GNOW American CareSource Holdings Inc (CE)

1. General

Basis of Presentation

The accompanying unaudited consolidated financial statements of American CareSource Holdings, Inc. and its subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information, with the instructions to Form 10-Q and Rule 8-03 of Regulation S-X of the rules and regulations of the Securities and Exchange Commission (“SEC”).  Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, these statements include all adjustments necessary to present a fair statement of our consolidated results of operations, financial position and cash flows. Operating results for any interim period are not necessarily indicative of the results that may be expected for the full year. Preparation of the Company’s 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 in the financial statements and notes. Actual results could differ from those estimates. This Quarterly Report on Form 10-Q should be read in conjunction with the Company’s consolidated financial statements and notes included in its Annual Report on Form 10-K for the fiscal year ended December 31, 2015.  References herein to "the Company," "we," "us," or "our" refer to American CareSource Holdings, Inc. and its subsidiaries.

Significant Accounting Policies

Goodwill resulted from our acquisition of urgent and primary care businesses during the years ended December 31, 2015 and 2014. In accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 805,  Business Combinations , the purchase method of accounting requires that the excess of the purchase price paid over the estimated fair value of identifiable tangible and intangible net assets of acquired businesses be recorded as goodwill. In accordance with ASC 350 , Intangibles – Goodwill   and Other , we are required to test goodwill for impairment annually or when indications of impairment occur. We perform our annual goodwill impairment test for our reporting units as of October 1, using a discounted cash flow method. In the interim, we review goodwill for impairment whenever events or circumstances indicate that the carrying amount might not be recoverable. We do not believe any event or circumstance in the second quarter of 2016 warranted an impairment review of goodwill, other than of our Florida clinics. Due to the closure of one of the Florida clinics we performed an interim goodwill impairment analysis for the Florida reporting unit and found no impairment was required.

Variable Interest Entities ("VIEs") – We consolidate VIEs when we are the “primary beneficiary” of the VIE. The primary beneficiary is the party that has (i) the power to direct the activities that most significantly impact the VIE’s economic performance and (ii) through its interests in the VIE, the obligation to absorb losses or the right to receive benefits from the VIE that could be significant to the VIE.

We have determined that Medac Health Services, P.A. (“Medac”) is a VIE and that we are the primary beneficiary. The financial results of Medac, our consolidated VIE, have been included in our operations since December 15, 2015, the date we closed the acquisition of certain assets from Medac (“the Medac Asset Acquisition”). Refer to Note 4 – Acquisitions and Variable Interest Entity.

For additional Significant Accounting Policies, refer to our Annual Report on Form 10-K for the fiscal year ended December 31, 2015.

Recent Accounting Pronouncements

In March 2016, the FASB issued ASU 2016-09 “Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting.” This standard requires the recognition of the income tax effects of awards in the income statement when the awards vest or are settled, thus eliminating additional paid in capital pools. The guidance also allows for the employer to repurchase more of an employee’s shares for tax withholding purposes without triggering liability accounting. In addition, the guidance allows for a policy election to account for forfeitures as they occur rather than on an estimated basis. The guidance is effective in 2017 with early adoption permitted. The Company is currently evaluating the impact of this guidance on its consolidated financial statements and the timing of adoption.

2.  Description of Business

The Company engages in two lines of business: our urgent and primary care business, which we operate under the tradenames GoNow Doctors and Medac, and our ancillary network business. These lines of business are supported by a shared services function.

On June 15, 2016, we entered into an asset purchase agreement to sell our legacy ancillary network business to our largest client and manager of the business, HealthSmart Preferred Care II, L.P. (“HealthSmart”). The purchase agreement contains customary representations, warranties, covenants, indemnification provisions, and closing conditions, and we anticipate closing the transaction in third or fourth quarter of 2016. Accordingly, we concluded that the ancillary network business qualifies as discontinued operations and financial results for the ancillary network business are presented as discontinued operations in our consolidated statements of operations, and the related asset and liability accounts are presented on our consolidated balance sheets as held for sale. Amounts previously reported have been reclassified, as necessary, to conform to this presentation to allow for meaningful comparison of continuing operations. Refer to Note 5 – Discontinued Operations.

In May 2014, we announced our entry into the urgent and primary care market. During the remainder of 2014, through our wholly-owned subsidiaries, we consummated five transactions resulting in our acquisition of ten urgent and primary care centers, located in Georgia (3), Florida (2), Alabama (3), and Virginia (2). In December 2015, we completed a key acquisition of urgent care assets comprising four sites in North Carolina. In January 2016 we closed one of our Georgia sites, on April 1, 2016 we sold the two Virginia centers, and on May 20, 2016 we closed our facility located in Panama City Beach, Florida.

Our healthcare centers offer a wide array of services for non-life-threatening medical conditions. We strive to improve access to quality medical care by offering extended hours and weekend service primarily on a walk-in basis. Our centers offer a broad range of medical services that generally fall within the urgent care, primary care, family care, and occupational medicine classifications. Specifically, we offer non-life-threatening, out-patient medical care for the treatment of acute, episodic, and some chronic medical conditions. When hospitalization or specialty care is needed, referrals to appropriate providers are made.

Patients typically visit our centers on a walk-in basis when their condition is not severe enough to warrant an emergency visit or when treatment by their primary care provider is inconvenient. We also attempt to capture follow-up, preventative and general primary care business after walk-in visits. The services provided at our centers include, but are not limited to, the following:

Our centers are typically equipped with digital x-ray machines, electrocardiograph machines and basic laboratory equipment, and are generally staffed with a combination of licensed physicians, nurse practitioners, physician assistants, medical support staff, and administrative support staff. Our medical support staff includes licensed nurses, certified medical assistants, laboratory technicians, and registered radiographic technologists.

3. Liquidity and Earnings (Loss) Per Share

Liquidity and Capital Resources

As of June 30, 2016, we had cash and cash equivalents of $299,000 and a working capital deficit of $14.6 million. As of December 31, 2015, we had cash and cash equivalents of $2.6 million and a working capital deficit of $13.2 million.

Our cash needs have been funded historically from loan proceeds and equity offerings. We entered into two lines of credit in 2014. As of June 30, 2016, maximum borrowings under these lines of credit was $12,000,000. As of June 30, 2016, we had no additional borrowing capacity under our lines of credit. Furthermore, both lines of credit are scheduled to mature in 2017 at which time the full outstanding principal balance of $11,800,000 will become due and payable. Substantially all of the borrowings under the lines of credit were used to finance acquisition activity, to fund losses, and $200,000, which is not currently available to us, was used to secure a bond required to obtain a state license for our ancillary network business. Although we intend to extend further the maturity dates of the two lines of credit and raise additional capital through the incurrence of additional debt or sale of equity or assets during the remainder of 2016 or in 2017, there is no assurance that we will be successful in completing such actions.

If we are unable to obtain additional extensions on our lines of credit or if we are unable to raise additional funds, we will not have sufficient cash on hand to meet our cash requirements over the next 12 months. These uncertainties raise substantial doubt about our ability to continue as a going concern. Our consolidated financial statements do not include any adjustments that might be necessary if we are unable to continue as a going concern.

Our financial statements have been prepared on a going concern basis, which contemplates the recoverability of assets and satisfaction of liabilities in the normal course of business. Based on the information herein, there is a substantial doubt as to the Company’s ability to continue as a going concern. We expect to need additional capital during 2016 to fund anticipated operating losses, to satisfy our debt obligations as they become due and to continue to improve the operating performance of our urgent and primary care business; however, there are no assurances we will be able to secure this capital at terms acceptable to us or at all. We may seek to raise such capital through the sale of assets or through one or more public or private equity offerings, debt financings, borrowings or a combination thereof. However, we currently have no plans to conduct equity offerings to raise capital. If we raise funds through the incurrence of additional debt or the issuance of debt securities, the lenders or purchasers of debt securities may require security that is senior to the rights of our common stockholders. In addition, our incurrence of additional debt could result in the imposition of covenants that restrict our operations or limit our ability to achieve our business objectives. The issuance of any new equity securities would likely dilute the interest of our current stockholders. In light of our historical performance, additional capital may not be available when needed on acceptable terms, or at all. If adequate funds are not available, we will need to, among other things, abandon our expansion plans, which would have a material adverse impact on our business prospects and results of operations. In addition, we may be required to reduce our operations, including further reductions in headcount, and sell assets. However, we may be unable to sell assets or undertake other actions to meet our operational needs. As a result, we may be unable to pay our ordinary expenses, including our debt service, on a timely basis, and we may therefore determine to exit the urgent and primary care business.

Earnings (Loss) Per Share

Basic earnings (loss) per share is computed using a two-class participating securities method. Losses have been allocated to the preferred stock, on an as-converted basis, without preference to the common stock because the dividend and liquidation rights of the preferred and common stock are equivalent on an as-converted basis.  Diluted earnings (loss) per share is computed similar to basic earnings per share except for adjustments for dilutive potential common shares outstanding during the period using the treasury stock method. We computed earnings (loss) per share for both continuing and discontinued operations for the three and six month periods ended June 30, 2016, and June 30, 2015.

Basic net income (loss) and diluted net income (loss) per share data were computed as follows (in thousands except per share amounts):

The following table summarizes potentially dilutive shares outstanding as of June 30, 2016 and June 30, 2015, which were excluded from the calculation due to being anti-dilutive (in thousands):

4.  Acquisitions, Variable Interest Entity, and Disposals

On December 15, 2015, ACSH Medical Management, LLC (“ACSH Management”), a wholly-owned subsidiary of the Company, purchased from Medac and its shareholders, substantially all the assets used in the operation of Medac’s four urgent care centers in the greater Wilmington, North Carolina area for $4,370,000 in cash, the assumption of $768,000 in liabilities and a $560,000 note payable.  Medac remains an urgent care operating entity, owned by a single physician, with which ACSH Management has entered into various agreements. ACSH Management has entered into a $1.0 million secured line of credit for the benefit of Medac to fund certain of Medac’s operating losses and to cover costs necessary to expand the Medac brand in North Carolina.

ACSH Management has the power to direct certain of Medac’s significant activities and has the right to receive benefits from Medac that are significant to Medac. We have determined, therefore, that Medac is a VIE and that ACSH Management is the primary beneficiary. Consequently, we have consolidated Medac and its financial results since the date we closed the Medac Asset Acquisition.

The following table provides the balance sheets of Medac (in thousands):

The following table provides certain pro forma financial information for the Company as if the acquisition of Medac had occurred on January 1, 2015.

In January 2016, we closed one of our Georgia clinics. This clinic produced net revenue of approximately $5,000 and $409,000 for the six month periods ending June 30, 2016 and 2015, resulting in net operating losses for such periods of $82,000 and $32,000, respectively.

On April 1, 2016, we exited the Virginia urgent and primary care market by consummating the sale of our two Virginia subsidiaries to UrgeMedical Group, Inc. For the six months ended June 30, 2016 and June 30 2015, our Virginia subsidiaries reported net revenues of approximately $254,000 and $551,000, respectively, and net operating losses of approximately $132,000 and $346,000, respectively.

The sales price for the Virginia subsidiaries was $610,000, $50,000 of which was paid in cash at closing and the balance by delivery of two promissory notes. The first promissory note has an initial principal balance of $160,000 and interest accrues on the outstanding balance at 1.5% per annum. The note is payable in two installments, the first installment of $50,000, which remains outstanding as of the date of this filing, was due within 90 days after closing and the second installment of $110,000 is due within 150 days after closing.

The second promissory note has an initial principal balance of $400,000 and interest accrues on the outstanding balance at 5.0% per annum. Interest-only payments are due each month beginning July 1, 2016. Principal is due in three equal installments of $133,333 on the first, second and third anniversaries of the closing date.

On May 20, 2016 we closed our facility located in Panama City Beach. This clinic produced net revenue of approximately $136,000 and $263,000 for the six month periods ending June 30, 2016 and 2015, resulting in a net operating loss of $120,000 and $116,000 for the six months ended June 30, 2016 and 2015.

5. Discontinued Operations

We expect to consummate our sale of our legacy business to HealthSmart during the 2016 calendar year. As such, we are presenting our ancillary network business as discontinued operations in our consolidated statements of operations and the related asset and liability accounts are presented as held for sale. To allow for meaningful comparison of continuing operations, amounts previously reported have been reclassified, as necessary, to conform to this presentation.

The ancillary network business offers cost containment strategies, primarily through the utilization of a comprehensive national network of ancillary healthcare service providers.  Services are marketed to a number of healthcare companies including third-party administrators, insurance companies, large self-funded organizations, various employer groups, and preferred provider organizations. Since October 1, 2014, HealthSmart has managed our ancillary network business under a management services agreement.

Major classes of assets and liabilities of the ancillary network business held for sale are as follows (in thousands):

Summary results of operations for the ancillary network business were as follows (in thousands):

We recognize revenue in our legacy business on the services we provide, which include (i) providing payor clients with a comprehensive network of ancillary healthcare providers; (ii) providing claims management, reporting, processing and payment services; (iii) providing network/need analysis to assess the benefits to payor clients of adding additional/different service providers to the client-specific provider networks; and (iv) providing credentialing of network service providers for inclusion in the client payor-specific provider networks.  Revenue is recognized when services are delivered, which occurs after processed claims are billed to the payor clients and collections are reasonably assured.  We estimate revenues and costs of revenues using average historical collection rates and average historical margins earned on claims.  Revenues are adjusted periodically to reflect actual cash collections so that revenues recognized accurately reflect cash collected.

We record a provision for refunds based on an estimate of historical refund amounts.  Refunds are paid to payors for overpayment on claims, claims paid in error, and claims paid for non-covered services.  In some instances, we will recoup payments made to the ancillary service provider if the claim has been fully resolved.  The evaluation is performed periodically and is based on historical data.  We present revenue net of the provision for refunds on the consolidated statement of operations.

After careful evaluation of the key gross and net revenue recognition indicators, we have concluded that our circumstances are most consistent with those key indicators that support gross revenue reporting, since we are fulfilling the services of a principal versus an agent.

Payments to providers is the largest component of our cost of revenues and it consists of payments for ancillary care services in accordance with contracts negotiated with providers for specific ancillary services, separately from contracts negotiated with our clients.

6.  Revenue Recognition and Accounts Receivable

In our urgent and primary care business, we have agreements with governmental and other third-party payors that provide for payments to us based on contractual adjustments to our established rates. Such agreements typically provide for a portion of the payment obligation to be borne by the patient, which we generally collect at the time services are rendered.

Net revenue is reported at the time of service at the estimated net realizable amounts, after giving effect to estimated contractual adjustments, payments from patients, third-party payors and others, and an estimate for bad debts. 

Contractual adjustments are accrued on an estimated basis in the period the related services are rendered and adjusted in future periods as final settlements are determined.  Although we attempt to collect all patient liability at the time of service, we frequently are left with a patient balance, which we bill expeditiously. Such credit is granted to patients, who consist primarily of local residents insured by third-party payors, without collateral.   A summary of the basis of reimbursement with major third-party payors is as follows:

In establishing our allowance for bad debts, we consider historical collection experience, the aging of the account, payor classification and patient payment patterns.  We adjust this allowance prospectively.

We collect payment from our uninsured patients at the time of service. When services are rendered to employees or contractors of clients for whom we render occupational medicine services, we typically bill the client employer within 30 days of the date of the services. We grant such client credit without collateral.

We recognize service agreement revenue through our contractual affiliation with Medac. Under a management services agreement with a local emergency medical business company, Medac leases certain employees and provides administrative services in exchange for a fee. Revenue related to the agreement is recorded during the period when the services are performed.

Below is a summary of accounts receivable as of June 30, 2016 and December 31, 2015, and revenues for the three and six month periods ended June 30, 2016 and 2015, respectively, for our urgent and primary care business. 

7.  Capital and Operating Lease Obligations

The following reflects the scheduled, minimum required payments under our lease agreements in effect at June 30, 2016 (in thousands):

8.  Lines of Credit, Promissory Notes, and Notes Payable

Below is a summary of our short-term and long-term debt obligations.

Lines of Credit

As of June 30, 2016, we had outstanding borrowings of $11,800,000 under our two credit agreements, with a weighted-average interest rate of 2.19%. Amounts outstanding under these credit agreements were recorded as a current liability on our consolidated balance sheet as of June 30, 2016, since both credit agreements, as amended, mature on June 1, 2017. Substantially all of the borrowings under the credit agreements were used to finance acquisition activity, fund losses, and $200,000, which is not currently available to be borrowed by us, was used to secure a bond required to obtain a state license for our ancillary network business. The obligations under the credit agreements are secured by all the assets of the Company and its subsidiaries, and include ordinary and customary covenants related to, among other things, additional debt, further encumbrances, sales of assets, and investments and lending.

Borrowings under the credit agreements are also secured by guarantees provided by certain officers and directors of the Company, among others.  In consideration of their guaranteeing such indebtedness, we originally issued the guarantors warrants to purchase an aggregate of 2,060,000 shares of our common stock.

A portion of the indebtedness under the credit agreements matured on June 1, 2016. On June 7, 2016 the Company extended the maturity date of all indebtedness under the credit agreements to June 1, 2017. In connection with the extension, the guarantors agreed to extend their respective guarantees to the modified maturity date. In consideration of such extension, the Company issued warrants to purchase an aggregate of 2,000,000 shares of common stock of the Company at an exercise price of $0.21 per share. The warrants vested immediately and are exercisable any time prior to their expiration on June 6, 2026.

Promissory Notes and Notes Payable

On June 3, 2016, we received a loan of $1,639,000 from the following three board members: John Pappajohn, Mark Oman, and Matt Kinley. The loan is evidenced by promissory notes bearing interest at 6% per annum issued to each of the respective directors. Interest-only payments are due and payable under the promissory notes on the first day of each calendar month after the date of issuance, and all principal and accrued but unpaid interest are due and payable in December 2017. The loans are subordinate to the credit agreements with Wells Fargo.

In 2015, as part of the Medac Asset Acquisition, the Company issued a promissory note to the seller for $560,000. The fair value of the note was subsequently adjusted for reporting purposes to $522,000. The promissory note accrues interest at 5% per annum and matures on June 15, 2017. Other acquisition notes of approximately $73,000 remained outstanding at June 30, 2016, mature in 2016 and bear interest at 5%.

The following is a summary of all Company debt as of June 30, 2016 (in thousands):

9. Intangible Assets

Identifiable intangible assets acquired in the urgent and primary care transactions are comprised of relationships with patients and contracts that drive patient volume (and therefore revenue) to our centers.  Identifiable intangible assets and related accumulated amortization consist of the following as of the dates presented (in thousands):

Total amortization expense related to intangibles was approximately $57,000 and $80,000 during the three months ended June 30, 2016 and 2015, and $115,000 and $161,000 during the six months ended June 30, 2016 and 2015, respectively. We amortize patient relationships and contracts using the straight-line method over their estimated useful lives between five and ten years. 

Estimated future amortization expense relating to intangibles is as follows (in thousands):

10.  Warrants

Warrants to purchase 15,167,396 shares and 1,782,222 shares of our common stock were outstanding as of June 30, 2016 and June 30, 2015, respectively. Warrants to purchase 11,085,174 shares of common stock were issued in the 2015 Offering. Warrants to purchase 2,060,000 shares of common stock were issued in 2014 and 2015 to the guarantors of our lines of credit, and additional warrants to purchase 2,000,000 shares of common stock were issued to the same guarantors in connection with the recent extension of our credit agreements. The remaining warrants to purchase 22,222 shares of common stock expire on February 1, 2017 and have an exercise price of $1.50 per share. The weighted average price of the outstanding warrants to purchase an aggregate of 15,167,396 of our common stock at June 30, 2016 was $0.76.

The fair value of the additional warrants issued to purchase 2,000,000 shares of common stock was calculated using the Black Sholes options-pricing model. Additional assumptions we used in our valuation calculations were as follows:

11.  Segment Reporting

As of June 30, 2016, we operated two segments, urgent and primary care and ancillary network.  We evaluate segment performance based on several factors, the primary financial measure of which is operating income.  We define segment income as income before interest expense, gain or loss on disposal of assets, income taxes, depreciation expense, non-cash amortization of intangible assets, intangible asset impairment, non-cash stock-based compensation expense, shared service expenses, severance charges and any other non-recurring costs.  Shared services primarily consists of compensation costs for our executive management team, corporate headquarters costs, certain transactional costs, support services such as finance and accounting, human resources, legal, marketing and information technology and general administration.  

The following tables set forth a comparison of operations for the following periods presented for our segments and shared services (certain prior year amounts have been reclassified for comparability purposes).

Consolidated statements of operations by segment for the respective three month period ended June 30 are as follows (in thousands):

* Presented as discontinued operations in statement of operations.

The following provides a reconciliation of reportable segment operating income (loss) to the Company’s consolidated totals (in thousands):

Segment assets include accounts receivable, prepaid expenses and other current assets, property and equipment, and intangibles.  Shared services assets consist of cash and cash equivalents, prepaid insurance, deferred income taxes and property and equipment primarily related to information technology assets.  Consolidated assets, by segment and shared services, as of the periods presented are as follows:

* Presented as discontinued operations in balance sheets.

12. Subsequent Events

 On July 26, 2016, we expanded our borrowing capacity with lines of credit with Wells Fargo by $1,000,0000. The additional funds will be used for working capital and will be due and payable on June 1, 2017, the date all indebtedness is due under our credit agreements. The line extension is governed by all terms and conditions set forth in the existing credit agreements.