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DYII > SEC Filings for DYII > Form 10-K on 21-Nov-2013All Recent SEC Filings

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Form 10-K for DYNACQ HEALTHCARE INC


21-Nov-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Our Management's Discussion and Analysis includes forward-looking statements that are subject to risks and uncertainties. Actual results may differ substantially from the statements we make in this section due to a number of factors that are discussed in Item 1A - Risk Factors.

Update on Board of Directors and Internal Investigation

As previously disclosed in our Annual Report on Form 10-K filed with the Securities and Exchange Commission (the "SEC") on March 22, 2013, Dr. Eric K. Chan is the sole remaining member of our Board of Directors (the "Board"). He also serves as our Chief Executive Officer and President. Our Board has five vacancies. We intend to seek qualified candidates to fill these Board vacancies, including some candidates that are deemed independent based on the independence standards of NASDAQ. There can be no assurance, however, that we will be able to fill any of these vacancies with new directors, independent or otherwise. In the interim, the sole remaining member of our Board will continue to fulfill the Board's responsibilities.

As also previously disclosed in our Annual Report on Form 10-K filed with the SEC on March 22, 2013, the internal investigation of our past business practices, potentially encompassing members of the Board, management and third persons, and related accounting matters (the "Investigation"), which was performed by outside legal counsel and other outside consultants at the direction of the Board, was substantially completed on December 27, 2012. We have determined that the questionable nature of certain expenditures identified during the Investigation may result in their reclassification in our financial statements, from operating costs and expenses to other expenses, depending on determinations that the Board may make in the future. We do not expect these reclassifications, even if they are made, to result in a material restatement of our financial statements.

As and when we have independent directors serving on our Board, they will consider whether and if any additional actions are to be pursued by the Company in relation to the Investigation.

Critical Accounting Policies and Estimates

The Consolidated Financial Statements and Notes to Consolidated Financial Statements contain information that is pertinent to the management's discussion and analysis. 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 any contingent assets and liabilities. Management believes these accounting policies involve judgment due to the significant assumptions and estimates necessary in determining the related asset and liability amounts. Management believes it has exercised proper judgment in determining these estimates based on the facts and circumstances available to it at the time the estimates were made. The significant accounting policies are described in the Company's financial statements (see Note 1 in Notes to the Consolidated Financial Statements). Of these policies, management believes the following ones may involve a comparatively higher degree of judgment and complexity. We have discussed the development and selection of the critical accounting policies and related disclosures with the Board of Directors.

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 has established billing rates for its medical services which it bills as gross revenue as services are delivered. Gross billed revenues are then reduced by the Company's estimate of allowances, which includes the contractual allowance and the provision for doubtful accounts, to arrive at net patient service revenues. Net patient service revenues may not represent amounts ultimately collected. The Company adjusts current period revenue for differences in estimated revenue recorded in prior periods and actual cash collections.

The following table shows gross revenues and allowances for fiscal years 2013 and 2012:

                                           2013             2012
                Gross billed charges   $ 19,498,962     $ 19,619,903
                Allowances               13,441,551       14,088,670
                Net revenue            $  6,057,411     $  5,531,233
                Allowance percentage             69 %             72 %

The table below sets forth the percentage of our gross patient service revenue by financial class for the fiscal years 2013 and 2012:

                        2013     2012
Workers' Compensation     11 %     11 %
Commercial                43 %     40 %
Medicare                  28 %     28 %
Medicaid                   1 %      1 %
Self-Pay                  14 %     16 %
Other                      3 %      4 %

Contractual Allowance

The Company computes its contractual allowance based on the estimated collections on its gross billed charges. The Company computes its estimate by taking into account collections received, up to 30 days after the end of the period, for the services performed and also estimating amounts collectible for the services performed within the last six months.

A significant amount of our net revenue results from Texas workers' compensation claims, which are governed by the rules and regulations of the Texas Department of Workers' Compensation ("TDWC") and the workers' compensation healthcare networks. If our hospital chooses to participate in a network, the amount of revenue that will be generated from workers' compensation claims will be governed by the network contract.

For claims arising prior to the implementation of workers' compensation networks and out of network claims, inpatient and outpatient surgical services are either reimbursed pursuant to the Acute Care In-Patient Hospital Fee Guideline or at a "fair and reasonable" rate for services in which the fee guideline is not applicable. Starting March 1, 2008, the Texas Workers' Compensation 2008 Acute Care Hospital Outpatient and Inpatient Facility Fee Guidelines (the "Guidelines") became effective. Under these Guidelines, the reimbursement amounts are determined by applying the most recently adopted and effective Medicare reimbursement formula and factors; however, if the maximum allowable reimbursement for the procedure performed cannot be calculated using these Guidelines, then reimbursement is determined on a fair and reasonable basis.

Based on these Guidelines, the reimbursement due the Company for workers' compensation cases is lower than we previously experienced. The Company has continued accepting Texas workers' compensation cases, and has not made any substantial changes in its focus towards such cases. Our net patient service revenue for Texas workers' compensation cases as a percentage of gross billings has decreased primarily as a result of lower reimbursement rates for workers' compensation procedures still being performed.

Should we disagree with the amount of reimbursement provided by a third-party payer, we are required to pursue the medical dispute resolution ("MDR") process at the TDWC to request proper reimbursement for services. From January 2007 to November 2008, the Company had been successful in its pursuit of collections regarding the stop-loss cases pending before the State Office of Administrative Hearings ("SOAH"), receiving positive rulings in over 90% of its claims presented for administrative determination. A 2007 district court decision upholding our interpretation of the statute as applied to the stop-loss claims was appealed by certain insurance carriers, and on November 13, 2008 the Third Court of Appeals determined that in order for a hospital to be reimbursed at 75% of its usual and customary audited charges for an inpatient admission, the hospital must not only bill at least $40,000, but also show that the admission involved unusually costly and unusually extensive services. Procedurally, the decision means that each case where a carrier raised an issue regarding whether the services provided were unusually costly or unusually extensive would be remanded to either SOAH or MDR for a case-by-case determination of whether the services provided meet these standards. As a result of the Third Court of Appeals opinion, any stop-loss cases pending at SOAH have been remanded to the TDWC since these cases have not been reviewed or decided by the two-prong standard decided by the Third Court of Appeals. The SOAH Administrative Law judges determined that the most appropriate location for these cases is the TDWC.

A petition asking the Texas Supreme Court to review the Third Court of Appeals decision has been denied. Therefore, the Company is bound by the Third Court of Appeals decision. The Texas Supreme Court's decision delayed final adjudication in these pending stop-loss cases. The uncertain outcome in these cases will depend on a very lengthy process. We anticipate further, lengthy litigation at the Travis County District Courts and the Texas Courts of Appeals. Because of this lengthy process and the uncertainty of recovery in these cases, collection of a material amount of funds in these pending stop-loss cases cannot be anticipated.

Through August 2013, insurance carriers have voluntarily paid the awards in the decisions and orders issued by SOAH, plus interest, in approximately 180 cases, involving approximately $11 million in claims. In most of these cases, when the payments were made, the carriers requested refunds of the payments made in the event that the SOAH decisions and orders were reversed on appeal (which they were). Our request that the TDWC Commissioner enforce the awards which were not voluntarily paid by the carriers was refused in approximately 130 cases. As a result of the reversal of the SOAH decisions and orders, Texas Mutual Insurance Company and other carriers filed petitions in Travis County district court seeking a refund in cases in which the awards were voluntarily paid. The district court found in favor of Texas Mutual and the Company was ordered to refund approximately $4.2 million, including prejudgment interest, pending remand for a case-by-case determination of whether the services provided were unusually costly and unusually extensive. The Company did not object to the reversal and remand of the SOAH decisions and orders, but did object to the judgments ordering refunds and those judgments were appealed to the Third Court of Appeals. As part of the appeals, the Company deposited the amounts that were ordered to be refunded as cash deposits into the registry of the court in order to stay execution of the judgments ordering refunds. On June 6, 2013, the judgments ordering refunds were reversed by the Court of Appeals. The Court of Appeals held that if Texas Mutual wants a refund, it must pursue the refund demand administratively through the TDWC rather than through the district courts. Texas Mutual filed a motion for rehearing with the Court of Appeals which ultimately was denied. The Vista entities have filed motions in all 47 cases with the district court asking that the district clerk be ordered to release the deposited funds to the Vista entities. These motions are pending. In addition, Texas Mutual filed three additional petitions in district court for cases that were left out of the original 47. The court granted Texas Mutual's petitions and ordered the Vista entities to refund approximately $300,000, including prejudgment interest to Texas Mutual. These judgments were granted before the Court of Appeals reversed the district court's original judgments. These three cases have been appealed to the Court of Appeals and the funds ordered refunded have been deposited with the district clerk. The Company expects that in due course these three additional judgments will be reversed. If the Court of Appeals' decision holds, all of the money deposited into the registry of the court will be refunded to the Company. At this time, Texas Mutual has not decided whether to file a petition for review with the Supreme Court of Texas. Should Texas Mutual be successful in reversing the Court of Appeals' decision, we anticipate that similar motions requesting remand and a refund for awards voluntarily paid will be filed and will likely be granted by the 345th Judicial District Court of Travis County, Texas. If and when these additional motions are granted, the Company will be ordered to refund an additional $8.1 million, not including prejudgment interest. As of August 31, 2013, the Company has accrued this amount of $8.1 million, and an additional amount of $2.2 million in interest payable, as accrued liabilities. If the Court of Appeals' decision holds, we do not anticipate that any other carriers will pursue refund demands through district court but instead will pursue them administratively through TDWC. The cases in which the SOAH decisions and orders were reversed have been or are being remanded to TDWC for determinations of whether the services provided were unusually costly and unusually extensive. Voluntary payments made pursuant to the Decisions and Orders are premature payments by the carriers and may be ordered to be refunded. Once the Company is given the opportunity to present its evidence regarding whether the services provided were unusually costly and unusually extensive, the Company anticipates that it will prevail in many of the underlying stop-loss fee disputes and that payments refunded to the carriers will be recaptured.

Due to the uncertainties associated with these stop-loss fee dispute cases, the Company recognized increases in the contractual allowance at our Pasadena facility of $10,254,990 and $149,875 during fiscal years 2011 and 2013, respectively, (and an additional amount of $779,583 and $136,542 in the contractual allowance during fiscal years 2011 and 2013, respectively, at our Garland facility, which is classified as discontinued operations), and interest expense of $1,751,478, $547,366 and $548,113 for the fiscal years 2011, 2012 and 2013, respectively, at our Pasadena facility (and an additional interest expense of $132,339, $42,954 and $44,829 for the fiscal years 2011, 2012 and 2013, respectively, at our Garland facility).

Claims regarding payment for ambulatory surgical center and hospital outpatient services remain pending at the TDWC. It is expected that these claims will be adjudicated at SOAH and possibly in the Texas district and appellate courts. The basis for reimbursement for these services made the subject of these pending cases is the determination of "fair and reasonable" charges. In 2007, we received unfavorable rulings from SOAH in all of our appeals of unfavorable decisions related to services provided in 2001 and 2002. The 179 cases, which were appealed to the Travis County district courts, challenged the constitutionality of the relevant statutory language. The Company received an unfavorable ruling in its lead case in March 2009, which ruling was appealed to and was upheld by the Third Court of Appeals on August 26, 2010. The Texas Supreme Court denied a petition asking for review of the Third Court of Appeals decision. The unfavorable interpretation by the Texas Courts of Appeal in our lead case negatively affects the recovery of additional reimbursement, not only in the lead case, but in the remaining 178 pending cases. Consequently, the Company is bound by the Third Court of Appeals' ruling that interprets the applicable statute and fee guideline to require that the amount that will be paid to a provider must not only be at a "fair and reasonable rate" but also must "ensure the quality of medical care" and "achieve effective cost control" and be the same or less than that charged to others with an equivalent standard of living. This ruling will impact cases in which a fee guideline was not applicable, specifically all pending cases involving ambulatory surgical services provided from 2001 through 2004 as well as all pending cases involving hospital outpatient services provided prior to March 1, 2008, when the Guidelines took effect. Since the Third Court of Appeals' unfavorable ruling, collection, if any, in these cases depends on the Company's ability to establish the criteria in this ruling. The Company was given the opportunity to establish the criteria in approximately 80 cases, which were set for hearing on the merits from March through May 2012 and was unsuccessful. Additionally, there are several thousand ambulatory surgical center and hospital outpatient cases pending at SOAH which will be heard beginning in January, 2014. Settlement offers have been made in the vast majority of these cases and the Company has been successful in settling many of the cases in which offers were made. Even so, it is likely that hundreds, if not more than a thousand, of these cases may go to hearing at SOAH at which the Company will have the opportunity to continue to establish the criteria in the cases still pending at SOAH during the 2014 fiscal year.

Due to the uncertainties regarding the accounts receivable in the MDR process, the 2008 and 2010 Third Court of Appeals' opinions and our legal counsel's advice that settlements with insurance carriers in stop-loss cases have virtually stopped, the Company had fully reserved all accounts receivable related to the MDR process as of August 31, 2008. The Company is in active settlement negotiations with insurance carriers for ambulatory surgical center and hospital outpatient cases. Any monies collected for these MDR accounts receivable will be recorded as current period's net patient service revenues.

Provision for Doubtful Accounts

Although outcomes vary, our policy is to attempt to collect amounts due from patients, including co-payments and deductibles due from patients with insurance, at the time of service while complying with all federal and state laws and regulations. In non-emergency circumstances or for elective procedures and services, it is our policy to verify insurance prior to a patient being treated; however, there are various exceptions that can occur.

The Company computes its allowances based on the estimated collections on its gross billed charges. The Company computes its estimate of allowance, which is a combination of contractual allowance and provision for doubtful accounts, by taking into account collections received, up to 30 days after the end of the period, for the services performed and also estimating amounts collectible for the services performed within the last six months.

Accounts receivable represent net receivables for services provided by the Company. At each balance sheet date management reviews the accounts receivable for collectibility and provides full allowance reserves for any accounts receivable deemed uncollectible.

The allowances stated as a percentage of gross receivables at the balance sheet dates is larger than the 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 allowances. The allowance amounts netted against gross receivables are not adjusted until such time as the final collections on an individual receivable are recognized.

The focal point of our business is providing patient care services, including complex orthopedic and bariatric procedures. The Company pursues optimal reimbursement from third-party payers for these services. In some instances, we do not have contractual arrangements with third-party payers which provide for "prompt payment" which may result in additional time to collect the expected reimbursement.

The collection process may also be extended due to our efforts to obtain all optimal reimbursement available to the Company. Specifically, for medical services provided to injured workers, the Company may initially receive reimbursement that may not be within the fee guidelines or regulatory guidelines mandating reimbursement. The Company reviews and pursues those particular claims that are determined to warrant additional reimbursement pursuant to the fee or regulatory guidelines. The Company's pursuit of additional reimbursement amounts that it believes are due under fee or regulatory guidelines may be accomplished through established dispute resolution procedures with applicable regulatory authorities.

Income Taxes

We provide for income taxes by taking into account the differences between the financial statement treatment and tax treatment of certain transactions. Deferred tax assets and liabilities are recognized for the anticipated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis amounts. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates is recognized as income or expense in the period that includes the enactment date. This calculation requires us to make certain estimates about our future operations and many of these estimates of future operations may be imprecise. Changes in state, federal, and foreign tax laws, as well as changes in our financial condition, could affect these estimates. In addition, we consider many factors when evaluating and estimating income tax uncertainties. These factors include an evaluation of the technical merits of the tax position as well as the amounts and probabilities of the outcomes that could be realized upon ultimate settlement. The actual resolution of those uncertainties will inevitably differ from those estimates, and such differences may be material to the financial statements. Our estimates and judgments associated with our calculations of income taxes have been reasonable in the past, however, the possibility for changes in the tax laws, as well as the current economic uncertainty, could affect the accuracy of our income tax estimates in future periods.

Stock-Based Compensation

We estimate the fair value of stock options granted using the Black-Scholes option pricing model. The fair value for awards that are expected to vest is then amortized on a straight-line basis over the requisite service period of the award, which is generally the option vesting term. The amount of expense attributed is based on an estimated forfeiture rate, which is updated as appropriate. This option pricing model requires the input of highly subjective assumptions, including the expected volatility of our common stock, pre-vesting forfeiture rate and an option's expected life. The financial statements include amounts that are based on our best estimates and judgments.

Results of Operations

                                                       Year Ended August 31, 2013                       Year Ended August 31, 2012
                                             U.S. Division      Corporate         Total       U.S. Division      Corporate         Total
Net patient service revenue                  $    6,057,411   $           -   $   6,057,411   $    5,531,233   $           -   $    5,531,233
Costs and expenses:
Compensation and benefits                         3,605,663       1,908,484       5,514,147        3,850,678       3,326,103        7,176,781
Medical services and supplies                     1,664,780               -       1,664,780        1,557,792               -        1,557,792
Other operating expenses                          2,913,767       3,042,425       5,956,192        3,158,835       1,240,448        4,399,283
Depreciation and amortization                       444,040          19,512         463,552          454,808          95,835          550,643
Total costs and expenses                          8,628,250       4,970,421      13,598,671        9,022,113       4,662,386       13,684,499

Operating loss                                  (2,570,839)     (4,970,421)     (7,541,260)      (3,490,880)     (4,662,386)      (8,153,266)
Other income (expense):
Rent and other income                                59,712       3,710,660       3,770,372           28,620         933,161          961,781
Interest income                                           -         872,624         872,624                -       1,225,910        1,225,910
Interest expense                                  (559,790)         (1,281)       (561,071)        (578,478)        (11,917)        (590,395)
Total other income (expense), net                 (500,078)       4,582,003       4,081,925        (549,858)       2,147,154        1,597,296

Loss before income taxes from continuing
operations                                   $  (3,070,917)   $   (388,418)     (3,459,335)   $  (4,040,738)   $ (2,515,232)      (6,555,970)
(Provision) benefit for income taxes                                                      -                                       (4,018,699)
Loss from continuing operations                                                 (3,459,335)                                      (10,574,669)
Discontinued operations, net of income
taxes                                                                               274,390                                       (1,394,984)
Loss on disposal of discontinued
operations, net of income taxes                                                   (122,975)                                         (229,201)
Net loss                                                                        (3,307,920)                                      (12,198,854)
Less: Net loss attributable to
noncontrolling interest                                                               2,836                                            47,358
Net loss attributable to Dynacq
Healthcare, Inc.                                                              $ (3,305,084)                                    $ (12,151,496)

Operational statistics (Number of medical
procedures) for Pasadena facility:
Inpatient:
Bariatric                                                58                                               68
Orthopedic                                               12                                               12
Other                                                    34                                               64
Total inpatient procedures                              104                                              144
Outpatient:
Orthopedic                                              118                                              112
Other                                                   508                                              446
Total outpatient procedures                             626                                              558
Total procedures                                        730                                              702

Comparison of the Fiscal Years Ended August 31, 2013 and August 31, 2012

U.S. Division

Through August 2013, insurance carriers have voluntarily paid the awards in the decisions and orders issued by SOAH, plus interest, in approximately 180 cases, involving approximately $11 million in claims. In most of these cases, when the payments were made, the carriers requested refunds of the payments made in the event that the SOAH decisions and orders were reversed on appeal (which they were). Our request that the TDWC Commissioner enforce the awards which were not voluntarily paid by the carriers was refused in approximately 130 cases. As a result of the reversal of the SOAH decisions and orders, Texas Mutual Insurance Company and other carriers filed petitions in Travis County district court seeking a refund in cases in which the awards were voluntarily paid. The district court found in favor of Texas Mutual and the Company was ordered to refund approximately $4.2 million, including prejudgment interest, pending remand for a case-by-case determination of whether the services provided were . . .

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