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 - June 30, 2008
OR
[_] TRANSITION REPORT PUSUANT 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)
Ten Progress Drive, Suite 200 Shelton, CT 06484
(Address of Principal Executive Offices)
(203) 925-9600
(Registrant's telephone number, including area code)
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 [X] NO [_]
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, a non-accelerated filer, or a smaller reporting company.
See the definitions of "large accelerated filer," "accelerated filer," and
"smaller reporting company" in Rule 12b-2 of the Exchange Act.
LARGE ACCELERATED FILER [_] ACCERLERATED 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 [_] NO [X]
The number of shares outstanding of each of the issuer's classes of common
stock, as of August 14, 2008 is 38,615,363.
HC INNOVATIONS, INC.
And Subsidiaries
Form 10-Q - June 30, 2008
TABLE OF CONTENTS
Page
----
PART I - Financial Information
Item 1. Condensed Consolidated Financial Statements. 1
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations. 18
Item 3. Quantitative and Qualitative Disclosures about Market Risk 27
Item 4. Controls and Procedures. 27
PART II - Other Information
Item 1. Legal Proceedings. 28
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. 28
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. 29
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HC INNOVATIONS, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
June 30, 2008 December 31, 2007
(UNAUDITED) (AUDITED)
------------- -----------------
Assets
Current assets:
Cash and cash equivalents $ 76,885 $ 3,442,290
Accounts receivable, net of contractual allowances 3,509,291 2,216,059
Prepaid expenses 422,441 546,027
------------ ------------
Total current assets 4,008,617 6,204,376
Fixed assets, net 1,029,082 1,030,920
Capitalized software development costs, net 2,288,149 2,217,975
Deferred issuance costs, net 413,884 648,485
Other assets, net 87,306 80,782
------------ ------------
Total assets $ 7,827,038 $ 10,182,538
============ ============
Liabilities and Stockholders' Equity (Deficit)
Current liabilities:
Lines of credit $ 200,000 $ 200,000
Current portion of notes payable 646,385 388,414
Current portion of capital lease obligations 291,283 284,943
Convertible debentures, net of discounts 6,290,839 4,069,140
Accounts payable 2,641,623 1,770,358
Accrued liabilities 1,445,198 1,196,882
Other current liabilities 611,061 317,128
------------ ------------
Total current liabilities 12,126,389 8,226,865
Capital lease obligations, net of current portion 416,866 530,717
------------ ------------
Total liabilities 12,543,255 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 18,376,739 17,377,800
Deficit (23,109,901) (15,969,774)
------------ ------------
Total stockholders' equity (deficit) (4,716,217) 1,424,956
------------ ------------
Total liabilities and stockholders' equity (deficit) $ 7,827,038 $ 10,182,538
============ ============
THE ACCOMPANY NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.
1
HC INNOVATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
for the six and three months ended June 30, 2008 and 2007
SIX MONTHS ENDED THREE MONTHS ENDED
----------------------------- -----------------------------
JUNE 30, 2008 JUNE 30, 2007 JUNE 30, 2008 JUNE 30, 2007
------------- ------------- ------------- -------------
Net revenues $ 12,151,783 $ 4,950,441 $ 6,833,433 $ 2,752,470
Cost of services 8,876,616 4,181,698 4,761,886 2,442,989
Selling, general and administrative expenses 7,597,936 3,736,348 4,127,676 2,102,098
Depreciation and amortization 272,274 205,364 141,752 82,480
------------ ------------ ------------ ------------
16,746,826 8,123,410 9,031,314 4,627,567
------------ ------------ ------------ ------------
Loss from operations (4,595,043) (3,172,969) (2,197,881) (1,875,097)
Other income (expense)
Interest income 14,375 28,148 194 24,925
Other expense (22,132) 200 (14,767) 706
Amortization - deferred issuance costs (358,354) -- (190,535) --
Interest expense (2,178,973) (196,814) (1,130,086) (29,968)
------------ ------------ ------------ ------------
(2,545,084) (168,466) (1,335,194) (4,337)
------------ ------------ ------------ ------------
Loss before provision for income taxes (7,140,127) (3,341,435) (3,533,075) (1,879,434)
Provision for income taxes -- -- -- --
------------ ------------ ------------ ------------
Net loss $ (7,140,127) $ (3,341,435) $ (3,533,075) $ (1,879,434)
============ ============ ============ ============
Basic and diluted net loss per share $ (0.18) $ (0.09) $ (0.09) $ (0.05)
============ ============ ============ ============
Weighted average common shares outstanding 38,611,657 35,560,928 38,615,407 37,198,018
============ ============ ============ ============
THE ACCOMPANY NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.
2
HC INNOVATIONS, INC. AND SUBSIDIARIES
Condensed Consolidated Statement of Changes in Stockholders' Equity (Deficit)
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 -- -- 359,000 -- -- 359,000
Issuance of warrants in connection with
convertible debentures -- -- 118,511 -- -- 118,511
Issuance of common stock in connection with
satisfaction of accounts payable 15,000 15 18,735 -- -- 18,750
Issuance of warrants for consulting services -- -- 112,014 -- -- 112,014
Issuance of warrants to advisor in connection
with convertible debentures -- -- 45,435 -- -- 45,435
Issuance of options to Directors -- -- 345,244 -- -- 345,244
Net loss -- -- -- -- (7,140,127) (7,140,127)
---------- ------- ----------- -------- ------------ -----------
Balance, June 30, 2008 38,615,407 $38,616 $18,376,739 $(21,671) $(23,109,901) $(4,716,217)
========== ======= =========== ======== ============ ===========
THE ACCOMPANY NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.
3
HC INNOVATIONS, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
SIX MONTHS ENDED
-----------------------------
JUNE 30, 2008 JUNE 30, 2007
------------- -------------
Cash flows from operating activities:
Net loss $(7,140,127) $(3,341,435)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization - fixed assets 127,693 100,969
Amortization - capitalized software development costs 141,822 101,636
Amortization - other assets 2,759 2,759
Amortization of discount - convertible debentures 516,877 137,044
Amortization of beneficial conversion discount 1,197,333 --
Amortization of deferred issuance costs 358,354 --
Consulting services expense - warrants 112,014 156,360
Stock based compensation expense 345,244 --
Consulting services expense - common stock 18,750 105,000
Changes in operating assets and liabilities:
(Increase) decrease in:
Accounts receivable (1,293,232) (837,794)
Prepaid expenses 123,586 (184,336)
Increase (decrease) in:
Accounts payable 871,265 4,690
Accrued liabilities 248,316 92,683
Other current liabilities 293,933 128,933
----------- -----------
Net cash used in operating activities (4,075,413) (3,533,491)
----------- -----------
Cash flow from investing activities:
Increase in other assets (9,283) (43,484)
Purchases of fixed assets (125,855) (24,233)
Expenditures for capitalized software development costs (211,996) (531,108)
----------- -----------
Net cash used in investing activities (347,134) (598,825)
----------- -----------
Cash flows from financing activities:
Proceeds from issuance of convertible debentures 985,000 --
Proceeds from issuance of common stock, net -- 7,846,283
Proceeds from notes payable 275,000 --
Payments on convertible debentures -- (50,000)
Payments on notes payable (17,029) (15,837)
Payments on capital lease obligations (107,511) (63,326)
Deferred issuance costs paid (78,318) --
----------- -----------
Net cash provided by financing activities 1,057,142 7,717,120
----------- -----------
Net (decrease) increase in cash and cash equivalents (3,365,405) 3,584,804
Cash and cash equivalents - beginning of period 3,442,290 151,534
----------- -----------
Cash and cash equivalents - end of period $ 76,885 $ 3,736,338
=========== ===========
Supplemental cash flow information:
Cash paid during the year for:
Interest $ 31,822 $ 38,130
=========== ===========
Noncash investing and financing activities:
Warrants issued for debt issuance costs 45,435 --
=========== ===========
Common stock issued in connection with conversion
of convertible debentures $ -- $ 1,707,985
=========== ===========
Common stock issued for prepaid consulting services $ -- $ 105,000
=========== ===========
Common stock issued in satisfaction of accounts payable
for consulting services $ 15,000 $ --
=========== ===========
Beneficial conversion discount on convertible debentures $ 359,000 $ --
=========== ===========
Discount on convertible debentures - warrants $ 118,511 $ --
=========== ===========
Computer equipment acquired through capital lease $ -- $ 115,672
=========== ===========
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
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
and six month periods ended June 30, 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, providing care support for high risk,
high cost patients, 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 ("MCOs") as well as state Medicaid departments.
NP Care, LLCs ("LLCs") are nursing home medical management systems. The
LLCs nurse practitioner program provides onsite medical care by an Advanced
Practice Nurse Practitioner ("APNP") under the oversight of the patient's
individual physician to residents in nursing homes and assisted living
facilities. The LLCs operate in the states of Connecticut, Florida, New
Jersey, Illinois, Tennessee, and Massachusetts and are managed exclusively
by ECI.
5
HC INNOVATIONS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
1. NATURE OF OPERATIONS (CONTINUED)
GOING CONCERN / MANAGEMENT'S PLAN
As shown in the accompanying condensed consolidated financial statements,
the Company has sustained a consolidated net loss for the six-month period
ended June 30, 2008 of approximately $7.1 million. The table below sets
forth, in millions, the balances of working capital (deficit), accumulated
deficits and stockholders' equity (deficit) at June 30, 2008 and December
31, 2007 respectively.
June 30, 2008 December 31, 2007
------------- -----------------
Working capital deficit $ (8.1) $ (2.0)
Accumulated deficit $(23.1) $(16.0)
Stockholders' (deficit) equity $ (4.7) $ 1.4
The report of our independent registered public accounting firm as of and
for the year ended December 31, 2007 contains an explanatory paragraph
relating to factors that raise 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 second quarter of 2008, the Company raised $560,000 through the
issuance of convertible notes. These notes mature in April, May and June of
2009 and carry interest rates of 10% with interest accruing monthly. During
the first quarter of 2008, the Company raised $425,000 through the issuance
of convertible notes including, $250,000 issued to the Company's non
executive Chairman. These notes mature in January and February 2009 and
carry interest rates of 10% with interest accruing monthly.
We will need additional financing in the near term to fund our working
capital needs and, therefore, are discussing potential financing
alternatives with potential investors. Any financing that may be available
to us is likely to be more expensive, and on less favorable terms, than
previous financings and there is no assurance that future financings can be
closed.
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. The infrastructure expenses (selling, general and
administrative) required to support these operations are a relatively fixed
but significant sum. As we continue to expand our operation and grow our
revenues the selling, general and administrative expenses are expected to
remain relatively constant and we expect to become cash flow positive.
6
HC INNOVATIONS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
1. NATURE OF OPERATIONS (CONTINUED)
NEW CONTRACTS
During 2007, the Company was successful in securing new contracts with
McKesson Corporation (McKesson) and with Health Insurance Plan of Greater
New York (HIP). Combined these contracts provide the Company with the
opportunity to enroll up to 18,000 members generating up to $3.8 million in
monthly revenue on a per member per month basis over a three year period.
In addition, in 2007, we entered into a new contract with HealthSpring of
Tennessee, HealthSpring of Texas, and HealthSpring of Alabama. The latter
allowing us to expand our services to a tenth state. Combined these
contracts represent an additional 1,000 to 1,500 patients under management.
In the second quarter of 2008, we entered into an Agreement with Senior
Whole Health, (SWH) a Medicare, Medicaid HMO to assist them in the care of
patients residing in nursing homes in the state of Connecticut. Since SWH
is a new HMO in Connecticut it is unclear what the financial impact of this
contract will be.
Also in the second quarter of 2008, we finalized a new contract with Aetna
Health Plan to provide care management services to their members residing
in nursing homes in New Jersey. This contract is for the care of patients
in the home for short term rehabilitation as well as long term life
setting.
HIP/GHI (Emblem Health) the largest health plan in New York City has
entered into a second contract with ECI in May 2008 to provide the
management services for their Medical Home Project. This is a two year
contract with a potential value of 4.5 million dollars.
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.
7
HC INNOVATIONS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
BASIS OF PRESENTATION (CONTINUED)
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 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 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.
In addition, the Company has an exclusive long-term management services
agreement with each of the LLC's and the member 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).
8
HC INNOVATIONS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
REVENUE RECOGNITION
The Company's revenue includes fees for service revenue and revenue from
capitated contracts. Net patient service revenue consists of the following
components for the six and three month periods ended June 30, 2008 and
2007:
Six Months ended Three Months ended
---------------------------- -----------------------------
June 30, 2008 June 30, 2007 June 30, 2008 June 30, 2007
------------- ------------- ------------- -------------
Gross patient service revenue $ 7,546,679 $ 4,282,397 $3,683,201 $2,281,644
Less: provision for contractual
allowances (2,136,217) (1,319,905) (779,937) (744,113)
----------- ----------- ---------- ----------
Net patient service revenue $ 5,410,462 $ 2,962,492 $2,903,264 $1,537,531
Capitated contract revenue 6,741,321 1,987,949 3,930,169 1,214,939
----------- ----------- ---------- ----------
Total revenue $12,151,783 $ 4,950,441 $6,833,433 $2,752,470
=========== =========== ========== ==========
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 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.
9
HC INNOVATIONS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
REVENUE RECOGNITION (CONTINUED)
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. The aggregate impact of
these resulting adjustments were not significant to the Company's
operations for the six months ended June 30, 2008 and 2007. Further, the
Company does not expect the reasonably possible effects of a change in
estimate related to unsettled June 30, 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.
STOCK BASED COMPENSATION
The Company applies the provisions of Statement of Financial Accounting
Standards No. 123 (Revised 2004), "Share-Based Payment" ("SFAS 123R") to
all share based payment awards made to employees and directors. SFAS 123R
establishes accounting for equity instruments exchanged for employee
services. Under the provisions of SFAS 123R, share based compensation is
measured at the grant date, based upon the fair value of the award, and is
recognized as an expense over the holders' requisite service period
(generally the vesting period of the equity award). The Company has
expensed its share-based compensation for share based payments under the
ratable method, which treats each vesting tranche as if it were an
individual grant.
The Company periodically grants stock options for a fixed number of shares
of common stock to its employees and directors. Stock options are granted
with an exercise price greater than or equal to the fair market value of
the Company's common stock at the date of the grant. The Company estimates
the fair value of stock options using a Black-Scholes valuation model. Key
inputs used to estimate the fair value of stock options include the
exercise price of the award, the expected post-vesting option life, the
expected volatility of the Company's stock over the option's expected term,
the risk free interest rate over the option's expected term, and the
expected annual dividend yield.
The Company recognizes stock-based compensation expense for the number of
awards that are ultimately expected to vest. As a result, recognized stock
compensation is reduced for estimated forfeitures prior to vesting. The
Company's estimate of annual forfeiture rates was approximately 30%.
Estimated forfeitures will be reassessed in subsequent periods and may
change based on new facts and circumstances.
Since the Company has not generated any taxable income to date and has not
paid any federal or state taxes based on income since inception, it has
provided a valuation allowance for the full amount of its net deferred tax
assets and, accordingly, no tax benefits related to stock compensation
expense have been recorded in its condensed consolidated financial
statements.
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 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 June 30, 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 2004-2007
remain open to examination by the I.R.S. and state authorities.
10
HC INNOVATIONS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
EARNINGS PER SHARE
Basic earnings 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 earnings per
share is antidilutive and, as such, basic and diluted earnings per share
are the same for the six and three month periods ended June 30, 2008 and
2007.
ACCOUNTING STANDARDS NOT YET ADOPTED
In March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative
Instruments and Hedging Activities" ("SFAS 161"), which changes the
disclosure requirements for derivative instruments and hedging activities.
SFAS 161 requires enhanced disclosures about (a) how and why an entity uses
derivative instruments, (b) how derivative instruments and related hedged
items are accounted for under SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" and its related interpretations, and
(c) how derivative instruments and related hedged items affect an entity's
financial position, financial performance, and cash flows. This Statement
is effective for financial statements issued for fiscal years and interim
periods beginning after November 15, 2008. The Company has not yet
determined the effect, if any, that SFAS 161 will have on its condensed
consolidated financial statements.
RECLASSIFICATIONS
Certain reclassifications have been made to prior period financial
information to conform to the current period classifications.
3. CAPITALIZED SOFTWARE DEVELOPMENT COSTS
Capitalized software development costs as of June 30, 2008 and December 31,
2007 are summarized as follows:
June 30, 2008 December 31, 2007
------------- -----------------
Capitalized software development costs $2,825,088 $2,613,092
Less: accumulated amortization (536,939) (395,117)
----------- ----------
$2,288,149 $2,217,975
=========== ==========
11
HC INNOVATIONS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
3. CAPITALIZED SOFTWARE DEVELOPMENT COSTS (CONTINUED)
Amortization expense related to capitalized software development costs for
the six month periods ended June 30, 2008 and 2007 totaled approximately
$142,000 and $102,000, respectively. For the three month periods ended June
30, 2008 and 2007 amortization expense totaled approximately $74,000 and
$55,000 respectively.
4. NOTES PAYABLE
Between May 27, 2008 and May 29, 2008, the Company issued $275,000
principal amount of unsecured subordinated promissory notes. The notes bear
interest at the rate of 10% per annum. The terms of the Company's
outstanding indebtedness require the consent of the senior secured
convertible note holders prior to the incurrence of any additional
indebtedness by the Company. The Company is in process of securing such
consents, although there can be no assurance that all such consents will be
received.
5. CONVERTIBLE NOTES
The Company issued approximately $6.5 million and $985,000 in twelve month,
10% interest, senior secured convertible notes to nine private investors
during the fourth quarter of 2007 and the first six months of 2008,
respectively. The company also issued $800,000 in twelve month, 10%
interest, unsecured convertible notes to two investors and one vendor (who
converted $500,000 of payables) in the fourth quarter of 2007. The Company
issued $250,000 of the $985,000 convertible notes to its 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 (25% for
$3 million worth of the notes) 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 six months 2008 convertible note sales,
the Company issued 636,477 and 98,500 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 consecutive trading days prior to the expire date per
share.
12
HC INNOVATIONS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
5. CONVERTIBLE NOTES (CONTINUED)
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.
The convertible notes issued during the fourth quarter of 2007 and the
first six months of 2008 contained beneficial conversion discounts totaling
$1,779,000 and $359,000, 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 six months of 2008 at $979,147 and $118,511
and allocated $5,385,618 and $866,489 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%,
volatilities ranging from 152% to 168% 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 $7,999,765 at June 30, 2008 and $7,014,765 at December 31, 2007
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 six months ended June 30, 2008 the Company
recorded interest expense of $1,197,333 related to the beneficial
conversion discount and $516,877 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 $671,278 in 2007 and an additional $123,753 during the
six-month period ended June 30, 2008 in deferred issuance costs relating to
the issuance of the convertible notes. Amortization expense associated with
the deferred issuance costs totaled $358,354 for the six month period ended
June 30, 2008.
13
HC INNOVATIONS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
5. CONVERTIBLE NOTES (CONTINUED)
At June 30, 2008 and December 31, 2007, the unamortized balance of the
beneficial conversion features were $1,204,334 and $2,042,667,
respectively, the unamortized balance of the warrant discounts were
$504,592 and $902,958, respectively, and the unamortized balance of
deferred issuance costs were approximately $490,000 and $648,000,
respectively.
6. STOCKHOLDERS' EQUITY (DEFICIT)
COMMON STOCK
During the first six months 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 Average Weighted Average
Warrants Price Price Life (Years)
--------- ----- ---------------- ----------------
Balance January 1, 2008 5,068,210 1.88 3.0
Issued 147,165 0.85 0.85 5.0
Issued 40,000 1.10 1.10 5.0
Issued 20,000 1.35 1.35 5.0
Issued 40,000 1.20 1.20 5.0
--------- ---- ----
Balance June 30, 2008 5,315,375 1.84 3.09
========= ==== ====
Exercisable June 30, 2008 4,339,733 2.06 2.8
========= ==== ====
STOCK OPTIONS
On March 25, 2008, the Company adopted the 2008 Stock Incentive Plan (the
"Plan"). The purpose of the Plan is to promote the long-term growth and
profitability of the Company by enabling the Company to attract, retain and
reward the best available persons for positions of substantial
responsibility within the Company or certain affiliates of the Company.
Under the Plan, eligible participants may be awarded options to purchase
common stock of the Company. The Board has authority to administer the Plan
and has delegated this authority to the Compensation Committee of the
Board. In addition, the Board or the Compensation Committee may delegate
duties to the Company's chief executive officer of other senior officers of
the Company, to the extent permitted by law and the Company's Bylaws.
Employees, officers, directors and consultants of the Company, or of
certain affiliates of the Company, are eligible to participate in the Plan.
However, the actual recipients of awards under the Plan are selected by the
Board or the Compensation Committee. The Plan authorizes the granting of
awards for up to a maximum of six million nine hundred forty eight thousand
seventy three (6,948,073) shares of common stock of the Company. If any
award granted under the Plan expires, terminates or is forfeited,
surrendered or canceled, without delivery (or, in the case of restricted
shares, vesting) of common stock or other consideration, the common stock
of the Company that were underlying the award shall again be available
under the Plan.
On March 28, 2008, the Board of Directors of the Company granted 1,050,000
nonqualified stock options to certain non-employee directors of the Company
(collectively, the "Non-Employee Director Options"). The Non-Employee
Director Options were granted pursuant to the Company's Plan. A portion of
the Non-Employee Director Options vested at grant with the balance vesting
over a four-year period beginning on the first anniversary of the initial
grant date and will expire on March 28, 2012. The exercise price per share
payable upon the exercise of each of the Non-Employee Director Options is
$1.22 which is equal to the fair market value as of March 28, 2008 of the
Company's common stock as determined by the March 28, 2008 closing price of
the Company's common stock. The fair value of the stock options were
determined using the Black-Scholes model assuming an exercise price of
$1.22, risk free interest rate of 5%, volatility of 165% and a term equal
to the contractual life of the stock options. As the result of the
resignation of one of the Company's non-executive directors in the three
month period ending June 30, 2008, 200,000 options were forfeited. No new
options were granted under the Plan for the three month period ending June
30, 2008.
Share information related to options granted under the 2008 Stock Incentive
Plan is as follows:
Non-Employee Wght. Average
Director Options Exercise Price
---------------- --------------
Outstanding at January 1, 2008 0 $1.22
Granted 1,050,000 $1.22
Forfeited (200,000) $1.22
Exercised 0
---------
Outstanding at June 30, 2008 850,000 $1.22
=========
Available for future grant
Average remaining term (years) 9.75
Exercisable at June 30, 2008 250,000 $1.22
Intrinsic Value:
Outstanding 0
Exercisable 0
The following table summarizes the components and classification of
stock-based compensation expense included in the statement of operations.
Stock options
granted pursuant Fair Value
to the 2008 Grant Options on Vested
Stock Incentive Plan Date Granted Grant Date Options Compensation Category
- ----------------------- --------- --------- ---------- -------- ------------ --------
Non-executive Directors 3/27/2008 1,050,000 1,271,953 250,000 302,846(1) SG&A
42,398(2) SG&A
(1) three months ending March 31, 2008
(2) three months ending June 30, 2008
Additional compensation expense (net of estimated forfeitures) related to
the unvested portion of stock options granted pursuant to the 2008 Stock
Incentive Plan totaled $635,977 as of June 30, 2008. Unvested compensation
expense related to stock options granted pursuant to the 2008 Stock
Incentive Plan is expected to be recognized over a remaining vesting period
of 3.75 years.
As the Company has not achieved profitable operations, management has
determined that it is more likely than not that the future benefits arising
from any stock based compensation will not be realized and has accordingly
recorded a valuation allowance for the full amount of any resulting
deferred tax assets.
14
HC INNOVATIONS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
7. 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 had an initial six
month term that was extended to August 2008. During the first six months of 2008
the Company incurred expenses of $55,000 related to this consulting agreement.
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 six months of 2008, the Company incurred
cash expenses of $60,000 related to this consulting agreement. The Company and
advisor mutually agreed to forgo the cash payment of $15,000 due in June.
During the first six months of 2008, the Company issued 100,000 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 approximately $112,000 assuming exercise prices
ranging from $1.10 and $1.35 from February through June 2008, respectively, a
risk free interest rate of 5%, volatility of 168% term equal to the contractual
life of the warrants. These transactions resulted in charges to additional paid
in capital during the six month period ended June 30, 2008.
15
HC INNOVATIONS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
8. BUSINESS SEGMENTS
The Company's operations by business segment for the six and three months ended
June 30, 2008 and 2007 were as follows:
Medical Management Systems Specialty Care Management
2008 - Facility - Community Total
- ------------------------- -------------------------- ------------------------- -------------
Net Revenues $ 5,410,462 $ 6,741,321 $ 12,151,783
=========== =========== ============
Business Unit Loss (1,559,210) (1,023,519) (2,582,729)
Unallocated Overhead (2,012,314)
============
Operating Loss ($4,595,043)
============
Identifiable Assets $ 2,053,593 $ 5,773,445 $ 7,827,038
=========== =========== ============
Medical Management Systems Specialty Care Management
2007 - Facility - Community Total
- ------------------------- -------------------------- ------------------------- -------------
Net Revenues $ 3,021,696 $1,928,745 $ 4,950,441
=========== ========== ===========
Business Unit Profit (Loss) (1,631,188) 261,262 (1,369,926)
Unallocated Overhead (1,803,043)
===========
Operating Loss ($3,172,969)
===========
Identifiable Assets $ 1,156,598 $6,303,932 $ 7,460,530
=========== ========== ===========
9. RISKS AND UNCERTAINTIES
PATIENT SERVICE REVENUE
Approximately 33% and 87% of net patient services revenue for the six months
ended June 30, 2008 and 2007 respectively, was derived under 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
16
HC INNOVATIONS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
9. RISKS AND UNCERTAINTIES (CONTINUED)
PATIENT SERVICE REVENUE (CONTINUED)
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.
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 six months ended June 30, 2008 and 2007, no
known malpractice claims have been asserted against the Company which, either
individually or in the aggregate, are in excess of insurance coverage.
10. RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS AND CHANGES TO PRIOR
PERIODS PRESENTATION
In the course of a review by the Company of its accounting for stock based
compensation undertaken during the preparation of the Company's unaudited
condensed consolidated financial statements for the three and six months ended
June 30, 2008, the Company identified an error in accounting for stock based
compensation relating to stock options issued to non-employee directors during
the three months ended March 31, 2008. The Company has restated its previously
issued unaudited interim condensed consolidated financial statements for the
three months ended March 31, 2008. The effect of the restatement on these
interim condensed consolidated financial statements for the three months ended
March 31, 2008 is as follows:
Condensed Consolidated Statement of Operations
Previously
Reported Adjustment Restated
------------- ---------- -------------
Selling, general and administrative $ 3,167,414 $ 302,846 $ 3,470,260
Loss from operations (2,262,135) (302,846) (2,564,981)
Net loss (3,304,206) (302,846) (3,607,052)
Condensed Consolidated Balance Sheets
Previously
Reported Adjustment Restated
------------- ---------- -------------
Additional paid-in capital $ 17,709,536 $ 302,846 $ 18,012,382
Deficit (19,273,980) (302,846) (19,576,826)
11. SUBSEQUENT EVENT
STOCK BASED COMPENSATION
On July 18, 2008, the Board granted employees 885,000 options with an exercise
price of $1.01 (closing price on July 18, 2008) under the Company's Stock
Incentive Plan.
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, which was filed on April 1st, 2008. 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 as filed on April
1, 2008 and (2) our Registration Statement Form 10-SB, as such Registration
Statement became effective on February 13, 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
Our corporate strategy is to 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
securing additional working capital, continued investment in information systems
and the ongoing execution of its growth plans. The cumulative losses to date are
largely a result of business development, 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. The corporate SGA required to
do business is substantial and largely fixed.
During 2007, the Company was successful in securing new contracts with
McKesson Corporation (McKesson) and with Health Insurance Plan of Greater New
York (HIP). Combined, these contracts provide us with the opportunity to enroll
up to 18,000 members, generating prospective monthly revenue in excess of $3.8
million (per member per month at current pricing).
In addition, the Company's contract with HealthSpring USA, LLC
("HealthSpring") has been expanded from the initial 300 members in the Tennessee
metropolitan statistical area ("MSA") to approximately 1,300 members in a total
of three Tennessee MSAs. HealthSpring has also awarded HCI contracts to serve
populations in Texas and Alabama, further extended its relationship with the
Company.
RESULTS OF OPERATIONS
The Company's focus for fiscal years 2003 through the second quarter of
2008 was to invest in the areas of IT infrastructure, systems development,
clinical protocol training and development, human resource recruiting, training
and development as well as marketing, business development expense and expansion
into new markets. The Company has 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. Since the second half of 2007,
and 2008 to date, the Company has also invested in additions to its management
and systems infrastructure in anticipation of the 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 also believes its business
models are highly scalable; however, there are significant start-up costs
associated with expansions into new markets and there can be no assurance that
the Company will be successful in securing new contracts and growing these new
markets profitably.
THREE AND SIX - MONTHS ENDED JUNE 30, 2008 AND 2007
Revenues
For the three months ended June 30, 2008, net revenue was $6,833,433,
representing an increase of $4,080,963 (148%) as compared to the net revenue of
$2,752,470 for the three months ended June 30, 2007. The increase is a result of
growth from existing operations in the amount of $943,281 or 34% as compared to
the second quarter of 2007 as well as $2,514,942 of revenue from new operations
in the second quarter of 2008. During the second quarter of 2008, new NP Care
operations generated $724,113 in revenue and new Easy Care operations generated
$1,790,829 in revenue.
19
For the six months ended June 30, 2008, net revenue was $12,151,783,
representing an increase of $7,201,342 (145%) as compared to the net revenue of
$4,950,441for the six months ended June 30, 2007. The increase is a result of
growth from existing operations in the amount of $1,852,427 or 37% as compared
to the first six months of 2007 as well as $4,456,175 of revenue from new
operations in the first six months of 2008. During the first six months of 2008,
new NP Care operations generated $1,300,769 in revenue and new Easy Care
operations generated $3,155,406 in revenue.
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.
Cost of Net Revenue and Gross Profit
For the three months ended June 30, 2008, cost of net revenue was
$4,761,886, representing an increase of $2,318,897 (95%) as compared to the cost
of net revenue of $2,442,989 for the three months ended June 30, 2007.
For the six months ended June 30, 2008, cost of net revenue was $8,876,616,
representing an increase of $4,694,918 (112%) as compared to the cost of net
revenue of $4,181,698 for the six months ended June 30, 2007. The increase is a
result of growth from existing operations in the amount of $3,123,227 or (75%)
as compared to the first six months of 2007 as well as $1,571,691 of cost of net
revenue from new operations in the first six months 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 June 30, 2008, gross margin was $2,071,547 (27%)
representing an increase of $1,762,066 (569%) as compared to the gross margin of
$309,481 (11%) for the three months ended June 30, 2007. The margin improvement
is a result of the Company's maturity of operations in new markets combined with
improved efficiencies in operations.
For the six months ended June 30, 2008, gross margin was $3,275,167 (27%)
representing an increase of $2,506,424 (326%) as compared to the gross margin of
$768,743 (28%) for the six months ended June 30, 2007. The margin improvement is
a result of the Company's maturity of operations in new markets combined with
improved efficiencies in operations.
Selling, General and Administrative (SG&A) Expense
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 June
30, 2008, total SG&A Expenses were $4,127,676 representing an increase of
$2,025,578 (96%) as compared to the total SG&A Expenses of $2,102,098 for the
three months ended June 30, 2007. For the six months ended June 30, 2008, total
SG&A Expenses were $7,597,936 representing an increase of $3,861,588 (103%) as
compared to the total SG&A Expenses of $3,736,348 for the six months ended June
30, 2007. The increases in both the three and six month periods of 2008 as
compared to the comparable periods of 2007 is due to the increase in the support
staff required to execute on new contracts, internalizing functions (finance)
which were outsourced and the introduction of stock based compensation.
For the three months ended June 30, 2008, depreciation and amortization
expense included in operating expenses was $141,752, representing an increase of
$59,272 (72%), as compared to the total depreciation and amortization expense of
$82,480 for the three months ended June 30, 2007. For the six months ended June
30, 2008, depreciation and amortization expense included in operating expenses
was $272,274, representing an increase of $66,910 (33%), as compared to the
total depreciation and amortization expense of $205,364 for the six months ended
June 30, 2007.
20
Income (Loss) from operations
For the three months ended June 30, 2008, we incurred a loss from
operations of $2,197,881 representing an increase of $322,784 (17%) compared to
a loss from operations of $1,875,097 for the three months ended June 30, 2007.
For the six months ended June 30, 2008, we incurred a loss from operations of
$4,595,043 representing an increase of $1,422,074 (45%) compared to a loss from
operations of $3,172,969 for the six months ended June 30, 2007.
Other Income (Expense)
For the three months ended June 30, 2008, net other expenses were
$1,335,194 representing an increase of $1,330,857 compared to net other expenses
of $4,337 for the three months ended June 30, 2007. For the six months ended
June 30, 2008, net other expenses were $2,545,084 representing an increase of
$2,376,618 compared to net other expenses of $168,466 for the six months ended
June 30, 2007. Amortization of beneficial conversion discounts and deferred
financing costs related to the issuance of convertible debentures in the fourth
quarter of 2007 and the first six months of 2008 were the primary factors
driving the increase of these expenses for both comparative time periods.
Primary Strategy - Specialty Care Management - Community
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 medium to large
sized Medicare Advantage programs - with Medicare enrollment above
25,000. These plans although they have disease management programs,
their programs don't extend into the community with a hands on
approach. They are growing their Medicare membership and need a
partner to help manage their most costly subset of members. Most of
these plans are well established, though some are relatively new to
Medicare. We have had significant success connecting with several of
these plans with several significant contracts pending.
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, 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. An example of this is
our contract with Amerigroup.
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. This is exemplified by our
contract with McKesson to assist them in the management of all
Medicaid recipients living in nursing homes in Illinois.
21
PLAN OF OPERATIONS - Medical Management Systems - Facility
We have established relationships with the key nursing home chains and
we are operating in the Connecticut, New Jersey, Tennessee, Massachusetts,
Illinois and Florida markets.
NP Care's revenue streams include four 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.
o State Medicaid Programs - our contract of March 2007 with McKesson
represents capitated revenue on a per member per month basis for up to
8,000 Medicaid recipients in the State of Illinois.
With the above acknowledged, management believes that the Easy Care and
Quality of Life Care businesses are more scalable. It is the intent of
management to focus resources on thes community based operations.
LIQUIDITY AND CAPITAL RESOURCES
As shown in the accompanying condensed consolidated financial statements,
the Company has sustained consolidated net losses for the six-month periods
ended June 30, 2008 and 2007 of $7,140,127 and $3,341,435, respectively. At June
30, 2008, the Company had a working capital deficiency of approximately $8.1
million, and has accumulated deficits of approximately $23.1 million and $16
million at June 30, 2008 and December 31, 2007, respectively. The report of our
independent registered public accounting firm as of and for the year ended
December 31, 2007 contains an explanatory paragraph relating to factors that
raise 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.
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 (HIP).
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.
The Company has historically financed its 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 debentures and cash
flows from operations. At June 30, 2008 and December 31, 2007, we had $76,885
and $3,442,290, respectively, in cash and cash equivalents. Operating activities
(operating loss plus depreciation, amortization and stock based compensation)
for the six months ended June 30, 2008 used $3,977,525, representing an increase
of $1,009,920 (34%) when compared to the cash used in operating activities of
$2,967,605 for the six months ended June 30, 2007. This level of cash
utilization reflects the continued investment in building corporate
infrastructure, start-up costs associated with new contracts, expansion into new
markets and increased spending with respect to business development. Management
believes that it will be
22
successful in its efforts to adequately meet its capital needs of the Company
and continue to execute on its operations plan.
During the three and six months ending June 30, 2008, the Company
raised $600,000 and $1.0 million of convertible debentures, respectively.
During the fourth quarter of 2007, the company issued $7.0 million of
convertible debentures as noted above.
During the second quarter of 2007, the Company sold to four (4)
private investors a total of 1,666,667 shares of restricted common stock for
aggregate net proceeds of $5,000,000. Additionally, the Company issued warrants
to purchase 833,333 shares of common stock at a strike price of $4.00 to these
same investors, the warrants are exercisable for a period of four (4) years. The
investors represented in writing that they were accredited investors and
acquired the securities for their own accounts. A legend was placed on the
securities stating that such securities have not been registered under the
Securities Act and cannot be sold or otherwise transferred without an effective
registration statement covering such shares or the availability of an exemption
from the registration requirements of the Securities Act.
During the first quarter of 2007, $1,707,985 of the outstanding
$1,757,985 convertible debentures were converted into common stock at a ratio of
one share per one dollar of debt resulting in a total issuance of common stock
of 1,707,985 shares during the quarter. The remaining $50,000 of convertible
debt was repaid on April 6, 2007.
During the six month period ending June 30, 2007, and in connection
with the September Offering, the Company requested that 29 investors exercise
their respective warrants and in return the Company offered the investors an
additional two year warrant ("2007 Warrant") at an exercise price of $3.00 for
every two warrants exercised from the September Offering. During the six month
period ending June 30, 2007, the Company received $1,875,000 upon the exercise
of 1,500,000 of the September Offering warrants and has issued warrants for an
additional 750,000 shares of the Company's common stock to Ten (10) September
Offering investors. The investors represented in writing that they were
accredited investors and acquired the securities for their own accounts. A
legend was placed on the securities stating that such securities have not been
registered under the Securities Act and cannot be sold or otherwise transferred
without an effective registration statement covering such shares or an the
availability of an exemption from the registration requirements of the
Securities Act.
The Company has incurred significant costs for the development of
software for internal use. As of June 30, 2008 and 2007, the Company incurred
$2,825,088 and $2,017,692 respectively, in capitalized software costs.
LIQUIDITY ANALYSIS
At June 30, 2008, we had cash and cash equivalents of only $76,885. We have
tightened controls of our operating expenses somewhat, but expect to have
continuing liquidity demands to meet our operating expenses and fund our growth.
We will need additional financing in the near term to fund our working capital
needs and, therefore, are discussing potential financing alternatives with
potential investors. Any financing that may be available to us is likely to be
more expensive, and on less favorable terms, than previous financings and there
is no assurance that future financings can be closed.
The senior secured and unsecured convertible notes issued on various dates from
November 28, 2007 through June 12, 2008 must be repaid in cash in unless the
notes are converted into shares of common stock. Our ability to repay the notes
will depend upon the willingness of the investors to accept repayment in stock
or on our having or raising the cash needed to repay. Each note matures twelve
months from its issuance date.
Certain provisions in the senior secured convertible notes limit our ability to
raise financing in the future. We agreed not to incur any additional
indebtedness, and substantially all of our assets have been pledged to secure
the indebtedness under the notes and we have agreed not to pledge any assets to
support other indebtedness. These provisions may hamper our ability to raise
additional capital while the notes are outstanding.
Accounts Receivable
As of June 30, 2008 and December 31, 2007, the Company's accounts
receivable aging by major payers was as follows:
JUNE 30, 2008 0 - 30 31 - 60 61 - 90 > 90 TOTAL
--------- ------- ------------------- ---------
Medicare 818,377 98,373 91,881 293,343 1,301,974
Healthnet 80,934 68,729 58,255 267,956 475,874
Medicaid 32,098 14,286 11,144 67,713 125,241
Blue Cross 44,709 34,143 40,835 237,838 357,525
Other Private 827,885 69,837 59,123 291,832 1,248,677
--------- ------- ------- --------- ---------
1,804,003 285,368 261,238 1,158,682 3,509,291
========= ======= ======= ========= =========
DECEMBER 31, 2007 0 - 30 31 - 60 61 - 90 > 90 TOTAL
--------- ------- ------- --------- ---------
Medicare 381,268 95,460 76,711 190,782 744,221
Healthnet 5,779 1,766 1,193 5,320 14,058
Medicaid 11,842 9,917 10,898 49,387 82,044
23
Blue Cross 33,267 19,154 18,040 59,626 130,088
Other Private 1,055,844 87,374 62,563 39,867 1,245,648
--------- ------- ------- --------- ---------
1,488,000 213,672 169,406 344,981 2,216,059
========= ======= ======= ========= =========
Receivables recorded at June 30, 2008 and December 31, 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 the Company's 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. The Company monitors its 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 the Company's consolidated financial
statements for six months ended June 30, 2008 and the year ended December 31,
2007 are recorded at the amount ultimately expected to be received from these
payers. For the six months ended June 30, 2008 and the year ended December 31,
2007, there were $2,136,217 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 six months ended June 30, 2008 and 2007, there were no bad debt direct
write-offs recorded in the Company's results of operations.
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.
24
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.
The Company is 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 June 30, 2008 are as follows:
Years Ending December 31,
- ----------------------------
2008 262,945
2009 523,241
2010 309,307
2011 90,347
2012 46,767
---------
Total minimum lease payments 1,232,607
---------
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 had an
initial six month term that was extended to August 2008. During the first six
months of 2008 the Company incurred expenses of $55,000 related to this
consulting agreement.
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 six months of 2008, the Company incurred
cash expenses of $60,000 related to this consulting agreement. The Company and
advisor mutually agreed to forgo the cash payment of $15,000 due in June.
During the first six months of 2008 the Company issued 100,000 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 $112,330 assuming exercise prices ranging from $1.10
and $1.35 from February through June 2008, respectively, a risk free interest
rate of 5%, volatility of 165% term equal to the contractual life of the
warrants. These transactions resulted in charges to additional paid in capital
during the six month period ended June 30, 2008.
Lease of facility for Corporate Headquarters
On August 3, 2007 the Company entered into a sublease agreement for
approximately 13,000 square feet of office space to be used as Corporate
Headquarters. The lease term expires in January of 2010 and calls for annual
lease payments of approximately $135,000 dollars for the term of the lease.
25
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.
REVENUE RECOGNITION
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. Payments for services rendered to patients covered by these programs
are generally less than billed charges. The Company monitors its 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 the Company's consolidated financial statements are
recorded at the amount ultimately expected to be received from these payers.
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 payer/service
mix. Contractual allowance estimates are adjusted to actual amounts as cash is
received and claims are settled. Further, the Company does 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.
STOCK BASED COMPENSATION
The Company applies the provisions of Statement of Financial
Accounting Standards No. 123 (Revised 2004), "Share-Based Payment" ("SFAS 123R")
to all share based payment awards made to employees and directors. SFAS 123R
establishes accounting for equity instruments exchanged for employee services.
Under the provisions of SFAS 123R, share based compensation is measured at the
grant date, based upon the fair value of the award, and is recognized as an
expense over the holders' requisite service period (generally the vesting period
of the equity award). The Company has expensed its share-based compensation for
share based payments under the ratable method, which treats each vesting tranche
as if it were an individual grant.
The Company periodically grants stock options for a fixed number of
shares of common stock to its employees and directors. Stock options are granted
with an exercise price greater than or equal to the fair market value of the
Company's common stock at the date of the grant. The Company estimates the fair
value of stock options using a Black-Scholes valuation model. Key inputs used to
estimate the fair value of stock options include the exercise price of the
award, the expected post-vesting option life, the expected volatility of the
Company's stock over the option's expected term, the risk free interest rate
over the option's expected term, and the expected annual dividend yield.
The Company recognizes stock-based compensation expense for the number
of awards that are ultimately expected to vest. As a result, recognized stock
compensation is reduced for estimated forfeitures prior to vesting. The
Company's estimate of annual forfeiture rates was approximately 30%. Estimated
forfeitures will be reassessed in subsequent periods and may change based on new
facts and circumstances.
Since the Company has not generated any taxable income to date and has
not paid any federal or state taxes based on income since inception, it has
provided a valuation allowance for the full amount of its net deferred tax
assets and, accordingly, no tax benefits related to stock compensation expense
have been recorded in its condensed consolidated financial statements.
CAPITALIZED SOFTWARE DEVELOPMENT COSTS
The Company has 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) 98-1,
"ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE DEVELOPED OR OBTAINED FOR
INTERNAL USE." In accordance with SOP 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 the Company with respect to
certain external factors, including, but not limited to, technological and
economic feasibility, and estimated economic life.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's financial instruments include cash, 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
26
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.
The Company provides 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.
ACCOUNTING STANDARDS NOT YET ADOPTED
In March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative
Instruments and Hedging Activities" ("SFAS 161"), which changes the disclosure
requirements for derivative instruments and hedging activities. SFAS 161
requires enhanced disclosures about (a) how and why an entity uses derivative
instruments, (b) how derivative instruments and related hedged items are
accounted for under SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities" and its related interpretations, and (c) how derivative
instruments and related hedged items affect an entity's financial position,
financial performance, and cash flows. This Statement is effective for financial
statements issued for fiscal years and interim periods beginning after November
15, 2008. The Company has not yet determined the effect, if any, that SFAS 161
will have on its condensed consolidated financial statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not required under Regulation S-K for "smaller reporting companies."
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
Interim 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 combined with the restatement of the Form 10-Q for the period
ending March 31, 2008 relating to errors in accounting for stock based
compensation 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 June 30, 2008, the Company believes that the condensed
consolidated financial statements contained in this report present fairly its
financial 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.
27
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 second quarter of 2008, we issued twelve month, 10% interest
secured convertible notes in the aggregate principal amount of $985,000 to nine
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% (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 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 (25% for $3 million worth of the notes) 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 98,500 warrants, 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 consecutive trading days prior to the expire date per share. 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.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
SENIOR SECURED CONVERTIBLE NOTES
During the second quarter of 2008, we issued twelve month, 10%
interest secured convertible notes in the aggregate principal amount of $985,000
to nine 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% (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 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 (25% for $3 million worth of the notes) 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 98,500 warrants, 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 consecutive trading days prior to the expire date per
share. 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.
28
ADDITIONAL RISK FACTORS
WE WILL NEED TO RAISE SIGNIFICANT ADDITIONAL CAPITAL TO CONTINUE OUR
BUSINESS OPERATIONS.
Our cash position on a consolidated basis at June 30, 2008 was $76,885 as
compared to $3.4 million at December 31, 2007. We currently anticipate the need
to raise an additional $10 million to $15 million through the sale of common
stock, debt issuance, or a combination of both during the remainder of 2008 in
order to fund operations and execute on our business plan. While we are speaking
with potential investors, our ability to raise such an amount of capital in
light of current market uncertainties cannot be assured. Furthermore, it is
likely that our existing shareholders will experience significant dilution in
connection with any future financing.
AN INABILITY TO ACCESS FINANCIAL MARKETS COULD ADVERSELY AFFECT THE
EXECUTION OF THE COMPANY'S BUSINESS PLAN.
Additional capital will be needed, either through issuing more common stock,
other equity securities or debt to fund the Company's operations. Any additional
debt or preferred equity securities would be senior to common equity holders in
bankruptcy. Any additional common stock issued by the Company would dilute
existing shareholder interests. Further, no assurance can be given as to how
much additional working capital will be required or that additional financing
can be obtained on terms that will allow the Company to execute its business
plans or meet its financial obligations as they become due.
The Company relies on access to the capital markets as a significant source of
liquidity for capital requirements not satisfied by cash flow from operations.
Management cannot assure that the Company and its subsidiaries will maintain
sufficient access to these financial markets based upon the Company's current
financial position. Moreover, certain developments outside of the Company's
control may increase the cost of borrowing or restrict its ability to access one
or more financial markets. Such developments could include, but are not limited
to, an economic downturn, an increase in interest rates or a further weakening
of the Company's financial position.
Departure of Directors or Principal Officers; Election of Directors; Appointment
of Certain Officers
(a) On July 28, 2008, Emile A. Laliberte resigned as Acting Chief Financial
Officer, Corporate Controller, Secretary and Treasurer of HC Innovations, Inc.
(the "Company"), to become effective August 15, 2008. The Board of Directors
appointed David Chess as the Interim Chief Financial Officer.
(b) Effective July 19, 2008, Tina Bartelmay was appointed to the position of
President and Chief Operating Officer of the Company.
Ms. Bartelmay (age 48) brings more than twenty-four years of diverse healthcare
experience to the Company, where she has focused her energies during the past
fifteen years in the care and disease management sectors. She has extensive
experience working with employers, health plans and emerging technology
companies to provide strategic planning, product development, and operations
support for innovative solution sets. She also brings significant experience in
sales and sales management from which she has forged a deep knowledge of the
marketplace and evolving customer needs. Prior to joining the Company, Ms.
Bartelmay was the Vice President of Employer Solutions for OptumHealth from 2007
to 2008,where she was responsible for building, coaching and leading a
world-class team of sales and business development professionals. Her past
experience also includes serving as the Vice President of Sales and Account
Management for Avivia Health from Kaiser Permanente (from 2005 to 2007),
Executive Vice President of Operations for CNA Health Partners (from 1993 to
1999) and running her own consulting company. Ms. Bartelmay has an MBA from
Texas A&M University, and a BS in Allied Health Professions from Ohio State
University.
There is no family relationship between Ms. Bartelmay and any director,
executive officer or person nominated or chosen by the Company to become a
director or executive officer.
ITEM 6. EXHIBITS
A. Exhibits:
31.1 Certification of the Chief Executive Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act.*
31.2 Certification of the Chief Financial Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act.*
32.1 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act.*
32.2 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act.*
- ----------
* Filed herewith.
29
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: August 15, 2008 By: /s/ David Chess, MD
----------------------------------
David Chess
Chief Executive Officer, President
and Director
HC Innovation, Inc.
Date: August 15, 2008 By: /s/ David Chess, MD
----------------------------------
David Chess
Interim Chief Financial Officer
30