Back to GetFilings.com

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended February 28, 2005

For the transition period from                      to                             

Commission File Number: 000-21574

DYNACQ HEALTHCARE, INC.

(Exact name of registrant as specified in its charter)

(713) 378-2000

(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 an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨ No x

As of April 1, 2005, the number of shares outstanding of the registrant’s common stock, par value $.001 per share, was 14,851,568.

Table of Contents

Table of Contents - PART I—FINANCIAL INFORMATION

2

Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We have reviewed the consolidated balance sheet of Dynacq Healthcare, Inc., as of February 28, 2005, the related consolidated statements of operations for the three-month and six-month periods ended February 28, 2005 and February 29, 2004, and cash flows for the six-month periods ended February 28, 2005 and February 29, 2004. These interim financial statements are the responsibility of the Company’s management.

We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to the consolidated interim financial statements for them to be in conformity with United States generally accepted accounting principles.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Dynacq Healthcare, Inc., as of August 31, 2004, and the related consolidated statements of operations, stockholders’ equity, and cash flows for the year then ended not presented herein, and in our report dated October 30, 2004, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of August 31, 2004, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

/s/ Killman, Murrell & Company, P.C.

Killman, Murrell & Company, P.C.

Houston, Texas

April 1, 2005

3

Table of Contents

PART I - FINANCIAL INFORMATION

Dynacq Healthcare, Inc.

Consolidated Balance Sheets

See accompanying notes.

4

Table of Contents

Dynacq Healthcare, Inc.

Consolidated Balance Sheets (continued)

See accompanying notes.

5

Table of Contents

Dynacq Healthcare, Inc.

Consolidated Statements of Operations

(Reviewed)

See accompanying notes.

6

Table of Contents

Dynacq Healthcare, Inc.

Consolidated Statements of Cash Flows

(Reviewed)

Continued

7

Table of Contents

Consolidated Statements of Cash Flows (continued)

See accompanying notes.

8

Table of Contents

Dynacq Healthcare, Inc.

Notes to Consolidated Financial Statements

February 28, 2005

(reviewed)

Basis of Presentation

The accompanying reviewed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete consolidated financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. All such adjustments are of a normal and recurring nature. The majority of the Company’s expenses are “cost of revenue” items. Costs that could be classified as general and administrative by the Company would include the corporate office costs, including advertising and marketing expenses, which were approximately $3.7 million and $4.4 million for the quarters ended February 28, 2005 and February 29, 2004, respectively, and $7.8 million and $7.8 million for the six months ended February 28, 2005 and February 29, 2004, respectively. These consolidated financial statements also include the accounts of Vista Hospital of Baton Rouge, LLC, an indirect majority-owned subsidiary of the Company that operates the Baton Rouge Facility, which is currently in Chapter 11 bankruptcy proceedings. These reviewed financial statements should be read in conjunction with the audited financial statements at August 31, 2004. Operating results for the quarter and six months ended February 28, 2005 are not necessarily indicative of the results that may be expected for the fiscal year ending August 31, 2005.

The Company operates in one line of business and its strategy is to develop and operate general acute care hospitals designed to handle specialized general surgeries such as bariatric, orthopedic and neuro spine surgeries. The Company manages these hospitals on an individual basis. The hospitals’ economic characteristics, nature of their operations, regulatory environment in which they operate and the manner in which they are managed are all similar. Accordingly, the Company aggregates its hospitals into a single reportable segment as that term is defined by SFAS No. 131 “Disclosures About Segments of an Enterprise and Related Information.”

General

As of February 28, 2005, the Company operated two facilities in the Houston, Texas metropolitan area (Pasadena and West Houston Facilities), and one each in the Dallas-Fort Worth, Texas area (Garland Facility) and in Baton Rouge, Louisiana (Baton Rouge Facility). The Garland Facility was acquired in August 2003, and surgical procedures started at this facility at the end of November 2003.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. The most significant of the Company’s estimates is the determination of revenue to recognize for the services the Company provides and the determination of the contractual allowance. See “Revenue Recognition” below for further discussion. Actual results could differ materially from those estimates used in preparation of these financial statements.

Reclassification

Accounts receivable-other of $152,525 has been stated separately out of other assets as of August 31, 2004 to be consistent with the current presentation.

Stock Based Compensation

The Company applies Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and related interpretations in accounting for its employee stock compensation, until required otherwise by Statement of Financial Accounting Standards No. 123(R) (SFAS 123R). In December 2004, the Financial

9

Table of Contents

Accounting Standards Board issued SFAS 123(R), “Share-Based Payment,” which requires companies to measure and recognize compensation expense for all stock-based payments at fair value. SFAS 123(R) will be effective for the Company beginning with the first fiscal quarter of 2006. The Company is currently evaluating the impact of SFAS 123(R) to its consolidated financial statements. As required by Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), the Company has determined pro forma net income and earnings per share, as if compensation cost for the employees stock options had been determined based upon fair values at the grant dates. These pro forma amounts are as follows:

The fair value of the stock-based awards was estimated using the Black-Scholes model with the following weighted average assumptions:

Revenue Recognition

Background

The Company’s revenue recognition policy is significant because net patient service revenue is a primary component of its results of operations. Revenue is recognized as services are delivered. The determination of the amount of revenue to be recognized in connection with the Company’s services is subject to significant judgments and estimates, which are discussed below.

Revenue Recognition Policy

The Company is normally not a party to any managed care contracts. The Company records revenue pursuant to the following policy. The Company has established billing rates for its medical services that it bills as gross revenue as services are delivered. Gross billed revenues are then reduced by the Company’s estimate of the discount (contractual allowance) to arrive at net patient service revenues. Net patient service revenues are based on historical cash collections as discussed below and may not represent amounts ultimately expected to be collected. At such time as the Company can determine that ultimate collections exceeded or have been less than the revenue recorded on a group of accounts, additional revenue or reduction in revenue is recorded.

10

Table of Contents

Contractual Allowance

The Company computes its contractual allowance based on the ratio of the Company’s historical cash collections during the trailing twelve months on a case-by-case basis to gross billed revenue on a case-by-case basis by operating facility. This ratio of cash collections to billed services is then applied to the gross billed services by operating facility. The following table shows gross revenues and contractual allowances for the three and six months ended February 28, 2005 and February 29, 2004:

Accounts Receivable

Accounts receivable represent net receivables for services provided by the Company. The estimated accounts receivable not expected to be collected within twelve months of the balance sheet date have been shown as long-term receivables and represent receivables in the Medical Dispute Resolution (“MDR”) and legal third party financial class. The contractual allowance is provided as revenue is recognized. At each balance sheet date management reviews the accounts receivables for collectibility. If after the review management believes certain receivables would be uncollectible, the receivable would be written down to the expected collectable amount. Management has not written down any receivables during the quarters and six months ended February 28, 2005 and February 29, 2004 as a result of the collectibility test.

The contractual allowance stated as a percentage of gross receivables at the balance sheet dates is larger than the contractual allowance percentage used to reduce gross billed charges due to the application of partial cash collections to the outstanding gross receivable balances without any adjustment being made to the contractual allowance. The contractual allowance amounts netted against gross receivables are not adjusted until such time as the final collections on the receivables are recognized.

Collections for services provided are generally settled or written off as uncollectible against the contractual allowance within six months of the date of service except for services provided to injured workers in Texas. Collections for services provided to injured workers in Texas may take up to three years or longer to be completely adjudicated. Because the Company has in recent years focused on providing services to injured workers in Texas, accounts receivable in the workers compensation and MDR financial classes have increased.

The MDR process is an established reimbursement resolution process available to providers of healthcare services under the regulations guiding reimbursement for services provided to injured workers in the State of Texas. Accounts generally do not become subject to the MDR process prior to being outstanding for at least 90 days subsequent to patient discharge. For medical services provided to injured workers’ in the state of Texas, the MDR process is specifically based upon the administrative and statutory regulations promulgated by the Texas Labor Code and Texas Administrative Code provisions.

Due to a number of factors outside the Company’s control, including a change in the Company’s reimbursement collection experience associated with potential changes in the reimbursement environment in which the Company operates, it is possible that management’s estimates of patient service revenues could change, which could have a material impact on the Company’s revenue and profitability in the future.

Allowance for Uncollectible Accounts

The Company has estimated uncollectible accounts expense as 1% of gross outpatient revenue. The Company normally makes no charge offs against allowance for uncollectible accounts, as historically all charge offs

11

Table of Contents

have been against the contractual allowance. However, during the quarter and six months ended February 29, 2004, the Company charged $22,264 and $222,518, respectively, against the allowance for uncollectible accounts.

Minority Interests

The equity of minority investors (generally physician groups and other healthcare providers that perform surgeries at the Company’s facilities) in certain subsidiaries of the Company is reported on the consolidated balance sheets as minority interests. Minority interests reported in the consolidated income statements reflect the respective interests in the income or loss of the limited partnerships or limited liability companies attributable to the minority investors (equity interests ranged from 2.14% to 10% at various facilities at February 28, 2005). During the quarter ended November 30, 2003, the Company purchased minority interest from certain minority interest holders at an amount that was $301,040 less than the net book value of the minority interest liability on the date of purchase. The $301,040 less applicable income taxes of $114,170 has been recorded as an extraordinary gain during the quarter ended November 30, 2003. The partnership agreement provided a means for the minority interest holders to be cashed out at the net book value. The amounts paid to the minority interest holders were less than the buy out amount that was called for in the partnership agreements. Legal counsel has advised the Company that the acquisitions were negotiated transactions occurring outside the partnership agreement.

Bankruptcy Filing by Subsidiary

On October 8, 2004, Vista Hospital of Baton Rouge, LLC (“VHBR”), an indirect majority-owned subsidiary of the Company that operates the Baton Rouge Facility, filed a voluntary petition under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Southern District of Texas. VHBR continues to operate its business and manage its property as a “debtor in possession” under the jurisdiction of the Bankruptcy Court.

VHBR filed for bankruptcy protection because, among other reasons, VHBR was unable to pay the alleged damages sought by, and the costs of defending against, a lawsuit, Liljeberg Enterprises International, L.L.C. v. Vista Hospital of Baton Rouge, LLC, d/b/a Vista Surgical Hospital, filed by Liljeberg Enterprises International, L.L.C. in September 2003 against both the Company and VHBR in the Twenty Fourth Judicial District Court for the Parish of Jefferson, State of Louisiana (case number 598-564). On March 18, 2005, the Bankruptcy Court approved a settlement between Liljeberg Enterprises International, LLC, VHBR, Dynacq and Mr. Chiu Chan. Pursuant to the terms of the settlement, a Dynacq affiliate paid $1.2 million (the settlement amount) to Liljeberg Enterprises, and Liljeberg Enterprises assigned its claim against VHBR to the Dynacq affiliate and released VHBR, Dynacq, Mr. Chan and all of their affiliates from any claims, known or unknown.

On April 7, 2005, the Bankruptcy Court confirmed the plan of reorganization to fully pay all creditors. Although VHBR anticipates that the confirmed plan of reorganization will become effective on or about April 18, 2005 (if no appeals are filed), Dynacq cannot predict the outcome of the Chapter 11 proceeding.

Debtor-in-Possession financial statements. Under the Bankruptcy Code, VHBR is required to periodically file with the Bankruptcy Court various documents, including financial statements of the VHBR as a Debtor-in-Possession. These financial statements are prepared according to requirements of the Bankruptcy Code. While these financial statements accurately provide information required by the Bankruptcy Code, which is not wholly in accordance with generally accepted accounting principles in the United States of America (U.S. GAAP), they are unconsolidated, unaudited, and prepared in a format different from that used in our consolidated financial statements filed under the securities laws and from that used in the consolidated financial statements, which are prepared in accordance with U.S. GAAP. Accordingly, we believe the substance and format of the financial statements prepared for the Bankruptcy Court do not allow meaningful comparison with the following financial statements.

Basis of presentation. We continue to consolidate VHBR as the Debtor in our consolidated financial statements. While generally it is appropriate to deconsolidate a subsidiary during its Chapter 11 proceedings on the basis that control no longer rests with the parent, the facts and circumstances particular to our situation support the continued consolidation of the subsidiary. Specifically:

12

Table of Contents

VHBR as Debtor-in-Possession

Condensed Statement of Operations

(Unaudited)

VHBR as Debtor-in-Possession

Condensed Balance Sheet

(Unaudited)

13

Table of Contents

VHBR as Debtor-in-Possession

Condensed Statement of Cash Flows

(Unaudited)

On April 7, 2005, the Bankruptcy Court approved VHBR’s proposed plan of reorganization. If such plan of reorganization is not consummated (or any revised plan of reorganization acceptable to us is not confirmed and consummated), such event could prolong the Chapter 11 proceeding. In such event, a prolonged Chapter 11 proceeding could adversely affect the Debtor’s relationships with customers, suppliers, and employees, which in turn could adversely affect the Debtor’s competitive position, financial condition, and results of operations. In addition, if the Debtor is unsuccessful in consummating the confirmed plan of reorganization, the assets of the Debtor could be liquidated in the Chapter 11 proceedings. Dynacq cannot predict the outcome of the Chapter 11 proceedings.

Contingencies

The Company maintains various insurance policies that cover each of its facilities. Specifically, the Company has claims-made malpractice coverage for its West Houston Facility and has occurrence coverage for its Pasadena and Garland Facilities. The Company previously had claims-made malpractice coverage for its Pasadena Facility until August 12, 2002, at which time the Company converted to the occurrence coverage. The Company purchased tail coverage through August 12, 2004 (the applicable statute of limitations expiration date). In Louisiana, the Company is a member of the Louisiana Patient Compensation Fund and purchases insurance through the Louisiana Patient Compensation Fund for medical malpractice. In addition, all physicians granted privileges at the Company’s facilities are required to maintain medical malpractice insurance coverage. The Company also maintains general liability and property insurance coverage for each facility and flood coverage for the Baton Rouge Facility. The Company maintains workers’ compensation coverage for the Baton Rouge Facility, but does not currently maintain worker’s compensation coverage in Texas. In regard to the Employee Health Insurance Plan, the Company is self insured with specific and aggregate re-insurance with stop-loss levels appropriate for the Company’s group size. Coverages are maintained in amounts management deems adequate.

A shareholder derivative action alleging breach of fiduciary duty, abuse of control, gross mismanagement and unjust enrichment, Flory v. Chan, et al., H-02-3123, was brought in U.S. District Court for the Southern District of Texas in August 2002, but was stayed on November 12, 2002 by the district court pending the outcome of a previously filed shareholder class action Hamilton v. Dynacq International, et. al., in another court in that district. Given the plaintiff’s dismissal of the appeal in the Hamilton shareholder class action and given the state court’s dismissal of the same or similar claims in the previously filed shareholder derivative action Brill v. Chan, et. al., filed in the 295^th District Court of Harris County, Texas, the Company moved in the fourth quarter of fiscal 2004 to dismiss this derivative action. The court dismissed the action in October 2004 with prejudice against refiling. The plaintiffs appealed the dismissal to the United States Fifth Circuit Court of Appeals on November 22, 2004. The appellant’s opening brief is due April 15, 2005. Oral arguments, if any, have not yet been scheduled.

In the second quarter of 2004, eight lawsuits were filed in the United States District Court for the Southern District of Texas (Houston Division) between December 24, 2003 and January 26, 2004, alleging federal securities law causes of action against the Company and various current and former officers and directors. The cases were filed as class actions brought on behalf of persons who purchased shares of Company common stock in the open market generally during the period of January 14, 2003 through December 18, 2003. Under the procedures of the Private Securities Litigation Reform Act, the court consolidated the actions and appointed a lead plaintiff in the matter. An amended complaint was filed on June 30, 2004, asserting a class period of November 27, 2002 –

14

Table of Contents

December 19, 2003 and naming additional defendants, including Ernst & Young LLP, the Company’s prior auditors. The amended complaint seeks certification as a class action and alleges that the defendants violated Sections 10(b), 20(a), 20(A) and Rule 10b-5 under the Exchange Act by publishing materially misleading financial statements that did not comply with generally accepted accounting principles, making materially false or misleading statements or omissions regarding revenues and receivables, operations and financial results and engaging in an intentional fraudulent scheme aimed at inflating the value of Dynacq’s stock. After the Company filed its Form 10-K for fiscal 2003 on July 30, 2004, the procedural schedule was amended so that plaintiffs had until 30 days after the Company was current in its filings to file an amended complaint. The plaintiffs filed an amended complaint in September 2004. The Company is vigorously defending against the allegations and filed a motion to dismiss all or some of the claims in October 2004. The Motion to Dismiss is scheduled for a non-evidentiary oral argument on May 13, 2005. The Company cannot predict the ultimate outcome of the lawsuit or whether the lawsuit will have a material adverse effect on the Company’s financial condition.

In September 2003, a lawsuit, case number 598-564, was filed in the Twenty Fourth Judicial District Court for the Parish of Jefferson, State of Louisiana, by Liljeberg Enterprises International, L.L.C. against Vista Hospital of Baton Rouge, LLC, d/b/a Vista Surgical Hospital (“VHBR”), Dynacq International, Inc., and Chiu M. Chan. On October 8, 2004, VHBR, an indirect majority-owned subsidiary of Dynacq, filed a voluntary petition under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Southern District of Texas. VHBR filed for bankruptcy protection because, among other reasons, it was unable to pay the alleged damages sought by, and the costs of defending against, the lawsuit. On the date of VHBR’s bankruptcy filing, the lawsuit was removed to the United States District Court for the Eastern District of Louisiana. During the bankruptcy proceeding, VHBR has continued to operate the Baton Rouge Facility and manage its property as a “debtor in possession” under the jurisdiction of the Bankruptcy Court. On March 18, 2005, the Bankruptcy Court approved a settlement between Liljeberg Enterprises International, LLC, VHBR, Dynacq and Mr. Chiu Chan. Pursuant to the terms of the settlement, a Dynacq affiliate paid $1.2 million (the settlement amount) to Liljeberg Enterprises, and Liljeberg Enterprises assigned its claim against VHBR to the Dynacq affiliate and released VHBR, Dynacq, Mr. Chan and all of their affiliates from any claims, known or unknown. On April 7, 2005, the Bankruptcy Court confirmed VHBR’s plan of reorganization to fully pay all creditors. Although VHBR anticipates that the plan of reorganization will become effective on or about April 18, 2005 (if no appeals are filed), Dynacq cannot predict the outcome of the Chapter 11 proceeding.

From time to time, the Company is involved in litigation and administrative proceedings that are incidental to its business. The Company cannot predict whether any litigation to which it is currently a party will have a material adverse effect on the Company’s results of operations, cash flows, or financial condition. See “Item 3. Legal Proceedings” on our Annual Report on Form 10-K for the fiscal year ended August 31, 2004.

Cautionary Statement Regarding Forward-Looking Statements

This quarterly report on Form 10-Q contains forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “intends,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or the negative of these terms or other comparable terminology. These statements are only predictions. Actual events or results may differ materially. Such forward-looking statements relate to future events or future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our Company’s actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by the forward-looking statements, including the following factors:

15

Table of Contents

and other risks described in “Risk Factors” in our annual report on Form 10-K for the fiscal year ended August 31, 2004. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. You must read the following discussion of the results of our business and our operations and financial condition in conjunction with our reviewed consolidated financial statements, including the notes, included in this quarterly report on Form 10-Q and our audited consolidated financial statements, including the notes, included in our Annual Report on Form 10-K for the fiscal year ended August 31, 2004.

Update on Critical Accounting Policies and Estimates

There have been no changes to the critical accounting policies used in our reporting of results of operations and financial position for the quarter ended February 28, 2005. For a discussion of our critical accounting policies see Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Form 10-K for the fiscal year ended August 31, 2004.

16

Table of Contents

Results of Operations