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UGHS > SEC Filings for UGHS > Form 10-Q/A on 30-May-2013All Recent SEC Filings

Show all filings for UNIVERSITY GENERAL HEALTH SYSTEM, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-Q/A for UNIVERSITY GENERAL HEALTH SYSTEM, INC.


30-May-2013

Quarterly Report

Food Services, Plant Operations & Management, Environmental and Other Services Agreement

Prior to the acquisition of Sybaris, certain shareholders of the Company had organized Sybaris Group, LLC ("Sybaris"), a Texas limited liability company, as a service company. The Company and Sybaris have entered into a management services agreement, pursuant to which Sybaris provides food services, plant operations and management, environmental and other services to the hospital for an initial term of five years. Compensation under this agreement is based on
(i) expense reimbursement for direct costs incurred by Sybaris, (ii) a general expense allowance of six percent (6.0%) of the direct costs incurred by Sybaris and (iii) a service fee of four percent (4.0%) of the direct costs incurred by Sybaris. Amounts payable to Sybaris under this agreement are adjusted annually based on cost of living and other customary adjustments.

On December 31, 2011, the Company, through wholly-owned subsidiaries, acquired certain assets and assumed certain of the liabilities of Sybaris. All accounts receivable of the Seller are specifically excluded from the acquisition and a majority of the accounts receivable balance is owed by the Company. The Company believes the terms of the transaction between Sybaris and the Company are fair, reasonable and reflects fair market value. The Company recognized $1,178,263 and $3,270,037 services fees to Sybaris for the three and nine months ended September 30, 2011, which were recorded as general and administrative expenses and included in the Consolidated Statements of Income. At September 30, 2012 and December 31, 2011, the Company had related party payables to Sybaris of $932,507, respectively.

Other Related Party Transactions

The Company also makes advances to and receives advances from certain other entities. As of September 30, 2012 and December 31, 2011, shareholders of the Company owe $0 and $438,820 for advances. The advances are non-interest bearing and due upon demand and collaterized by shares of the Company with value in excess of amounts owed.

The Company received and issued non-interest bearing advances from an executive officer for working capital purposes. At September 30, 2012 and December 31, 2011, the Company had receivables of $0 and $145,201 from an executive officer, respectively.

Certain shareholders of the Company have organized Sigma Consulting LLC ("Sigma"), a Texas limited liability company, as a service company. Sigma provided information technology consulting services to UGH LP, and for the three and nine months ended September 30, 2012 and 2011, UGH LP incurred total service expenses of $85,890 and $61,163 and $267,786 and $200,908, respectively, which were recorded as general and administrative expenses in the Consolidated Statements of Income. The Company believes that these payments to Sigma are fair and reasonable.


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Notes Payable to Related Parties

Notes payable to related parties consist of the following:



`                                              September 30, 2012           December 31, 2011
Note payable to a shareholder, due on
demand, interest rate of 10.0%                $          1,923,000         $         1,923,000
Notes payable to shareholder, due on
demand, non-interest bearing                                    -                       84,962
Trinity notes payable to a shareholder,
due on demand, non-interest bearing                        247,143                     263,499
Note payable to a shareholder, due on
demand, interest rate of 15.0%                                  -                      154,000
Note payable to a shareholder, maturing
in 2017, non-interest bearing                                   -                      370,000
Note payable to a shareholder, maturing
in 2017, interest rate of 2.43%, with a
discount of $112,791 at December 31,
2011                                                            -                    1,286,836
Subordinated promissory notes payable
to shareholders, maturing in 2028,
interest rate of 15.0% at September 30,
2012                                                            -                      700,000

Total notes payable to related parties        $          2,170,143         $         4,782,297
Less: current portion                                    2,170,143                   2,798,783

Notes payable to related parties, less
current portion $ - $ 1,983,514

On October 5, 2006, the Company entered into a $2,000,000 loan agreement with Dr. Spiegel, bearing interest at a rate of 10.0%, and which is due on demand. Dr. Spiegel beneficially owns more than ten percent (10%) of the Company's common stock. The purpose of this loan agreement is to support the Company's working capital. As of September 30, 2012 and December 31, 2011, the outstanding balance on this loan agreement was $1,923,000.

The Company recognized total interest expense on all of its related party notes payable and capital lease of $571,394 and $641,293 for the three months ended and $1,734,144 and $1,815,568 for the nine months ended September 30, 2012 and 2011, respectively. Total accrued interest on notes payable to related parties was $1,214,248 and $1,560,581 at September 30, 2012 and December 31, 2011, respectively.

NOTE 9 - COMMITMENTS AND CONTINGENCIES

Litigation

From time to time, the Company may become involved in litigation relating to claims arising out of its operations in the normal course of business. The Company is not involved in any pending legal proceeding or litigation and, to the best of the Company's knowledge, no governmental authority is contemplating any proceeding to which the Company is a party or to which any of its properties is subject, which would reasonably be likely to have a material adverse effect on the Company, except for the following:

Prexus

On December 4, 2009, Prexus Health Consultants, LLC and its affiliate, Prexus Health LLC (collectively, "Prexus"), sued UGH LP and Ascension Physician Solutions, LLC ("APS") in the 270th District Court of Harris County, Texas, Cause No. 2009-77474, seeking (i) $224,863 for alleged breaches of a Professional Services Agreement (the "PSA") under which Prexus provided billing, coding and transcription services, (ii) $608,005 for alleged breaches of a Consulting Services Agreement (the "CSA") under which Prexus provided professional management and consulting services, and (iii) lost profit damages for the remaining term of the agreements (UGH LP and APS terminated these contracts effective September 9, 2009). Prexus subsequently added additional claims seeking lost profits and other damages for alleged tortious interference of Prexus contracts. In October 2010, UGH LP and APS filed counterclaims against Prexus seeking $1,687,242 in damages caused by Prexus' breach of the CSA.


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On October 11, 2011, the trial court judge entered judgment against UGH LP for approximately $2,900,000, including $2,100,000 in lost profits. The judgment also awarded additional amounts for pre-judgment and post-judgment interest. UGH LP timely appealed the lost profits portion of the judgment and has suspended enforcement of the judgment pending the result of the appeal. The Company believes the appellate court is likely to reduce the amount of the judgment to $861,000 which is the amount of unpaid fees to Prexus prior to the effective date of termination. As a result, the Company accrued this amount plus $139,000 for attorney fees and estimated post judgment interest as of September 30, 2012, which is included in the Consolidated Balance Sheets.

Siemens

On June 29, 2010, Siemens Medical Solutions USA, Inc. ("Siemens") sued UGH LP, University Hospital Systems, LLP ("UHS") and several individual guarantors in the 215th District Court of Harris County, Texas, Cause No. 2010-40305, seeking approximately $7,000,000 for alleged breaches of (i) a Master Equipment Lease Agreement dated August 1, 2006 and related agreements (the "Lease Agreements"), pursuant to which UGH LP leased certain radiology equipment and (ii) an Information Technology Agreement dated March 31, 2006 and related agreements (the "IT Agreements") pursuant to which Siemens agreed to provide an information technology system, software and related services. On November 22, 2010 UGH LP filed counterclaims against Siemens seeking approximately $5,850,000 against Siemens for breach of contract, negligent representation and breach of warranty based on Siemens' breach of the Lease Agreements and the IT Agreements. On February 28, 2011, the court signed an order granting partial summary judgment in favor of Siemens and against UGH LP as to UGH LP's liability for breach of the Lease Agreements, but not as to damages sought by Siemens.

On October 17, 2011, the parties entered into a Confidential Settlement Agreement and Mutual Release (the "Settlement Agreement") resolving this dispute. On September 15, 2011, the parties to the Siemens litigation reached a settlement of the pending litigation. As part of the settlement, UGH LP agreed to pay Siemens an aggregate of $4,850,000 over a period of 20 months beginning in October 2011 through May 2013. Thereafter, a dispute arose regarding the Settlement Agreement, and on February 2, 2012 the trial court entered an Agreed Judgment against UGH LP and UHS in the amount of $5,500,000, less credits for amounts paid by UGH LP under the Settlement Agreement. UGH LP is currently in a dispute with Siemens regarding the settlement agreement entered into on September 15, 2011. Specifically UGH LP disputes the entry of the agreed judgment securing the settlement as a result of an alleged breach of the settlement agreement. UGH LP has a timely filed an appeal and suspended enforcement of the Agreed Judgment during the pendency of the pending such appeal. Case No. 01-12-00174-CV, First Court of Appeals, Houston, Texas. UGH LP also filed a Petition for Writ of Mandamus challenging the trial court's jurisdiction to enter the Agreed Judgment. Case No. 01-12-00186-CV, First Court of Appeals, Houston, Texas. All briefing in the appeal and the mandamus proceeding is complete. The appellate court has not yet issued a ruling. As of September 30, 2012 and December 31, 2011 the Company accrued the estimated present value of this unpaid claim of $2,753,232 and $3,451,555, respectively, in the Consolidated Balance Sheets.

Internal Revenue Service

UGH LP currently owes the Internal Revenue Service (the "IRS") past due payroll taxes. Until paid in full, statutory penalties and interest will continue to accrue. The IRS has filed tax liens covering such amounts with various governmental authorities and has taken other actions to collect these balances. UGH LP is working with IRS representatives on payment arrangements to satisfy these balances on an amicable basis. In August 2011, UGH LP entered into an installment agreement with the IRS pursuant to which UGH LP paid $165,000 per month towards satisfaction of the outstanding balance for various quarters in 2009. In March 2012, this agreement was terminated and the outstanding balance thereunder was paid in full. At September 30, 2012 and December 31, 2011, the Company accrued $3,640,381 and $4,171,826, respectively. At November 14, 2012, the outstanding balance is $1,008,303.


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NOTE 10 - DERIVATIVES

The table summarizes the Company's derivative instruments:



                                                            Preferred C  Shares
                                Preferred C Shares               Warrants                Consulting Warrants            Total
Balance, December 31,
2011                           $                 -         $                  -         $                  -         $         -
Issuance of Preferred C
Shares                                    2,996,548                    2,974,238                           -            5,970,786
Issuance of Consulting
Warrants                                         -                            -                       341,440             341,440
Change in fair value                      2,122,329                    2,063,383                       71,268           4,256,980

Balance, September 30,
2012                           $          5,118,877        $           5,037,621        $             412,708        $ 10,569,206

The fair values of derivative instruments were estimated using the Binomial pricing model based on the following weighted-average assumptions:

                                 Preferred C Shares
                                  Shares/Warrants     Consulting Warrants
           Risk-free rate           0.62%-0.82%           0.62%-0.78%
           Expected volatility          100%                 100%
           Expected life           3.59-5.0 years       4.59-5.0 years

The following table summarizes derivative warrants outstanding and exercisable as at September 30, 2012:

                                                            Weighted Average
         Issuance                    Number of Shares        Exercise Price
         Preferred C Shares (a)             19,090,909     $             0.22
         Preferred C Warrants (a)           19,090,909                   0.26
         Consulting Warrants (b)             1,605,818                   0.29

                                            39,787,636                   0.24

(a) Preferred C Shares and Warrants:

In conjunction with the Series C Convertible Preferred Stock (See Note 11) issuance on May 2, 2012, the Company issued preferred stock with warrants. The Preferred C Stock and Warrants have round-down provisions where if the Company sells or grants any option to purchase or sells or grants any right to re-price, or otherwise disposes of or issues (or announces any sale, grant or any option to purchase or other disposition), any common stock or common stock equivalents entitling any person to acquire shares of common stock at an effective price per share that is lower than the then conversion price then the conversion price shall be reduced to equal the base conversion price. The Company accounted for these features as derivative liabilities. The Company concluded that since these provisions are not indexed to the Company's stock, the provisions are precluded from equity classification. The Company recorded the fair market value of the derivative as a direct investor expense.

(b) Consulting Warrants:

During the nine months ended September 30, 2012, the Company issued warrants to consultants for services. The warrants have round-down provisions where if the Company sells or grants any option to purchase or sells or grants any right to re-price, or otherwise disposes of or issues (or announces any sale, grant or any option to purchase or other disposition), any common stock or common stock equivalents entitling any person to acquire shares of common stock at an effective price per share that is lower than the then conversion price then the conversion price shall be reduced to equal the base conversion price. The Company accounted for these features as derivative liabilities. The Company concluded that since these provisions are not indexed to the Company's stock, the provisions are precluded from equity classification. The Company recorded the fair market value of the derivative as a direct investor expense.


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                                                                                                                       Fair Value
Date of Issue                    Number of Warrants         Exercise Price          Maturity Date         Issue Date         September 30, 2012
May-2, 2012                                  605,818       $           0.26       May 1, 2017            $     88,470       $            159,738
September 28, 2012                         1,000,000                   0.32       September 27, 2017          252,970                    252,970

                                           1,605,818                                                     $    341,440       $            412,708

NOTE 11 - EQUITY

Common Stock

Effective April 30, 2012 the Company completed a private placement transaction for the purchase of 35,950,000 shares of its Common Stock at a price of $0.14 per share from a group of accredited investors, resulting in net proceeds to the Company of approximately $5,033,000. The Company used these proceeds to pay tax payments and retired certain outstanding loan balances.

On April 30, 2012, the Company entered into Executive Stock Agreement with a key executive (the "Executive"), pursuant to which the Company sold to the Executive in the aggregate 1,071,429 shares of common stock ("Executive Shares") at a purchase price of approximately $0.14 per share, and the Executive entered into promissory note with the Company for $150,000. The shares purchased by the Executive are subject to repurchase by the Company if, prior to the second anniversary of the issuance date, the Executive's employment with the Company is terminated for "cause" (as defined in the Executive Stock Agreement) or the Executive resigns from his employment without "good reason" (as defined in the Executive Stock Agreement). The Executive Shares are subject to time vesting that will vest annually over a two-year period (i.e., 50% per year). The Company used the proceeds for working capital purposes. The promissory note is due and payable on December 31, 2022. The promissory note bears interest rate at 4.0%, and the accrued interest shall be paid in full on the date of on which the final principal payment on this note is made.

On May 31, 2012, the Company entered into a $2,000,000 promissory note with a third-party financial institution. In lieu of cash interest on the principal balance of this note, the company issued 2,000,000 shares of the common stock, $0.001 par value per share of the Company to the payee valued at $520,000.

On June 1, 2012, the Company issued 1,865,000 shares of its common stock in connection with the acquisition of UGH Diagnostic Imaging and UGH Physical Therapy at a price of $0.40 per share.

On July 30, 2012, the Company issued 702,376 shares of its common stock in connection with the acquisition of UGH Kingwood Diagnostic and Rehabilitation Center at a price of approximately $0.25 per share.

Sigma Opportunity Fund, LLC purchased from the Company 625,000 shares of common stock, par value $0.001 per share, of the Company for an aggregate purchase price of $162,500 in cash. In addition to assist in the financing of the acquisition of the TrinityCare, and the retirement of certain debt, the Company entered into a note purchase agreement with Sigma Opportunity Fund, LLC (the "Service Provider") on August 8, 2012.

Preferred Stock

The Company is authorized to issue up to 20,000,000 shares of preferred stock of $0.001 par value per share, in one or more series, and to determine the price, rights, preferences and privileges of the shares of each such series without any further vote or action by the stockholders. The rights of the holders of common stock will be subject to, and may be adversely affected by, the rights of the holders of any shares of preferred stock that may be issued in the future.


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Series C Preferred Stock

On May 2, 2012 the Company completed the private placement of Series C Variable Rate Convertible Preferred Stock (the "Preferred Shares") with accredited investors at a price of $1,000 per share (the "Stated Value"), with an original issue discount of 12%. On September 4, 2012, a shareholder exercised greenshoe option of $350,000 for 392 Preferred Shares. Each Preferred Share is convertible into approximately 4,545 shares of the Company's common stock (the "Conversion Shares") and warrants to purchase up to an aggregate of 19,090,909 shares of the Company's common stock (the "Warrants"). The warrants are exercisable at $0.26 per share and expire in five years. After deducting for fees and expenses, the aggregate net proceeds from the sale of the Preferred Shares and Warrants was approximately $3.1 million. At any time after the six month anniversary of the date of issuance of the Preferred Shares, the Company has the right to redeem the Preferred Shares at a premium of 115%, subject to certain conditions. Furthermore, at any time after the six month anniversary of the date of issuance of the Preferred Shares the Company has the right to require the holders to convert their Preferred Shares in the event that the Company's common stock meets certain trading premiums, and subject to other conditions.

The holders of the Preferred Shares are entitled to receive cumulative dividends at a rate per share of 8% per annum until October 31, 2013, increasing to 16% per annum from November 1, 2013 until January 31, 2014, further increasing to 20% per annum from February 1, 2014 until April 30, 2014 and finally increasing to 25% per annum thereafter, payable quarterly on February 1, May 1, August 1 and November 1, beginning on May 1, 2012. In the event if funds are not legally available for the payment of dividends, then, at the election of such holder, such dividends shall accrue to the next dividend payment date or shall be accreted to, and increase, the outstanding value of the Preferred Share. In addition, dividends are subject to late fees payment. Any dividends that are not paid within three trading days following a dividend payment date shall continue to accrue and shall entail a late fee, which must be paid in cash, at the rate of 18.0% per annum or the lesser rate permitted by applicable law which shall accrue daily from the dividend payment date through and including the date of actual payment in full. On August 1, 2012, the Board declared and paid a quarterly cash dividend of approximately $76,160. As of September, the Company has accrued dividend of $53,387. In addition, the Company has recorded an accretion non-cash dividend in the amount of $236,879 for the increasing variable dividend rate.

In the event of any liquidation, dissolution or winding-up of the Corporation, whether voluntary or involuntary, the holders shall be entitled to receive out of the assets, whether capital or surplus, of the corporation an amount equal to the Stated Value, plus any accrued and unpaid dividends thereon and any other fees or liquidated damages then due and owing for each share of Preferred Stock before any distribution or payment shall be made to the holders of any junior securities, and if the assets of the corporation shall be insufficient to pay in full such amounts, then the entire assets to be distributed to the holders shall be ratably distributed among the holders in accordance with the respective amounts that would be payable on such shares if all amounts payable thereon were paid in full. A fundamental transaction or change of control transaction shall not be deemed a liquidation. The corporation shall mail written notice of any such Liquidation, not less than 45 days prior to the payment date stated therein, to each holder.

Each Preferred Share is convertible at any time at the option of the holder into a number of shares of the Company's common stock determined by dividing the purchase price of $1,000 by the conversion price of $0.22 per share in effect on the date of the certificate is surrendered for conversion. The conversion price is subject to equitable adjustment in the event of any stock splits, stock dividends, recapitalizations and the like. As of September 30, 2012, no Preferred Shares have been converted into the Company's common stock.

In addition, the Company incurred approximately $356,000 of direct costs including warrants issued to the Company placement agents as part of their compensation for the transaction. The expense was recorded as a contra preferred stock account and is being accreted to expense over the expected maturity of the preferred stock. The warrants allow for the purchase of up to 19,090,909 shares of the Company's common stock at an exercise price of $0.26 per share, are exercisable at any time, and expire on May 2, 2017.

Distributions of Noncontrolling Interests

During the nine months ended September 30, 2012, the Company distributed cash to holders of noncontrolling interests of $172,762.


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NOTE 12 - GAIN ON EXTINGUISHMENT OF LIABILITIES

In the three and nine months ended September 30, 2012 and 2011, the Company settled certain accounts payable with vendors, and reduced the accounts payable owed to those vendors. In addition, the Company also settled certain debt obligations with debt holders and reduced principal balance, accrued interest, taxes and penalties due on promissory notes that have been extinguished in accordance with the statute of limitations. For the three and nine months ended September 30, 2012 and 2011, the Company recognized a gain on extinguishment of liabilities of $618,353 and $1,947,134, and $3,521,879 and $3,411,479, respectively, related to the accounts payable settlements.

The Company evaluated the classification of these gain and determined that the gain does not meet the criteria for classification as an extraordinary item. As a result, the gain has been included as "Gain on extinguishment of liabilities" within income from continuing operations in the accompanying Statement of Income for the three and nine months ended September 30, 2012.

NOTE 13 - EARNINGS PER SHARE

Basic earnings per share is computed using the weighted average number of common shares outstanding during the measurement period. Diluted earnings per share is computed using the weighted average number of common shares and all potentially dilutive common share equivalents outstanding during the measurement period. The diluted earnings per share calculation excludes 16.8 million and 18.3 million potential shares related to Preferred C Warrants for the three and nine months ended September 30, 2012 due to their anti-dilutive effect.

The following table summarizes the components used to determine total diluted shares:

                                             For the Three Months Ended September 30,               For the Nine Months Ended September 30,
                                                2012                          2011                     2012                         2011
Net income attributable to the
Company                                 $          1,995,202          $          1,045,450      $         3,645,034          $           377,946
Less: Cash dividend-Convertible
Preferred C Stock                                    (53,387 )                          -                   (53,387 )                         -
Less: Accretion non-cash
dividend-Convertible Preferred C
Stock                                               (145,562 )                          -                  (236,879 )                         -

Net income attributable to common
shareholders                            $          1,796,253          $          1,045,450      $         3,354,768          $           377,946
. . .
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