Notes to Unaudited Condensed Consolidated Financial Statements
March 31, 2016
(unaudited)
Note 1: Basis of Presentation
Hooper Holmes, Inc. and its subsidiaries (“Hooper Holmes” or the "Company”) provides on-site screenings, laboratory testing, risk assessment, and sample collection services to individuals as part of comprehensive health and wellness programs offered through corporate and government employers. The acquisition of Accountable Health Services, Inc ("AHS") ("the Acquisition"), which is discussed further in Note 3 to the condensed consolidated financial statements, allows Hooper Holmes to also deliver telephonic health coaching, wellness portals, and data analytics and reporting services. Hooper Holmes is engaged by the organizations sponsoring such programs, including health and care management companies, broker and wellness companies, disease management organizations, reward administrators, third party administrators, clinical research organizations, and health plans. Hooper Holmes provides these services through a national network of health professionals.
The Company's business is subject to some seasonality, with the second quarter sales typically dropping below other quarters and the third and fourth quarter sales typically the strongest quarters due to increased demand for screenings from mid-August through November related to annual benefit renewal cycles.
The unaudited condensed consolidated financial statements of the Company have been prepared in accordance with instructions for Form 10-Q and the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") have been condensed or omitted pursuant to such rules and regulations. The unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company's 2015 Annual Report on Form 10-K, filed with the SEC on March 30, 2016.
Financial statements prepared in accordance with U.S. GAAP require management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses and other disclosures. The financial information included herein is unaudited; however, such information reflects all adjustments that are, in the opinion of the Company's management, necessary for a fair statement of results for the interim periods presented.
The results of operations for the
three month periods ended
March 31, 2016
and
2015
, are not necessarily indicative of the results to be expected for any other interim period or the full year. See “Management's Discussion and Analysis of Financial Condition and Results of Operations” for additional information.
On September 30, 2013, the Company completed the sale of certain assets comprising its Portamedic service line. The Portamedic service line is accounted for as a discontinued operation in this Quarterly Report on Form 10-Q (the "Report"). During 2014, the Company sold certain assets comprising the Heritage Labs and Hooper Holmes Services businesses. The operating results of these businesses are also segregated and reported as discontinued operations in this Report.
New Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standard Update ("ASU") 2014-09, "Revenue from Contracts with Customers", which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. ASU 2014-09 will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. This new guidance is effective for the Company in the first quarter of 2018, with early adoption permitted as of the original effective date or first quarter of 2017. The Company is currently evaluating the effect that ASU 2014-09 will have on the consolidated financial statements and related disclosures.
In April 2015, the FASB issued ASU 2015-03, "Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs", which requires that debt issuance costs be presented in the balance sheet as a direct deduction from the carrying value of the debt liability. The Company adopted the provisions of ASU 2015-03 in the first quarter of 2016. The retrospective application of the new standard resulted in a
$0.2 million
reduction to both noncurrent assets and current liabilities as of December 31, 2015. The debt issuance costs associated with the 2013 Loan and Security Agreement remain classified in noncurrent assets in accordance with ASU 2015-15.
In February 2016, the FASB issued ASU No. 2016-02, "Leases", which is intended to improve financial reporting about leasing transactions. This standard requires a lessee to record on the balance sheet the assets and liabilities for the rights and obligations created by lease terms of more than 12 months. This standard will be effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is currently evaluating the impact the adoption of ASU 2016-02 will have on its consolidated financial position, results of operations or cash flows.
In March 2016, the FASB issued ASU No. 2016-09, "Improvements to Employee Share-Based Payment Accounting ", which is intended to simplify the accounting for share-based compensation. This standard simplifies the accounting for income taxes in relation to share-based compensation, modifies the accounting for forfeitures, and modifies the statutory tax withholding requirements. This standard will be effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The Company is currently evaluating the impact the adoption of ASU 2016-09 will have on its consolidated financial position, results of operations or cash flows.
Note 2: Liquidity
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and discharge of liabilities in the normal course of business for the foreseeable future. The uncertainty regarding the Company's ability to generate sufficient cash flows and liquidity to fund operations raises substantial doubt about its ability to continue as a going concern. These financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Already in 2016, the Company has taken the following actions toward alleviating the substantial doubt that exists with regard to the Company's ability to continue as a going concern:
|
|
•
|
On January 25, 2016, the Company completed a rights offering to current shareholders, in which it raised
$3.5 million
that is being used to fund working capital;
|
|
|
•
|
On March 28, 2016, the Company received
$1.2 million
in additional equity by issuing
10,000,000
shares of its common stock,
$0.04
par value, to 200 NNH, LLC, which will be used to fund working capital;
|
|
|
•
|
On March 28, 2016, the Company renegotiated its financial covenants in the 2013 Loan and Security Agreement (as defined below) and the Credit Agreement (as defined below) to requirements based on its forecast models; and
|
|
|
•
|
On April 29, 2016, the Company entered into a new Credit and Security Agreement with SCM Specialty Finance Opportunities Fund, L.P. replacing the 2013 Loan and Security Agreement (as defined below) eliminating the requirement of the Company to issue the additional warrant for the purchase of common stock valued at
$1.25 million
to SWK (as defined below), the holder of the Company’s Credit Agreement (as defined below). Refer to Note 14 to the condensed consolidated financial statements for additional discussion.
|
The Company expects to continue to monitor its liquidity carefully, work to reduce this uncertainty, and address its cash needs through a combination of one or more of the following actions:
|
|
•
|
The Company will continue to implement further cost actions and efficiency improvements;
|
|
|
•
|
The Company will continue to aggressively seek new and return business from its existing customers and expand its presence in the Health and Wellness marketplace;
|
|
|
•
|
The Company expects to continue to carefully manage receipts and disbursements, including amounts and timing, focusing on reducing days receivables outstanding and managing days payables outstanding.
|
The Company's primary sources of liquidity are cash and cash equivalents as well as availability under the 2013 Loan and Security Agreement, as amended on March 28, 2013, July 9, 2014, April 17, 2015, August 10, 2015, November 10, 2015, and March 28, 2016, (the "2013 Loan and Security Agreement") with ACF FinCo I LP (“Ares”), as assignee of Keltic Financial Partners II, LP. At
March 31, 2016
, the Company had
$2.0 million
in cash and cash equivalents and had
$2.6 million
outstanding under the 2013 Loan and Security Agreement, with available borrowing capacity of
$0.3 million
. As of
May 11, 2016
, we had
$3.1 million
outstanding under the SCM Agreement (refer to note 14 of the condensed consolidated financial statements), with estimated available borrowing capacity of
$1.1 million
. The Company also entered into the Credit Agreement on April 17, 2015, as amended on February 25, 2016, and March 28, 2016, (the "Credit Agreement") with SWK Funding LLC ("SWK") for a
$5.0 million
term loan ("the Term Loan"), which provided funding for the cash component of the Acquisition. As of
March 31, 2016
, the Company
owed approximately
$4.5 million
under the Credit Agreement. Each of these agreements contain certain financial covenants, including various affirmative and negative covenants including minimum aggregate revenue, EBITDA, and consolidated unencumbered liquid assets requirements. The Company was in compliance with these covenants as of
March 31, 2016
. For additional information regarding the 2013 Loan and Security Agreement, Credit Agreement, and the related covenants, see Note 9 to the condensed consolidated financial statements.
The Company incurred a loss from continuing operations of
$3.3 million
during the
three month period ended
March 31, 2016
. The Company’s net cash used in operating activities for the
three month period ended
March 31, 2016
, was
$3.4 million
. The Company has managed its liquidity through availability under a revolving credit facility, raising additional equity, and a series of cost reduction initiatives.
The Company has historically used availability under a revolving credit facility to fund operations. The Company experiences a timing difference between the operating expenses and cash collection of the associated revenue based on Health and Wellness customer payment terms. To conduct successful screenings, the Company must expend cash to deliver equipment and supplies required for the screenings as well as pay its health professionals and site management, which is in advance of the customer invoicing process and ultimate cash receipts for services performed. Given the seasonal nature of the Company's operations, which are largely dependent on second half volumes, management expects to continue using a revolving credit facility in 2016 and beyond.
Other Considerations
The Health and Wellness business sells services directly to end customers and also through wellness, disease management, benefit brokers, and insurance companies (referred to as channel partners) who ultimately have the relationship with the end customer. Sales to direct customers offer the full suite of our services while sales of our screenings through channel partners are often aggregated with other offerings from these channel partners to provide a total solution to the end-user. As such, the Company's success is largely dependent on that of its partners.
Additionally, the Acquisition provides new offerings including the wellness portal and telephonic coaching, along with new staff, new systems, and new customers. During the
three month period ended
March 31, 2016
, the Company incurred
$0.1 million
of costs associated with the ongoing integration of AHS, which are recorded in selling, general and administrative expenses. These costs relate primarily to transition services purchased from AHS and the ongoing transition of information technology infrastructure. The Company does not expect to continue to incur material transition costs going forward.
In addition, the Company has contractual obligations related to operating leases and employment contracts which could adversely affect liquidity.
The Company’s ability to satisfy its liquidity needs and meet future covenants is dependent on growing revenues, improving profitability, and raising additional equity. These profitability improvements primarily include the successful integration of AHS and expansion of the Company’s presence in the Health and Wellness marketplace. The Company must increase screening, telephonic health coaching, and wellness portal volumes in order to cover its fixed cost structure and improve gross profits. These improvements may be outside of management’s control. The integration of AHS and marketplace expansion may require additional costs to grow and operate the newly integrated entity, which the Company must recover through expanded revenues. If the Company is unable to increase volumes or control integration or operating costs, liquidity may adversely be affected.
There can be no assurance that cash flows from operations, combined with any additional borrowings available to the Company, will be obtainable in an amount sufficient to enable the Company to repay its indebtedness, or to fund other liquidity needs. If the Company is unable to comply with financial covenants in 2016 and in the event that the Company were unable to modify the covenants, find new or additional lenders, or raise additional equity, the Company would be considered in default, which would then enable the lenders to accelerate the repayment of all amounts outstanding and exercise remedies with respect to collateral, which would have a material adverse impact on the Company's business.
Note 3: Acquisition
The Company entered into and consummated the Purchase Agreement on April 17, 2015, among the Company and certain of its subsidiaries, AHS and Accountable Health, Inc. ("Seller" or "Shareholder"). Pursuant to the Purchase Agreement, the Company acquired the assets and certain liabilities representing the health and wellness business of the Seller for approximately
$7.0 million
-
$4.0 million
in cash and up to
6,500,000
shares of the Company’s common stock,
$0.04
par value, with a value of
$3.0 million
, which was subject to a working capital adjustment as described in the Purchase Agreement. At the closing of the Purchase Agreement, the Company issued and delivered
5,576,087
shares of Common Stock to the Shareholder at closing and
issued and held back
326,087
shares of Common Stock for the working capital adjustment, which were subsequently released on October 9, 2015, and
597,826
shares of Common Stock for indemnification purposes.
No
additional shares will be issued under the terms of the Purchase Agreement. The shares were issued pursuant to an exemption from registration under Section 4(a)(2) of the Securities Act of 1933, which provides an exemption for private offerings of securities.
In order to fund the Acquisition, the Company entered into and consummated the Credit Agreement with SWK on April 17, 2015. Refer to Note 9 of the condensed consolidated financial statements for discussion of the Credit Agreement and related warrants.
The Acquisition was treated as a purchase in accordance with Accounting Standards Codification (ASC) 805,
Business Combinations
, which requires allocation of the purchase price to the estimated fair values of the assets acquired and liabilities assumed in the transaction. The allocation of purchase price is based on management’s judgment after evaluating several factors, including a valuation assessment.
The allocation of the purchase price was finalized in the first quarter of 2016 and is as follows:
|
|
|
|
|
|
(in thousands)
|
|
|
Accounts receivable, net of allowance of $2
|
|
$
|
918
|
|
Inventory and other current assets
|
|
117
|
|
Fixed assets
|
|
123
|
|
Customer portal (existing technologies)
|
|
4,151
|
|
Customer relationships
|
|
2,097
|
|
Goodwill
|
|
633
|
|
Accounts payable and accrued expenses
|
|
(743
|
)
|
Deferred revenue
|
|
(296
|
)
|
Purchase Price
|
|
$
|
7,000
|
|
Intangible assets acquired include existing technology in the form of a customer-facing wellness portal and customer relationships. The fair value of the customer relationships acquired was determined using the excess earnings method under the income approach for customer relationships; and the fair value of the wellness portal software was determined using the replacement cost method. The estimated useful life for the wellness portal and customer relationships is
4 years
and
8 years
, respectively. Amortization is recorded on a straight-line basis over the estimated useful life of the asset. The Company recorded amortization expense of
$0.3 million
during the
three month period ended
March 31, 2016
, related to the intangible assets acquired in the Acquisition, of which
$0.2 million
is recorded as a component of cost of operations and
$0.1 million
is recorded as a component of selling, general and administrative expenses. The goodwill of
$0.6 million
was recorded in one reporting unit, the Health and Wellness operations, and is deductible for tax purposes.
The consolidated statement of operations for the
three month period ended
March 31, 2016
,
includes revenue of
$2.3 million
attributable to AHS. Disclosure of the earnings contribution from the AHS business is not practicable, as the Company has already integrated operations.
The following table provides unaudited pro forma results of operations for the
three month period ended
March 31, 2015
,
as if AHS was part of operations on the first day of the 2015 fiscal year.
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
(in thousands)
|
|
2015
|
Pro forma revenues
|
|
$
|
8,089
|
|
|
|
|
Pro forma net loss from continuing operations
|
|
$
|
(3,105
|
)
|
These pro forma results are based on estimates and assumptions, which the Company believes are reasonable. They are not the results that would have been realized had the Company been a combined company during the periods presented, nor are they indicative of the consolidated results of operations in future periods. The pro forma results for the
three month period ended
March 31, 2015
, include pre-tax adjustments for amortization of intangible assets of
$0.3 million
and elimination of acquisition
costs of
$0.1 million
.
Basic loss per share equals net loss divided by the weighted average common shares outstanding during the period. Diluted loss per share equals net loss divided by the sum of the weighted average common shares outstanding during the period plus dilutive common stock equivalents. The calculation of loss per common share on a basic and diluted basis was the same for the
three month periods ended
March 31, 2016
and
2015
, because the inclusion of dilutive common stock equivalents and the Warrant issued in connection with the Acquisition would have been anti-dilutive for all periods presented. The Company has granted options to purchase shares of the Company's common stock through employee stock plans with the weighted average options outstanding as of
March 31, 2016
and
2015
, being
4,456,063
and
4,033,458
, respectively, and a warrant to purchase
8,152,174
shares issued to SWK was outstanding as of
March 31, 2016
, but are anti-dilutive because the Company is in a net loss position.
Note 5: Share-Based Compensation
Employee
Share-Based Compensation Plans
- On May 29, 2008, the Company's shareholders approved the 2008 Omnibus Employee Incentive Plan (the "2008 Plan") providing for the grant of stock options, stock appreciation rights, non-vested stock, and performance shares. During the
three month periods ended
March 31, 2016 and 2015
, the Company granted
800,000
and
590,000
options, respectively, for the purchase of shares under the 2008 Plan. As of
March 31, 2016
,
1,600,318
shares remain available for grant under the 2008 Plan.
On May 24, 2011, the Company's shareholders approved the 2011 Omnibus Employee Incentive Plan, as subsequently amended and restated, (the "2011 Plan") providing for the grant of stock options and non-vested stock awards. During the
three month periods ended
March 31, 2016 and 2015
, there were
no
options for the purchase of shares granted under the 2011 Plan. As of
March 31, 2016
,
90,120
shares remain available for grant under the 2011 Plan.
The fair value of the stock options granted during the
three month period ended
March 31, 2016
, was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions:
|
|
|
|
|
Three Months Ended March 31,
|
|
2016
|
Expected life (years)
|
4.67
|
Expected volatility
|
82.8%
|
Expected dividend yield
|
—%
|
Risk-free interest rate
|
1.7%
|
Weighted average fair value of options granted during the period
|
$0.10
|
The following table summarizes stock option activity for the
three month period ended
March 31, 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of Options
|
|
Weighted Average Exercise Price Per Option
|
|
Weighted Average remaining Contractual Life (years)
|
|
Aggregate Intrinsic Value (in thousands)
|
Outstanding balance at December 31, 2015
|
|
4,398,700
|
|
|
$
|
0.43
|
|
|
|
|
|
Granted
|
|
800,000
|
|
|
0.15
|
|
|
|
|
|
Exercised
|
|
—
|
|
|
—
|
|
|
|
|
|
Forfeited and Expired
|
|
(165,000
|
)
|
|
0.59
|
|
|
|
|
|
Outstanding balance at March 31, 2016
|
|
5,033,700
|
|
|
0.38
|
|
|
8.41
|
|
$0
|
Options exercisable at March 31, 2016
|
|
2,104,389
|
|
|
$
|
0.51
|
|
|
7.44
|
|
$0
|
There were
no
options exercised during the
three month periods ended
March 31, 2016 and 2015
. Options for the purchase of an aggregate of
283,168
shares of common stock vested during the
three month period ended
March 31, 2016
, and the aggregate fair value at grant date of these options was
$0.07 million
. As of
March 31, 2016
, there was approximately
$0.4 million
of total
unrecognized compensation cost related to stock options. The cost is expected to be recognized over a weighted average period of
1.74
years.
The Company recorded
$0.1 million
of share-based compensation expense in selling, general and administrative expenses for the
three month periods ended
March 31, 2016 and 2015
.
Note 6: Inventories
Included in inventories at
March 31, 2016
, and
December 31, 2015
, are
$0.4 million
and
$0.3 million
, respectively, of finished goods and
$0.3 million
and
$0.3 million
, respectively, of components.
Note 7: Goodwill and Other Intangible Assets
The Company recorded Goodwill of
$0.6 million
as of
March 31, 2016
and
December 31, 2015
.
Intangible assets subject to amortization are amortized on a straight-line basis and are summarized in the table below.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2016
|
|
December 31, 2015
|
(in thousands)
|
Gross Carrying Amount
|
|
Accumulated Amortization
|
|
Intangibles Assets, net
|
|
Gross Carrying Amount
|
|
Accumulated Amortization
|
|
Intangibles Assets, net
|
Portal
|
$
|
4,151
|
|
|
$
|
992
|
|
|
$
|
3,159
|
|
|
$
|
4,151
|
|
|
$
|
732
|
|
|
$
|
3,419
|
|
Customer relationships
|
2,097
|
|
|
245
|
|
|
1,852
|
|
|
2,097
|
|
|
185
|
|
|
1,912
|
|
Total
|
$
|
6,248
|
|
|
$
|
1,237
|
|
|
$
|
5,011
|
|
|
$
|
6,248
|
|
|
$
|
917
|
|
|
$
|
5,331
|
|
Amortization expense for the
three month period ended
March 31, 2016
, was
$0.3 million
. There was
no
amortization expense for the
three month period ended
March 31, 2015
.
Note 8: Restructuring Charges
At
March 31, 2016
, there was a
$0.6 million
liability related to Portamedic branch closure costs, which is recorded in accrued expenses and other long-term liabilities in the accompanying consolidated balance sheet. Charges recorded during the
three month period ended
March 31, 2016
, were recorded as a component of discontinued operations. The following table provides a summary of the activity in the restructure accrual for the
three month period ended
March 31, 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
December 31, 2015
|
|
Adjustments
|
|
Payments
|
|
March 31, 2016
|
Facility closure obligation
|
$
|
657
|
|
|
$
|
52
|
|
|
$
|
(110
|
)
|
|
$
|
599
|
|
Note 9: Debt
As of March 31, 2016, the Company maintained the 2013 Loan and Security Agreement and the Term Loan provided by the Credit Agreement. The following table summarizes the Company's outstanding borrowings:
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
March 31, 2016
|
|
December 31, 2015
|
|
|
|
|
|
2013 Loan and Security Agreement
|
|
$
|
2,645
|
|
|
$
|
3,278
|
|
Term Loan
|
|
4,474
|
|
|
5,000
|
|
Discount on Term Loan
|
|
(2,374
|
)
|
|
(2,785
|
)
|
Unamortized debt issuance costs related to Term Loan
|
|
(139
|
)
|
|
(163
|
)
|
Total debt
|
|
4,606
|
|
|
5,330
|
|
Short-term portion
|
|
(4,606
|
)
|
|
(5,330
|
)
|
Total long-term debt, net
|
|
$
|
—
|
|
|
$
|
—
|
|
There was no significant interest expense for the
three month period ended
March 31, 2015
. The following table summarizes the components of interest expense for the
three month period ended
March 31, 2016
:
|
|
|
|
|
|
(in thousands)
|
|
Three Months Ended
|
|
|
March 31, 2016
|
Interest expense on Term Loan (interest at LIBOR, plus 14%)
|
|
$
|
180
|
|
Interest expense on 2013 Loan and Security Agreement
|
|
32
|
|
Accretion of termination fees (over term of Term Loan at rate of 8%)
|
|
46
|
|
Amortization of deferred financing costs
|
|
61
|
|
Accretion of debt discount associated with Warrant
|
|
306
|
|
Accretion of discount associated with additional warrant feature
|
|
105
|
|
Mark to market of the additional warrant feature
|
|
59
|
|
Total
|
|
$
|
789
|
|
2013 Loan and Security Agreement
As of March 31, 2016, the Company maintained the 2013 Loan and Security Agreement with Ares. Borrowings under the 2013 Loan and Security Agreement were to be used for working capital purposes and capital expenditures. The amount available for borrowing was less than the
$7 million
under this facility at any given time due to the manner in which the maximum available amount was calculated. The Company had an available borrowing base, subject to reserves established at Ares' discretion, of
85%
of Eligible Receivables up to
$7 million
under this facility. As of
March 31, 2016
, the Company had
$2.6 million
borrowings outstanding under the 2013 Loan and Security Agreement with available borrowing capacity of
$0.3 million
.
Interest on revolving credit loans was calculated based on the greater of (i) the annualized prime rate plus
2.75%
, (ii) the
90
day
LIBOR
rate plus
5.25%
, and (iii)
6%
per annum. The interest rate on the 2013 Loan and Security Agreement was
6%
as of
March 31, 2016
. The Company was obligated to pay, on a monthly basis in arrears, an annual facility fee equal to
1%
of the revolving credit limit. During the
three month periods ended
March 31, 2016
and
2015
, the Company incurred facility fees of
$0.03 million
and
$0.05 million
, respectively. As of
March 31, 2016
, the remaining balance in deferred financing costs recorded in Other Assets on the condensed consolidated balance sheet was
$0.3 million
.
The 2013 Loan and Security Agreement contained various covenants, including financial covenants which required the Company to achieve a minimum adjusted EBITDA amount (earnings before interest expense, income taxes, depreciation, and amortization). On March 28, 2016, the Company obtained a Waiver and Sixth Amendment to the Loan and Security Agreement (the "Sixth Amendment") in which Ares modified the existing covenants and replaced them with minimum adjusted EBITDA covenants of negative
$1.6 million
for the three months ending March 31, 2016, negative
$2.0 million
for the six months ending June 30, 2016, negative
$1.1 million
for the nine months ending September 30, 2016, and
$0.8 million
for the twelve months ending December 31, 2016, and each twelve consecutive calendar month period ending on the last day of each fiscal quarter thereafter. In addition, the Company was required to obtain new equity contributions in an aggregate amount of not less than
$4.0 million
between November 10, 2015, and June 30, 2016, which condition was satisfied by its completion of the rights offering earlier this year and the private offering to the investor described above. The Company was in compliance with the covenants under the 2013 Loan and Security Agreement, as amended, as of
March 31, 2016
.
Subsequent to quarter end, the Company replaced the 2013 Loan and Security Agreement with a new revolving credit facility. For additional discussion regarding this new credit facility, see Note 14 to the condensed consolidated financial statements.
Credit Agreement
In order to fund the Acquisition, the Company entered into the Credit Agreement with SWK. The Credit Agreement provides the Company with a
$5.0 million
Term Loan. The proceeds of the Term Loan were used to pay certain fees and expenses related to the negotiation and consummation of the Purchase Agreement and the Acquisition described in Note 3 and general corporate purposes. The Company paid SWK an origination fee of
$0.1 million
. The Term Loan is due and payable on April 17, 2018. The Company is also required to make quarterly revenue-based payments in an amount equal to eight and one-half percent (
8.5%
) of yearly aggregate revenue up to and including
$20 million
, seven percent (
7%
) of yearly aggregate revenue greater than
$20 million
up to and including
$30 million
, and five percent (
5%
) of yearly aggregate revenue greater than
$30 million
. The revenue-based payment will be applied to fees and interest, and any excess to the principal of the Term Loan. Revenue-based payments commenced
in February 2016, and the maximum principal portion of the aggregate revenue-based payment is capped at
$600,000
per quarter. The Company made its first principal payment of
$0.5 million
, on
February 16, 2016
, in addition to
$0.2 million
of interest expense, for a total payment of
$0.7 million
.
The outstanding principal balance under the Credit Agreement bears interest at an adjustable rate per annum equal to the LIBOR Rate (subject to a minimum amount of one percent (
1.0%
)) plus fourteen percent (
14.0%
) and is due and payable quarterly, in arrears, which commenced on August 14, 2015. Upon the earlier of (a) the maturity date on April 17, 2018, or (b) full repayment of the Term Loan, whether by acceleration or otherwise, the Company is required to pay an exit fee equal to eight percent (
8%
) of the aggregate principal amount of all term loans advanced under the Credit Agreement. The Company is recognizing the exit fee over the term of the Term Loan through an accretion accrual to interest expense using the effective interest method.
The Credit Agreement also contains certain financial covenants including minimum aggregate revenue, adjusted EBITDA, and consolidated unencumbered liquid assets requirements. On March 28, 2016, the Company obtained a Second Amendment to the Credit Agreement (the "Second Amendment") in which the lender modified the existing covenants and replaced them with minimum aggregate revenue covenants of
$33.0 million
for the twelve months ending March 31, 2016,
$34.0 million
for the twelve months ending June 30, 2016,
$37.0 million
for the twelve months ending September 30, 2016,
$40.0 million
for the twelve months ending December 31, 2016, and
$45.0 million
for the twelve months ending each fiscal quarter thereafter. The Second Amendment also modified the minimum adjusted EBITDA covenants for 2016 and replaced them with minimum adjusted EBITDA covenants of negative
$1.6 million
for the three months ending March 31, 2016, negative
$2.0 million
for the six months ending June 30, 2016, negative
$1.1 million
for the nine months ending September 30, 2016,
$0.8 million
for the twelve months ending December 31, 2016,
$0.5 million
for the twelve months ending March 31, 2017,
$0.9 million
for the twelve months ending June 30, 2017, and
$2.5 million
for the twelve months ending September 30, 2017, and each twelve consecutive calendar month period ending on the last day of each fiscal quarter thereafter. In addition, the Company was required to obtain new equity contributions in an aggregate amount of not less than
$0.5 million
between March 23, 2016 and June 30, 2016, which requirement the Company has satisfied through the private offering to the investor described above. The Second Amendment also required the Company to issue shares of its common stock,
$0.04
par value, with a value of
$100,000
to SWK, which the Company issued during the first quarter of 2016 and recorded in Selling, general and administrative expenses in the condensed consolidated statement of operations for the
three month period ended
March 31, 2016
. The Company was in compliance with the covenants under the Credit Agreement, as amended, as of
March 31, 2016
. If the Company is unable to comply with financial covenants in the future and in the event that the Company was unable to modify the covenants, find new or additional lenders, or raise additional equity, it would be considered in default, which would then enable the lenders to accelerate the repayment of all amounts outstanding and exercise remedies with respect to collateral, which would have a material adverse impact on the Company's business.
The Credit Agreement contains a cross-default provision that can be triggered if the Company has more than
$0.25 million
in debt outstanding under the 2013 Loan and Security Agreement and the Company fails to make payments to Ares when due or if Ares is entitled to accelerate the maturity of debt in response to a default situation under the 2013 Loan and Security Agreement, which may include violation of any financial covenants.
As of March 31, 2016, as security for payment and other obligations under the 2013 Loan and Security Agreement, Ares held a security interest in all of the Company's, and its subsidiary guarantors', existing and after-acquired property, including receivables (which are subject to a lockbox account arrangement), inventory and equipment. Additionally, SWK holds a security interest for final and indefeasible payment. The security interest held by SWK is in substantially all of the Company's assets and the Company's subsidiaries.
In connection with the execution of the Credit Agreement, the Company issued SWK a warrant (the "Warrant") to purchase
8,152,174
shares of the Company’s common stock. The Warrant is exercisable after October 17, 2015, and up to and including April 17, 2022, at an exercise price of
$0.46
per share. The Warrant is exercisable on a cashless basis. The exercise price of the Warrant is subject to customary adjustment provisions for stock splits, stock dividends, recapitalizations and the like. The Warrant grants the holder certain piggyback registration rights. The Warrant was considered equity classified, and as such, the Company allocated the proceeds from the Term Loan to the Warrant using the Relative Fair Value Method. The fair value of the Warrant of
$2.7 million
was recorded as debt discount, which is being recognized as interest expense over the term of the Credit Agreement using the effective interest method. The Company valued the Warrant using the Black-Scholes pricing model using volatility of
85.0%
, a risk-free rate of
1.4%
, dividend rate of
zero
and term of
7
years, which is consistent with the exercise period of the Warrant and is a Level 3 valuation technique.
Further, pursuant to the Credit Agreement, if the 2013 Loan and Security Agreement was not repaid in full and terminated, and all liens securing the 2013 Loan and Security Agreement were not released, on or prior to April 30, 2016, as amended per below, the Company agreed to issue an additional warrant to SWK to purchase common stock valued at
$1.25 million
, with an exercise price of the closing price on April 30, 2016, as amended per below. As discussed in Note 14 to the condensed consolidated
financial statements, the Company met this requirement and was not required to issue the additional warrant. As of March 31, 2016, the Company considered whether the issuance of the additional warrant was a “credit sensitive payment”, as the issuance of the additional warrant was contingent upon the repayment of debt (the 2013 Loan and Security Agreement). However, as the repayment date specified in the Term Loan was prior to the maturity date of the 2013 Loan and Security Agreement and therefore this was an incentive feature, rather than a reflection of the Company’s creditworthiness, the Company did not think it was appropriate to consider this feature credit related. Therefore, the feature was not clearly and closely related to the debt host. The Company determined that the additional warrant feature did not contain an explicit limit on the number of warrants to be delivered for settlement. As the Company was required to deliver a number of additional warrants that would satisfy the fixed monetary amount of
$1.25 million
, the number of warrants (and underlying shares) to be delivered could not be determined. Therefore, the additional warrant feature was considered an embedded derivative.
As the issuance of the additional warrant was contingent, the evaluation of the likelihood of the occurrence of the contingency was considered in determining the fair value of the embedded derivative. As of
March 31, 2016
, the Company believed that the contingency (i.e. not repaying in full and terminating the 2013 Loan and Security Agreement by April 30, 2016) was probable as the Company did not believe that the 2013 Loan and Security Agreement would be paid in full and terminated by April 30, 2016, due to the fact that there was no executed agreement in place, and the Company was in the very early stages of identifying and evaluating potential lenders as of
March 31, 2016
. Accordingly, as of
March 31, 2016
, the fair value of the embedded derivative of
$0.9 million
was included in Other long-term liabilities on the condensed consolidated balance sheet with the loss associated with the change in the fair value of the derivative liability during the three months ended
March 31, 2016
, of
$0.1 million
recorded in Interest Expense. The Company valued the additional warrant using the Black-Scholes pricing model using volatility of
81.4%
, a risk-free rate of
1.54%
, dividend rate of
zero
, and term of
7
years, which was consistent with the exercise period of the additional warrant.
On February 25, 2016, the Company entered into a First Amendment to Credit Agreement (“First Amendment”) with SWK. The First Amendment modified the Credit Agreement to extend the date the Company had to issue the additional warrant to SWK from February 28, 2016, to April 30, 2016, if the 2013 Loan and Security Agreement was not repaid in full and terminated and all liens securing the 2013 Loan and Security Agreement were not released. The First Amendment also modified the exercise price of the warrant from
one
cent over the closing price on February 28, 2016, and replaced it with the closing price of the Company's stock on April 30, 2016. The First Amendment also required the Company to issue
454,545
shares of our common stock,
$0.04
par value, with a value of
$50,000
to SWK, which the Company issued during the first quarter of 2016 and recorded in Selling, general and administrative expenses in the condensed consolidated statement of operations for the
three month period ended
March 31, 2016
.
Note 10: Commitments and Contingencies
The Company leases its corporate headquarters in Olathe, Kansas, which includes the Health and Wellness operations center, under an operating lease which expires in 2018. The Company leases its AHS operations centers in Des Moines, Iowa and Indianapolis, IN, under operating leases which expire in 2018. The Company also leases copiers and other miscellaneous equipment. These leases expire at various times through 2017.
The Company is obligated under a lease related to the discontinued Hooper Holmes Services operations center through 2018 and has ceased use of this facility. The Company is still the primary lessee under operating leases for
four
Portamedic branch offices and has recorded a facility closure obligation related to the above mentioned leases for future rent payments not utilized for continuing operations and such related costs are recorded in the reporting for discontinued operations. The Company has recorded a facility closure obligation of
$0.6 million
as of
March 31, 2016
, related to the above mentioned leases.
The Company has employment agreements with certain executive employees that provide for payment of base salary for up to a
one year
period in the event their employment with the Company is terminated in certain circumstances, including following a change in control, as further defined in the agreements.
In the past, some federal and state agencies have claimed that the Company improperly classified its health professionals as independent contractors for purposes of federal and state unemployment and/or worker's compensation tax laws and that the Company was therefore liable for taxes in arrears or for penalties for failure to comply with their interpretation of the laws. There are no assurances that the Company will not be subject to similar claims in the future.
Note 11: Litigation
The Company, in the normal course of business, is a party to various claims and other legal proceedings. In the opinion of management, the Company has substantial legal defenses and/or insurance coverage (subject to deductibles) with respect to all
of its pending legal actions. If management believes that a material loss not covered by insurance arising from these actions is probable and can reasonably be estimated, the Company may record the amount of the estimated loss or, if a loss cannot be estimated but the minimum liability may be estimated using a range and no point is more probable than another, the Company may record the minimum estimated liability. As additional information becomes available, any potential liability related to these actions is assessed and the estimates are revised, if necessary. Management believes that the ultimate outcome of all pending legal actions, individually and in the aggregate, will not have a material adverse effect on the Company's financial position that is inconsistent with its loss reserves or on its overall trends in results of operations. However, litigation and claims are subject to inherent uncertainties and unfavorable outcomes can occur that exceed any amounts reserved for such losses. If an unfavorable outcome were to occur, there exists the possibility of a material adverse impact on the results of operations in the period in which the outcome occurs or in future periods.
On May 24, 2012, a complaint was filed against the Company in the United States District Court for the District of New Jersey alleging, among other things, that the Company failed to pay overtime compensation to a purported class of certain independent contractor examiners who, the complaint alleges, should be treated as employees for purposes of federal law. The complaint seeks award of an unspecified amount of allegedly unpaid overtime wages to certain examiners. The Company filed an answer denying the substantive allegations therein. On August 1, 2014, the Magistrate Judge issued a Report and Recommendation to conditionally certify the class of all contract examiners from August 16, 2010, to the present. On August 29, 2014, the Company submitted its objections to the Report and Recommendation of the Magistrate Judge. The Magistrate has suspended ruling concerning those objections while the parties pursue the possibility of a settlement. On April 29, 2016, the Company reached a preliminary understanding with the plaintiffs with respect to a settlement of the lawsuit involving a release of all claims by the plaintiffs and the Company's establishment of a settlement fund of
$0.45 million
. Accordingly, as of
March 31, 2016
, the Company had accrued $
0.45 million
related to this matter versus
$0.3 million
as of December 31, 2015. The litigation accrual for all periods was included in the Accrued expenses line item on the condensed consolidated balance sheet. The additional expense of
$0.15 million
recorded during the three month period ended March 31, 2016, is included in the Discontinued operations line item on the condensed consolidated statements of operations. This preliminary understanding is subject to approval by the Magistrate and the parties' entry into a definitive settlement agreement. The claim is not covered by insurance, and the Company is incurring legal costs to defend the litigation which are recorded in discontinued operations. This matter relates to the former Portamedic service line for which the Company retained liability.
Note 12: Income Taxes
The Company recorded tax expense of less than
$0.01 million
for each of the
three month periods ended
March 31, 2016
and
2015
, respectively, reflecting a state tax liability to
one
state. No amounts were recorded for unrecognized tax benefits or for the payment of interest and penalties during the
three month periods ended
March 31, 2016
and
2015
. No federal or state tax benefits were recorded relating to the current year loss, as the Company continues to believe that a full valuation allowance is required on its net deferred tax assets.
The tax years 2012 through 2015 may be subject to federal examination and assessment. Tax years from 2007 through 2011 remain open solely for purposes of federal and certain state examination of net operating loss and credit carryforwards. State income tax returns may be subject to examination for tax years 2011 through 2015, depending on state tax statute of limitations.
As of
December 31, 2015
, the Company had U.S. federal and state net operating loss carryforwards of
$167.2 million
and
$149.8 million
, respectively. There has been no significant change in these balances as of
March 31, 2016
. The net operating loss carryforwards, if not utilized, will expire in the years
2016
through
2035
.
Since the Company had changes in ownership during 2015 and continuing into the first quarter of 2016, additional limitations under IRC Section 382 of the Internal Revenue Code of 1986 may apply to the future utilization of certain tax attributes including net operating loss (“NOL”) carryforwards, other tax carryforwards, and certain built-in losses. The Company has not yet completed its analysis of any impact of these ownership changes. No tax benefit has been reported since a full valuation allowance offsets these tax attributes. However, limitations could apply even if the valuation allowance was released.
Note 13: Fair Value Measurements
The Company determines the fair value measurements used in our consolidated financial statements based upon the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value hierarchy distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets
or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are described below:
|
|
•
|
Level 1 - Valuations based on quoted prices in active markets for identical assets or liabilities that the entity has the ability to access.
|
|
|
•
|
Level 2 - Valuations based on quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable data for substantially the full term of the assets or liabilities.
|
|
|
•
|
Level 3 - Valuations based on inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
|
The Company estimated the fair value of the Term Loan and derivative liability using the Black-Scholes valuation model, which is a Level 3 valuation technique.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2016
|
(in thousands)
|
|
Face Value
|
|
Fair Value
|
|
Carrying Amount
|
Term Loan
|
|
$
|
5,000
|
|
|
$
|
2,885
|
|
|
$
|
1,961
|
|
Derivative liability
|
|
$
|
1,250
|
|
|
$
|
887
|
|
|
$
|
887
|
|
Note 14: Subsequent Events
On April 29, 2016, the Company entered into a Credit and Security Agreement (the “Agreement”) with SCM Specialty Finance Opportunities Fund, L.P. ("SCM”). The Agreement provides the Company with a revolving credit facility, the proceeds of which are to be used for general working capital purposes and capital expenditures. The Agreement replaces the 2013 Loan and Security Agreement, eliminating the requirement of the Company to issue the additional warrant for the purchase of common stock valued at
$1.25 million
to SWK, the holder of the Company’s Credit Agreement. An early termination fee of
$140,000
, approximately
$30,000
of legal fees, and approximately
$107,000
of other ordinary course fees, which were all owed to Ares and were accelerated due to the termination of the 2013 Loan and Security Agreement, were rolled into the opening outstanding borrowings under the Agreement with SCM and will be reflected in Results of Operations in the second quarter of 2016. As of
May 11, 2016
, we had
$3.1 million
outstanding under the Agreement, with estimated available borrowing capacity of
$1.1 million
.
Under the terms of the Agreement, SCM has agreed to make cash advances to the Company in an aggregate principal at any one time outstanding not to exceed
$7 million
, subject to certain loan balance limits based on the value of the Company’s eligible collateral (the “Revolving Loan Commitment Amount”). The Agreement has a term of
three
years, expiring on April 29, 2019.
Borrowings pursuant to the Agreement will bear interest at a fluctuating rate that when annualized is equal to the Prime Rate plus
5.5%
, subject to increase in the event of a default.
In connection with the Agreement, the Company paid to SCM a
$140,000
facility fee. Monthly, SCM will receive an unused line fee equal to one-half of one percent (
0.5%
) per annum of the difference derived by subtracting (i) the greater of (x) the average daily outstanding balance under the Revolving Facility during the preceding month and (y) the Minimum Balance, from (ii) the Revolving Loan Commitment Amount and also a collateral management fee equal to one-half of one percent (
0.5%
) per annum of the Revolving Loan Commitment Amount.
The Agreement contains customary representations and warranties and various affirmative and negative covenants including minimum aggregate revenue, EBITDA, and consolidated unencumbered liquid assets requirements. Minimum aggregate revenue must not be less than
$33.0 million
for the twelve months ending March 31, 2016,
$34.0 million
for the twelve months ending June 30, 2016,
$37.0 million
for the twelve months ending September 30, 2016,
$40.0 million
for the twelve months ending December 31, 2016, and
$45.0 million
for the twelve months ending each fiscal quarter thereafter. Adjusted EBITDA must not be less than negative
$1.6 million
for the three months ending March 31, 2016, negative
$2.0 million
for the six months ending June 30, 2016, negative
$1.1 million
for the nine months ending September 30, 2016,
$0.8 million
for the twelve months ending December 31, 2016,
$0.5 million
for the twelve months ending March 31, 2017,
$0.9 million
for the twelve months ending June 30, 2017, and
$2.5 million
for the twelve months ending September 30, 2017. In addition, consolidated unencumbered liquid assets must not be less than
$0.75 million
on the last day of any quarter.
Borrowings under the Agreement are secured by a security interest in all existing and after-acquired property of the Company, including, but not limited to, its receivables (which are subject to a lockbox account arrangement), inventory and equipment.
If the Company is unable to comply with financial covenants in the future and in the event that the Company was unable to modify the covenants, find new or additional lenders, or raise additional equity, it would be considered in default, which would then enable the lenders to accelerate the repayment of all amounts outstanding and exercise remedies with respect to collateral, which would have a material adverse impact on the Company's business.