranging from 160% and 165% and term equal to the contractual life of
the warrants. These transactions resulted in charges to additional paid in
capital during the three month period ended March 31, 2008.
15
HC INNOVATIONS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
7. BUSINESS SEGMENTS
The Company's operations by business segment for the three months ended
March 31, 2008 and 2007 were as follows:
Professional Disease
2008 Services Management Total
- ------------------------------ --------------------- --------------------- ---------------------
Net Revenues $ 2,507,198 $ 2,811,152 $ 5,318,350
===================== ===================== =====================
Business Unit Profit Loss (900,587) 325,690 (574,897)
-
Unallocated Overhead - (1,687,238)
---------------------
Operating Profit Loss $ (2,262,135)
=====================
Identifiable Assets $ 2,275,373 $ 6,723,990 $ 8,999,363
===================== ===================== =====================
Professional Disease
2007 Services Management Total
- ------------------------------ --------------------- --------------------- ---------------------
Net Revenues $ 1,424,961 $ 773,010 $ 2,197,971
===================== ===================== =====================
Business Unit Profit Loss (551,361) 75,748 (475,613)
Unallocated Overhead - - (822,259)
---------------------
Operating Profit Loss $ (1,297,872)
=====================
Identifiable Assets $ 972,287 $ 2,963,264 $ 3,935,551
===================== ===================== =====================
16
HC INNOVATIONS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
8. RISKS AND UNCERTAINTIES
PATIENT SERVICE REVENUE
Approximately 37% and 58% of net patient services revenue in the three
months ended March 31, 2008 and 2007, respectively, was derived the
combination of federal (Medicare) and state (Medicaid) third-party
reimbursement programs. These revenues are based, in part, on cost
reimbursement principles and are subject to audit and retroactive
adjustment by the respective third-party fiscal intermediaries. The general
trend in the healthcare industry is lower private pay utilization due to
liberal asset transfer rules and the degree of financial planning that
takes place by the general public. The Company's ability to maintain the
current level of private pay utilization and thereby reduce reliance on
third-party reimbursement is uncertain due to the economic and regulatory
environment in which the Company operates.
Approximately 22% and 17% of net patient services revenue in the three
months ended March 31, 2008, were derived from two customers; during the
first quarter of 2007 these two customers generated less than 10% of net
patient service revenue.
MALPRACTICE INSURANCE
The Company maintains malpractice insurance coverage on an occurrence
basis. It is the intention of the Company to maintain such coverage on the
occurrence basis in ensuing years. During the three month periods ended
March 31, 2008, no known malpractice claims have been asserted against the
Company which, either individually or in the aggregate, are in excess of
insurance coverage.
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS.
This management's discussion and analysis of results of operations and
financial condition contains forward-looking statements that involve risks and
uncertainties. In some cases, you can identify these statements by
forward-looking words such as "may," "might," "will," "should," "expect(s),"
"plan(s)," "anticipate(s)," "believe(s)," "estimate(s)," "predict(s),"
"intend(s)," "potential" and similar expressions. All of the forward-looking
statements contained in this registration statement are based on estimates and
assumptions made by our management. These estimates and assumptions reflect our
best judgment based on currently known market and other factors. Although we
believe such estimates and assumptions are reasonable, they are inherently
uncertain and involve risks and uncertainties. In addition, management's
assumptions about future events may prove to be inaccurate. We caution you that
the forward-looking statements contained in this registration statement are not
guarantees of future performance and we cannot assure you that such statements
will be realized. In all likelihood, actual results will differ from those
contemplated by such forward-looking statements as a result of a variety of
factors, including, but not limited to, those factors discussed in our Form
10-KSB (File No. 0-52197) for the year ended December 31, 2007. Except as
required by law, we undertake no obligation to update any of these
forward-looking statements.
The discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America ("GAAP"). The following discussion of our financial
condition and results of operations should be read in conjunction with (1) our
audited consolidated financial statements for the years ended December 31, 2007
and 2006, together with notes thereto included on Form 10-KSB and (2) our
Registration Statement Form 10-SB (File No. 0-52197), as such Registration
Statement became effective on February 13th, 2007.
OVERVIEW
HC Innovations, Inc. ("HCI") is a holding company incorporated in
Delaware that, through its subsidiaries, provides specialty care management
products and services.
Our wholly owned subsidiary and operating company is Enhanced Care
Initiatives, Inc. (ECI). ECI is a specialty disease and care management company
comprised of several divisions each with a specific focus and intervention. Our
mission is to identify subgroups of people with high costs and disability and to
create and implement systems that improve their health, resulting in dramatic
reductions in the cost of their care. As a specialty disease and care management
company, we bring to our clients the ability to impact the health and cost of
their sickest, costliest subsets of patients. We combine our proprietary state
of the art information systems with highly trained nurses and nurse
practitioners. We provide intense, hands-on involvement with call center backup
and biometric monitoring. We connect care around the patient and around the
clock providing case management if the patient requires hospitalization or
rehabilitation in a nursing home -- always working to bring the patient safely
home. We connect directly with the patient's physician by going with the patient
to the doctor visit. The applications for our unique systems are numerous.
CLINICAL STRATEGY
We identify subgroups of people with common needs and create programs
to fill the gaps in care, stabilizing the health of the individual. These are
highly complex populations that require complex solutions. We combine best
practices, state of the art electronic health record (EHR), communication tools,
calls center support and biometrics, with community-based, hands-on, high-touch
care.
18
CORPORATE STRATEGY
We create scalable interventions which result in significant healthcare
cost savings which drive our growth visibility and profitability.
Management has retained an investment advisory firm for the purpose of
developing a strategy to secure additional capital for working capital,
continued investment in information systems and the ongoing execution of our
growth plans. As is typical with early stage, growth companies, fiscal year 2007
and first quarter 2008 losses are largely a result of business development
expenses as well as significant investment in building infrastructure for
growing our divisions, business and clinical systems and programs. During 2007,
we opened NP Care operations in the states of Illinois and Massachusetts
bringing the total number of NP Care operations to seven at December 31, 2007
and March 31, 2008. During 2007 we opened Easy Care operations in the state of
New York under a contract with Health Insurance Plan of New York bringing the
total number of Easy Care operations to four at December 31, 2007. During the
first quarter of 2008 we opened Easy Care operations in the state of Alabama
bringing the total number of Easy Care operations to five at March 31, 2008.
In addition to the new operations opened during 2007 and the first
quarter of 2008, we experienced growth in members under care within its Easy
Care Operations. As of March 31, 2008 we had approximately 3,200 members under
care throughout its Easy Care operations representing a 5% increase from members
under care as of December 31, 2007.
RESULTS OF OPERATIONS
Our focus for fiscal years 2003 through the first quarter of 2008 was
to invest in the areas of IT/Systems, clinical protocol training and
development, human resource recruiting, training and development as well as
marketing and business development expense. We have invested heavily in the
development of its proprietary software systems for fully integrated electronic
health records for its principal divisions: Easy Care and NP Care. During 2007
and 2008 to date, we have also invested in additions to its management and
systems infrastructure in anticipation of rapid growth of its programs.
Management believes that these investments in building the management
infrastructure and systems is critical, both to ensure effective execution of
its business model(s) in each market area, and to sustain high levels of revenue
growth and margin enhancement over time. Management believes its models are
highly scalable however there are significant start-up costs associated with
scaling to new markets and there can be no assurance that we will be successful
in securing new contracts and growing these new markets profitably.
THREE - MONTHS ENDED MARCH 31, 2008 AND 2007
Revenues
For the three months ended March 31, 2008, net revenue was $5,318,350,
representing an increase of $3,120,379 (142%), as compared to the net revenue of
$2,197,971 for the three months ended March 31, 2007. The increase is a result
of growth from existing operations in the amount of $992,694 or 45% as compared
to the first quarter of 2007 as well as $2,127,685 of revenue from new
operations in the first quarter of 2008. During the first quarter of 2008, new
NP Care operations generated $763,108 in revenue and new Easy Care operations
generated $1,364,577 in revenue.
19
Cost of Net Revenue and Gross Profit
For the three months ended March 31, 2008, cost of net revenue was
$4,114,730, representing an increase of $2,376,021 (137%), as compared to the
cost of net revenue of $1,738,709 for the three months ended March 31, 2007. The
increase is a result of growth from existing operations in the amount of
$804,330 or (46%) as compared to the first quarter of 2007 as well as $1,571,691
of cost of net revenue from new operations in the first quarter of 2008. During
the first quarter of 2008, new NP Care operations generated $779,488 in net cost
of revenue and new Easy Care operations generated $792,203 in net cost of
revenue.
For the three months ended March 31, 2008, gross margin was $1,203,620
or 23% of net revenue representing an increase of $744,358, or 162% as compared
to the gross margin of $459,262, or 21% of net revenue for the three months
ended March 31, 2007. The increase is a result of growth from existing
operations in the amount of $188,364 or 41% as compared to the first quarter of
2007 as well as $555,994 of gross margin from new operations in the first
quarter of 2008. During the first quarter of 2007, new NP Care operations
generated ($16,380) in gross margin and new Easy Care operations generated
$572,374 in gross margin.
Selling, General and Administrative Expense ("SG&A Expenses")
SG&A expenses include the wages and salaries of administrative and
business development personnel, as well as other general and corporate overhead
costs not directly related to generation of net revenue. For the three months
ended March 31, 2008, total SG&A Expenses were $3,167,414, representing an
increase of $1,533,164 or 94% as compared to the total SG&A Expenses of
$1,634,250 for the three months ended March 31, 2007. This increase is a result
of the Company's continuing enhancement to the senior management and additional
expenses for the opening of new offices and system and infrastructure costs.
Depreciation and amortization expense are calculated using the straight
line method over the estimated useful lives of the assets, or, in the case of
leasehold improvements over the remaining term of the related lease, whichever
is shorter. For the three months ended March 31, 2008, depreciation and
amortization expense included in operating expenses was $298,341, representing
an increase of $175,457 or (143%), as compared to the total depreciation and
amortization expense of $122,884 included in SG&A for the three months ended
March 31, 2007. This increase is a result of the amortization of deferred
issuance costs related to our convertible debt.
Income (Loss) from operations
For the three months ended March 31, 2008, we incurred a loss from
operations of ($2,262,135) representing an increase of $964,263 or 74%, compared
to ($1,297,872) for the three months ended March 31, 2007. We expect improvement
in our results of operations as revenues increase and we begin to absorb the
incremental fixed costs associated with our expansion. Revenues and operating
results are expected to fluctuate from period to period as a result of the
timing of new contracts and additional start-up costs associated with additional
planned new markets.
20
Income Tax Expense
We have incurred net operating losses (NOLs) since inception. At March
31, 2008, we had net operating loss carry forwards for federal income tax
purposes of approximately $9.3 million, which is available to offset future
federal taxable income, if any, ratably through 2027. These net operating losses
are subject to review by federal and state tax authorities.
PLAN OF OPERATIONS - EASY CARE
Primary Strategy
Our primary strategy consists of the following:
1. MANAGED MEDICARE MARKET - Currently over five million enrolled --
150,000 Easy Care(SM) eligible. We are focusing on small to medium sized
Medicare Advantage programs with Medicare enrollment between 10,000 and 60,000.
These plans are independent and not part of large networks; they are growing
their Medicare membership, and are less likely to have their own disease
management programs. Most of these plans are well established, though some are
relatively new to Medicare. We believe we are well positioned to grow with the
enrollment of these companies.
2. SUBCONTRACTING WITH POPULATION BASED-SINGLE DISEASE ORIENTED DISEASE
MANAGEMENT COMPANIES -- many of these companies either have large Medicare
populations, are partnering with an HMO in a CCI (Medicare demonstration
project), or seeking contracts with the states for Medicaid populations which
include the disabled. In these cases we subcontract with the company and enable
them to provide a complete spectrum of care which includes hands-on and presence
in the community for the medically complex and frail; a capability which none of
these companies has developed: Alere, Health Dialog, Health Management
Corp/Wellpoint and McKesson.
3. DUAL ELIGIBLE MEDICARE/MEDICAID PLANS - these are relatively new
entities but a number of companies who are already in the Medicaid market are
seeking to enroll Medicare members who have both insurances since the
reimbursement incentives are favorable. Most of these companies do not have
experience with the medically complex and frail patients and are seeking
partners to help them.
4. MEDICAID CONTRACTS --although this is a population which could
benefit from our programs, the sales cycle is very long (up to two years) and
the RFP (Request for Proposal) process too distracting for EASY CARE(SM) at this
time. Our approach in this context is to partner with other Disease Management
and Managed Care Organizations as part of their Request for Proposal responses.
5. MCKESSON - we have a partnership agreement in place and are working
with their Disease Management Division on specific opportunities. A contract was
signed in March, 2007 for State of Illinois Medicaid patients in long term care
facilities.
21
PLAN OF OPERATIONS - NP CARE
We hope to achieve the growth at a rate of nine facilities per quarter
over a period of four years in targeted markets. We anticipate growth will then
slow down secondary to saturation of prime facilities, decreased availability of
nurse practitioners and potential competition.
We have established relationships with the key nursing home chains (for
example Harborside, Genoa, Sava, CareOne, THI, NHC), and have aggressively and
successfully competed with Evercare in the Connecticut and New Jersey markets.
We are confident that our continued focus on excellence in customer service and
delivering health outcomes will continue to position NP Care as the provider of
choice.
NP Care's revenue streams include three channels:
o Fee-for-Service -- our nurse practitioners are paid on an event basis
in all of our current nursing homes.
o Special Services -- Resident Risk Assessments, Employee Physicals,
Nursing Home-based Educational programs are available on a
service-based fee schedule.
o Medicare Advantage SNPs -- we have entered into a relationship with
Aetna to be the nurse practitioner source of care for their managed
care nursing home patients in select homes in New Jersey. We are now
entering into contractual relations with HealthSpring in Nashville,
Tennessee.
LIQUIDITY AND CAPITAL RESOURCES
We have historically financed our liquidity needs through a variety of
sources including proceeds from the sale of common stock, borrowing from banks,
loans from our stockholders, issuance of convertible notes and cash flows from
operations. At March 31, 2008 and 2007, we had $945,696 and $948,084,
respectively, in cash and cash equivalents. Operating activities for the three
months ended March 31, 2008 used $2,590,315, representing an increase of
$1,477,355 or (133%), when compared to the cash used in operating activities of
$1,112,960 for the three months ended March 31, 2007. This change is primarily
due to the increased investment in corporate infrastructure; start-up costs
associated new contracts and increased spending with respect to business
development.
During the first quarter of 2008, we issued to four (4) private
investors $425,000 in twelve month, 10% interest, senior secured convertible
notes, and of this amount $250,000 was issued to the Company's non-executive
Chairman. The investors represented in writing that they were accredited
investors and acquired the securities for their own accounts. The notes are
convertible into common stock at any time prior to maturity at an amount equal
to 70% of the average low bid price for the twenty day period prior to the
conversion date subject to a floor price of $1.00. Additionally, if there is a
Qualified Financing (As defined below) the note holders are entitled to, but not
required to, convert at a rate equal to a 30% discount of the price paid per
share in the Qualified Financing with the same limitation of a floor of $1.00.
In connection with the convertible note sale, the Company issued 42,500 warrants
which are exercisable at any time prior to expiry at a strike price per share
equal to the strike price for warrants granted under a Qualified Financing or if
no Qualified Financing takes place at the average of the lowest bid price for
the 20 trading days prior to the expire date per share. The Warrants have a five
year maturity date from the date of the note issuance. The term "Qualified
Financing" is defined as the sale for cash by the Company in a transaction or
series of related transactions of debt, equity, equity-linked securities or any
combination thereof generating gross proceeds to us (excluding the principal
amount of any notes tendered in connection therewith) of at least $10,000,000.
22
We have incurred significant costs for the development of software for
internal use. For the three month period ended March 31, 2008 and the year ended
December 31, 2007, the Company incurred $234,848 and $1,126,508 respectively, in
capitalized software costs. We used one vendor to develop this software.
Accounts Receivable
As of March 31, 2008 and 2007, our accounts receivable aging by major
payers was as follows:
March 31, 2008
0-30 31-60 61-90 > 90 Total
Medicare 603,817 127,599 66,193 158,747 956,356
Medicaid 27,621 13,893 9,196 55,795 106,505
Healthnet 30,691 6,960 4,935 27,388 69,974
Blue Cross 28,472 15,324 14,532 70,033 128,362
Other Private 1,115,543 680,002 412,459 152,567 2,360,570
---------- -------------- ------------- ---------- ---------
1,806,143 843,777 507,316 464,530 3,621,767
========== ============== ============= ========== =========
March 31, 2007
0-30 31-60 61-90 > 90 Total
Medicare 428,937 106,423 16,128 18,898 570,386
Medicaid 21,813 2,514 144 420 24,891
Healthnet 41,418 25,376 1,744 5,154 73,692
Blue Cross 8,693 3,979 598 872 14,142
Other Private 28,295 16,668 3,608 5,655 54,226
---------- -------------- ------------- ---------- ---------
529,156 154,960 22,222 30,999 737,337
========== ============== ============= ========== =========
Receivables recorded at March 31, 2008 and 2007 consists primarily of
fees for services to be reimbursed by Medicare, Medicaid and other private
insurance payers. Self pay accounts are not material. These accounts are
actively monitored by a third party billing company responsible for collecting
amounts due.
A significant portion of our fee for service revenues have been
reimbursed by federal Medicare and, to a lesser extent, state Medicaid programs.
Payments for services rendered to patients covered by these programs are
generally less than billed charges. We monitor our revenues and receivables from
these reimbursement sources, as well as other third-party insurance payers, and
records an estimated contractual allowance for certain service revenues and
receivable balances in the month of revenue recognition, to properly account for
anticipated differences between billed and reimbursed amounts. Reimbursement is
determined based on historical payment trends as well as current contract terms.
Accordingly, a substantial portion of the total net revenues and receivables
reported in our condensed consolidated financial statements for three month's
ended March 31, 2008 and the year ended December 31, 2007 are recorded at the
amount ultimately expected to be received from these payers. For the three
month's ended March 31, 2008 and the year ended December 31, 2007, there were
$1,356,280 and $4,565,333, respectively, recorded as contractual allowances.
Management has provided for uncollectible accounts receivable through
direct write-offs and such write-offs have been within management's
expectations. Historical experience indicates that after such write-offs have
been made, potential collection losses are considered minimal and, therefore, no
allowance for doubtful accounts is considered necessary by management. On a
monthly basis, management reviews the accounts receivable aging by payer and
rejected claims to determine which receivables, if any are to be written off.
For the three months ended March 31, 2008 and 2007, there were no bad debt
direct write-offs recorded in our results of operations.
23
Based on our current financial resources, we will require additional
working capital to fund our ongoing business, business strategy including
acquisitions and further development of our proprietary software systems. There
can be no assurance that additional financing will be available, or if
available, that such financing will be on favorable terms. Any such failure to
secure additional financing could impair our ability to achieve our business
strategy. There can be no assurance that we will have sufficient funds or
successfully achieve our plans to a level that will have a positive effect on
our results of operations or financial condition. Our ability to execute our
growth strategy is contingent upon sufficient capital as well as other factors,
including, but not limited to, our ability to further increase awareness of our
programs, our ability to consummate acquisitions of complimentary businesses,
general economic and industry conditions, our ability to recruit, train and
retain a qualified sales and nursing staff, and other factors, many of which are
beyond our control. Even if our revenues and earnings grow rapidly, such growth
may significantly strain our management and our operational and technical
resources. If we are successful in obtaining greater market penetration with our
programs, we will be required to deliver increasing outcomes to our customers on
a timely basis at a reasonable cost to us. No assurance can be given that we can
meet increased program demand or that we will be able to execute our programs on
a timely and cost-effective basis.
COMMITMENTS, CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS
There are no guarantees, commitments, lease and debt agreements or
other agreements that would trigger adverse changes in our credit rating,
earnings, or cash flows, including requirements to perform under stand-by
agreements.
We are obligated under various operating leases for the rental of
office space and office equipment. Future minimum rental commitments with a
remaining term in excess of one year as of March 31, 2008 are as follows:
PERIODS ENDING DECEMBER 31,
2008 $ 383,399
2009 523,241
2010 309,307
2011 90,347
2012 46,767
--------------------
Total minimum lease payments $1,353,061
====================
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
We believe that the following critical policies affect our more
significant judgments and estimates used in preparation of our financial
statements.
24
REVENUE RECOGNITION
A significant portion of our fee for service revenues have been
reimbursed by federal Medicare and, to a lesser extent, state Medicaid programs.
Payments for services rendered to patients covered by these programs are
generally less than billed charges. We monitor our revenues and receivables from
these reimbursement sources, as well as other third-party insurance payers, and
records an estimated contractual allowance for certain service revenues and
receivable balances in the month of revenue recognition, to properly account for
anticipated differences between billed and reimbursed amounts. Accordingly, a
substantial portion of the total net revenues and receivables reported in our
consolidated financial statements are recorded at the amount ultimately expected
to be received from these payers.
We evaluate several criteria in developing the estimated contractual
allowances for unbilled and/or initially rejected claims on a monthly basis,
including historical trends based on actual claims paid, current contract and
reimbursement terms, and changes in patient base and payer/service mix.
Contractual allowance estimates are adjusted to actual amounts as cash is
received and claims are settled. Further, we do not expect the reasonably
possible effects of a change in estimate related to unsettled contractual
allowance amounts from Medicaid and third-party payers to be significant to its
future operating results and consolidated financial position.
CAPITALIZED SOFTWARE DEVELOPMENT COSTS
We have capitalized costs related to the development of software for
internal use. Capitalized costs include external costs of materials and services
and consulting fees devoted to the specific software development. These costs
have been capitalized based upon Statement of Position (SOP) No. 98-1,
"Accounting for the Costs of "Computer Software Developed or Obtained for
Internal Use." In accordance with SOP No. 98-1, internal-use software
development costs are capitalized once (i) the preliminary project stage is
completed, (ii) management authorizes and commits to funding a computer software
project, and (iii) it is probable that the project will be completed, and the
software will be used to perform the function intended. Costs incurred prior to
meeting these qualifications are expensed as incurred. Capitalization of costs
ceases when the project is substantially complete and ready for its intended
use. Internal-use software development costs are amortized using the
straight-line method over estimated useful lives approximating five years.
The capitalization and ongoing assessment of recoverability of
development costs requires considerable judgment by us with respect to certain
external factors, including, but not limited to, technological and economic
feasibility, and estimated economic life.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Our financial instruments include cash, accounts receivable, accounts
payable and notes payable. The carrying amounts of these financial instruments
approximate their fair value, due to the short-term nature of these items. The
carrying amount of the notes payable approximates their fair value due to the
use of market rates of interest.
FIXED ASSETS
Fixed assets are stated at cost, less accumulated depreciation and
amortization. Major improvements and betterments to the fixed assets are
capitalized. Expenditures for maintenance and repairs which do not extend the
estimated useful lives of the applicable assets are charged to expense as
incurred. When fixed assets are retired or otherwise disposed of, the assets and
the related accumulated depreciation are removed from the accounts and any
resulting profit or loss is recognized in operations.
We provide for depreciation and amortization using the straight-line
method over the estimated useful lives of the assets, or, in the case of
leasehold improvements, over the remaining term of the related lease, whichever
is shorter.
25
NEWLY ADOPTED ACCOUNTING STANDARDS
In September 2006, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 157, "Fair Value Measurements," which defines fair value, establishes a
framework in generally accepted accounting principles for measuring fair value
and expands disclosures about fair value measurements. This standard only
applies when other standards require or permit the fair value measurement of
assets and liabilities. It does not increase the use of fair value measurement.
SFAS No. 157 is effective for fiscal years beginning after November 15, 2007,
except as it relates to nonrecurring fair value measurements of nonfinancial
assets and liabilities for which the standard is effective for fiscal years
beginning after November 15, 2008. The adoption of SFAS No. 157 with respect to
financial assets and liabilities in the first quarter of 2008 did not have a
significant effect on our condensed consolidated results of operations or
financial position. In addition, we are evaluating the impact of SFAS No. 157
for measuring nonfinancial assets and liabilities on future results of
operations and financial position.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities - Including an Amendment of FASB
Statement No. 115." SFAS No. 159 permits entities to choose to measure eligible
items at fair value at specified election dates and report unrealized gains and
losses on items, for which the fair value option has been elected, in earnings
at each subsequent reporting date. SFAS No. 159 is effective for fiscal years
beginning after November 15, 2007. The adoption of SFAS No. 159 in the first
quarter of 2008 did not have an impact on our condensed consolidated results of
operations or financial position.
Recently Issued Accounting Standards
There are no new accounting standards that are expected to have a significant
impact on the Company.
ITEM 3. QUANTITIVE AND QUALTITIVE DISCLOSURES ABOUT MARKET RISK.
NO DISCUSSION IS REQUIRED PURSUANT TO FORM 10-Q INSTRUCTIONS TO
PARAGRAPH 305(o).
ITEM 4. CONTROLS AND PROCEDURES.
Pursuant to Rule 13a-15(b) of the Exchange Act, the Company has
reevaluated the effectiveness of the design and operation of its disclosure
controls and procedures to allow timely decisions regarding required disclosure
as of the period covered by this report. . This reevaluation was done under the
supervision and with the participation of management, including the Company's
Chief Executive Officer ("CEO") and acting Chief Financial Officer ("CFO"), as
appropriate. Based on this evaluation, the Company concluded that because of
weakness in our internal controls over financial reporting, our disclosure
controls and procedures as defined in Rule 13a-15(e) may not be effective in
timely alerting them to material information relating to the Company required to
be included in its periodic Securities and Exchange Commission filings and to
ensure information required to be included by the Company in reports we file or
submit under the Securities Exchange Act is (i) recorded, processed, summarized
and reported, within the time periods specified in the SEC rules and forms and
(ii) accumulated and communicated to management including the Company's CEO and
CFO, as appropriate, to allow timely decisions regarding disclosure as of the
end of the period covered by this report.. The audit adjustments recorded for
2007 and 2006 are indicative of a lack of effective controls over the
application of generally accepted accounting principles commensurate with the
Company's financial reporting requirements. Management has engaged in
remediation efforts to address the material weakness identified in the Company's
disclosure controls and procedures and to improve and strengthen our overall
control environment. Notwithstanding weakness in the Company's internal control
over financial reporting as of March 31, 2008, the Company believes that the
condensed consolidated financial statements contained in this report present
fairly its financial
26
condition, the results of our operations and cash flows for the periods covered
thereby in all material respects in accordance with accounting principles
generally accepted in the United States.
CHANGES IN INTERNAL CONTROLS
As stated herein, the Company is currently working on changes to its
internal control over financial reporting (as such term is defined in Rules
13a-15(f) and 15d-15(f) of the Exchange Act) and hopes to have these changes
fully implemented by the end of the fiscal third quarter of 2008.
LIMITATIONS ON THE EFFECTIVENESS OF CONTROLS
The Company's management, including its CEO and CFO, does not expect
that our disclosure controls and procedures and internal controls will prevent
all errors 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. Further, 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 fraud, if
any, within the 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 a 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 or board override of the
control.
The design of any system of controls also 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, controls may become inadequate because of changes
in conditions, or the degree of compliance with the policies or procedures may
deteriorate. Because of the inherent limitations in a cost-effective control
system, misstatements due to error or fraud may occur and not be detected.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
We are not a party to any material legal proceedings, nor to our
knowledge, is there any proceeding threatened against it.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following is a list of our securities that have been sold or issued
by us during the period covered by this report. These securities were sold
without registration under the Securities Act in reliance on Section 4(2) of the
Securities Act. There were no underwriting discounts or commissions paid in
connection with the sale of these securities.
During the first quarter of 2008, we issued twelve month, 10% interest
secured convertible notes in the aggregate principal amount of $425,000 to four
private investors, of which $250,000 was issued to our non-executive chairman.
The investors represented in writing that they were accredited investors and
acquired the securities for their own accounts. The notes are convertible into
common stock at any time prior to maturity at an amount equal to 70% of the
average low bid price for the twenty day period prior to the conversion date
subject to a floor price of $1.00 per share. Additionally, if there is a
Qualified Financing (as defined below), the note holders are entitled to, but
not required to, convert at a rate equal to a 30% discount of the price paid per
share in the Qualified Financing with the floor of $1.00 per share. In
connection with the issuance of these notes, we issued 42,500 warrants to the
four private investors which are exercisable at any time prior to expiration
date of the warrants at a strike price per share equal to the strike price for
warrants granted under a Qualified Financing or if no Qualified Financing takes
place at the
27
average of the lowest bid price for the 20 trading days prior to the expiration
date of the warrants. The warrants expire on the fifth anniversary of the date
of their issuance. For purposes hereof, the term "Qualified Financing" is
defined as the sale for cash by the Company in a transaction or series of
related transactions of debt, equity, equity-linked securities or any
combination thereof generating gross proceeds to the Company (excluding the
principal amount of any notes tendered in connection therewith) of at least
$10,000,000.
During the first quarter of 2008 the Company issued 15,000 shares in
satisfaction of accounts payable to one vendor. The share value on the date of
issuance was $1.25, the dollar amount of accounts payable satisfaction was
$15,000.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
During the first quarter of 2008, we issued twelve month, 10%
interests secured convertible notes in the aggregate principal amount of
$425,000 to four private investors, of which $250,000 was issued to our
non-executive chairman. The investors represented in writing that they were
accredited investors and acquired the securities for their own accounts. The
notes are convertible into common stock at any time prior to maturity at an
amount equal to 70% of the average low bid price for the twenty day period prior
to the conversion date subject to a floor price of $1.00 per share.
Additionally, if there is a Qualified Financing (as defined below), the note
holders are entitled to, but not required to, convert at a rate equal to a 30%
discount of the price paid per share in the Qualified Financing with the floor
of $1.00 per share. In connection with the issuance of these notes, we issued
42,500 warrants to the four private investors which are exercisable at any time
prior to expiration date of the warrants at a strike price per share equal to
the strike price for warrants granted under a Qualified Financing or if no
Qualified Financing takes place at the average of the lowest bid price for the
20 trading days prior to the expiration date of the warrants. The warrants
expire on the fifth anniversary of the date of their issuance. For purposes
hereof, the term "Qualified Financing" is defined as the sale for cash by the
Company in a transaction or series of related transactions of debt, equity,
equity-linked securities or any combination thereof generating gross proceeds to
the Company (excluding the principal amount of any notes tendered in connection
therewith) of at least $10,000,000.
There were no changes to the procedures by which security holders may
recommend nominees to the Company's Board of Directors since the Company last
disclosed these procedures.
ITEM 6. EXHIBTS
A. Exhibits:
31.1 Certification of the Chief Executive Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act.*
31.2 Certification of the Acting Chief Financial Officer Pursuant to Section 302
of the Sarbanes-Oxley Act.*
32.1 Certifications of the Chief Executive Officer Pursuant to Section 906 of
the Sarbanes-Oxley Act.*
32.2 Certifications of the Acting Chief Financial Officer Pursuant to Section
906 of the Sarbanes-Oxley Act.*
- ------
*Filed herewith.
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SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
HC Innovation, Inc.
Date: May 15, 2008 By: /S/ DAVID CHESS, MD
-------------------
David Chess
Chief Executive Officer, President
and Director
HC Innovation, Inc.
Date: May 15, 2008 By: /S/ EMILE A. LALIBERTE
----------------------
Emile A. Laliberte
Acting Chief Financial Officer
29