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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________to________
Commission file number 0-28456
METROPOLITAN HEALTH NETWORKS, INC.
(Exact name of registrant as specified in its charter)
Florida 65-0635748
(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification No.)
500 Australian Avenue, West Palm Beach, Fl. 33401
(Address of principal executive office) (Zip Code)
(561) 805-8500
(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 the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Class Outstanding as of September 30, 2002
----- ------------------------------------
Common Stock par value $.001 31,364,127
METROPOLITAN HEALTH NETWORKS, INC.
INDEX
Page
----
Part I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (Unaudited):
Condensed Consolidated Balance Sheets
as of September 30, 2002 and December 31, 2001 3
Condensed Consolidated Statements of
Operations for the Three and Nine Months
Ended September 30, 2002 and 2001 4
Condensed Consolidated Statements of
Cash Flows for the Nine Months Ended
September 30, 2002 and 2001 5
Notes to Condensed Consolidated
Financial Statements 6-12
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of
Operations 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
PART II. OTHER INFORMATION
Summary of Legal Proceedings 19
Changes in Securities and Use of Proceeds 19
Default Upon Senior Securities 19
Submission of Matters to a Vote of Security
Holders 19
Other Information 19
Forward Looking Statements and
Associated Risks 20
SIGNATURES 20
2
METROPOLITAN HEALTH NETWORKS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2002 AND DECEMBER 31, 2001
================================================================================
September 30, 2002 December 31, 2001
(Unaudited) (Audited)
------------------ -----------------
ASSETS
CURRENT ASSETS
Cash and equivalents $ 219,066 $ 393,968
Accounts receivable, net of allowances 14,305,882 13,362,782
Inventory 1,276,777 697,489
CDs-restricted 600,000 --
CDs receivable-restricted 400,000 --
Other current assets 499,855 451,627
------------ ------------
Total current assets 17,301,580 14,905,866
PROPERTY AND EQUIPMENT, net 1,227,894 1,336,168
GOODWILL, net 1,993,824 2,977,874
OTHER ASSETS 350,001 142,767
------------ ------------
TOTAL ASSETS $ 20,873,299 $ 19,362,675
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 4,110,919 $ 4,076,628
Advances from HMO 663,953 1,152,953
Payroll taxes payable 3,387,185 2,631,179
Accrued expenses 876,838 1,000,976
Notes payable 1,387,205 --
Current maturities of capital lease obligations 123,958 106,002
Current maturities of long-term debt 578,751 828,788
------------ ------------
Total current liabilities 11,128,809 9,796,526
------------ ------------
CAPITAL LEASE OBLIGATIONS 134,705 197,103
------------ ------------
LONG-TERM DEBT 2,769,089 689,812
------------ ------------
CONTINGENCIES
STOCKHOLDERS' EQUITY
Preferred stock, par value $.001 per share; stated value $100 per share;
10,000,000 shares authorized; 5,000 issued and outstanding 500,000 500,000
Common stock, par value $.001 per share; 80,000,000 shares authorized;
31,364,127 and 27,479,087 issued and outstanding 31,364 27,479
Additional paid-in capital 29,840,403 26,044,905
Accumulated deficit (23,188,126) (17,575,786)
Common stock issued for services to be rendered (342,945) (317,364)
------------ ------------
Total stockholders' equity 6,840,696 8,679,234
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 20,873,299 $ 19,362,675
============ ============
See accompanying notes - unaudited
3
METROPOLITAN HEALTH NETWORKS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
================================================================================
Nine Months Ended Three Months Ended
------------------------------------- -----------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
----------------- ----------------- --------------- -----------
REVENUES $ 114,723,677 $ 92,357,885 $ 37,709,460 $ 32,321,966
------------- ------------- ------------- -------------
EXPENSES
Direct medical costs 93,090,296 78,619,733 29,860,948 27,252,555
Cost of sales 7,016,852 435,722 2,364,929 417,339
Payroll, payroll taxes and benefits 8,614,815 4,515,856 2,750,196 1,756,108
Medical supplies 1,414,464 55,236 643,798 27,376
Depreciation and amortization 797,529 612,122 264,941 201,853
Consulting expense 1,961,090 605,841 598,177 315,804
General and administrative 4,456,542 2,224,134 1,536,087 719,260
------------- ------------- ------------- -------------
Total expenses 117,351,588 87,068,644 38,019,076 30,690,295
------------- ------------- ------------- -------------
INCOME (LOSS) BEFORE OTHER INCOME (EXPENSE) (2,627,911) 5,289,241 (309,616) 1,631,671
------------- ------------- ------------- -------------
OTHER INCOME (EXPENSE):
Interest and penalty expense (1,664,498) (492,063) (396,425) (141,289)
Other income 62,294 19,796 29,973 7,797
------------- ------------- ------------- -------------
Total other income (expense) (1,602,204) (472,267) (366,452) (133,492)
------------- ------------- ------------- -------------
INCOME (LOSS) FROM CONTINUING OPERATIONS
(4,230,115) 4,816,974 (676,068) 1,498,179
------------- ------------- ------------- -------------
DISCONTINUED OPERATIONS:
Loss from operations of discontinued operations (481,901) (405,787) (412,833) (107,667)
Loss on disposal of discontinued operations (900,324) -- (900,324) --
------------- ------------- ------------- -------------
LOSS FROM DISCONTINUED OPERATIONS (1,382,225) (405,787) (1,313,157) (107,667)
------------- ------------- ------------- -------------
NET INCOME (LOSS) BEFORE INCOME TAXES (5,612,340) 4,411,187 (1,989,225) 1,390,512
INCOME TAXES -- 63,827 -- 63,827
------------- ------------- ------------- -------------
NET INCOME (LOSS) $ (5,612,340) $ 4,347,360 $ (1,989,225) $ 1,326,685
============= ============= ============= =============
Weighted Average Number of Common Shares
Outstanding 30,068,891 $ 25,333,662 31,273,935 $ 27,241,510
============= ============= ============= =============
Income (Loss) from continuing operations $ (0.14) $ 0.19 $ (0.02) $ 0.05
============= ============= ============= =============
Loss from discontinued operations $ (0.05) $ (0.02) $ (0.04) $ 0.00
============= ============= ============= =============
Net earnings (loss) per share - basic $ (0.19) $ 0.17 $ (0.06) $ 0.05
============= ============= ============= =============
Net earnings (loss) per share - diluted $ (0.19) $ 0.15 $ (0.06) $ 0.04
============= ============= ============= =============
See accompanying notes - unaudited
4
METROPOLITAN HEALTH NETWORKS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
================================================================================
SEPTEMBER 30, SEPTEMBER 30,
2002 2001
(Unaudited) (Unaudited)
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $(5,612,340) $ 4,347,360
----------- -----------
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Provision for bad debt and additional IBNR 3,786,971 200,000
Loss on disposal of discontinued operations 900,324 --
Write-down of goodwill 22,209 --
Depreciation and amortization 1,087,299 661,800
Interest expense on beneficial conversion feature 808,372 --
Stock and warrants issued in lieu of cash for services 264,451 311,097
Changes in assets and liabilities:
Accounts receivable, net (4,730,071) (7,917,195)
Inventory (579,288) --
Other current assets (48,228) (569,597)
Other assets (640,469) (69,708)
Accounts payable and accrued expenses 884,588 (282,043)
Payroll taxes payable 756,006 (200,862)
Due to related parties -- (105,800)
Unearned revenue -- (906,944)
----------- -----------
Total adjustments 2,512,164 (8,879,252)
----------- -----------
Net cash used in operating activities (3,100,176) (4,531,892)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of restricted CDs (600,000) --
Capital expenditures (263,481) (414,343)
----------- -----------
Net cash used in investing activities (863,481) (414,343)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net repayments on line of credit -- (76,104)
Borrowings on notes payable 5,026,357 198,391
Repayments on notes payable (1,063,014) (279,039)
Net borrowings (repayments) on capital leases (92,867) 83,936
Proceeds from issuance of stock 530,105 5,177,375
Proceeds from exercise of options 67 386,583
Cash paid for stock price guarantee on settlement of debt (122,893) --
Repayments on advances from HMO (489,000) (140,202)
----------- -----------
Net cash provided by financing activities 3,788,755 5,350,940
----------- -----------
NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS (174,902) 404,705
CASH AND EQUIVALENTS - BEGINNING 393,968 44,724
----------- -----------
CASH AND EQUIVALENTS - ENDING $ 219,066 $ 449,429
=========== ===========
See accompanying notes - unaudited
5
METROPOLITAN HEALTH NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
================================================================================
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with accounting principles generally accepted in
the United States for interim financial information and with the
instructions to Form 10-Q. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally
accepted in the United States for complete financial statements. In the
opinion of management, all adjustments considered necessary for a fair
presentation have been included and such adjustments are of a normal
recurring nature. Operating results for the three and nine months ended
September 30, 2002 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2002.
The audited financial statements at December 31, 2001, which are included in
the Company's Form 10-KSB, should be read in conjunction with these
condensed consolidated financial statements.
SEGMENT REPORTING
The Company applies Financial Accounting Standards Boards ("FASB") statement
No. 131, "Disclosure about Segments of an Enterprise and Related
Information". The Company has considered its operations and has determined
that it operates in three operating segments for purposes of presenting
financial information and evaluating performance, PSN (managed care and
direct medical services), pharmacy and clinical laboratory. As such, the
accompanying financial statements present information in a format that is
consistent with the financial information used by management for internal
use.
INCOME TAXES
The Company accounts for income taxes according to Statement of Financial
Accounting Standards No. 109, which requires a liability approach to
calculating deferred income taxes. Under this method, the Company records
deferred taxes based on temporary differences between the tax bases of the
Company's assets and liabilities and their financial reporting bases. A
valuation allowance is established when it is more likely than not that some
or all of the deferred tax assets will not be realized.
The effective tax rate for the nine months ended September 30, 2002 differed
from the federal statutory rate due principally to an increase in the
deferred tax asset valuation allowance.
REVENUES
Revenues are recorded when services are rendered or pharmacy products are
sold. Revenues from one health maintenance organization (HMO) accounted for
approximately 91% and 98% of the Company's total revenues for the quarters
ended September 30, 2002 and 2001, and 90% and 98% for the nine months then
ended.
Contracts with the HMO in the South Florida and Daytona markets renew
automatically unless cancelled by either party with 120-day notice. These
contracts expire December 31, 2002, however the contracts have been renewed
for one year effective January 1, 2003. The Company expects the contracts to
continue for the foreseeable future.
RECLASSIFICATION
Certain amounts reported in the comparative financial statements have been
reclassified to conform with the presentation for the periods ended
September 30, 2002.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to
make estimates and assumptions that affect the 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.
6
ACCOUNTS RECEIVABLE
Accounts receivable at September 30, 2002 and December 31, 2001 were as
follows:
September 30, December 31,
2002 2001
----------- -----------
HMO accounts receivable, net $11,037,000 $10,540,000
Non HMO accounts receivable, net 3,269,000 2,823,000
----------- -----------
Accounts receivable $14,306,000 $13,363,000
=========== ===========
In the health care environment, it is almost always at least reasonably
possible that accounts receivable estimates could change in the near term as
a result of one or more future confirming events. With regard to revenues,
expenses and resulting accounts receivable arising from agreements with the
HMO, the Company estimates amounts it believes will ultimately be realizable
through the use of judgments and assumptions about future decisions.
Programs with the HMO are sometimes complex and at times subject to
different interpretation by the Company and the HMO. As a result certain
revenue and cost estimates during the quarter may be settled for amounts
different than previously estimated. To assist it in its efforts to estimate
and ultimately collect amounts due from the HMO, the Company has contracted
with several outside consultants that have worked closely with the HMO or
other HMOs for extended periods of time. These consultants provide numerous
services including, but not limited to, HMO revenue, expense and accounts
receivable analysis and monthly claims and contestation analysis.
Direct HMO medical expenses are based in part upon estimates of claims
incurred but not reported (IBNR) and estimates of retroactive adjustments to
be applied by the HMO. The IBNR estimates are made by the HMO utilizing
actuarial methods and are continually evaluated by management of the
Company, based upon its specific claims experience. This evaluation is
typically in conjunction with the Company's outside consultants. During the
quarter ended June 30, 2002, as part of the Company's periodic review of
medical claims, which are retroactively applied to the period in which they
were incurred, management determined that the IBNR previously estimated were
not sufficient to cover approximately $2.0 million in retroactive claims
that were charged to the Company. Accordingly, an adjustment to medical
costs was recorded to cover the estimated IBNR shortfall. The estimates of
retroactive adjustments to be applied by the HMO are based upon i) current
agreements with the HMO to modify certain amounts previously charged to the
Company and ii) Company estimates of certain charges the HMO has agreed were
charged at incorrect rates but has not yet quantified.
The HMO has agreed to certain credits in their entirety and to analyze other
amounts it has not yet quantified on certain past transactions. The HMO is
in the process of quantifying past transactions charged at incorrect rates.
In connection therewith, management has established a reserve of
approximately $1.5 million against the estimated net credits (aggregating
$8.6 million) and therefore $7.1 million is included in accounts receivable,
net of allowances. The estimated credits currently outstanding relate to the
years from 2000 to the present. Management is in the process of, and intends
to pursue collection of all estimated retroactive adjustments. Management
believes its estimates of IBNR claims and estimates of retroactive
adjustments are reasonable, however, it is reasonably possible the Company's
estimate of these costs could change in the near term, and those changes may
be material.
In addition to the retroactive adjustments, from time to time the Company is
charged by the HMO for certain medical expenses which the Company believes
it is not liable for. In connection therewith, the Company, through its
outside consultants, is contesting certain costs aggregating approximately
$10.9 million. Management's estimate of recovery on these contestations is
determined based upon its and the consultants' judgment, and their
consideration of several factors including the nature of the contestations,
historical recovery rates and other qualitative factors. Accordingly,
accounts receivable due from the HMO includes approximately $2.2 million,
which represents estimated recovery of 20% of 2000, 2001 and 2002
contestations outstanding at September 30, 2002. It is reasonably possible
the Company's estimate of these recoveries could change in the near term,
and those changes may be material.
Under the contracts with the HMO, the Company receives payments from the
HMO, net of direct medical costs paid on behalf of the Company, on a monthly
basis. From time to time the HMO will also make advances to the Company.
Payments on adjustments are paid as processed by the HMO. However, as it is
sometimes difficult to quantify these adjustments, payment can often be
delayed for extended periods.
7
Non-HMO accounts receivable, aggregating approximately $7.7 million at
September 30, 2002 relate principally to prescription sales and medical
services provided on a fee for service basis, and are reduced by amounts
estimated to be uncollectible (approximately $4.4 million). Management's
estimate of uncollectible amounts is based upon its analysis of historical
collections and other qualitative factors, however it is reasonable possible
the Company's estimate of uncollectible amounts could change in the near
term, and those changes may be material. Non-HMO accounts receivable
included approximately $4.6 million from discontinued operations of which
$3.8 million is estimated to be uncollectible.
Non-HMO accounts receivable are typically uncollateralized customer
obligations due under normal trade terms requiring payment within 30-90 days
from the invoice date. The Company does not charge late fees or penalties on
delinquent invoices, however it continually evaluates the need for a
valuation allowance (Allowance). The Allowance reflects management's best
estimate of the amounts that will not be collected. Management reviews all
non-current accounts receivable balances on an ongoing basis and, based on
this assessment of current creditworthiness, estimates the portion, if any,
that will not be collected. It is reasonably possible that some or all of
these estimates could change in the near term by an amount that could be
material to the financial statements.
NET INCOME PER SHARE
The Company applies Statement of Financial Accounting Standards No. 128,
"Earnings Per Share" (FAS 128) which requires dual presentation of net
income per share; Basic and Diluted. Basic earnings per share is computed
using the weighted average number of common shares outstanding during the
period; 31,273,935 and 30,068,891 for the three and nine months ended
September 30, 2002. Diluted earnings per share is computed using the
weighted average number of common shares outstanding during the period
adjusted for incremental shares attributed to outstanding options and
warrants to purchase shares of common stock. Outstanding stock equivalents
were not considered in the calculation of diluted earnings (loss) per common
share for the three and nine months ended September 30, 2002, as their
effect would have been anti-dilutive.
Nine Months Ended Three Months Ended
------------------------------- -------------------------------
9/30/02 9/30/01 9/30/02 9/30/01
------------ ------------ ------------ ------------
Net Income (loss) $ (5,612,340) $ 4,347,360 $ (1,989,225) $ 1,326,685
Less: Preferred stock dividend -- (37,500) -- (12,500)
------------ ------------ ------------ ------------
Income (loss) available to common shareholders $ (5,612,340) $ 4,309,860 $ (1,989,225) $ 1,314,185
============ ============ ============ ============
Denominator:
Weighted average common shares outstanding 30,068,891 25,333,662 31,273,935 27,241,510
============ ============ ============ ============
Basic earnings (loss) per common share $ (0.19) $ 0.17 $ (0.06) $ 0.05
============ ============ ============ ============
Net Income (loss) $ (5,612,340) $ 4,347,360 $ (1,989,225) $ 1,326,685
Interest on convertible securities -- 32,327 -- 10,471
------------ ------------ ------------ ------------
$ (5,612,340) $ 4,379,687 $ (1,989,225) $ 1,337,156
============ ============ ============ ============
Weighted average common shares outstanding 30,068,891 28,590,688 31,273,935 30,520,870
============ ============ ============ ============
Diluted earnings (loss) per common share $ (0.19) $ 0.15 $ (0.06) $ 0.04
============ ============ ============ ============
NEW ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB") issued three
new pronouncements: Statement of Financial Accounting Standards ("SFAS") No
141, "Business Combinations," SFAS No. 142, "Goodwill and Other Intangible
Assets" and SFAS No. 143, "Accounting for Asset Retirement Obligations." In
August 2001, the FASB issued SFAS No. 144, "Accounting for the impairment or
Disposal of Long-Lived Assets." SFAS No. 141 is effective as follows: a) use
of the pooling-of-interest method is prohibited for business combinations
initiated after June 30, 2001; and b) the provisions of SFAS 141 apply to
all business combinations accounted for by the purchase method that are
completed after June 30, 2001 (that is, the date of the acquisition is July
2001 or later). There are also transition provisions that apply to business
combinations completed before July 1, 2001, that were accounted for by the
purchase method. SFAS No. 142 is effective for fiscal years beginning after
December 15, 2001 for all goodwill and other intangible assets recognized in
8
an entity's statement of financial position at that date, regardless of when
those assets were initially recognized. SFAS No. 142 specifies that goodwill
and some intangible assets will no longer be amortized but instead will be
subject to periodic impairment testing. The Company adopted certain
provisions of these pronouncements effective July 1, 2001, as required for
goodwill and intangible assets acquired in purchase business combinations
consummated after June 30, 2001. The Company adopted the remaining
provisions of SFAS 141 and SFAS 142 effective January 1, 2002. There was not
a cumulative transition adjustment upon adoption as of July 1, 2001 or
January 1, 2002. SFAS 141 and SFAS 142 required the Company to perform the
following as of January 1, 2002; (i) review goodwill and intangible assets
for possible reclassifications; (ii) reassess the lives of intangible
assets; and (iii) perform a transitional goodwill impairment test. The
Company has reviewed the balances of goodwill and identifiable intangibles
and determined that the Company does not have any amounts that are required
to be reclassified from goodwill to identifiable intangibles, or vice versa.
The Company has also reviewed the useful lives of its identifiable
intangible assets and determined that the original estimated lives remain
appropriate. The Company has completed the transitional goodwill impairment
test and has determined that the Company did not have a transitional
impairment of goodwill.
As required by SFAS 142, the Company has not amortized goodwill associated
with acquisitions completed after June 30, 2001, or any period presented and
ceased amortization of goodwill associated with acquisitions completed prior
to July 1, 2001, effective January 1, 2002. Prior to January 1, 2002, the
Company amortized goodwill associated with the pre-July 1, 2001 acquisitions
over ten years using the straight-line method. A reconciliation of reported
net income (loss) adjusted to reflect the adoption of SFAS No. 142 is
provided below:
For the Nine Months For the Three Months
Ended September 30, Ended September 30,
--------------------------------- ---------------------------------
2002 2001 2002 2001
------------- ------------- ------------- -------------
Reported net income (loss) $ (5,612,340) $ 4,347,360 $ (1,989,225) $ 1,326,685
Add-back goodwill amortization, net of tax -- 294,367 -- 98,564
------------- ------------- ------------- -------------
Adjusted net income (loss) $ (5,612,340) $ 4,641,727 $ (1,989,225) $ 1,425,249
============= ============= ============= =============
Reported basic net income per share $ (0.19) $ 0.17 $ (0.06) $ 0.05
Add-back goodwill amortization -- 0.01 -- --
------------- ------------- ------------- -------------
Adjusted basic net income (loss) per share $ (0.19) $ 0.18 $ (0.06) $ 0.05
============= ============= ============= =============
Reported diluted net income (loss) per share $ (0.19) $ 0.15 $ (0.06) $ 0.04
Add-back goodwill amortization -- 0.01 -- --
------------- ------------- ------------- -------------
Adjusted diluted net income (loss) per share $ (0.19) $ 0.16 $ (0.06) $ 0.04
============= ============= ============= =============
SFAS No. 143 requires entities to record the fair value of a liability for
an asset retirement obligation in the period in which it is incurred and a
corresponding increase in the carrying amount of the related long-lived
asset. Subsequently, the asset retirement cost should be allocated to
expense using a systematic and rational method over its useful life. SFAS
No. 143 is effective for fiscal years beginning after June 15, 2002. The
Company is currently assessing the impact of SFAS No. 143, which is not
expected to have a material impact on the Company's financial statements.
SFAS No. 144 addresses financial accounting and reporting for the impairment
of long-lived assets and for long-lived assets to be disposed of. It
supersedes, with exceptions, SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of" and is
effective for fiscal years beginning after December 15, 2001. The Company
has adopted SFAS No. 144, and it did not have a material impact on the
Company's financial statements.
In April 2002, the FASB issued SFAS No. 145, rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13 and Technical
Corrections. This statement, among other things, eliminated an inconsistency
between required accounting for certain sale-leaseback transactions and
provided for other technical corrections. Management believes adoption of
this statement will not have a material effect on the financial statements
of the company.
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities. This statement addresses accounting and
reporting for costs associated with exit or disposal activities and
nullifies emerging issues Task Force Issue No. 94-3. The statement is
effective for exit or disposal costs initiated after December 31, 2002, with
early application encouraged. This statement has not yet been adopted by the
Company and management has not determined the impact of this statement on
the financial statements of the Company.
9
NOTE 3. LIQUIDITY AND CAPITAL RESOURCES
The accompanying financial statements have been prepared in conformity with
accounting principles generally accepted in the United States, which
contemplates continuation of the Company as a going concern. However, the
Company has incurred negative cash flows from operations, partly as a
result of the Company's diversification of its revenue base, including the
pharmacy and clinical laboratory operations. Although the Company expects
its cash flow from operations to continue to improve, there can be no
assurance that this will occur. In the absence of achieving positive cash
flows from operations or obtaining additional debt or equity financing, the
Company may have difficulty meeting current and long-term obligations, and
may be forced to discontinue a material business segment or overall
operations.
In the first nine months of 2002, the Company issued 500,000 shares of
common stock in connection with private placement offerings, resulting in
net proceeds of $500,000. Additionally, the Company borrowed $1,700,000 in
short-term notes payable and $2,780,000 in long-term notes and debentures,
with varying interest rates and maturities (see Notes 5-6).
Management has negotiated and is in the process of closing an accounts
receivable financing agreement to support the growth in its pharmacy
division. In addition, the Company projects cash flow from HMO agreements to
increase in 2003 from the expansion and implementation of new agreements.
Also, management has taken measures to reduce overhead and is reviewing its
operations for further reductions.
In conjunction with its review of its operations, the Company decided to
dispose of its clinical laboratory, which the Company believes will result
in an increase in both operational profitability and cash flow. Accordingly,
in the quarter ended September 30, 2002, the Company recognized a $1.2
million loss on disposal of discontinued operations.
In view of these matters, realization of a major portion of the assets in
the accompanying balance sheet is dependent upon continued operations of the
Company, which in turn is dependent upon the Company's ability to meet its
financial obligations. Management believes that actions presently being
taken, as described in the preceding paragraphs, provide the opportunity for
the Company to continue as a going concern, however, there is no assurance
this will occur.
NOTE 4. EQUITY LINE OF CREDIT AGREEMENT
On March 30, 2001, the Company entered into an equity line of credit
agreement with a British Virgin Islands corporation (Purchaser), in order to
establish a possible source of funding for the Company's planned operations.
The equity line of credit agreement established what is sometimes also
referred to as an equity draw down facility (Equity Facility). Under the
Equity Facility, the Purchaser agreed to provide the Company with up to
$12,000,000 of funding during the twenty-four (24) month period following
the date of an effective registration statement. During this twenty-four
(24) month period, the Company may request a draw down under the Equity
Facility by selling shares of its common stock to the Purchaser, and the
Purchaser would be obligated to purchase the shares.
During 2002, the Company received approximately $40,000 under the Equity
Facility and on March 5, 2002, the Company terminated the Equity Facility.
NOTE 5. SHORT-TERM DEBT
In the first quarter of 2002, the Company borrowed a total of $1,700,000 due
in June 2002, since extended through February 2003. The notes bear interest
of 24-25% and are collateralized by a total of 3,200,000 shares of common
stock and by all the Company's assets. The proceeds from these transactions
were used for working capital.
NOTE 6. LONG-TERM DEBT
In May 2002, the Company entered into a "Securities Purchase Agreement", in
which it issued $1,580,000 6% Convertible debentures due May 24, 2004 and
150,000 warrants to purchase common stock. The purchase price for the
promissory note and Warrants was $1,501,000 or 95% of the principal amount
of the Convertible Debentures. The Holder shall have the right at its option
to convert the Convertible Debenture into shares of common stock. The number
of shares shall be determined by dividing the conversion amount (principal
10
plus accrued interest) by the conversion price as defined ($0.43 per share
at issuance). In connection with the issuance of the convertible debentures
the company recorded an interest charge of $808,000 relating to the
beneficial conversion feature. Approximately $60,000 of the purchase price
was assigned to the warrants and this amount, along with the $79,000
discount, is being amortized and charged to interest expense over two years
under the interest method.
Also in May 2002, the Company entered into a "Securities Purchase Agreement"
in which the Company issued a $1,200,000 principal amount Promissory Note
due May 24, 2004 and 500,000 warrants to purchase common stock. The purchase
price for the promissory note and warrants was $1.2 million. Interest is
payable quarterly at a rate of 12% per annum, commencing June 30, 2002, and
principal is due at maturity. Approximately $254,000 of the purchase price
was assigned to the warrants and this amount is being amortized and charged
to interest expense over two years under the interest method.
NOTE 7. STOCKHOLDERS' EQUITY
During the first quarter of 2002, the Company issued 500,000 shares of
common stock to accredited investors, resulting in proceeds of $500,000. In
addition, the Company issued approximately 1,200,000 shares of common stock
to convert approximately $1,100,000 of long-term debt to equity.
NOTE 8. STOCK OPTIONS
The Company adopted the disclosure-only provisions of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation,"
("SFAS 123") in 1997. The Company has elected to continue using Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
in accounting for employee stock options.
Accordingly, compensation expense has been recorded to the extent the market
value of the underlying stock exceeded the exercise price at the date of
grant. For the three and nine months ended September 30, 2002 no
compensation was recorded. During those same periods in 2001, there was no
compensation in the three months and approximately $54,000 in the nine
months ended September 30, 2001.
NOTE 9. COMMITMENTS AND CONTINGENCIES
LITIGATION
The Company is a party to various claims arising in the ordinary course of
business. Management believes that the outcome of these matters will not
have a material adverse effect on the financial position or the results of
operations of the Company.
PAYROLL TAXES PAYABLE
In 2000, the Company negotiated an installment plan with the Internal
Revenue Service (IRS) related to unpaid payroll tax liabilities including
interest and penalties totaling approximately $2.1 million at September 30,
2002. Under the plan the Company made monthly installments of $100,000 on
the amount in arrears. This agreement has expired and the full amount is
deemed due upon demand. The Company is currently negotiating with the IRS
for a new installment agreement and has proposed a three-year payout whereby
the liability would be retired at the end of the agreement. This amount plus
approximately $1.3 million related to 2002 payroll taxes are included as
payroll taxes payable at September 30, 2002. While management believes it
will be successful in negotiating a new agreement, there can be no assurance
that the IRS will accept the proposal on these delinquent taxes.
LETTER OF CREDIT
In March 2002, two investors, on behalf of the Company, provided funding for
certificates of deposit aggregating $1,000,000 that are used as collateral
for a letter of credit in favor of the HMO. The letter of credit was
required by the Company's contract with the HMO and enabled the Company to
favorably renegotiate certain terms of the contract. Included in CDs
receivable - restricted are CDs (collateralizing the Letter of Credit) that
the Company has purchased from investors. Payments for these CDs are due
over ten months at amounts that result in an effective interest rate of 24%
per annum and at September 30, 2002, $600,000 had been purchased.
11
NOTE 10. BUSINESS SEGMENT INFORMATION
The Company has considered its operations and has determined that it operates in
three operating segments for purposes of presenting financial information and
evaluating performance, PSN (managed care and direct medical services), pharmacy
and clinical laboratory. The Company has allocated corporate overhead to the
clinical laboratory during the time the laboratory was operational. However, the
overhead allocation is not included in the loss from operations of the
discontinued business segment shown in the condensed consolidated statements of
operations. The PSN segment also includes all costs incurred in the development
of the Company's HMO.
THREE MONTHS ENDED SEPTEMBER 30, 2002 PSN PHARMACY LABORATORY TOTAL
-------------------------------------------- -------------- ------------------ ----------------- ---------------
Revenues from external customers $ 34,613,000 $ 3,096,000 $ -- $ 37,709,000
Intersegment revenues -- 308,000 -- 308,000
Revenues from discontinued business
segment -- -- 142,000 142,000
Segment gain (loss) before allocated
overhead 1,488,000 (364,000) (1,313,000) (189,000)
Allocated corporate overhead 1,231,000 569,000 -- 1,800,000
Segment gain (loss) after allocated overhead 257,000 (933,000) (1,313,000) (1,989,000)
THREE MONTHS ENDED SEPTEMBER 30, 2001 PSN PHARMACY LABORATORY TOTAL
-------------------------------------------- -------------- ------------------ ----------------- ---------------
Revenues from external customers $ 32,000,000 $ 322,000 -- $ 32,322,000
Intersegment revenues -- 164,000 -- 164,000
Revenues from discontinued business
segment -- -- 140,000 140,000
Segment gain (loss) before allocated
overhead 3,012,000 (263,000) (108,000) 2,641,000
Allocated corporate overhead 962,000 201,000 151,000 1,314,000
Segment gain (loss) after allocated overhead 2,050,000 (464,000) (259,000) 1,327,000
NINE MONTHS ENDED SEPTEMBER 30, 2002 PSN PHARMACY LABORATORY TOTAL
-------------------------------------------- -------------- ------------------ ----------------- ---------------
Revenues from external customers $ 105,226,000 $ 9,498,000 -- $ 114,724,000
Intersegment revenues -- 870,000 -- 870,000
Revenues from discontinued business
segment -- -- 1,028,000 1,028,000
Segment gain (loss) before allocated
overhead 2,892,000 (1,050,000) (1,382,000) 460,000
Allocated corporate overhead 3,743,000 1,907,000 422,000 6,072,000
Segment gain (loss) after allocated overhead (851,000) (2,957,000) (1,804,000) (5,612,000)
NINE MONTHS ENDED SEPTEMBER 30, 2001 PSN PHARMACY LABORATORY TOTAL
-------------------------------------------- -------------- ------------------ ----------------- ---------------
Revenues from external customers $ 92,012,000 $ 346,000 -- $ 92,358,000
Intersegment revenues -- 164,000 -- 164,000
Revenues from discontinued business
segment -- -- 199,000 199,000
Segment gain (loss) before allocated
overhead 9,163,000 (283,000) (406,000) 8,474,000
Allocated corporate overhead 3,338,000 293,000 496,000 4,127,000
Segment gain (loss) after allocated overhead 5,825,000 (576,000) (902,000) 4,347,000
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
Metropolitan Health Networks, Inc. (the "Company" or "Metcare ") was
incorporated in the State of Florida in January 1996. In 2000, the Company
implemented its new strategic plan, operating as a Provider Service Network
12
(PSN), specializing in managed care risk contracting. The Company's ability to
control its Network has produced favorable medical loss ratios, allowing the
Company to successfully tap into the trillion dollar healthcare market. Through
its Network, the Company provides care to over 27,000 Medicare+Choice patients,
3,000 commercial HMO patients and approximately 15,000 fee-for- service patients
aligned with various health plans.
The primary focus of the PSN division is the continuous development and
expansion of its network and infrastructure to provide services under its
existing HMO contract. Current legislation and a political environment that has
demonstrated support for the Medicare+Choice program have augmented many
opportunities in the managed care industry. An example of this support is the
current additional funding that has been proposed to begin in 2003, along with
bonuses for health plans that are willing to establish a presence in underserved
markets. The Company's business plan is modeled to take full advantage of the
new direction of the Medicare+Choice program with the initial underserved market
of the Treasure Coast of Florida (Martin, St. Lucie and Okeechobee Counties) as
well as expanding its market share in South and Central Florida.
Responding to rapid increases in pharmacy spending, in June of 2001 the Company
formed Metcare Rx, Inc., a wholly owned subsidiary, to control costs and to
reduce prescription drug expenditures that are forecasted to increase by over
100% in the next decade. An increasing number of health plans with low-cost
co-pays for drug coverage, direct-to-consumer advertising, and newer, better
therapies requiring high-cost branded products all drive up the cost of pharmacy
benefits. In an effort to reduce these costs, the Company has negotiated
agreements allowing the Company to directly negotiate contracts for the
purchase, filling and delivery of prescriptions. The Company believes it can
achieve better management and control to provide cost savings and incremental
revenues. As of the date of this filing, Metcare Rx operates in New York,
Maryland and various locations in Florida, with additional contracts to provide
services in Buffalo, New York beginning later in 2002 or early 2003.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with generally accepted
accounting principles requires the Company's management to make a variety of
estimates and assumptions. These estimates and assumptions affect, among other
things, the reported amounts of assets and liabilities, the disclosure of
contingent liabilities and the reported amounts of revenues and expenses. Actual
results can differ from the amounts previously estimated, which were based on
the information available at the time the estimates were made.
The critical accounting policies described below are those that the Company
believes are important to the portrayal of the Company's financial condition and
results, and which require management to make difficult, subjective and/or
complex judgments. Critical accounting policies cover accounting matters that
are inherently uncertain because the future resolution of such matters is
unknown. The Company believes that critical accounting policies include accounts
receivable and revenue recognition, use of estimates and goodwill.
Accounts Receivable and Revenue Recognition
The Company is a party to certain managed care contracts and provides medical
care to its patients through owned and non-owned medical practices. In
connection with its Provider Service Network (PSN) operations, the Company is
exposed to losses to the extent of its share of deficits. Accordingly, revenues
under these contracts are reported as PSN revenue, and the cost of provider
services under these contracts are reported as an operating expense.
The Company recognizes non-PSN revenues, net of contractual allowances, as
medical services are provided or pharmaceuticals are sold. These services or
goods are typically billed to patients, Medicare, Medicaid, health maintenance
organizations, insurance companies and other third parties. The Company provides
an allowance for uncollectible amounts and for contractual adjustments relating
to the difference between standard charges and agreed upon rates paid by certain
third party payers.
Use of Estimates-PSN
In HMO-PSN arrangements, it is almost always at least reasonably possible that
accounts receivable estimates could change in the near term as a result of one
or more future confirming events. With regard to revenues, expenses and
resulting accounts receivable arising from agreements with the HMO, the Company
estimates amounts it believes will ultimately be realizable through the use of
13
judgments and assumptions about future decisions. Contractual terms with the HMO
are sometimes complex and at times subject to different interpretation by the
Company and the HMO. As a result certain revenue, expense and accounts
receivable estimates may differ from amounts recorded in the financial
statements and may require subsequent adjustments. To assist estimating and
collecting amounts due from the HMO, the Company has contracted with several
outside consultants that have worked closely with the HMO or other HMOs for
extended periods of time. These consultants provide numerous services including,
but not limited to, HMO revenue, expense and accounts receivable analysis and
monthly claims and contestation analysis. However, it is still reasonably
possible that actual results may differ from the estimates.
Direct HMO medical expenses include costs incurred directly by the Company and
costs paid by the HMO on the Company's behalf. These costs also include
estimates of claims incurred but not reported (IBNR), estimates of retroactive
adjustments to be applied by the HMO and adjustments for charges which the
Company believes it is not liable ("contestations"). The IBNR estimates are made
by the HMO utilizing actuarial methods and are continually evaluated and
adjusted by management of the Company, based upon its specific claims experience
and input from outside consultants. The Company bases its estimates of
retroactive adjustments on agreements with the HMO to modify previous charges.
Some of these adjustments have been quantified while others involve situations
where the HMO has agreed the charges were at incorrect rates, but they have not
yet quantified the difference. Contestations involve charges where the Company,
with the assistance of its consultants, contests certain expenses charged by the
HMO. The estimate of direct medical expense includes an estimated recovery of
20% of outstanding contestations with the HMO. It is reasonably possible that
estimates of such recoveries could change and the effect of the change could be
material.
Accounts receivable from the HMO represents the combined effect of the Company's
interpretation of the contract with the HMO and the HMO payment patterns.
Collection times on these accounts typically exceed normal collection periods
reflecting the need to reconcile the different interpretations and the HMO's
cash management practices.
Goodwill
The Company has made several acquisitions in the past that included a
significant amount of goodwill. Under generally accepted accounting principles
in effect thorough December 31, 2001, these assets were amortized over their
useful lives and tested periodically to determine if they were recoverable from
operating earnings on a discounted basis over their useful lives.
Effective January 1, 2002, goodwill is accounted for under SFAS No. 142,
"Goodwill and Other Intangible Assets". The new rules eliminate amortization of
goodwill but subject these assets to impairment tests. See "New Accounting
Pronouncements" in Note 2 for a more complete discussion. Management is required
to make assumptions and estimates, such as the discount factor, in determining
fair value. Such estimated fair values might produce significantly different
results if other reasonable assumptions and estimates were to be used.
RESULTS OF OPERATIONS
The Company had revenues of $37.7 million for the quarter ended September 30,
2002 and operating expenses of $38.0 million, resulting in a loss from
operations of approximately $310,000 and a net loss of approximately $2.0
million, inclusive of the $1.3 million loss on disposition of its clinical
laboratory discussed below. For the nine months ended September 30, 2002, the
Company had revenues of $114.7 million and operating expenses of $117.4 million,
a loss from operations of approximately $2.6 million and a net loss of
approximately $5.6 million. Included in the quarter and nine months ended
September 30, 2002 are approximately $1.3 million and $1.4 million,
respectively, in losses related to the disposal of the Company's clinical
laboratory. Management believes that the disposal of the lab will result in both
an increase in operational profitability and cash flow on a go-forward basis. In
addition, included in the nine months ended September 30, 2002 are significant
adjustments of approximately $5.4 million, as discussed below. Excluding these
adjustments and the disposal of the lab, the Company's operating expenses would
have been $112.8 million for the nine months ended September 30, 2002, resulting
in income from operations of $2.0 and net income of $1.2 million. The net loss
for the quarter ended September 30, 2002, exclusive of the loss on disposal of
the lab, would have been $676,000.
For the same periods in 2001, revenues amounted to $32.3 million for the quarter
and $92.4 million for the nine months, resulting in net income of $1.3 million
and $4.3 million respectively. On a diluted per share basis, earnings were $0.04
and $0.15 for the quarter and nine months ended September 30, 2001,
respectively, compared to losses of $0.06 and $0.19 for the same periods in
2002.
In addition, the Company had working capital of $6.2 million at September 30,
2002 compared to $8.8 million a year earlier while shareholders' equity was $6.8
million at September 30, 2002 compared to $11.8 million at September 30, 2001.
As disclosed in its previous SEC filings, the Company makes certain cost
estimates with regards to its contract with the HMO. Programs with the HMO are
sometimes complex and at times subject to different interpretation. These cost
estimates may be settled for amounts different than previously estimated or the
14
Company's estimate of these costs could change in amounts that could be material
to the financial statements. As such, these estimates are continuously reviewed
and, based on its second quarter review; management determined that an
adjustment to direct medical costs of approximately $2.0 million relating to
prior IBNR estimates was required. In addition, management felt an additional
reserve on the remaining carrying amounts of its estimated retroactive cost
adjustments would be prudent. Although it will aggressively attempt to collect
these amounts, the Company established a $1.5 million reserve by a charge to its
direct medical costs in the second quarter.
Additionally, direct medical expenses are based in part upon estimates of claims
incurred but not reported (IBNR) by the HMO utilizing actuarial methods, and are
continually evaluated by management of the Company based upon its specific
claims experience. During the second quarter the HMO revised its Part A
(hospital) IBNR methodology, resulting in a charge to direct medical costs of
$1.1 million.
In conjunction with a Convertible Debenture financing completed in May 2002, the
Company incurred a second quarter charge to interest of approximately $808,000.
This charge was necessary as the holder may convert the debt at any time into
company stock at a price lower than it was at the issuance of the debt.
During 2001, in an effort to diversify its revenue base and ultimately increase
shareholder value, the Company implemented its pharmacy division and began the
process of filing for its own HMO license. As such, the results for the quarter
and nine months ended September 30, 2002 included losses incurred by the
Company's pharmacy and HMO divisions, as well as its clinical laboratory, which,
including allocation of corporate overhead, totaled approximately $953,000 for
the quarter and $3.6 million for the nine months. It is expected that these
operations, in total, will achieve profitability in the fourth quarter of 2002
through a combination of increased revenue and cost cutting measures. In line
with this goal, the Company decided to dispose of its clinical laboratory, which
should result in both an increase in operational profitability and cash flow.
Accordingly, in the quarter ended September 30, 2002, the Company recognized
$1.3 million in losses on discontinued operations.
Quarter Ended September 30, 2002
REVENUES
Revenues for the quarter ended September 30, 2002 increased 17% compared to the
same period in 2001, from $32.3 million to $37.7 million. PSN revenues from the
HMO increased $2.4 million from $31.8 million to $34.2 million. September 2002
PSN revenues included approximately $1.5 million of additional Medicare and
commercial funding over the September 2001 quarter and the Company expects to
receive similar additional monthly amounts for the foreseeable future. An
increase in the number of covered lives within the PSN network accounted for the
balance of the increase in revenues over the prior year.
Revenues for the third quarter of 2002 included approximately $3.4 million from
Metcare Rx, the Company's pharmacy division, which began operations in the
Daytona market in June 2001, New York in July 2001, and Maryland in October
2001. For the same period in 2001, pharmacy revenues were only $486,000.
Management believes that with the proper capitalization, MetcareRx will
eventually account for a significant percentage of overall revenues of the
Company as it continues to expand in its existing markets and enter other
markets. Pharmacy sales to the PSN of approximately $308,000 have been
eliminated in consolidation. In addition, revenues for the third quarter of 2002
included $602,000 from its Daytona oncology offices, as compared to nothing the
prior year. These increases were offset, in part, by approximately $200,000 in
decreases due to a closed medical practice and a reduction in fee-for-service
revenue in its primary care medical offices.
EXPENSES
Operating expenses for the third quarter of 2002 were $38.0 million, a 24%
increase over prior year operating expenses of $30.7 million. Direct medical
costs for the quarter ended September 30, 2002 were $29.9 million compared to
$27.3 million for the quarter ended September 30, 2001. Direct medical costs,
the largest component of expense, represent certain costs associated with
providing services of the PSN operation including direct medical payments to
physician providers, hospitals and ancillaries on a capitated or fee for service
basis. As a percentage of PSN revenues, the medical loss ratio (MLR) amounted to
87.4% and 85.7% for the quarters ended September 30, 2002 and 2001,
respectively. This increase due primarily due to increases in Part A (hospital)
costs due to new contracts with hospitals in the Company's Daytona network.
These increases were offset in part by the Company's continually improving
utilization initiatives, including its hospitalist, partners in quality (PIQ),
and oncology programs.
Cost of sales for the third quarter of 2002 totaled $2.4 million and represents
the cost of the pharmaceuticals sold by MetcareRx. The pharmacy division had a
gross profit percentage for the 2002 quarter of 31%.
15
Salaries and benefits for the third quarter of 2002 increased $994,000 over the
third quarter of the prior year to $2.8 million. MetcareRx, the Company's
pharmacy division, accounted for $697,000 of the increase, while expansion of
the services the Company provides in its Daytona market in an effort to control
its medical costs accounted for $317,000 of increases. The Company believes it
has the necessary management in place to support the revenue growth the Company
anticipates in 2003 and beyond.
Medical supplies were $644,000 for the September quarter, compared to $27,000 in
2001. Medical supply costs are incurred in all the Company's medical offices,
most prominently in the Company's two Daytona oncology offices, which accounted
for $630,000 of the quarter's expense.
Depreciation and amortization for the quarter ended September 30, 2002 was
$265,000 compared to $202,000 the year before. The increase is due primarily to
depreciation on fixed assets acquired over the past twelve months.
Consulting expense increased approximately $282,000, from $316,000 in the
quarter ended September 30, 2001 to $598,000 in the same period in 2002. Of the
increase, $248,000 was incurred in the Company's Hospitalist, Oncology and
Utilization/Quality Assurance/Management programs, which are designed to lower
direct medical costs while improving patient care, and $20,000 was spent in the
development of the Company's HMO, part of its long-term goal to diversify its
revenue base.
General and administrative expenses increased from $719,000 in the third quarter
of 2001 to $1.5 million in the third quarter of 2002, an increase of $781,000.
The pharmacy operations accounted for $340,000 in incremental general and
administrative expenses while the costs of the Company's oncology and
hospitalist programs and other PSN expansion accounted for an additional
$166,000 in incremental costs. The prior year quarter also included
approximately $112,000 in accounts payable write-offs and settlements relating
to discontinued operations and $98,000 in incremental insurance increases.
Interest expense increased $255,000 for the September quarter due to the
increased amount of debt carried by the Company at September 30, 2002 as
compared to the prior year.
Nine Months Ended September 30, 2002
REVENUES
Revenues for the nine months ended September 30, 2002 increased 24% compared to
the same period in 2001, from $92.4 million to $114.7 million. PSN revenues from
the HMO increased $13.0 million from $91.0 million to $104.0 million. September
2002 PSN revenues included approximately $4.7 million of additional Medicare and
commercial funding over the nine months ended September 2001 and the Company
expects to receive similar additional monthly amounts for the foreseeable
future. In addition, an increase in the number of covered lives within the PSN
network contributed approximately $8.3 million of the increase in revenues over
the prior year.
Revenues for the first nine months of 2002 included approximately $10.4 million
from Metcare Rx, the Company's pharmacy division, which began operations in the
Daytona market in June 2001, New York in July 2001, and Maryland in October
2001. For the same period in 2001, pharmacy revenues were only $511,000.
Management believes that with the proper capitalization, MetcareRx will
eventually account for a significant percentage of overall revenues of the
Company as it continues to expand in its existing markets and enter other
markets. Pharmacy sales to the PSN of approximately $870,000 have been
eliminated in consolidation. In addition, revenues for 2002 included $1.3 from
its Daytona oncology offices, as compared to nothing the prior year. These
increases were partially offset by decreases in revenue due to closed medical
practices totaling $354,000 over 2001.
EXPENSES
Operating expenses for first nine months of 2002 increased 35% over the prior
year, higher than the 24% increase in revenues. However, included in 2002 are
approximately $4.6 million in significant charges to direct medical costs, as
discussed above. Exclusive of these charges, operating expenses increased 29%,
more in line with its increase in revenues.
Direct medical costs for the nine months ended September 30, 2002 were $93.1
million compared to $78.6 million for the same period in 2001. Exclusive of the
charges discussed above, the expense for 2002 would have been $88.5 million,
16
more in line with the increase in PSN revenue. Direct medical costs, the largest
component of expense, represent certain costs associated with providing services
of the PSN operation including direct medical payments to physician providers,
hospitals and ancillaries on a capitated or fee for service basis. As a
percentage of PSN revenues, the medical loss ratio (MLR) amounted to 89.5% and
86.4% for the nine months ended September 30, 2002 and 2001, respectively.
Adjusted for the charges discussed above, the MLR for the 2002 would amount to
85.0%, a 1.4% improvement over 2001. This improvement resulted from the
Company's continually improving utilization initiatives, including its
hospitalist, partners in quality (PIQ), and oncology programs, and the increased
funding it received during 2002, offset in part by increases in Part A
(hospital) costs due to new contracts with hospitals in the Company's Daytona
network.
Cost of sales for the first three quarters of 2002 totaled $7.0 million and
represents the cost of the pharmaceuticals sold by MetcareRx. The pharmacy
division had a gross profit percentage for the six months ending September 30,
2002 of 32%.
Salaries and benefits for the first nine months of 2002 increased $4.1 million
over 2001 to $8.6 million. Since June 30, 2001, the Company expanded its
operations as it continued to implement its business plan. In July 2001, a
medical center was opened in Boca Raton, incurring $241,000 in incremental
payroll costs for the first nine months of 2002, with other PSN medical offices
opened in March 2001 accounting for an additional $201,000 in increases.
MetcareRx accounted for $2.6 million of incremental payroll costs in its
Florida, New York and Maryland facilities. Expansion of the services the Company
provides in its Daytona market in an effort to control its medical costs
accounted for an additional $974,000 of the increase while salary increases,
increases in medical insurance premiums and a bolstering of staffing throughout
the Company, particularly in the PSN, accounted for the balance of the increase,
which was partially offset by a $91,000 incremental decrease resulting from the
closure of a medical practice in the second half of 2001. The Company believes
it has the necessary management in place to support the revenue growth the
Company anticipates in 2002 and beyond.
Medical supplies were $1.4 million for the nine months ended September 30, 2002,
compared to $55,000 in 2001. Medical supply costs are incurred in all the
Company's medical offices, most prominently in the Company's two Daytona
oncology offices, which account for all but $54,000 of the quarter's expense.
Depreciation and amortization for the nine months ended September 30, 2002 was
$798,000 compared to $612,000 the year before. The increase of approximately
$186,000 is due primarily to amortization of financing costs and an increase in
depreciation on fixed assets acquired over the past twelve months.
Consulting expense increased approximately $1.4 million, from $606,000 in the
nine months ended September 30, 2001to $2.0 million in the same period in 2002.
Of the increase, $806,000 was incurred in the Company's Hospitalist, Oncology
and Utilization/Quality Assurance/Management programs, which are designed to
lower direct medical costs while improving patient care, $358,000 of incremental
expense was incurred in connection with investment banking and advisory services
and $162,000 was spent in the development of the Company's HMO, part of its
long-term goal to diversify its revenue base.
General and administrative expenses increased from $2.2 million in the first
three quarters of 2001 to $4.5 million in 2002, an increase of $2.3 million. The
pharmacy operations accounted for $1.3 million in incremental general and
administrative expenses while the costs of the Company's oncology and
hospitalist programs and other PSN expansion accounted for an additional
$401,000 in incremental costs. Increases also were incurred in accounting and
legal fees ($156,000) and insurance ($166,000).. The prior year quarter also
included approximately $313,000 in accounts payable write-offs and settlements
relating to discontinued operations, These increases were partially offset by
the savings of $142,000 resulting from the closure of a medical practice in the
second half of 2001.
Interest expense increased $1.2 million for the nine months ended September 30,
2002 as compared to 2001, due in large part to the previously mentioned charge
to interest expense of $808,000 incurred in conjunction with a Convertible
Debenture financing completed in May 2002. The balance of the increase is due to
the increased amount of debt carried by the Company at September 30, 2002 as
compared to the prior year.
LIQUIDITY AND CAPITAL RESOURCES
During the nine months ended September 30, 2002 the Company raised approximately
$5.2 million in debt and equity financing. However, the Company has sustained
negative cash flows from operations since 2000, primarily as a result of the
Company's diversification of its revenue base, including the pharmacy and
17
clinical laboratory operations. Although the Company expects its cash flow from
operations to continue to improve, there can be no assurance that this will
occur. In the absence of achieving positive cash flows from operations or
obtaining additional debt or equity financing, the Company may have difficulty
meeting current and long-term obligations. The auditor's report on the Company's
financial statements for the year ended December 31, 2001 states that certain
matters raise substantial doubt about the Company's ability to continue as a
going concern.
To address these concerns, the Company has negotiated and is in the process of
closing an accounts receivable financing agreement to support the growth in its
pharmacy division. In addition, the Company projects cash flow from HMO
agreements to increase significantly in 2003 from expansion and implementation
of new agreements. Also, management has taken measures to reduce overhead and is
reviewing its operations for further reductions.
In conjunction with its review of its operations, the Company decided to dispose
of its clinical laboratory. Accordingly, in the quarter ended September 30,
2002, the Company recognized $1.3 million in losses on discontinued
operations. Management has implemented and continues to review other cost
cutting measures as well as potential sources of increased revenue in order to
accomplish its goals.
In view of these matters, realization of a major portion of the assets in the
accompanying balance sheet is dependent upon continued operations of the
Company, which in turn is dependent upon the Company's ability to meet its
financial obligations. Management believes that actions presently being taken,
as described in the preceding paragraphs, provide the opportunity for the
Company to continue as a going concern.
During the first quarter of 2002, the Company issued 500,000 shares to
accredited investors, in connection with private placements, resulting in
proceeds of $500,000 that were used for working capital. Additionally, the
Company borrowed $1.7 million on short-term notes payable that were due June
2002, since extended, and $625,000 in long-term notes payable, with varying
interest rates ranging from 5% to 24% and beneficial conversion features.
Certain notes also provided for issuance of 65,000 warrants in the aggregate and
are collateralized by all the Company's assets. The proceeds from these
transactions were used for working capital. Such offerings were to accredited
investors pursuant to Section 4(2) of the Securities and Exchange Act of 1934.
In May 2002, the Company entered into a "Securities Purchase Agreement", in
which it issued $1,580,000 6% Convertible debentures due 5/24/04 and 150,000
warrants to purchase common stock. The purchase price for the promissory note
and Warrants was $1,501,000 or 95% of the principal amount of the Convertible
Debentures. The Holder shall have the right at its option to convert the
Convertible Debenture into shares of common stock. In addition, in May the
Company entered into a "Securities Purchase Agreement" in which the Company
issued a $1,200,000 principal amount Promissory Note due 5/24/04 and 500,000
warrants to purchase common stock. The purchase price for the promissory note
and warrants was $1.2 million. Interest is payable quarterly at a rate of 12%
per annum, commencing June 30, 2002, and principal is due at maturity.
The primary source of the Company's liquidity is derived from payments from its
full-risk contracts with an HMO. In March 2002, two investors, on behalf of the
Company, funded $1.0 million as collateral for a letter of credit in favor of
the HMO. The letter of credit was required by the Company's contract with the
HMO and enabled the Company to favorably renegotiate certain terms of the
contract. The Company has agreed to purchase the collateral over ten months at
an effective rate of 24% per annum and at September 30, 2002, $600,000 had been
purchased.
As discussed in Note 2, the Company, in conjunction with its outside
consultants, makes certain estimates with regards to revenues, expenses and
resulting accounts receivable arising from agreements with the HMO. While the
Company believes these amounts will ultimately be realizable, the collection
cycle of these estimated amounts usually exceeds the typical collection time
required to collect medical accounts receivable. Often these amounts are subject
to different interpretation by the Company and the HMO and, accordingly, needs
to be reconciled with the HMO. As a result, certain revenue and cost estimates
may be settled for amounts different than previously estimated. Accordingly,
management recorded a reserve of $1.5 million against these receivables in the
second quarter.
At September 30, 2002 the Company had a recorded liability for unpaid payroll
taxes of approximately $2.2 million, exclusive of accrued interest and penalties
of $1.2 million. The Company previously negotiated an installment plan with the
Internal Revenue Service (IRS) whereby it made monthly installments of $100,000
on the amount in arrears. The Company is currently negotiating with the IRS for
a new installment agreement and has proposed a three-year payout whereby the
liability would be retired at the end of the agreement.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
None
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures
Within the 90 days prior to the filing date of this report, the Company
carried out an evaluation of the effectiveness of the design and
operation of its disclosure controls and procedures pursuant to
Exchange Act Rule 13a-14. This evaluation was done under the
supervision and with the participation of the Company's Principal
Executive Officer and Principal Financial Officer. Based upon that
evaluation, they concluded that the Company's disclosure controls and
procedures are effective in gathering, analyzing and disclosing
information needed to satisfy the Company's disclosure obligations
under the Exchange Act.
Changes in internal controls
There were no significant changes in the Company's internal controls or
in other factors that could significantly affect those controls since
the most recent evaluation of such controls.
PART II OTHER INFORMATION
ITEM 1. SUMMARY OF LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
NONE
ITEM 3. DEFAULT UPON SENIOR SECURITIES
NONE
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
NONE
ITEM 5. OTHER INFORMATION
NONE
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
EXHIBITS
No. 99.1 - Certification of CEO
No. 99.2 - Certification of CFO
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FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS
Except for historical information contained herein, the matters discussed in
this report are forward-looking statements made pursuant to the safe harbor
provisions of the Securities Litigation Reform Act of 1995. These
forward-looking statements are based largely on the Company's expectation and
are subject to a number of risks and uncertainties, including but not limited to
economic, competitive and other factors affecting the Company's operations,
ability of the Company to obtain competent medical personnel, the cost of
services provided versus payment received for capitated and full-risk managed
care contracts, negative effects of prospective healthcare reforms, the
Company's ability to obtain medical malpractice coverage and the cost associated
with malpractice, access to borrowed or equity capital on favorable terms, the
fluctuation of the Company's common stock price, and other factors discussed
elsewhere in this report and in other documents filed by the Company with the
Securities and Exchange Commission from time to time. Many of these factors are
beyond the Company's control. Actual results could differ materially from the
forward-looking statements. In light of these risks and uncertainties, there can
be no assurance that the forward-looking information contained in this report
will, in fact, occur.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
Undersigned thereunto duly authorized.
METROPOLITAN HEALTH NETWORKS, INC.
Registrant
Date: November 14, 2002 /s/ Fred Sternberg
-------------------------
Fred Sternberg
Chairman, President and
Chief Executive Officer
Date: November 14, 2002 /s/ David S. Gartner
------------------------
David S. Gartner
Chief Financial Officer
20