Form 10-Q Amendment No. 1

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549

 

 

FORM 10-Q/A

(Amendment No. 1)

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2011

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission File Number 1-12607

 

 

SUNLINK HEALTH SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Ohio   31-0621189

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

900 Circle 75 Parkway, Suite 1120, Atlanta, Georgia 30339

(Address of principal executive offices)

(Zip Code)

(770) 933-7000

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filings requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter during the preceding 12 months (of for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The number of Common Shares, without par value, outstanding as of May 21, 2012 was 9,447,949.

 

 

 


Amendment No. 1 Overview

SunLink Health Systems, Inc. (“SunLink) is filing this Amendment No. 1 of Form 10-Q/A to our Form 10-Q for the three and nine month periods ended December 31, 2011 and 2010 to reflect the restatement of our previously issued condensed consolidated financial statements and other in response to comments issued by the SEC and to clarify certain prior disclosures. For further discussion of the restatement, see Note 1, Restatement and Basis of Presentation, to our condensed consolidated financial statements and Item 4 contained herein.

The information contained in this Amendment, including the condensed consolidated financial statements and the notes hereto, amends only Items 1 and 2 of Part I and Item 4 of Part II of the originally filed Quarterly Report on Form 10-Q for the three and nine month period ended December 31, 2011 and 2010 and no other items in our originally filed Form 10-Q are hereby amended. Accordingly, this Form 10-Q/A should be read in conjunction with our filings made with the Securities and Exchange Commission. In addition, currently dated certifications from our Chief Executive Officer and Chief Financial Officer have been included as exhibits to this amendment.

 

2


PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

SUNLINK HEALTH SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

 

     December 31,        
     2011     June 30,  
     (unaudited)     2011  
     (Restated)     (Restated)  
ASSETS     

Current Assets:

    

Cash and cash equivalents

   $ 519      $ 7,250   

Receivables - net

     16,113        16,302   

Inventory

     4,321        4,371   

Income tax receivable

     1,621        1,526   

Deferred income tax asset

     5,891        8,846   

Electronic Health Records incentive reimbursement receivable

     466        277   

Current assets of Memorial Hospital of Adel

     339        437   

Prepaid expense and other

     3,893        4,356   
  

 

 

   

 

 

 

Total current assets

     33,163        43,365   

Property, plant and equipment, at cost

     66,493        65,967   

Less accumulated depreciation

     34,572        32,283   
  

 

 

   

 

 

 

Property, plant and equipment - net

     31,921        33,684   

Noncurrent Assets:

    

Intangible assets - net

     3,393        3,477   

Goodwill

     1,392        1,392   

Noncurrent assets of Adel

     6,685        6,780   

Deferred income tax asset

     3,711        2,786   

Other noncurrent assets

     585        346   
  

 

 

   

 

 

 

Total noncurrent assets

     15,766        14,781   
  

 

 

   

 

 

 

TOTAL ASSETS

   $ 80,850      $ 91,830   
  

 

 

   

 

 

 
LIABILITIES AND SHAREHOLDERS’ EQUITY     

Current liabilities:

    

Accounts payable

   $ 7,855      $ 7,509   

Revolving advances

     6,700        5,300   

Current maturities of long-term debt

     1,832        1,814   

Current maturities of subordinated long-term debt

     300        300   

Accrued payroll and related taxes

     4,459        5,064   

Deferred gain - Medicare Electronic Health Records incentives

     8,521        8,521   

Other accrued expenses

     2,929        2,824   
  

 

 

   

 

 

 

Total current liabilities

     32,596        31,332   

Long-Term Liabilities

    

Long-term debt

     18,595        27,441   

Subordinated long-term debt

     2,302        2,197   

Noncurrent liability for professional liability risks

     3,442        3,583   

Other noncurrent liabilities

     1,221        1,209   
  

 

 

   

 

 

 

Total long-term liabilities

     25,560        34,430   

Commitment and Contingencies

    

Shareholders’ Equity

    

Preferred Shares, authorized and unissued, 2,000 shares

     0        0   

Common Shares, without par value:

    

Issued and outstanding, 9,448 shares at December 31, 2011 and 8,120 shares at June 30, 2011

     4,724        4,060   

Additional paid-in capital

     13,462        11,751   

Retained earnings

     4,713        10,462   

Accumulated other comprehensive loss

     (278     (278
  

 

 

   

 

 

 

Total Parent Company Shareholders’ Equity

     22,621        25,995   

Noncontrolling interest

     73        73   
  

 

 

   

 

 

 

Total Shareholders’ Equity

     22,694        26,068   
  

 

 

   

 

 

 

Total Liabilities and Shareholders’ Equity

   $ 80,850      $ 91,830   
  

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

3


SUNLINK HEALTH SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)

 

     THREE MONTHS ENDED     SIX MONTHS ENDED  
     DECEMBER 31,     DECEMBER 31,  
     2011     2010     2011     2010  
     (Restated)           (Restated)        

Net Revenues

   $ 37,038      $ 40,541      $ 72,555      $ 77,337   

Costs and Expenses

        

Cost of goods sold

     7,807        8,443        12,741        14,251   

Salaries, wages and benefits

     15,980        16,048        31,856        31,806   

Provision for bad debts

     3,097        3,630        7,646        8,114   

Supplies

     2,418        2,839        4,984        5,722   

Purchased services

     2,210        2,523        4,659        5,031   

Other operating expenses

     4,817        4,749        9,793        9,747   

Rent and lease expense

     695        709        1,414        1,412   

Depreciation and amortization

     1,197        1,422        2,374        2,845   

Medicaid Electronic Health Records incentives

     (614     0        (1,627     0   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating profit (loss)

     (569     178        (1,285     (1,591

Other Income (Expense):

        

Interest expense

     (1,029     (3,229     (2,335     (4,077

Interest income

     0        1        2        2   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss from Continuing Operations before income taxes

     (1,598     (3,050     (3,618     (5,666

Income Tax Benefit

     (505     (961     (1,274     (1,526
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss from Continuing Operations

     (1,093     (2,089     (2,344     (4,140

Earnings (Loss) from Discontinued Operations

     159        323        (145     (394
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Loss

   $ (934   $ (1,766   $ (2,489   $ (4,534
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (Loss) Per Share:

        

Continuing Operations:

        

Basic

   $ (0.12   $ (0.26   $ (0.25   $ (0.51
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ (0.12   $ (0.26   $ (0.25   $ (0.51
  

 

 

   

 

 

   

 

 

   

 

 

 

Discontinued Operations:

        

Basic

   $ 0.02      $ 0.04      $ (0.02   $ (0.05
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ 0.02      $ 0.04      $ (0.02   $ (0.05
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Loss:

        

Basic

   $ (0.10   $ (0.22   $ (0.27   $ (0.56
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ (0.10   $ (0.22   $ (0.27   $ (0.56
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-Average Common Shares Outstanding:

        

Basic

     9,448        8,082        9,253        8,081   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

     9,448        8,082        9,253        8,081   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

4


SUNLINK HEALTH SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

     SIX MONTHS ENDED  
     DECEMBER 31,  
     2011     2010  

Net Cash Used in Operating Activities

   $ (1,023   $ (1,394

Cash Flows from Investing Activities:

    

Expenditures for property, plant and equipment - continuing operations

     (447     (710

Expenditures for property, plant and equipment - discontinued operations

     (71     (125
  

 

 

   

 

 

 

Net Cash Used in Investing Activities

     (518     (835

Cash Flows from Financing Activities:

    

Revolving advances - net

     1,400        2,800   

Payments on long-term debt

     (8,935     (1,052

Net proceeds from issuance of common shares

     2,345        8   
  

 

 

   

 

 

 

Net Cash Provided by (Used in) Financing Activities

     (5,190     1,756   
  

 

 

   

 

 

 

Net decrease in Cash and Cash Equivalents

     (6,731     (473

Cash and Cash Equivalents Beginning of Period

     7,250        1,704   
  

 

 

   

 

 

 

Cash and Cash Equivalents End of Period

   $ 519      $ 1,231   
  

 

 

   

 

 

 

Supplement Disclosure of Cash Flow Information:

    

Cash Paid (Received) for:

    

Interest

   $ 2,371      $ 2,857   
  

 

 

   

 

 

 

Income taxes

   ($ 27   $ 413   
  

 

 

   

 

 

 

Non-cash investing and financing activities:

    

Assets acquired under capital lease obligation - continuing operations

   $ 80      $ 34   

Assets acquired under capital lease obligation - discontinued operations

     316        0   
  

 

 

   

 

 

 
   $ 396      $ 34   
  

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

5


SUNLINK HEALTH SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

THREE AND SIX MONTHS ENDED DECEMBER 31, 2011

(all dollar amounts in thousands except per share amounts)

(unaudited)

Note 1. – Restatement and Basis of Presentation

Restatement

We have restated our Condensed Consolidated Financial Statements and other financial information in our Quarterly Report on Form 10-Q for the three and six month periods ended December 31, 2011 and 2010 in response to comments issued by the SEC and to clarify certain prior disclosures.

On May 7, 2012, the Board of Directors and Audit Committee of SunLink Health Systems, Inc., (“SunLink”, or the “Company”) concluded that, as a results of comments issued by the SEC on its Form 10-Q for three and six months ended December 31, 2011, the financial statements for the three and six months ended December 31, 2011 should no longer be relied upon in light of Accounting Standards Codification 450-30, “Gain Contingencies”, (“ASC 450-30”) and the existing non-authoritative guidance that Medicare and Medicaid incentive payments for implementation of electronic health records (“EHR”) technology be accounted for on the basis of the gain contingency accounting model rather than a grant based accounting model as employed by SunLink with respect to such payments in fiscal quarters ending prior to December 31, 2011. As a result, the Company is restating its financial statements for the three and six months ended December 31, 2011. The restatement of financial statements does not affect the amount or the timing of past or future Medicare and Medicaid incentive payments.

In an unrelated matter, the amended reports listed above will reflect the retroactive reclassification of financial information with respect to the reclassification of the Company’s Memorial Hospital of Adel to discontinued operations (“Discontinued Operations Reclassification”) as a result of the Company’s decision in the quarter ended March 31, 2012 to sell such operations and the entry by the Company and its HealthMont of Georgia, Inc. subsidiary, on March 8, 2012, into an Asset Purchase Agreement by and among HealthMont of Georgia, Inc., SunLink and Hospital Authority of Tift County, Georgia (“Buyer”) effective as of March 1, 2012 (the “Adel Sale Agreement”) to sell substantially all of the assets of the Company’s owned Memorial Hospital of Adel and Memorial Convalescent Center (“Adel”) to the Buyer for approximately $8,300.

 

6


The following table sets forth the effects of the restatement adjustments and discontinued operations reclassification on line items within our previously reported condensed consolidated balance sheet as of December 31, 2011:

 

     As of December 31, 2011  
     As Previously
Reported
    Restatement
Adjustments
    Discontinued
Operations
Reclassification
    As Restated  

ASSETS

        

Current Assets:

        

Cash and cash equivalents

   $ 519      $ 0      $ 0      $ 519   

Receivables - net

     16,113        0        0        16,113   

Inventory

     4,634        0        (313     4,321   

Net current assets of Memorial Hospital of Adel

     0        0        339        339   

Income tax receivable

     1,621        0        0        1,621   

Deferred income tax asset

     5,545        346        0        5,891   

Electronic Health Records incentive reimbursement receivable

     1,310        (844     0        466   

Prepaid expense and other

     4,175        (200     (82     3,893   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total current assets

     33,917        (698     (56     33,163   

Property, plant and equipment, at cost

     75,935        0        (9,442     66,493   

Less accumulated depreciation

     39,034        0        (4,462     34,572   
  

 

 

   

 

 

   

 

 

   

 

 

 

Property, plant and equipment - net

     36,901        0        (4,980     31,921   

Noncurrent Assets:

        

Intangible assets - net

     3,741        0        (348     3,393   

Goodwill

     2,976        0        (1,584     1,392   

Net noncurrent assets of Memorial Hospital of Adel

     0        0        6,685        6,685   

Deferred income tax asset

     3,711        0        0        3,711   

Other noncurrent assets

     591        0        (6     585   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total noncurrent assets

     11,019        —          4,747        15,766   
  

 

 

   

 

 

   

 

 

   

 

 

 

TOTAL ASSETS

   $ 81,837      $ (698   $ (289   $ 80,850   
  

 

 

   

 

 

   

 

 

   

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

        

Current liabilities:

        

Accounts payable

   $ 7,855      $ 0      $ 0      $ 7,855   

Revolving advances

     6,700        0        0        6,700   

Current maturities of long-term debt

     1,888        0        (56     1,832   

Current maturities of subordinated long-term debt

     300        0        0        300   

Accrued payroll and related taxes

     4,459        0        0        4,459   

Deferred gain - Medicare Electronic Health Records incentive reimbursement

     0        8,521        0        8,521   

Other accrued expenses

     2,929        0        0        2,929   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total current liabilities

     24,131        8,521        (56     32,596   

Long-Term Liabilities

        

Long-term debt

     18,828        0        (233     18,595   

Subordinated long-term debt

     2,302        0        0        2,302   

Noncurrent liability for professional liability risks

     3,442        0        0        3,442   

Other noncurrent liabilities

     1,221        0        0        1,221   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total long-term liabilities

     25,793        0        (233     25,560   

Commitment and Contingencies

        

Shareholders’ Equity

        

Preferred Shares, authorized and unissued, 2,000 shares

     0        0        0        0   

Common Shares, without par value:

        

Issued and outstanding, 9,448 shares at December 31, 2011 and 8,120 shares at June 30, 2011

     4,724        0        0        4,724   

Additional paid-in capital

     13,462        0        0        13,462   

Retained earnings

     13,932        (9,219     0        4,713   

Accumulated other comprehensive loss

     (278     0        0        (278
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Parent Company Shareholders’ Equity

     31,840        (9,219     0        22,621   

Noncontrolling interest

     73        0        0        73   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Shareholders’ Equity

     31,913        (9,219     0        22,694   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Liabilities and Shareholders’ Equity

   $ 81,837      $ (698   $ (289   $ 80,850   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

7


The impact of the restatement adjustments and discontinued operations reclassification on the Company’s previously reported condensed consolidated statement of earnings and loss for the three and six months ended December 31, 2011 is shown in the following tables (in thousands, except per share data):

 

     Three Months Ended December 31, 2011  
     As Previously
Reported
    Restatement
Adjustments
    Discontinued
Operations
Reclassification
    As Restated  

Net Revenues

   $ 41,231      $ 0      $ (4,193   $ 37,038   

Costs and Expenses

        

Cost of goods sold

     7,807        0        0        7,807   

Salaries, wages and benefits

     18,157        0        (2,177     15,980   

Provision for bad debts

     3,645        0        (548     3,097   

Supplies

     2,860        0        (442     2,418   

Purchased services

     2,547        0        (337     2,210   

Other operating expenses

     5,466        0        (649     4,817   

Rent and lease expense

     772        0        (77     695   

Depreciation and amortization

     1,324        0        (127     1,197   

Medicaid Electronic Health Records incentives

     —          (1,068     454        (614
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating loss

     (1,347     1,068        (290     (569

Other Income (Expense):

        

Interest expense

     (1,035     0        6        (1,029

Interest income

     0        0        0        0   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss from Continuing Operations before income taxes

     (2,382     1,068        (284     (1,598

Income Tax Benefit

     (796     402        (111     (505
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss from Continuing Operations

     (1,586     666        (173     (1,093

Earnings (Loss) from Discontinued Operations

     (14     0        173        159   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Loss

   $ (1,600   $ 666      $ 0      $ (934
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (Loss) Per Share:

        

Continuing Operations:

        

Basic

   $ (0.17   $ 0.07      $ (0.02   $ (0.12
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ (0.17   $ 0.07      $ (0.02   $ (0.12
  

 

 

   

 

 

   

 

 

   

 

 

 

Discontinued Operations:

        

Basic

   $ (0.00   $ 0.00      $ 0.02      $ 0.02   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ (0.00   $ 0.00      $ 0.02      $ 0.02   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Loss:

        

Basic

   $ (0.17   $ 0.07      $ 0.00      $ (0.10
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ (0.17   $ 0.07      $ 0.00      $ (0.10
  

 

 

   

 

 

   

 

 

   

 

 

 

 

8


     Six Months Ended December 31, 2011  
     As Previously
Reported
    Restatement
Adjustments
    Discontinued
Operations
Reclassification
    As Restated  

Net Revenues

   $ 84,284      $ (2,998   $ (8,731   $ 72,555   

Costs and Expenses

           0   

Cost of goods sold

     12,741        0        0        12,741   

Salaries, wages and benefits

     36,392        0        (4,536     31,856   

Provision for bad debts

     9,121        0        (1,475     7,646   

Supplies

     5,922        0        (938     4,984   

Purchased services

     5,344        0        (685     4,659   

Other operating expenses

     11,106        0        (1,313     9,793   

Rent and lease expense

     1,566        0        (152     1,414   

Depreciation and amortization

     2,628        0        (254     2,374   

Medicaid Electronic Health Records incentives

     0        (2,081     454        (1,627
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating loss

     (536     (917     168        (1,285

Other Income (Expense):

        

Interest expense

     (2,346     0        11        (2,335

Interest income

     2        0        0        2   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss from Continuing Operations before income taxes

     (2,880     (917     179        (3,618

Income Tax Benefit

     (989     (346     61        (1,274
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss from Continuing Operations

     (1,891     (571     118        (2,344

Loss from Discontinued Operations

     (27     0        (118     (145
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Loss

   $ (1,918   $ (571   $ 0      $ (2,489
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss Per Share:

        

Continuing Operations:

        

Basic

   $ (0.20   $ (0.06   $ 0.01      $ (0.25
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ (0.20   $ (0.06   $ 0.01      $ (0.25
  

 

 

   

 

 

   

 

 

   

 

 

 

Discontinued Operations:

        

Basic

   $ (0.00   $ 0.00      $ (0.01   $ (0.02
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ (0.00   $ 0.00      $ (0.01   $ (0.02
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Loss:

        

Basic

   $ (0.21   $ (0.06   $ 0.00      $ (0.27
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ (0.21   $ (0.06   $ 0.00      $ (0.27
  

 

 

   

 

 

   

 

 

   

 

 

 

 

9


Basis of Presentation

The accompanying unaudited Condensed Consolidated Financial Statements as of December 31, 2011 and for the three and six month periods ended December 31, 2011 and 2010 have been prepared in accordance with Rule 10-01 of Regulation S-X of the Securities and Exchange Commission (“SEC”) and, as such, do not include all information required by accounting principles generally accepted in the United States of America. These Condensed Consolidated Financial Statements should be read in conjunction with the audited consolidated financial statements included in the SunLink Health Systems, Inc. (“SunLink”, “we”, “our”, “ours”, “us” or the “Company”) Annual Report on Form 10-K/A for the fiscal year ended June 30, 2011, filed with the SEC on May 21, 2012. In the opinion of management, the Condensed Consolidated Financial Statements, which are unaudited, include all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the financial position and results of operations for the periods indicated. The results of operations for the three and six month periods ended December 31, 2011 are not necessarily indicative of the results that may be expected for the entire fiscal year or any other interim period.

Note 2. – Business Operations

Business Operations

SunLink Health Systems, Inc. is a provider of healthcare services in certain rural and exurban markets in the United States. SunLink’s business is composed of two business segments:

 

   

Healthcare Facilities, which consist of

 

   

Our five community hospitals which have a total of 282 licensed beds;

 

   

Our two nursing homes, which have a total of 166 licensed beds, each of which is located adjacent to a corresponding SunLink community hospital; and

 

   

Our one home health agency, which operates in connection with a corresponding SunLink community hospital.

 

   

Specialty Pharmacy, which consists of

 

   

Specialty pharmacy services;

 

   

Durable medical equipment;

 

   

Institutional pharmacy services; and

 

   

Retail pharmacy products and services, all of which are conducted in rural markets.

SunLink has conducted its healthcare facilities business since 2001 and its specialty pharmacy business since April 2008.

SunLink’s Board and management has determined to focus the Company’s strategic efforts on enhancing its existing hospital portfolio, including the selective disposal of underperforming and non-strategic facilities, and on pursuing selected potential hospital acquisitions. SunLink is committed to enhancing shareholder value while maintaining high standards of responsibility to its patients, employees and the communities it serves and will continue to pursue strategic alternatives consistent with that commitment.

Note 3. – Subsequent Events

On March 8, 2012, the Company and its HealthMont of Georgia, Inc. subsidiary entered into an Asset Purchase Agreement by and among HealthMont of Georgia, Inc., SunLink and Buyer effective March 1, 2012 to sell substantially all of the assets of the Company’s owned Adel to the Buyer for approximately $8,300. Effective April 1, 2012, Buyer began management of Adel under a management agreement to continue from such date until the scheduled date of closing. The transaction is subject to a number of conditions and is expected to close in SunLink’s first fiscal quarter of 2013. (See Note 4. – Discontinued Operations.)

 

10


On March 26, 2012, SunLink Health Systems, Inc., HealthMont of Missouri, LLC (“Borrower”), HealthMont LLC (“HLLC”) entered into and closed on a $5,000 Loan Agreement with a bank dated as of March 16, 2012 (the “Callaway RDA Loan”). The loan is guaranteed by the Company and HLLC. HealthMont of Missouri, LLC owns and operates Callaway Community Hospital (“Callaway”) in Fulton, Missouri. The Loan Agreement consists of two promissory notes; a $4,000 note and $1,000 note. The $4,000 was drawn in its entirety on March 26, 2012. The $1,000 will be drawn upon commencement of construction and improvement projects.

Note 4. – Discontinued Operations

All of the businesses discussed below are reported as discontinued operations and the condensed consolidated financial statements for all prior periods have been adjusted to reflect this presentation.

Results for all of the businesses included in discontinued operations are presented in the following table:

 

     Three Months Ended     Six Months Ended  
     December 31,     December 31,  
     2011     2010     2011     2010  

Net Revenues:

        

Memorial Hospital of Adel

   $ 4,193      $ 4,512      $ 8,731      $ 8,582   

Chilton Medical Center

     0        3,698        0        7,036   
  

 

 

   

 

 

   

 

 

   

 

 

 
   $ 4,193      $ 8,210      $ 8,731      $ 15,618   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (loss) from discontinued operations:

        

Memorial Hospital of Adel

        

Earnings (loss) from operations

   $ 284      $ (10   $ (179   $ (350

Income tax expense (benefit)

     111        2        (61     (126
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (loss) from Memorial Hospital of Adel after taxes

     173        (12     (118     (224
  

 

 

   

 

 

   

 

 

   

 

 

 

Life sciences and engineering segment:

        

Loss from operations

   $ (22   $ (21   $ (44   $ (42

Income tax benefit

     (8     (8     (17     (16
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss from life sciences and engineering segment after taxes

     (14     (13     (27     (26
  

 

 

   

 

 

   

 

 

   

 

 

 

Chilton Medical Center:

        

Earnings (loss) from operations

     0        3        0        (497

Income tax benefit

     0        (18     0        (137
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (loss) from Chilton Medical Center after taxes

     0        21        0        (360
  

 

 

   

 

 

   

 

 

   

 

 

 

Mountainside Medical Center:

        

Earnings from operations

     0        525        0        347   

Income tax expense

     0        198        0        131   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings from Mountainside Medical Center after taxes

     0        327        0        216   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (loss) from discontinued operations

   $ 159      $ 323      $ (145   $ (394
  

 

 

   

 

 

   

 

 

   

 

 

 

Memorial Hospital of Adel – On March 8, 2012, the Company and its HealthMont of Georgia, Inc. subsidiary entered into an Asset Purchase Agreement by and among HealthMont of Georgia, Inc., SunLink

 

11


and Buyer effective March 1, 2012 to sell substantially all of the assets of the Company’s owned Adel to the Buyer for approximately $8,300. Excluded assets include accounts receivable as of the Cutoff Date and all Medicare and Medicaid incentive payments for meaningful use of electronic health record technology and all receivables, claims and settlements made pursuant to the Indigent Care Trust Fund of the State of Georgia paid with respect to the fiscal year ending June 30, 2012. Retained liabilities generally consist of liabilities incurred prior to the closing date of the transaction. Effective April 1, 2012, Buyer began management of Adel under a management agreement to continue from such date until the scheduled date of closing. Pursuant to the management agreement, the Buyer is to retain any profit earned and fund any losses incurred during the management period. The transaction is subject to a number of conditions and is expected to close in SunLink’s first fiscal quarter of 2013. The agreement may be terminated by either SunLink or the Buyer if the transaction is not consummated prior to July 31, 2012 or such later date as the parties may agree. Subject to certain conditions, if the Buyer terminates the agreement during the period April 1, 2012 through July 31, 2012 from other than a default by the Company, SunLink will be entitled to a breakup fee of $900. SunLink anticipates that the sale of assets of Adel for approximately $8,300, less estimated sale expenses, will result in net proceeds of approximately $7,500 to the Company and that the Company will be required to use all or substantially all of the net proceeds to pay down senior debt under the Company’s Credit Facility.

Adel’s operations have been reclassified as discontinued operations in our condensed consolidated financial statements for the three and six month periods ended December 31, 2011 and 2010 and as of June 30, 2011.

Chilton Medical Center – On March 1, 2011, SunLink entered into an agreement to lease its owned Chilton Medical Center (“Chilton”) and sold its 83% membership interest in Clanton Hospital LLC (“Clanton”), which manages Chilton, to Carraway Medical Systems, Inc. (“Carraway”). The lease agreement is for a six-year term with monthly rent of $37 and includes an option under which Carraway can purchase Chilton from SunLink. The option purchase price is $3,700, less the amount paid, up to a maximum of $615, to purchase the 17% membership interest of Clanton owned by local physicians. The purchase price of SunLink’s 83% membership interest in Clanton was a $1,000 six-year zero-coupon note plus a six-year 6% note for the net working capital of Clanton at purchase. If the purchase option for Chilton is exercised during the six-year term of the lease, any amount paid under the $1,000 note will be credited to the option purchase price and any remaining balance on the note will be cancelled. As a result, the note at December 31, 2011 was recorded on the balance sheet at net $0. Pursuant to the terms of the sale and lease and agreement, SunLink is entitled to receive 75% of the Electronic Health Records Medicare and Medicaid incentive reimbursements received by Clanton.

Mountainside Medical Center – On June 1, 2004, SunLink sold its Mountainside Medical Center (“Mountainside”) hospital in Jasper, Georgia, for approximately $40,000 pursuant to the terms of an asset sale agreement. In connection with this sale, claims by the buyer and counter claims by SunLink were litigated which resulted in a judgment for SunLink. The judgment, which included damages, prejudgment interest and certain losses, was collected by SunLink in the amount of $1,246 in May 2010 and $540 in December 2010, and the parties executed a mutual release. Included in the pre-tax loss of Mountainside for the three and six months ended December 31, 2010 were legal expenses related to the litigation with the buyer’s claim and SunLink’s counterclaim.

Life Sciences and Engineering Segment – SunLink retained a defined benefit retirement plan which covered substantially all of the employees of this segment when the segment was sold in fiscal 1998. Effective February 28, 1997, the plan was amended to freeze participant benefits and close the plan to new participants. Pension expense and related tax benefit or expense is reflected in the results of operations for this segment for the three and six months ended December 31, 2011 and 2010. The components of pension expense for the three and six months ended December 31, 2011 and 2010, respectively, were as follows:

 

     Three Months Ended     Six Months Ended  
     December 31,     December 31,  
     2011     2010     2011     2010  

Interest Cost

   $ 18      $ 18      $ 36      $ 37   

Expected return on assets

     (10     (11     (20     (21

Amortization of prior service cost

     14        14        28        26   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net pension expense

   $ 22      $ 21      $ 44      $ 42   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

12


SunLink did not contribute to the plan in the six months ended December 31, 2011. We expect to make no contribution to the plan through the end of the fiscal year ending June 30, 2012.

Note 5. – Shareholders’ Equity

Stock-Based Compensation

For the three months ended December 31, 2011 and 2010, the Company recognized $29 and $2, respectively, in salaries, wages and benefit expense for share options issued to employees and directors of the Company. For the six months ended December 31, 2011 and 2010, the Company recognized $34 and $5, respectively, in salaries, wages and benefit expense for share options issued to employees and directors of the Company. The fair value of the share options granted was estimated using the Black-Scholes option pricing model. There were 180,000 share options granted during the six months ended December 31, 2011 under the 2005 Equity Incentive Plan and no share options granted during the six months ended December 31, 2010.

Private Placement of Shares

In the first quarter of fiscal 2012, the Company sought to sell up to 3,800,000 common shares in a private offering at a price equal to the average closing price for the shares over the ten trading days prior to the applicable closing with a minimum placement of $2,500.

On July 28, 2011, SunLink announced a closing under the private placement of approximately 1,329,000 common shares at approximately $1.90 per share. Such shares were sold to certain of the Company’s officers and directors and/or their affiliates. The net proceeds of the private placement of approximately $2,500 were used, together with the Company’s operating funds, to make an $8,000 pre-payment on the Credit Facility Term Loan. Concurrent with and conditioned upon the Term Loan pre-payment, the Company’s lenders modified the Credit Facility to reduce the interest rate, revise certain financial and other covenants and extend the maturity date of the Credit Facility until January 1, 2013 (see Note 8 – Long-Term Debt). A special committee of the Company’s Board of Directors comprised of non-participating disinterested directors evaluated the private placement transaction and obtained an opinion of an outside advisor selected by the special committee that the price and terms of the private placement were fair from a financial point of view to the Company.

Note 6. – Receivables- net

Summary information for receivables is as follows:

 

     December 31,     June 30,  
     2011     2011  

Accounts receivable (net of contractual allowances)

   $ 28,059      $ 28,619   

Less allowance for doubtful accounts

     (11,946     (12,317
  

 

 

   

 

 

 

Receivables - net

   $ 16,113      $ 16,302   
  

 

 

   

 

 

 

 

13


Net revenues included increases of $51 and $653 for the three months ended December 31, 2011 and 2010, respectively, for the settlements and filings of prior year Medicare and Medicaid cost reports. Net revenues included increases of $51 and $662 for the six months ended December 31, 2011 and 2010, respectively, for the settlements and filings of prior year Medicare and Medicaid cost reports.

Note 7. – Medicare and Medicaid Electronic Health Records Incentives

Deferred Gain – Medicare Electronic Health Records Incentives

EHR incentive reimbursements are payments received under the Health Information Technology for Economic and Clinical Health Act (the “HITECH Act”) which was enacted into law on February 17, 2009 as part of the American Recovery and Reinvestment Act of 2009 (“ARRA”). The HITECH Act includes provisions designed to increase the use of EHR by both physicians and hospitals. Beginning with federal fiscal year 2011 (federal fiscal year is October 1 through September 30) and extending through federal fiscal year 2016, eligible hospitals and critical access hospitals (“CAH”) participating in the Medicare and Medicaid programs are eligible for reimbursement incentives based on successfully demonstrating meaningful use of their certified EHR technology. Conversely, those hospitals that do not successfully demonstrate meaningful use of EHR technology are subject to payment penalties or downward adjustments to their Medicare payments beginning in federal fiscal year 2015.

The Company accounts for EHR incentive payments in accordance with ASC 450-30. In accordance with ASC 450-30, the Company recognizes EHR incentive payments when all contingencies relating to the incentive payment have been satisfied and compliance with the EHR meaningful use criteria have been attested to. For recognition of Medicaid EHR incentive payments, recognition of the payments will be at the time of attestation to EHR meaningful use criteria since Medicaid payments for the states in which the Company operates are based upon historical cost report information with no subsequent payment adjustment. However, for Medicare EHR incentive payments, recognition is being deferred until both the Medicare federal fiscal year during which EHR meaningful use was demonstrated ends and the cost report information utilized to determine the final amount of reimbursement is known. The demonstration of meaningful use is based on meeting a series of objectives and varies among hospitals, between the Medicare and Medicaid programs, and within the Medicaid program from state to state. Additionally, meeting the series of objectives in order to demonstrate meaningful use becomes progressively more stringent as its implementation is phased in through stages as outlined by the Centers for Medicare and Medicaid Services.

SunLink’s five operating hospitals and Adel and Chilton (see Note 4. – Discontinued Operations) successfully attested for the Medicare EHR program for the fiscal year ended June 30, 2011. Incentive payments for all five operating hospital and Adel and Chilton totaling $8,521 were received by SunLink during the quarter ended June 30, 2011. As Medicare EHR incentive payments cannot be recognized until the cost report information utilized to determine the final amount of reimbursement is known, SunLink has recorded the $8,521 of deferred gain as of December 31, 2011 and June 30, 2011. This deferred gain is expected to be recognized in the quarter ended June 30, 2012, when information for the cost report period July 1, 2011 through June 30, 2012 is known.

SunLink’s two Missouri hospitals, its two Georgia hospitals, and Chilton successfully attested for the Medicaid EHR program for the federal attestation year ending September 30, 2011 and recognized and received the EHR incentive payments in the six month period ended December 31, 2011 in the amount of $1,627.

Note 8. – Goodwill and Intangible Assets

SunLink has goodwill and intangible assets related to its Healthcare Facilities and Specialty Pharmacy Segments.

 

14


Intangibles consist of the following, net of amortization:

 

     December 31,     June 30,  
     2011     2011  

Healthcare Facilities Segment

    

Certificates of Need

   $ 80      $ 80   

Noncompetition Agreements

     83        83   
  

 

 

   

 

 

 
     163        163   

Accumulated Amortization

     (104     (91
  

 

 

   

 

 

 
     59        72   
  

 

 

   

 

 

 

Specialty Pharmacy Segment

    

Trade Name

     2,000        2,000   

Customer Relationships

     1,089        1,089   

Medicare License

     769        769   
  

 

 

   

 

 

 
     3,858        3,858   

Accumulated Amortization

     (524     (453
  

 

 

   

 

 

 
     3,334        3,405   
  

 

 

   

 

 

 

Total

   $ 3,393      $ 3,477   
  

 

 

   

 

 

 

The trade name intangible asset under the Specialty Pharmacy Segment is a non-amortizing intangible asset.

Amortization expense was $42 and $154 for the three months ended December 31, 2011 and 2010, respectively. Amortization expense was $85 and $307 for the six months ended December 31, 2011 and 2010, respectively.

Goodwill consists of the following:

 

     December 31,      June 30,  
     2011      2011  

Healthcare Facilities Segment

   $ 931       $ 931   

Specialty Pharmacy Segment

     461         461   
  

 

 

    

 

 

 
   $ 1,392       $ 1,392   
  

 

 

    

 

 

 

Note 9. – Long-Term Debt and Revolving Line of Credit

Long-term debt consisted of the following:

 

     December 31,     June 30,  
     2011     2011  

Term Loan

   $ 20,211      $ 29,086   

Capital lease obligations

     216        169   
  

 

 

   

 

 

 

Total

     20,427        29,255   

Less current maturities

     (1,832     (1,814
  

 

 

   

 

 

 
   $ 18,595      $ 27,441   
  

 

 

   

 

 

 

 

15


SunLink Credit Facility – On April 23, 2008, SunLink entered into a $47,000 seven-year senior secured credit facility (“Credit Facility”) comprised of a revolving line of credit of up to $12,000 (the “Revolving Loan”) and a $35,000 term loan (the “Term Loan”). The Credit Facility has subsequently been amended by three modification agreements, on July 28, 2011 (“July 2011 Modification”), March 1, 2011 (“March 2011 Modification”), and September 27, 2010 (“September 2010 Modification”). The termination date for the Credit Facility currently is January 1, 2013 and the maximum Revolving Loan commitment currently is $9,000. At December 31, 2011, SunLink’s calculated net collectible value of eligible accounts receivable was $8,206, the Revolving Loan balance was $6,700 with an interest rate at LIBOR plus 9.125% (11.875% at December 31, 2011), and the Term Loan balance was $20,211 with an interest rate at LIBOR plus 11.07% (13.82% at December 31, 2011). Borrowings under the Credit Facility are at LIBOR plus the applicable interest rate. Under the Credit Facility, LIBOR is defined as the Thirty-Day published rate, not to be less than 2.75%, nor more than 5.50%. The maximum availability of the Revolving Loan is keyed to the calculated net collectible value of eligible accounts receivable.

The Credit Facility is secured by a first priority security interest in substantially all real and personal property of the Company and its consolidated subsidiaries, including a pledge of all of the equity interests in such subsidiaries. The Credit Facility contains various terms and conditions, including operational and financial restrictions and limitations, and affirmative and negative covenants. The covenants include financial covenants measured on a quarterly basis which require SunLink to comply with maximum leverage and minimum fixed charge ratios, maximum capital expenditure amounts, collateral value to loan amount and liquidity and cash flow measures, all as defined in the Credit Facility. The Company was in compliance with the revised levels of financial covenants and terms in the Credit Facility as of December 31, 2011, but there is no assurance that the Company will remain in compliance. If we fail to remain in compliance with the Credit Facility as modified, we would cease to have a right to draw on the revolving line of credit facility and the lenders would, among other things, be entitled to call a default and demand repayment of the indebtedness outstanding. If SunLink or its applicable subsidiaries experience a material adverse change in their business, assets, financial condition, management or operations, or if the value of the collateral securing the Credit Facility decreases, we may be unable to draw on the Revolving Loan.

Unamortized financing costs and expenses related to the Credit Facility of $140 are being amortized over the current remaining life of the Credit Facility. Accumulated amortization was approximately $2,405 and $2,321 as of December 31, 2011 and June 30, 2011, respectively. Amortization of the fees and expenses recorded in interest expense were approximately $42 and $995 for the three months ended December 31, 2011 and 2010, respectively. Amortization of the fees and expenses recorded in interest expense were approximately $84 and $1,102 for the six months ended December 31, 2011 and 2010, respectively.

Under the terms of the July 2011 Modification, the termination date of the Credit Facility was extended to January 1, 2013, Under the terms of the July 2011 Modification, SunLink also made an $8,000 prepayment on the Term Loan and paid a modification fee of $131. The source of the repayment was $2,500 of proceeds from a private placement of SunLink common shares and $5,500 of operating funds. Under the July 2011 Modification, the interest rate under the Revolving Loan was adjusted to LIBOR plus an applicable interest rate of 8.875%, or a total interest rate of 11.625% at July 28, 2011 and the interest rate under the Term Loan was adjusted to LIBOR plus an applicable interest rate of 10.82%, or a total interest rate of 13.57% at July 28, 2011. The July 2011 Modification also included covenants calling for further reductions in the principal balance of the term loan in September and December of 2011. Under the September 2011 and December 2011 Term Loan Reduction Covenants, if the principal balance under the Term Loan was not reduced by the prescribed amounts, the interest rate for both the Term Loan and the Revolving Loan would increase by an aggregate additional 0.50% over the prescribed interest rate for the remainder of the Credit Facility’s term. Because the September 2011 and December 2011 Term Loan Reduction Covenants were not met, the interest on the Term Loan and the Revolving Loan increased by 0.25% at October 1, 2011 and 0.25% at January 1, 2012.

 

16


The March 2011 Modification and the September 2010 included increases to the interest rate for the Revolving Loan to LIBOR plus 6.50% from the waiver date through November 14, 2010, LIBOR plus 7.50% from November 15, 2010 to February 15, 2011, LIBOR plus 8.50% from February 16, 2011 to April 14, 2011, LIBOR plus 9.50% from April 15, 2011 to May 15, 2011, LIBOR plus 10.50% from May 16, 2011 to July 15, 2011 and LIBOR plus 11.50% from July 16, 2011 through the July 28, 2011 closing date of the July 2011 Modification. Such modifications also increased the interest rate for the Term Loan to LIBOR plus 8.07% from the September 2010 Modification date through November 14, 2010, LIBOR plus 9.07% from November 15, 2010 to February 15, 2011, LIBOR plus 10.07% from February 16, 2011 to April 15, 2011, LIBOR plus 11.07% from April 15, 2011 to May 15, 2011, LIBOR plus 12.07% from May 16, 2011 to July 15, 2011 and LIBOR plus 13.07% from July 16, 2011 through the July 28, 2011, the effective date of the July 2011 Modification.

Under the terms of the September 2010 Modification, the Revolving Loan commitment was reduced to $9,000. Under the September 2010 Modification, the term of the Credit Facility also was shortened and the termination date of the Credit Facility was changed from April 22, 2015 to September 30, 2011. The September 2010 Modification also contained conditions for waivers of the non-compliance with financial covenants for the quarters ended September 30, 2010, December 31, 2010 and March 31, 2011. A waiver fee of 2.00% of the then current Credit Facility commitment totaling approximately $788 was paid at the September 2010 Modification closing and additional waiver fees of 0.50% of the then current total Credit Facility commitment were paid at November 15, 2010, February 15, 2011 and May 15, 2011.

Note 10. – Subordinated Long-Term Debt

Subordinated long-term debt consisted of the following:

 

     December 31,     June 30,  
     2011     2011  

Carmichael’s

   $ 2,602      $ 2,497   

Less current maturities

     (300     (300
  

 

 

   

 

 

 
   $ 2,302      $ 2,197   
  

 

 

   

 

 

 

Carmichael Notes – On April 22, 2008, SunLink Scripts Rx, LLC (formerly known as SunLink Homecare Services, LLC) entered into a $3,000 promissory note agreement with an interest rate of 8% with the former owners of Carmichael as part of the acquisition purchase price (the “Carmichael Purchase Note”). The Carmichael Purchase Note is payable in semi-annual installments of $150, which began on April 22, 2009, with the remaining balance of $1,200 due April 22, 2015. Interest is payable in arrears semi-annually on the six and twelve-month anniversary of the issuance of the note. The Carmichael Purchase Note is guaranteed by SunLink Health Systems, Inc. The note and the guarantee are subordinate to the Credit Facility.

On April 12, 2011, an amendment to the Carmichael Purchase Note was entered into under which SunLink has the option to issue subordinated promissory notes to the former owners of Carmichael in payment of up to two semi-annual payments of principal and interest due under the Carmichael Purchase Note (the “PIK Notes”). The PIK Notes bear an interest rate of 8% and are due on April 22, 2015. A PIK Note for $247 was issued on April 22, 2011 for the principal and interest payment that would have been due on April 22, 2011. A PIK Note for $252 was issued on October 22, 2011 for the principal and interest payment that would have been due on October 22, 2011.

Under the terms of the Credit Facility (see Note 8 – Long-Term Debt and Revolving Line of Credit), if SunLink is in violation of certain terms and conditions of such facility, the Company cannot make principal payments due under the Carmichael Purchase Note without permission of the agent for the lenders of the Credit Facility.

 

17


Note 11. – Income Taxes

Income tax benefit of $505 ($411 federal tax benefit and $94 state tax benefit) and income tax benefit of $961 ($965 federal tax benefit and $4 state tax expense) was recorded for the three months ended December 31, 2011 and 2010, respectively.

Income tax benefit of $1,274 ($949 federal tax benefit and $325 state tax benefit) and income tax benefit of $1,526 ($1,722 federal tax benefit and $196 state tax expense) was recorded for the six months ended December 31, 2011 and 2010, respectively.

We had an estimated net operating loss carry-forward for federal income tax purposes of approximately $8,518 at December 31, 2011. Use of this net operating loss carry-forward is subject to the limitations of the provisions of Internal Revenue Code Section 382. As a result, not all of the net operating loss carry-forward is available to offset federal taxable income in the current year. At December 31, 2011, we have provided a partial valuation allowance against the deferred tax asset so that the net tax asset was $9,602. Based upon management’s assessment that it was more likely than not that a portion of its deferred tax asset (primarily its net operating losses subject to limitation) would not be recovered, the Company established a valuation allowance for the portion of the tax asset which management estimates will not be utilized.

The Company accounts for uncertainty in income taxes for a change in judgment related to prior years’ tax positions in the quarter of such change. Activity in the unrecognized tax benefit liability account was as follows from July 1, 2010 through December 31, 2011:

 

Balance at July 1, 2010

     71   

Reduction for tax positions of prior years

     (34
  

 

 

 

Balance at June 30, 2011

     37   

Reduction for tax positions of prior years

     (8
  

 

 

 

Balance at December 31, 2011

   $ 29   
  

 

 

 

Note 12. – Commitments and Contingencies

Legal Proceedings

The Company is a party to claims and litigation incidental to its business, for which it is not currently possible to determine the ultimate liability, if any. Based on an evaluation of information currently available and consultation with legal counsel, management believes that resolution of such claims and litigation is not likely to have a material effect on the financial position, cash flows, or results of operations of the Company. The Company expenses legal costs as they are incurred.

On December 7, 2007, Southern Health Corporation of Ellijay, Inc. (“SHC-Ellijay”), a SunLink subsidiary, filed a Complaint against James P. Garrett and Roberta Mundy, both individually and as Fiduciary of the Estate of Randy Mundy (collectively, “Defendants”), seeking specific performance of an Option Agreement (the “Option Agreement”) dated April 17, 2007, between SHC-Ellijay, Mr. Garrett, and Ms. Mundy as Executrix of the Estate of Randy Mundy for the sale of approximately 24.74 acres of real property located in Gilmer County, Georgia, and recovery of SHC-Ellijay’s damages suffered as a result of Defendants’ failure to close the transaction in accordance with the Option Agreement. SHC-Ellijay also stated alternative claims for breach of the Option Agreement and fraud, along with claims to recover attorney’s fees and punitive damages.

In January 2008, Ms. Mundy and Mr. Garrett filed motions to strike, motions to dismiss, answers, affirmative defenses, and counterclaims against SHC-Ellijay. On March 3, 2009, SHC-Ellijay filed a First Amended and Restated Complaint for Damages, which effectively dropped the cause of action for specific performance of the Option Agreement. On May 7, 2009, Mr. Garrett and Ms. Mundy served a motion for summary judgment on all counts and causes of action stated in the First Amended Complaint,

 

18


contending that Mr. Garrett and Ms. Mundy did not intentionally breach the Option Agreement. SHC-Ellijay filed opposition papers in June 2009. In May 2011, SHC-Ellijay filed a motion for partial summary judgment on Count I of the Amended Complaint, seeking a judgment holding that Defendants willfully and intentionally breached the Option Agreement in eight ways, which would entitle SHC-Ellijay to recover damages from Defendants. In July 2011, SHC-Ellijay filed a reply brief in further support of its motion for partial summary judgment on the complaint and full summary judgment on the Defendants’ counterclaims and brief in opposition to Defendants’ cross motion for summary judgment. The summary judgment motions remain pending.

SunLink denies that it has any liability to Mr. Garrett and Ms. Mundy and intends to vigorously defend the claims asserted against SunLink by Mr. Garrett’s and Ms. Mundy’s counterclaims and to vigorously pursue its claims against Mr. Garrett and Ms. Mundy. While the ultimate outcome and materiality of the litigation cannot be determined, in management’s opinion the litigation will not have a material adverse effect on SunLink’s financial condition or results of operations.

Contractual Obligations, Commitments and Contingencies

Contractual obligations, commitments and contingencies related to long-term debt, non-cancelable operating leases, physician guarantees and interest on outstanding debt from continuing operations at December 31, 2011 were as follows:

 

Payments due in:

   Long-Term Debt      Subordinated
Long-Term
Debt
     Operating Leases      Physician
Guarantees
     Interest on
Outstanding Debt
     Interest on
Outstanding
Subordinated

Debt
 

1 year

   $ 1,832       $ 300       $ 2,913       $ 54       $ 1,415       $ 196   

2 years

     18,546         300         1,221         54         1,345         172   

3 years

     16         300         614         54         3         148   

4 years

     17         1,702         492         35         2         68   

5+ years

     16         0         693         0         1         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 20,427       $ 2,602       $ 5,933       $ 197       $ 2,766       $ 584   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

At December 31, 2011, SunLink had guarantee agreements with two physicians. A physician with whom a guarantee agreement is made generally agrees to maintain his or her practice within a hospital geographic area for a specific period (normally three years) or be liable to repay all or a portion of the guarantee received. The physician’s liability for any guarantee repayment due to non-compliance with the provisions of a guarantee agreement generally is collateralized by the physician’s patient accounts receivable and/or a promissory note from the physician. Included in the Company’s consolidated balance sheet at December 31, 2011 is a liability of $197 for one physician guarantee. SunLink expensed $236 and $96 on physician guarantees and recruiting for the three months ended December 31, 2011 and 2010, respectively. SunLink expensed $298 and $140 on physician guarantees and recruiting for the six months ended December 31, 2011 and 2010, respectively. The table above shows non-cancelable commitments under physician guarantee contracts as of December 31, 2011.

Note 13. – Related Party Transactions

A director of the Company and our company secretary (who was a director of SunLink until November 2003 and is now a director emeritus) are members of two different law firms, each of which provides services to SunLink. The Company has paid an aggregate of $103 and $166 for legal services to these law firms in the three months ended December 31, 2011 and 2010, respectively, and $358 and $433 for legal services to these law firms in the six months ended December 31, 2011 and 2010, respectively.

 

19


Note 14. – Financial Information by Segment

Under ASC Topic No. 280, Segment Reporting, operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision-making group, in deciding how to allocate resources and in assessing performance. Our chief operating decision-making group is composed of SunLink’s chief executive officer and other members of SunLink’s senior management. Our two reportable operating segments are Healthcare Facilities and Specialty Pharmacy.

We evaluate performance of our operating segments based on revenue and operating income (loss). Segment information for the three and six months ended December 31, 2011 and 2010 is as follows:

 

     Healthcare      Specialty     Corporate        
     Facilities      Pharmacy     and Other     Total  

Three months ended December 31, 2011 (Restated)

         

Net revenues from external customers

   $ 26,366       $ 10,672      $ 0      $ 37,038   

Operating profit (loss)

     648         51        (1,268     (569

Depreciation and amortization

     826         235        136        1,197   

Assets

     54,314         12,259        14,277        80,850   

Expenditures for property, plant and equipment

     98         98        21        217   

Six months ended December 31, 2011 (Restated)

         

Net revenues from external customers

   $ 54,128       $ 18,427      $ 0      $ 72,555   

Operating profit (loss)

     1,438         (223     (2,500     (1,285

Depreciation and amortization

     1,640         463        271        2,374   

Assets

     54,314         12,259        14,277        80,850   

Expenditures for property, plant and equipment

     197         211        39        447   

Three months ended December 31, 2010

         

Net revenues from external customers

   $ 29,058       $ 11,483      $ 0      $ 40,541   

Operating profit (loss)

     1,831         (7     (1,646     178   

Depreciation and amortization

     916         393        113        1,422   

Assets

     58,829         25,957        11,631        96,417   

Expenditures for property, plant and equipment

     96         86        21        203   

Six months ended December 31, 2010

         

Net revenues from external customers

   $ 56,952       $ 20,385      $ 0      $ 77,337   

Operating loss

     1,538         (212     (2,917     (1,591

Depreciation and amortization

     1,836         781        228        2,845   

Assets

     58,829         25,957        11,631        96,417   

Expenditures for property, plant and equipment

     362         255        93        710   

 

20


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(dollars in thousands, except per share and admissions data)

Amendment No. 1 Overview

As discussed in Note 1, Basis of Presentation and Restatement, in the Notes to the condensed consolidated financial statements, we have restated our previously issued financial statements for the three and six months ended December 31, 2011; accordingly, Management’s Discussion and Analysis of Financial Condition and Results of Operations have been revised for the effects of the restatement.

Forward-Looking Statements

This Quarterly Report and the documents that are incorporated by reference in this Quarterly Report contain certain forward-looking statements within the meaning of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Forward-looking statements include all statements that do not relate solely to historical or current facts and may be identified by the use of words such as “may,” “believe,” “will,” “expect,” “project,” “estimate,” “anticipate,” “plan” or “continue.” These forward-looking statements are based on current plans and expectations and are subject to a number of risks, uncertainties and other factors which could significantly affect current plans and expectations and our future financial condition and results. These factors, which could cause actual results, performance and achievements to differ materially from those anticipated, include, but are not limited to:

General Business Conditions

 

   

general economic and business conditions in the U.S., both nationwide and in the states in which we operate;

 

   

increases in uninsured and/or underinsured patients due to unemployment or other conditions resulting in higher bad debt amounts;

 

   

the competitive nature of the U.S. community hospital, nursing home, homecare and specialty pharmacy businesses;

 

   

demographic changes in areas where we operate;

 

   

the availability of new long-term financing to replace our existing credit facility;

 

   

the availability of cash or borrowings to fund working capital, renovations, replacements, expansions and capital improvements at existing hospital facilities and for acquisitions and replacement hospital facilities;

 

   

changes in accounting principles generally accepted in the U.S.; and,

 

   

fluctuations in the market value of equity securities including SunLink common shares;

Operational Factors

 

   

inability to operate profitability in one or more segments of the healthcare business;

 

   

the availability of, and our ability to attract and retain, sufficient qualified staff physicians, management, nurses, pharmacists and staff personnel for our operations;

 

   

timeliness and amount of reimbursement payments received under government programs;

 

   

increases in interest rates under debt agreements

 

   

the inability to refinance existing indebtedness and potential defaults under existing indebtedness;

 

   

restrictions imposed by debt agreements;

 

   

the cost and availability of insurance coverage including professional liability (e.g., medical malpractice) and general liability insurance;

 

   

the efforts of insurers, healthcare providers, and others to contain healthcare costs;

 

   

the impact on hospital services of the treatment of patients in lower acuity healthcare settings, whether with drug therapy or in alternative healthcare settings, such as surgery centers or urgent care centers;

 

21


   

changes in medical and other technology;

 

   

risks of changes in estimates of self insurance claims and reserves;

 

   

increases in prices of materials and services utilized in our Healthcare Facilities and Specialty Pharmacy Segments;

 

   

increases in wages as a result of inflation or competition for management, physician, nursing, pharmacy and staff positions;

 

   

increases in the amount and risk of collectability of accounts receivable, including deductibles and co-pay amounts;

 

   

the functionality or costs with respect to our information systems for our Healthcare Facilities and Specialty Pharmacy Segments and our corporate office, including both software and hardware; and

 

   

the availability of and competition from alternative drugs or treatments provided by our Specialty Pharmacy Segment;

Liabilities, Claims, Obligations and Other Matters

 

   

claims under leases, guarantees and other obligations relating to discontinued operations, including sold facilities, retained or acquired subsidiaries and former subsidiaries;

 

   

potential adverse consequences of known and unknown government investigations;

 

   

claims for product and environmental liabilities from continuing and discontinued operations;

 

   

professional, general and other claims which may be asserted against us; and,

 

   

natural disasters and weather-related events such as earthquakes, flooding, snow, ice and wind damage and population evacuations affecting areas in which we operate.

Regulation and Governmental Activity

 

   

existing and proposed governmental budgetary constraints;

 

   

the regulatory environment for our businesses, including state certificate of need laws and regulations, rules and judicial cases relating thereto;

 

   

anticipated adverse changes in the levels and terms of government (including Medicare, Medicaid and other programs) and private reimbursement for SunLink’s healthcare services including the payment arrangements and terms of managed care agreements;

 

   

changes in or failure to comply with Federal, state or local laws and regulations affecting the healthcare industry including Federal healthcare reform legislation and,

 

   

the possible enactment of Federal healthcare reform laws or reform laws in states where we operate hospital and pharmacy facilities (including Medicaid waivers and other reforms);

Acquisition Related Matters

 

   

the availability and terms of capital to fund acquisitions;

 

   

impairment or uncollectibility of certain acquired assets;

 

   

assumed liabilities discovered subsequent to an acquisition;

 

   

our ability to integrate acquired healthcare businesses and implement our business strategy; and,

 

   

competition in the market for acquisitions of hospitals and healthcare businesses.

The foregoing are significant factors we think could cause our actual results to differ materially from expected results. However, there could be additional factors besides those listed herein that also could affect SunLink in an adverse manner.

You should read this Quarterly Report completely and with the understanding that actual future results may be materially different from what we expect. You are cautioned not to unduly rely on forward-looking statements when evaluating the information presented in this Quarterly Report or our other disclosures because current plans, anticipated actions, and future financial conditions and results may differ from those expressed in any forward-looking statements made by or on behalf of SunLink.

We have not undertaken any obligation to publicly update or revise any forward-looking statements. All of our forward-looking statements speak only as of the date of the document in which they are made or, if a date is specified, as of such date. We disclaim any obligation or undertaking to provide any updates or

 

22


revisions to any forward-looking statement to reflect any change in our expectations or any changes in events, conditions, circumstances or information on which the forward-looking statement is based. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the foregoing factors and the risk factors set forth elsewhere in this report and in our Annual Report on Form 10-K.

Corporate Business Strategy

SunLink’s Board and management has determined to focus the Company’s strategic efforts on enhancing its existing hospital portfolio, including the selective disposal of underperforming and non-strategic facilities, and on pursuing selected potential hospital acquisitions. SunLink is committed to enhancing shareholder value while maintaining high standards of responsibility to its patients, employees and the communities it serves and will continue to pursue strategic alternatives consistent with that commitment.

Operations

Our operational strategy is focused on efforts to improve operations and generate internal growth. Our primary operational strategy for our community hospitals is to improve the operations and profitability of such hospitals by reducing out-migration of patients, recruiting physicians, improving quality and safety of services, expanding services and implementing and maintaining effective cost controls. Our operational strategy for our nursing homes and home health agency is similar to that for our community hospitals and is focused on quality patient care, expanding services and implementing and maintaining effective cost controls. Our operational strategy for our Specialty Pharmacy Segment is focused on increasing market share, expanding services, and implementing and maintaining effective cost controls.

Acquisitions and Dispositions Strategy

The Company continues to evaluate certain rural and exurban hospitals and healthcare businesses, which may be for sale, and monitor other selected rural and exurban healthcare acquisition targets which it believes might become available for sale or lease.

We believe there may be renewed opportunities for acquisitions or dispositions of individual hospitals in the future due to, among other things, continued negative trends in certain government reimbursement programs and other factors. We also believe there may be opportunities for the acquisition or disposition of individual or groups of hospitals in the future as other for-profit and not-for-profit hospital operators seeking to re-align the focus of their portfolios.

We also may consider the disposition of one or more of our healthcare facilities, Specialty Pharmacy Segment service lines or business segments, particularly if we determine that the operating results or potential growth of such facility, service line or segment no longer meet our business objectives.

Critical Accounting Estimates

The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires us to make estimates and assumptions that affect reported amounts and related disclosures. We consider an accounting estimate to be critical if:

 

   

it requires assumptions to be made that were uncertain at the time the estimate was made; and

 

   

changes in the estimate or different estimates that could have been made could have a material impact on our consolidated results of operations or financial condition.

Our critical accounting estimates are more fully described in our 2011 Annual Report on Form 10-K/A and continue to include the following areas:

 

   

Receivables – net and provision for doubtful accounts;

 

23


   

Revenue recognition / Net Patient Service Revenues;

 

   

Goodwill, intangible assets and accounting for business combinations;

 

   

Professional and general liability claims; and

 

   

Accounting for income taxes; and

 

   

Electronic Health Record incentives

Financial Summary

The results of continuing operations shown in the financial summary below are for our two business segments, Healthcare Facilities and Specialty Pharmacy.

 

     December 31,     December 31,  
     2011     2010     % Change     2011     2010     % Change  

Net Revenues - Healthcare Facilities

   $ 26,366      $ 29,058        -9.3   $ 54,128      $ 56,952        -5.0

Net Revenues - Specialty Pharmacy

     10,672        11,483        -7.1     18,427        20,385        -9.6
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Net Revenues

     37,038        40,541        -8.6     72,555        77,337        -6.2

Costs and expenses

     (37,607     (40,363     -6.8     (73,840     (78,928     -6.4
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating profit

     (569     178        419.7     (1,285     (1,591     19.2

Interest expense

     (1,029     (3,229     -68.1     (2,335     (4,077     -42.7

Interest income

     —          1        -100.0     2        2        0.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from continuing operations before income taxes

   $ (1,598   $ (3,050     47.6   $ (3,618   $ (5,666     36.1
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Healthcare Facilities Segment:

            

Admissions

     1,173        1,236        -5     2,354        2,502        -6

Equivalent admissions

     4,102        3,893        5     8,237        8,067        2

Surgeries

     533        628        -15     1,086        1,296        -16

Revenue per equivalent admission

   $ 6,401      $ 7,464        -14   $ 6,544      $ 7,060        -7

Equivalent admissions – Equivalent admissions is used by management (and certain investors) as a general measure of combined inpatient and outpatient volume for our hospital operations. Equivalent admissions are computed by multiplying admissions (inpatient volume) by the sum of gross inpatient revenues and gross outpatient revenues and dividing the result by gross inpatient revenues. The equivalent admissions computation is intended to relate outpatient revenues to the volume measure (admissions) used to measure inpatient volume to result in a general approximation of combined inpatient and outpatient volume (equivalent admissions).

 

24


Results of Operations

Our net revenues are from our two business segments, healthcare facilities and specialty pharmacy.

Healthcare Facilities Segment

Net revenues for the three months ended December 31, 2011 were $26,366 with a total of 4,102 equivalent admissions and revenue per equivalent admission of $6,401 compared to net revenues of $29,058 with a total of 3,893 equivalent admissions and revenue per equivalent admission of $7,464 for the quarter ended December 31, 2010. Net revenues for the six months ended December 31, 2011 were $54,128 with a total of 8,237 equivalent admissions and revenue per equivalent admission of $6,544 compared to net revenues of $56,952 with a total of 8,067 equivalent admissions and revenue per equivalent admission of $7,060 for the six months ended December 31, 2010.

The following table sets forth the percentage of net patient revenues from major payor sources for the Company’s six hospitals during the periods indicated:

 

     Three Months Ended     Six Months Ended  
     December 31,     December 31,  
     2011     2010     2011     2010  

Source:

        

Medicare

     42.1     40.2     40.6     40.4

Medicaid

     11.5     17.6     13.8     14.5

Self-pay

     11.6     11.5     14.4     13.9

Managed Care Insurance & Other

     34.8     30.7     31.2     31.2
  

 

 

   

 

 

   

 

 

   

 

 

 
     100.0     100.0     100.0     100.0
  

 

 

   

 

 

   

 

 

   

 

 

 

Medicaid as a percentage of total revenues decreased in the three and six months ended December 31, 2011 compared to the comparable prior year period as a result of declining volumes. The increase in self-pay and managed care insurance and other net revenues as a percentage of total revenues in the current year’s quarter compared to the comparable prior year quarter was due to a shift in payor mix from Medicaid net revenues.

Specialty Pharmacy Segment

Specialty Pharmacy net revenues for the three months ended December 31, 2011 was $10,672, a decrease of $811, or 7.1%, from $11,483 for the three months ended December 31, 2010. Specialty Pharmacy net revenues for the six months ended December 31, 2011 was $18,427, a decrease of $1,958, or 9.6%, from $20,385 for the six months ended December 31, 2010. The decrease was due to the conversion of numerous institutional pharmacy direct-servicing contracts to a pharmacy management contract, the loss of certain other institutional contracts and a decrease in the sale of the seasonal infusion therapy drug from the same period of the prior year, offset somewhat by the realization of net revenues related to a new component of the institutional pharmacy business.

Healthcare Facilities Segment Cost and Expenses

Costs and expenses for our Healthcare Facilities, including depreciation and amortization, were $25,718 and $27,225 for the three months ended December 31, 2011 and 2010, respectively. Costs and expenses for our Healthcare Facilities, including depreciation and amortization, were $52,690 and $55,414 for the six months ended December 31, 2011 and 2010, respectively.

 

25


     Cost and Expenses  
     as a % of Net Revenues  
     Three Months Ended     Six Months Ended  
     December 31,     December 31,  
     2011     2010     2011     2010  

Salaries, wages and benefits

     51.4     45.7     50.0     46.7

Provision for bad debts

     11.6     12.1     14.0     14.0

Supplies

     9.0     9.6     9.2     10.0

Purchased services

     7.1     7.3     7.4     7.4

Medicaid EHR incentives

     -2.3     0.0     -3.0     0.0

Other operating expenses

     15.6     13.8     15.9     14.8

Rent and lease expense

     2.2     2.1     2.2     2.0

Depreciation and amortization expense

     2.7     3.2     3.0     3.2

Salaries, wages and benefits increased as a percentage of net revenue in the three and six months ended December 31, 2011 due to increased employee medical claims expense and the overall decrease in net patient revenues for the three and six months ended December 31, 2011. For the three and six months ended December 31, 2011, employee medical claims expense increased $529 and $786, respectively, as compared to the three and six months ended December 31, 2010.

Provision for bad debts decreased as a percentage of net revenue in the three months ended December 31, 2011 due to concentration on upfront collection efforts as well as increased indigent care write offs in the current year period compared to the comparable prior year period.

Supplies decreased as a percentage of net revenue in the six months ended December 31, 2011 due to a decrease in the number of surgeries performed as compared to the six months ended December 31, 2010. Surgeries for the six months ended December 31, 2011 were 1,210 compared to 1,389 for the comparable prior year period.

Medicaid EHR incentives as a percentage of net revenue is a negative 2.3% and 3.0% for the three and six months ended December 31, 2011. This is related to the $614 and $1,627 of Medicaid EHR incentive payments recognized in the three and six months ended December 31, 2011, respectively. There were no Medicaid EHR incentive payments recognized in the three and six months ended December 31, 2010.

Other operating expenses decreased slightly from the comparable prior year quarter but increased as percentage of net revenue in the three months ended December 31, 2011 due to the overall decrease in net revenues for the three months ended December 31, 2011.

Depreciation and amortization expense for the three months ended December 31, 2011 and 2010 were $826 and $916, respectively. Depreciation and amortization expense for the six months ended December 31, 2011 and 2010 were $1,640 and $1,836, respectively. The decrease in the six months ended December 31, 2011 compared to the six months ended December 31, 2010 is due to assets being fully depreciated in the current six month period as compared to the prior year period.

Specialty Pharmacy Segment Cost and Expenses

Cost and expenses for our Specialty Pharmacy Segment, including depreciation and amortization, were $10,621 and $11,491 for the three months ended December 31, 2011 and 2010, respectively. For the six months ended December 31, 2011 and 2010, cost and expenses for our Specialty Pharmacy Segment, including depreciation and amortization, were $18,650 and $20,597, respectively.

 

26


     Cost and Expenses  
     as a % of Net Revenues  
     Three Months Ended     Six Months Ended  
     December 31,     December 31,  
     2011     2010     2011     2010  

Cost of goods sold

     73.2     73.5     69.1     69.9

Salaries, wages and benefits

     16.4     14.4     19.1     16.9

Provision for bad debts

     0.4     0.9     1.7     1.8

Supplies

     0.6     0.4     0.6     0.5

Purchased services

     3.1     3.6     3.6     4.0

Other operating expenses

     3.0     3.2     3.6     3.4

Rent and lease expense

     0.8     0.6     0.9     0.7

Depreciation and amortization expense

     2.2     3.4     3.4     3.8

Cost of goods sold as a percent of net revenues decreased in the three and six month periods ended December 31, 2011 as compared to the comparable periods of the prior year due the current periods’ decreases in sales of certain infusion therapy products, which have a higher cost of sales as a percentage of net revenues, favorable purchasing contracts negotiations, and improved margins for the institutional pharmacy business.

Salaries, wages and benefits as a percent of net revenues increased in the three and six month periods ended December 31, 2011 as compared to the comparable periods of the prior year due to the increased staffing requirements related to a new component of the institutional pharmacy business.

Provision for bad debts as a percent of net revenues decreased in the three and six month periods ended December 31, 2011 as compared to the comparable periods of the prior year due primarily to the implementation of additional business office and intake policies and procedures, offset somewhat by the continued decline of economic conditions in the region.

Purchased services as a percent of net revenues decreased in the three and six month periods ended December 31, 2011 as compared to the comparable periods of the prior year due to the impact of cost-cutting measures.

Other operating expenses as a percent of net revenues increased in the three and six month periods ended December 31, 2011 as compared to the comparable periods of the prior year due to increased utilities and fuel cost and expenses, offset somewhat by the impact of cost-cutting measures.

Depreciation and amortization expense decreased due to impairment of certain intangible assets during fiscal year 2011 which decreased the amount of annual amortization on the remaining intangible assets. Amortization expense for three months ended December 31, 2011 was $36 compared to $146 for the comparable prior year period. Amortization expense for six months ended December 31, 2011 was $71 compared to $292 for the comparable prior year period.

Corporate Overhead Costs and Expenses

Cost and expenses for Corporate Overhead including depreciation and amortization, was $1,268 and $1,646 for the three months ended December 31, 2011 and 2010, respectively. For the six months ended December 31, 2011 and 2010, cost and expenses for Corporate Overhead including depreciation and amortization, was $2,500 and $2,917, respectively. Corporate Overhead decreased in the three and six months ending December 31, 2011 due to $484 of severance expense incurred in the comparable prior year periods that was not incurred during the current year periods, partially offset by in increases in stock option expense during the current year periods.

 

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Operating Profit

SunLink had an operating loss of $569 for the three months ended December 31, 2011 and an operating profit of $178 for the three months ended December 31, 2010. SunLink had an operating loss of $1,285 and $1,591 for the six months ended December 31, 2011 and December 31, 2010, respectively. The operating losses for the three and six months ended December 31, 2011 compared to the prior year periods resulted from decreases in net revenues partially offset by decreases in cost and expenses as a result of the decrease in net revenues and effective cost control measures implemented at the facilities.

Interest Expense

Interest expense was $1,029 and $3,229 for the three months ended December 31, 2011 and 2010, respectively and $2,335 and $4,077 for the six months ended December 31, 2011 and 2010, respectively. Interest expense for the three and six months ended December 31, 2011 decreased from the same periods last year due to an $8,000 prepayment on the term loan resulting in reduced interest expense which was partially offset by an increase in interest rates. The decrease also resulted from decreased waiver fees and non-cash amortization of costs and fees in the current year periods. Non-cash amortization expense of costs and fees was $42 and $84 for the three and six months ended December 31, 2011, respectively, compared to $995 and $1,102 for the three and six months ended December 31, 2010, respectively. Waiver fees and costs were $0 and $131 for the three and six months ended December 31, 2011, respectively, compared to $984 for both the three and six months ended December 31, 2010.

Income Taxes

Income tax benefit of $505 ($411 federal tax benefit and $94 state tax benefit) and income tax benefit of $961 ($965 federal tax benefit and $4 state tax expense) was recorded for the three months ended December 31, 2011 and 2010, respectively.

Income tax benefit of $1,274 ($949 federal tax benefit and $325 state tax benefit) and income tax benefit of $1,526 ($1,722 federal tax benefit and $196 state tax expense) was recorded for the six months ended December 31, 2011 and 2010, respectively.

We had an estimated net operating loss carry-forward for federal income tax purposes of approximately $8,518 at December 31, 2011. Use of this net operating loss carry-forward is subject to the limitations of the provisions of Internal Revenue Code Section 382. As a result, not all of the net operating loss carry-forward is available to offset federal taxable income in the current year. At December 31, 2011, we have provided a partial valuation allowance against the deferred tax asset so that the net tax asset was $9,602. Based upon management’s assessment that it was more likely than not that a portion of its deferred tax asset (primarily its net operating losses subject to limitation) would not be recovered, the Company established a valuation allowance for the portion of the tax asset which management estimates will not be utilized.

Earnings (Loss) After Taxes

Loss from continuing operations was $1,093 ($0.12 loss per fully diluted share) for the quarter ended December 31, 2011 compared to loss from continuing operations of $2,089 ($0.26 loss per fully diluted share) for the quarter ended December 31, 2010. The decreased loss in the current year’s quarter resulted from the decrease in interest expense partially offset by the increase in operating loss as compared to the prior year’s quarter. Loss from continuing operations was $2,344 ($0.27 loss per fully diluted share) for the six months ended December 31, 2011 compared to loss from continuing operations of $4,140 ($0.56 loss per fully diluted share) for the quarter ended December 31, 2010. The decreased loss for the six months ended December 31, 2011 resulted from decreased interest expense partially offset by decreased operating loss and income tax benefit as compared to the comparable prior year period.

Earnings from discontinued operations of $159 for the three months ended December 31, 2011 resulted from earnings from operations of Adel of $ 173 and from losses resulting from pension items relating to

 

28


discontinued operations. Loss from discontinued operations of $145 for the six months ended December 31, 2011 resulted from losses from operations of Adel of $118 and losses resulting from pension items relating to discontinued operations.

Net loss for the quarter ended December 31, 2011 was $934 ($0.10 loss per fully diluted share) compared to net loss of $1,766 ($0.22 loss per fully diluted share) for the quarter ended December 31, 2010. Net loss for the six months ended December 31, 2011 was $2,489 ($0.21 loss per fully diluted share) compared to net loss of $4,534 ($0.56 loss per fully diluted share) for the six months ended December 31, 2010.

Adjusted earnings before income taxes, interest, depreciation and amortization

Earnings before income taxes, interest, depreciation and amortization (“EBITDA”) represent the sum of income before income taxes, interest, depreciation and amortization. We understand that certain industry analysts and investors generally consider EBITDA to be one measure of the liquidity of a company, and it is presented to assist analysts and investors in analyzing the ability of a company to generate cash, service debt and meet capital requirements. We believe increased EBITDA is an indicator of improved ability to service existing debt and to satisfy capital requirements. EBITDA, however, is not a measure of financial performance under accounting principles generally accepted in the United States of America and should not be considered an alternative to net income as a measure of operating performance or to cash liquidity. Because EBITDA is not a measure determined in accordance with accounting principles generally accepted in the United States of America and is thus susceptible to varying calculations, EBITDA, as presented, may not be comparable to other similarly titled measures of other corporations. Where we adjust EBITDA for non-cash charges we refer to such measurement as “Adjusted EBITDA”, which we report on a company wide basis. Non-cash adjustments in Adjusted EBITDA are not intended to be identified or characterized in any respect as “non-recurring, infrequent or unusual,” if we believe such charge is reasonably likely to recur within two years, or if there was a similar charge (or gain) within the prior two years. Where we report Adjusted EBITDA, we typically also report Healthcare Facilities Segment Adjusted EBITDA and Specialty Pharmacy Segment Adjusted EBITDA which is the EBITDA for the applicable segments without any allocation of corporate overhead, which we report as a separate line item, gains on sales of businesses and without any allocation of the non-cash adjustments, which we also report as a separate line item in Adjusted EBITDA. Net cash used in operations for the three and six months ended December 31, 2011 and 2010, respectively, is shown below.

 

     Three Months Ended     Six Months Ended  
     December 31,     December 31,  
     2011     2010     2011     2010  

Healthcare Facilities Adjusted EBITDA

   $ 1,465      $ 2,745      $ 3,071      $ 3,374   

Specialty Pharmacy Adjusted EBITDA

     285        386        239        569   

Corporate overhead costs

     (1,122     (1,533     (2,220     (2,689

Taxes and interest expense

     (622     (2,440     (983     (2,402

Other non-cash expenses and net change in operating assets and liabilities

     308        (1,499     (1,130     (246
  

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) operations

   $ 314      $ (2,341   $ (1,023   $ (1,394
  

 

 

   

 

 

   

 

 

   

 

 

 

Liquidity and Capital Resources

Our primary sources of liquidity are cash generated from continuing operations, including EHR Revenues and availability under the Revolving Loan under our Credit Facility which is discussed below. Subject to the risks and uncertainties discussed herein, we believe we have adequate financing and liquidity to support our current level of operations through the next twelve months.

 

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On April 23, 2008, SunLink entered into a $47,000 seven-year senior secured credit facility (“Credit Facility”) comprised of a revolving line of credit of up to $12,000 (the “Revolving Loan”) and a $35,000 term loan (the “Term Loan”). The Credit Facility has subsequently been amended by three modification agreements, on July 28, 2011 (“July 2011 Modification”), March 1, 2011 (“March 2011 Modification”), and September 27, 2010 (“September 2010 Modification”). The termination date for the Credit Facility currently is January 1, 2013 and the maximum Revolving Loan commitment currently is $9,000. At December 31, 2011, SunLink’s calculated net collectible value of eligible accounts receivable was $8,206, the Revolving Loan balance was $6,700 with an interest rate at LIBOR plus 9.125% (11.875% at December 31, 2011), and the Term Loan balance was $20,211 with an interest rate at LIBOR plus 11.07% (13.82% at December 31, 2011). Borrowings under the Credit Facility are at LIBOR plus the applicable interest rate. Under the Credit Facility, LIBOR is defined as the Thirty-Day published rate, not to be less than 2.75%, nor more than 5.50%. The maximum availability of the Revolving Loan is keyed to the calculated net collectible value of eligible accounts receivable.

The Credit Facility is secured by a first priority security interest in substantially all real and personal property of the Company and its consolidated subsidiaries, including a pledge of all of the equity interests in such subsidiaries. The Credit Facility contains various terms and conditions, including operational and financial restrictions and limitations, and affirmative and negative covenants. The covenants include financial covenants measured on a quarterly basis which require SunLink to comply with maximum leverage and minimum fixed charge ratios, maximum capital expenditure amounts, collateral value to loan amount and liquidity and cash flow measures, all as defined in the Credit Facility. We believe that the Company should be able to continue in compliance with the revised levels of financial covenants and terms in the Credit Facility through December 31, 2012, but there is no assurance that the Company will be able to do so. If we fail to remain in compliance with the Credit Facility as modified, we would cease to have a right to draw on the revolving line of credit facility and the lenders would, among other things, be entitled to call a default and demand repayment of the indebtedness outstanding. If SunLink or its applicable subsidiaries experience a material adverse change in their business, assets, financial condition, management or operations, or if the value of the collateral securing the Credit Facility decreases, we may be unable to draw on the Revolving Loan.

We also believe our current level of operations will allow us to continue to borrow under the Revolving Loan if we otherwise remain in compliance with all of the current terms and covenants under the Credit Facility. Failure to remain in compliance with all the terms of and covenants under the Credit Facility could have adverse material effects on the Company. The current remaining availability under the Revolving Loan could be adversely affected by, among other things, the risk, uncertainties and other factors listed in Item 3. – Quantitative and Qualitative Disclosures about Market Risk (“Item 3”), as well as lower earnings due to lower demand for our services by patients, changes in patient mix and changes in terms and levels of government and private reimbursement for services. Cash generated from operations could be adversely affected by, among other things, the risks, uncertainties and other factors listed in Item 3, as well as lower patient demand for our services, higher operating costs (including, but not limited to, salaries, wages and benefits, provisions for bad debts, general liability and other insurance costs, cost of pharmaceutical drugs and other operating expenses) or by changes in terms and levels of government and private reimbursement for services, and the regulatory environment of the community hospital segment.

Under the terms of the July 2011 Modification, the termination date of the Credit Facility was extended to January 1, 2013, Under the terms of the July 2011 Modification, SunLink also made an $8,000 prepayment on the Term Loan and paid a modification fee of $131. The source of the repayment was $2,500 of proceeds from a private placement of SunLink common shares and $5,500 of operating funds. Under the July 2011 Modification, the interest rate under the Revolving Loan was adjusted to LIBOR plus an applicable interest rate of 8.875%, or a total interest rate of 11.625% at July 28, 2011 and the interest rate under the Term Loan was adjusted to LIBOR plus an applicable interest rate of 10.82%, or a total interest rate of 13.57% at July 28, 2011. The July 2011 Modification also included covenants calling for further reductions in the principal balance of the term loan in September and December of 2011. Under the September 2011 and December 2011 Term Loan Reduction Covenants, if the principal balance under the Term Loan was not reduced by the prescribed amounts, the interest rate for both the Term Loan

 

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and the Revolving Loan would increase by an aggregate additional 0.50% over the prescribed interest rate for the remainder of the Credit Facility’s term. Because the September 2011 and December 2011 Term Loan Reduction Covenants were not met, the interest on the Term Loan and the Revolving Loan increased by 0.25% at October 1, 2011 and 0.25% at January 1, 2012.

The March 2011 Modification and the September 2010 Modification included increases to the interest rate for the Revolving Loan to LIBOR plus 6.50% from the waiver date through November 14, 2010, LIBOR plus 7.50% from November 15, 2010 to February 15, 2011, LIBOR plus 8.50% from February 16, 2011 to April 14, 2011, LIBOR plus 9.50% from April 15, 2011 to May 15, 2011, LIBOR plus 10.50% from May 16, 2011 to July 15, 2011 and LIBOR plus 11.50% from July 16, 2011 through the July 28, 2011 closing date of the July 2011 Modification. Such modifications also increased the interest rate for the Term Loan to LIBOR plus 8.07% from the September 2010 Modification date through November 14, 2010, LIBOR plus 9.07% from November 15, 2010 to February 15, 2011, LIBOR plus 10.07% from February 16, 2011 to April 15, 2011, LIBOR plus 11.07% from April 15, 2011 to May 15, 2011, LIBOR plus 12.07% from May 16, 2011 to July 15, 2011 and LIBOR plus 13.07% from July 16, 2011 through the July 28, 2011, the effective date of the July 2011 Modification.

Under the terms of the September 2010 Modification, the Revolving Loan commitment was reduced to $9,000. Under the September 2010 Modification, the term of the Credit Facility also was shortened and the termination date of the Credit Facility was changed from April 22, 2015 to September 30, 2011. The September 2010 Modification also contained conditions for waivers of the non-compliance with financial covenants for the quarters ended September 30, 2010, December 31, 2010 and March 31, 2011. A waiver fee of 2.00% of the then current Credit Facility commitment totaling approximately $788 was paid at the September 2010 Modification closing and additional waiver fees of 0.50% of the then current total Credit Facility commitment were paid at November 15, 2010, February 15, 2011 and May 15, 2011.

We generated $314 of cash from operations during the three months ended December 31, 2011 compared to $2,341 of cash used in operations during the comparable prior year periods. Cash provided by operations resulted from the decrease in interest expense and severance expense paid offset partially by net loss. We used $1,035 of cash in operations during the six months ended December 31, 2011 compared to $1,360 during the comparable prior year periods. The decrease in cash used in operations for the six months ended December 31, 2011 compared to the comparable prior year period resulted from the decrease in interest expense and severance expense paid offset partially by net loss.

 

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Contractual Obligations, Commitments and Contingencies

Contractual obligations, commitments and contingencies related to long-term debt, non-cancelable operating leases, physician guarantees and interest on outstanding debt from continuing operations at December 31, 2011 were as follows:

 

Payments due in:

   Long-Term Debt      Subordinated
Long-Term
Debt
     Operating Leases      Physician
Guarantees
     Interest on
Outstanding Debt
     Interest on
Outstanding
Subordinated

Debt
 

1 year

   $ 1,832       $ 300       $ 2,913       $ 54       $ 1,415       $ 196   

2 years

     18,546         300         1,221         54         1,345         172   

3 years

     16         300         614         54         3         148   

4 years

     17         1,702         492         35         2         68   

5+ years

     16         0         693         0         1         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 20,427       $ 2,602       $ 5,933       $ 197       $ 2,766       $ 584   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

At December 31, 2011, SunLink had guarantee agreements with two physicians. A physician with whom a guarantee agreement is made generally agrees to maintain his or her practice within a hospital geographic area for a specific period (normally three years) or be liable to repay all or a portion of the guarantee received. The physician’s liability for any guarantee repayment due to non-compliance with the provisions of a guarantee agreement generally is collateralized by the physician’s patient accounts receivable and/or a promissory note from the physician. Included in the Company’s consolidated balance sheet at December 31, 2011 is a liability of $197 for one physician guarantee. SunLink expensed $236 and $96 on physician guarantees and recruiting for the three months ended December 31, 2011 and 2010, respectively. SunLink expensed $298 and $140 on physician guarantees and recruiting for the six months ended December 31, 2011 and 2010, respectively. The table above shows non-cancelable commitments under physician guarantee contracts as of December 31, 2011.

At December 31, 2011, we had outstanding long-term debt and subordinated debt of $23,813 of which $20,211 was incurred under the Term Loan, $2,602 was incurred under the subordinated Carmichael Notes, and $216 was related to capital leases. Also outstanding at December 31, 2011 was $6,700 under the Revolving Loan.

During the quarter ended December 31, 2011, the Company completed an impairment assessment of the goodwill and certain intangible assets of its subsidiaries. Based on the Company’s assessment of strategies and forecasted cash flows at these subsidiaries, there was no indication of impairment of goodwill or certain intangible assets at December 31, 2011. The Company cannot predict the occurrence of certain events or changes in circumstances that might adversely affect the carrying value of goodwill and certain intangible assets. As a result, the Company will continue to monitor the results of these subsidiaries and consider impairment charges to goodwill and certain intangible assets in future periods.

Discontinued Operations

On March 8, 2012, the Company and its HealthMont of Georgia, Inc. subsidiary entered into an Asset Purchase Agreement by and among HealthMont of Georgia, Inc., SunLink and Hospital Authority of Tift County, Georgia (“Buyer”) effective March 1, 2012 to sell substantially all of the assets of the Company’s owned Memorial Hospital of Adel and Memorial Convalescent Center (“Adel”) to the Buyer for approximately $8,300. Excluded assets include accounts receivable as of the Cutoff Date and all Medicare and Medicaid incentive payments for meaningful use of electronic health record technology and all receivables, claims and settlements made pursuant to the Indigent Care Trust Fund of the State of Georgia paid with respect to the fiscal year ending June 30, 2012. Retained liabilities generally consist of liabilities incurred prior to the closing date of the transaction. Effective April 1, 2012, Buyer began management of Adel under a management agreement to continue from such date until the scheduled date of closing. Pursuant to the terms of the management agreement, Buyer is to retain any profit earned and fund any

 

32


losses incurred during the management period. The transaction is subject to a number of conditions and is expected to close in SunLink’s first fiscal quarter of 2013. The agreement may be terminated by either SunLink or the Buyer if the transaction is not consummated prior to July 31, 2012 or such later date as the parties may agree. Subject to certain conditions, if the Buyer terminates the agreement during the period April 1, 2012 through July 31, 2012 from other than a default by the Company, SunLink will be entitled to a breakup fee of $900. SunLink anticipates that the sale of assets of Adel for approximately $8,300, less estimated sale expenses, will result in net proceeds of approximately $7,500 to the Company and that the Company will be required to use all or substantially all of the net proceeds to pay down senior debt under the Company’s Credit Facility.

Adel’s operations have been reclassified as discontinued operations in our condensed consolidated financial statements for the three and six month periods ended December 31, 2011 and 2010 and as of June 30, 2011.

On March 1, 2011, SunLink entered into an agreement to lease its owned Chilton Medical Center (“Chilton”) and sold its 83% membership interest in Clanton Hospital LLC (“Clanton”), which manages Chilton, to Carraway Medical Systems, Inc. (“Carraway”). The lease agreement is for a six-year term with monthly rent of $37 and includes an option under which Carraway can purchase Chilton from SunLink. The option purchase price is $3,700, less the amount paid, up to a maximum of $615, to purchase the 17% membership interest of Clanton owned by local physicians. The purchase price of SunLink’s 83% membership interest of Clanton was a $1,000 six-year zero-coupon note plus a six-year 6% note for the net working capital of Clanton at purchase. If the purchase option for Chilton is exercised during the six-year term of the lease, any amount paid under the $1,000 note will be credited to the option purchase price and any remaining balance on the note will be cancelled. As a result, the note is reserved on the balance sheet at $1,000. Pursuant to the terms of the sale and lease and agreement, SunLink is entitled to receive 75% of the Electronic Health Records Medicare and Medicaid incentive reimbursements received by Clanton.

Related Party Transactions

A director of the Company and our company secretary (who was a director of SunLink until November 2003 and is now a director emeritus) are members of two different law firms, each of which provides services to SunLink. The Company has paid an aggregate of $103 and $166 for legal services to these law firms in the three months ended December 31, 2011 and 2010, respectively, and $358 and $433 for legal services to these law firms in the six months ended December 31, 2011 and 2010, respectively.

 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to interest rate changes, primarily as a result of borrowing under our Credit Facility. At December 31, 2011, borrowings under the Credit Facility of $26,911 have been drawn at an interest rate based upon LIBOR plus the applicable margin. A one percent change in the LIBOR rate or the applicable interest rate would result in a change in interest expense of $269 on an annual basis. No action has been taken to mitigate our exposure to interest rate market risk and we are not a party to any interest rate market risk management activities.

ITEM 4. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

We seek to maintain controls and procedures designed to ensure that we are able to collect the information we are required to disclose in the reports we file with the SEC, and to process, summarize and disclose this information within the time periods specified in the rules of the SEC.

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, for the reasons set forth below under “Restatement,” our disclosure controls and procedures were not effective as of June 30, 2011. In addition, our chief executive officer and chief financial officer also have reevaluated the conclusions regarding our disclosure controls and procedures for other prior periods and have concluded that our disclosure controls and procedures were not effective as of: the quarterly period ended March 31, 2011, the quarterly period ended September 30, 2011 and the quarterly period ended December 31, 2011 for the same reason.

Restatement

The Health Information Technology for Economic and Clinical Health Act, promulgated as part of the American Recovery and Reinvestment Act of 2009, provides for Medicare and Medicaid incentive payments beginning in calendar year 2011 for eligible hospitals and professionals that implement and achieve meaningful use of certified electronic health record technology. Each of SunLink’s five operating hospitals and its formerly owned Chilton Medical Center (“Chilton”) and its held-for-sale Memorial Hospital of Adel (“Adel”) registered for the program with CMS and, on April 18, 2011, all successfully attested compliance with Part I of the Medicare EHR incentive program for such first year. The Company has also successfully attested to the meaningful use requirements for Medicaid programs for its five operating hospitals as have Chilton and Adel. The Company has the right to receive 75% of EHR received by Chilton under a 2011 sale agreement. The Company has received approximately $7,731 in Medicare EHR incentive funds and approximately $2,169 in Medicaid EHR incentive funds to date, which includes Adel’s funds. The Company also has received approximately $790 Medicare EHR incentive funds and approximately $188 Medicaid HER incentive funds to date from Chilton.

For Medicare and Medicaid EHR incentive payments prior to the beginning of the quarter ended December 31, 2011, SunLink followed what it considered the existing accounting guidance and utilized a grant accounting model to recognize these incentive payments. Under this accounting policy, EHR incentive payments were recognized as revenues when attestation that the EHR meaningful use criteria for the required period of time was demonstrated and were recognized ratably over the relevant cost report period to determine the amount of reimbursement. This accounting policy was specifically reviewed on several occasions in the past by the Company’s management and the Audit Committee of the Company’s Board of Directors. In addition, the Company’s believed its practices were similar to those being used by other healthcare companies.

 

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During the quarter ended December 31, 2011, SunLink became aware of what it understood to be the position of the staff (“Staff”) of the SEC regarding incentive reimbursement accounting for public companies. The Company gained such knowledge from its review of filings of other public companies and the issues analysis paper issued by the Healthcare Financial Management Association in December 2011. In light of what the Company understood were the Staff’s views, the Company elected to apply such interpretation of accounting for the EHR incentive reimbursement to future transactions beginning with the quarter ended December 31, 2011. Accordingly, the Company changed its recognition policy to a gain contingency accounting model for incentive payments recognized after October 1, 2011 based upon the Company’s understanding of the informal guidance provided by the SEC and certain other non-authoritative guidance. SunLink also reclassified the incentive payment income to a line item in the Costs and Expense category of the Consolidated Statement of Earnings and Loss and is reclassifying herein the amounts previously reported as revenue as a line item in the Costs and Expense category of the consolidated Statement of Earnings and Loss for previously reported periods presented in this and other applicable amended periodic reports. Under the gain contingency based model, EHR incentive payments are recognized when all contingencies relating to the incentive payment have been satisfied and compliance with the EHR meaningful use criteria have been attested to. For recognition of Medicaid EHR incentive payments, recognition of the payments will be at the time of attestation to EHR meaningful use criteria since Medicaid payments for the states in which the Company operates are based upon historical cost report information with no subsequent payment adjustment. However, for Medicare EHR incentive payments, recognition is being deferred until both the Medicare federal fiscal year during which EHR meaningful use was demonstrated ends and the cost report information utilized to determine the final amount of reimbursement is known.

On February 2, 2012, the Company received a letter from the Staff of the SEC with respect to the Staff’s review of, and comments on, the Company’s Form 10-K for the fiscal year ended June 30, 2011 (the “Form 10-K”) and the Company’s Form 10-Q for the fiscal quarter ended September 30, 2011 (the “Form 10-Q”). Following correspondence and other communications with the Staff, on April 24, 2012, SunLink received correspondence from the Staff asserting the Staff’s view that, among other things, the Company’s prior accounting for EHR incentive payments should have been on a contingency based model rather than the grant model being utilized. Subsequent to the Company’s receipt of the Staff’s April 2012 letter and following additional consultation by management with the Company’s independent registered public accounting firm and the Audit Committee of the Company’s Board of Directors, SunLink concluded that, in light of Accounting Standards Codification 450-30, “Gain Contingencies”, (“ASC 450-30”) and the existing non-authoritative guidance, it will use the gain contingency based model for recognition of EHR payments rather than the grant model in order for the Company’s financial statements to be reported in accordance with generally accepted accounting principles in the United States (“GAAP”). Accordingly, management determined and the Audit Committee concurred that the Company should report on Form 8-K (filed on May 8, 2012) that the Company’s historical financial statements with respect to EHR incentive payments should no longer be relied upon and that the Company’s applicable periodic reports should be amended and its historical financial statements restated to reflect the gain contingency based model for recognition of EHR incentive payments. Such restatements of SunLink’s financial statements did not and will not affect the amount or the timing of receipts of past or future Medicare and Medicaid EHR incentive payments.

Based on the Public Company Accounting Oversight Board’s Auditing Standard No. 2, an “Audit of Internal Control over Financial Reporting Performed in Conjunction with Audit of Financial Statements”, restatement of financial statements in prior filings with the SEC is said to be a strong indicator of the existence of a “material weakness” in the design or operation of internal control over financial reporting. The Company has concluded that, because its historical financial statements required restatement in light of ASC 450-30 such that treatment of the EHR incentive payments be based upon the contingency based model, a material weakness existed in the effectiveness of the Company’s internal controls to provide reasonable assurance that its accounting for EHR incentive payments was in accordance with GAAP as of the date of the Company’s annual report on Form 10-K for the period ended June 30, 2011, and as of the date of the Company’s quarterly report on Form 10-Q for the period ended March 31, 2011, Form 10-Q for the period ended September 30, 2011 and quarterly report on Form 10-Q for the period ended December 30, 2011 and assuming it should have used the gain contingency based model, to this extent, its internal control over financial reporting was not effective.

 

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This annual report (restated) does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to rules of the SEC that permit the Company to provide only management’s report in this annual report.

Remediation of Material Weakness in Internal Control

As noted under “Restatement” above, we identified a material weakness in our accounting for EHR incentive payments as a result of our use of the grant method rather than the gain contingency method for accounting for EHR incentive payments. The change from the grant model to the gain contingency model required that previously issued financial statements of the Company be restated. The Company believes that it has implemented procedures which will remediate for future periods such material weakness in internal controls resulting by reason of our accounting for EHR incentive payments on the grant method rather than the gain contingency method.

Changes in Internal Control Over Financial Reporting

Except as described above, there were no changes during the quarter ended December 31, 2011, or in the other periods referred to above, in our internal control over financial reporting or in other factors that materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

 

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PART II. OTHER INFORMATION

Items required under Part II not specifically shown below are not applicable.

 

ITEM 1. LEGAL PROCEEDINGS

There have been no material developments in the legal proceeding previously reported in SunLink’s Annual Report on Form 10-K for the period ended June 30, 2011.

On December 7, 2007, Southern Health Corporation of Ellijay, Inc. (“SHC-Ellijay”), a SunLink subsidiary, filed a Complaint against James P. Garrett and Roberta Mundy, both individually and as Fiduciary of the Estate of Randy Mundy (collectively, “Defendants”), seeking specific performance of an Option Agreement (the “Option Agreement”) dated April 17, 2007, between SHC-Ellijay, Mr. Garrett, and Ms. Mundy as Executrix of the Estate of Randy Mundy for the sale of approximately 24.74 acres of real property located in Gilmer County, Georgia, and recovery of SHC-Ellijay’s damages suffered as a result of Defendants’ failure to close the transaction in accordance with the Option Agreement. SHC-Ellijay also stated alternative claims for breach of the Option Agreement and fraud, along with claims to recover attorney’s fees and punitive damages.

In January 2008, Ms. Mundy and Mr. Garrett filed motions to strike, motions to dismiss, answers, affirmative defenses, and counterclaims against SHC-Ellijay. On March 3, 2009, SHC-Ellijay filed a First Amended and Restated Complaint for Damages, which effectively dropped the cause of action for specific performance of the Option Agreement. On May 7, 2009, Mr. Garrett and Ms. Mundy served a motion for summary judgment on all counts and causes of action stated in the First Amended Complaint, contending that Mr. Garrett and Ms. Mundy did not intentionally breach the Option Agreement. SHC-Ellijay filed opposition papers in June 2009. In May 2011, SHC-Ellijay filed a motion for partial summary judgment on Count I of the Amended Complaint, seeking a judgment holding that Defendants willfully and intentionally breached the Option Agreement in eight ways, which would entitle SHC-Ellijay to recover damages from Defendants. In July 2011, SHC-Ellijay filed a reply brief in further support of its motion for partial summary judgment on the complaint and full summary judgment on the Defendants’ counterclaims and brief in opposition to Defendants’ cross motion for summary judgment. The summary judgment motions remain pending.

SunLink denies that it has any liability to Mr. Garrett and Ms. Mundy and intends to vigorously defend the claims asserted against SunLink by Mr. Garrett’s and Ms. Mundy’s counterclaims and to vigorously pursue its claims against Mr. Garrett and Ms. Mundy. While the ultimate outcome and materiality of the litigation cannot be determined, in management’s opinion the litigation will not have a material adverse effect on SunLink’s financial condition or results of operations.

SunLink is a party to claims and litigation incidental to its business, for which it is not currently possible to determine the ultimate liability, if any. Based on an evaluation of information currently available and consultation with legal counsel, management believes that resolution of such claims and litigation is not likely to have a material effect on the financial position, cash flows, or results of operations of the Company. The Company expenses legal costs as they are incurred.

 

ITEM 1A. RISK FACTORS

Risk Factors Relating to an Investment in SunLink

Information regarding risk factors appears in “MD&A – Forward-Looking Statements,” in Part I – Item 2 of this Form 10-Q/A and in “MD&A -Risks Factors Relating to an Investment in SunLink” in Part I – Item 1A of the Company’s Annual Report on Form 10-K/A for the year ended June 30, 2011. While we believe there have been no material changes from the risk factors previously disclosed in such Annual Report, you should carefully consider, in addition to the other information set forth in this report, the risk factors discussed in our Annual Report which could materially affect our business, financial condition or future results. Such risk factors are expressly incorporated herein by reference. The risks described in our Annual Report are not the only risks facing our Company. In addition to risks and uncertainties inherent

 

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in forward looking statements contained in this Report on Form 10-Q/A, additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results. Whenever we refer to “SunLink,” “Company”, “we,” “our,” or “us” in this Item 1A, we mean SunLink Health Systems, Inc. and its subsidiaries, unless the context suggests otherwise.

 

ITEM 6. EXHIBITS

Exhibits:

 

  31.1    Chief Executive Officer’s Certification Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.
  31.2    Chief Financial Officer’s Certification Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.
  32.1    Chief Executive Officer’s Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  32.2    Chief Financial Officer’s Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101    The following materials from the Company’s quarterly report on Form 10-Q/A for the three and six months ended December 31, 2011, formatted in XBRL (eXtensible Business Reporting Language): (i) Condensed Consolidated Balance Sheets as of December 31, 2011 (unaudited) and June 30, 2011, (ii) Condensed Consolidated Statements of Operations for the three and six months ended December 31, 2011 and 2010 (unaudited), (iii) Condensed Consolidated Statements of Cash Flows, for the three months ended December 31, 2011 and 2010 (unaudited), and (iv) Notes to Condensed Consolidated Financial Statements (unaudited), tagged as blocks of text.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, SunLink Health Systems, Inc. has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

SunLink Health Systems, Inc.
By:  

/s/ Mark J. Stockslager

  Mark J. Stockslager
  Chief Financial Officer

Dated: May 21, 2012

 

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