united surgeons, llc consolidated · expressing an opinion on the effectiveness of the entity’s...

UNITED SURGEONS, LLCD/B/A UNITY MEDICAL AND SURGICAL HOSPITAL, LLC

CONSOLIDATED FINANCIAL STATEMENTSDecember 31, 2012 and 2011


Mishawaka, Indiana

CONSOLIDATED FINANCIAL STATEMENTSDecember 31, 2012 and 2011

CONTENTS

INDEPENDENT AUDITOR'S REPORT ................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................1

CONSOLIDATED FINANCIAL STATEMENTS

CONSOLIDATED BALANCE SHEETS................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................3

CONSOLIDATED STATEMENTS OF OPERATIONS................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................4

CONSOLIDATED STATEMENTS OFCHANGES IN MEMBERS' DEFICIT................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................5

CONSOLIDATED STATEMENTS OF CASH FLOWS................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................6

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................7

INDEPENDENT AUDITOR'S REPORT

Board of Directors and Members of United Surgeons, LLCd/b/a Unity Medical and Surgical Hospital, LLCMishawaka, Indiana

Report on the Financial Statements

We have audited the accompanying consolidated financial statements of United Surgeons, LLC d/b/aUnity Medical and Surgical Hospital, LLC, which comprise the consolidated balance sheets as ofDecember 31, 2012 and 2011, and the related consolidated statements of operations,changes inmembers' deficit, and cash flows for the years then ended, and the related notes to the financialstatements.

Management's Responsibility for the Financial Statements

Management is responsible for the preparation and fair presentation of these consolidated financialstatements in accordance with accounting principles generally accepted in the United States of America;this includes the design, implementation, and maintenance of internal control relevant to the preparationand fair presentation of consolidated financial statements that are free from material misstatement,whether due to fraud or error.

Auditor's Responsibility

Our responsibility is to express an opinion on these financial statements based on our audits. Weconducted our audits in accordance with auditing standards generally accepted in the United States ofAmerica. Those standards require that we plan and perform the audit to obtain reasonable assuranceabout whether the consolidated financial statements are free from material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures inthe consolidated financial statements. The procedures selected depend on the auditor’s judgment,including the assessment of the risks of material misstatement of the consolidated financial statements,whether due to fraud or error. In making those risk assessments, the auditor considers internal controlrelevant to the entity’s preparation and fair presentation of the consolidated financial statements in orderto design audit procedures that are appropriate in the circumstances, but not for the purpose ofexpressing an opinion on the effectiveness of the entity’s internal control. Accordingly, we express nosuch opinion. An audit also includes evaluating the appropriateness of accounting policies used and thereasonableness of significant accounting estimates made by management, as well as evaluating theoverall presentation of the consolidated financial statements.

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis forour qualified audit opinion.

(Continued)

1.

Basis for Qualified Opinion

Management did not provide an assessment of goodwill and intangible assets for impairment in 2011 andtherefore, we were unable to determine if goodwill and intangible asset impairment existed at December31, 2011. As a result of this matter, we were unable to determine whether any adjustments might havebeen necessary with respect to goodwill and intangible asset impairment elements making up theconsolidated statements of operations and changes in members' deficit, and cash flows in 2011.Management provided their goodwill and intangible asset impairment analysis for 2012 and recognized$1,667,108 of goodwill impairment loss and $197,100 of intangible asset impairment loss recorded asamortization expense during 2012. We were unable to determine whether any of the 2012 impairmentlosses related to 2011, if any, and the impact on any adjustments that might have been necessary withrespect to goodwill and intangible asset impairment elements making up the consolidated statements ofoperations and changes in members' deficit, and cash flows in 2012.

Qualified Opinion

In our opinion, except for the possible effects of the matter described in the Basis for Qualified Opinionparagraph, the consolidated financial statements referred to above present fairly, in all material respects,the consolidated financial position of United Surgeons, LLC d/b/a Unity Medical and Surgical Hospital,LLC as of December 31, 2012 and 2011, and the results of its operations and its cash flows for the yearsthen ended in accordance with accounting principles generally accepted in the United States of America.

Emphasis of Matter

As discussed in Note 11 to the consolidated financial statements, there were significant operationalimprovements, changes in member ownership and debt restructuring in 2013. Our opinion is not modifiedwith respect to this matter.

Crowe Horwath LLP

South Bend, IndianaMay 29, 2014

2.


CONSOLIDATED BALANCE SHEETSDecember 31, 2012 and 2011

2012 2011ASSETSCurrent assets

Cash $ 121,224 $ 242,952Patient receivables, net 8,215,904 8,589,555Inventory 769,423 587,881Prepaid expenses and other assets 90,818 243,149Other receivables 1,237,400 -Affiliates receivables 1,366,125 1,290,492Third party settlements - 1,777,775

Total current assets 11,800,894 12,731,804

Property and equipment, net 20,238,284 18,400,480Goodwill 493,725 1,564,108Intangibles, net 2,000,000 197,100Deposits 23,215 23,000

22,755,224 20,184,688

Total assets $ 34,556,118 $ 32,916,492

LIABILITIES AND MEMBERS' DEFICITCurrent liabilities

Lines of credit $ 8,200,000 $ 6,445,668Current portion of long-term debt 4,787,835 2,214,076Current portion of capital lease obligations 524,844 209,511Accounts payable 6,841,142 3,675,490Accrued expenses 1,718,844 1,085,087Affiliate payables 679,551 151,420Third party settlements 1,055,954 -Distributions payable 227,317 227,317Due to seller 1,239,632 -

Total current liabilities 25,275,119 14,008,569

Long-term liabilitiesLong-term debt, net of current portion 5,599,397 7,178,883Capital lease obligations, net of current portion 17,992,206 14,903,788

Total long-term liabilities 23,591,603 22,082,671 Total liabilities 48,866,722 36,091,240

Members' deficit (14,310,604) (3,174,748)

Total liabilities and members' deficit $ 34,556,118 $ 32,916,492

See accompanying notes to consolidated financial statements.

3.


CONSOLIDATED STATEMENTS OF OPERATIONSYears ended December 31, 2012 and 2011

2012 2011Revenues

Patient service $ 21,111,400 $ 24,272,252Physician practice 2,662,388 1,287,336Other 1,262,643 25,903

Total revenues 25,036,431 25,585,491

Operating expenses Contract services 14,107,782 10,726,039Bad debt expense 1,099,939 1,002,267Professional fees 512,271 229,781Management fees 504,000 672,000Medical director fees - 121,325Medical supplies 8,000,727 6,238,482Office expense 726,330 426,622Equipment rent 293,418 255,817Building rent 590,211 480,022Repairs and maintenance 356,868 355,672Utilities 400,962 387,025Insurance 212,029 89,667Property taxes 384,717 380,424Dues, licenses and subscriptions 36,835 45,845Travel, meals and conferences 130,810 131,978Depreciation and amortization expense 2,440,220 1,990,869Collection fees 228,933 239,063Human resource expense 170,985 127,351Education and training 111,622 195,999Miscellaneous expenses 3,572 107,798

Total operating expenses 30,312,231 24,204,046

Income (loss) from operations (5,275,800) 1,381,445

Other income (expense) Interest expense (3,795,469) (3,417,585)Rental income 38,308 107,583Impairment of goodwill (1,667,108) -Gain (loss) on asset disposals (111,047) 8,057Other income 1,602 3,502

Total other expense (5,533,714) (3,298,443)

Net loss $ (10,809,514) $ (1,916,998)


4.


CONSOLIDATED STATEMENTS OF CHANGES IN MEMBERS' DEFICITYears ended December 31, 2012 and 2011

Balances, January 1, 2011 $ (257,750)

Net loss (1,916,998)

Distributions (1,000,000)

Balances, December 31, 2011 (3,174,748)

Due from Parent (Note 9) (325,342)

Net loss (10,809,514)

Distributions (1,000)

Balances, December 31, 2012 $ (14,310,604)


5.


CONSOLIDATED STATEMENTS OF CASH FLOWSYears ended December 31, 2012 and 2011

2012 2011Cash flows from operating activities

Net loss $ (10,809,514) $ (1,916,998)Adjustments to reconcile net loss to net cash from operating

activitiesDepreciation and amortization expense 2,440,220 1,990,869Bad debt expense 1,099,939 1,002,267(Gain) loss on disposal of fixed assets 111,047 (8,057)Impairment of goodwill 1,667,108 -Excess of interest over capital lease payments 488,857 486,609Change in assets and liabilities

Patient receivables (73,688) 3,507,762Third party settlements 2,833,729 (1,038,689)Affiliate receivables (75,633) 123,203Other receivables (1,237,400) -Prepaid expenses and other assets 162,451 (29,943)Inventory (153,542) (108,945)Deposits (215) (1,000)Accounts payable 3,165,172 (1,494,756)Affiliate payables 528,131 (281,672)Accrued expenses 595,108 244,724

Net cash from operating activities 741,770 2,475,374

Cash flows from investing activitiesAcquisition of businesses, net of cash acquired (2,068,775) -Purchase of property and equipment (481,769) (344,017)

Net cash from investing activities (2,550,544) (344,017)

Cash flows from financing activitiesGross proceeds on lines of credit 1,754,332 700,000Proceeds from issuance of long-term debt 4,050,000 -Payments on long-term debt (3,055,727) (1,752,388)Payments on capital lease obligations (735,217) (235,847)Distributions (1,000) (772,683)Advances to parent (325,342) -

Net cash from financing activities 1,687,046 (2,060,918)

Net change in cash (121,728) 70,439

Cash at beginning of year 242,952 172,513

Cash at end of year $ 121,224 $ 242,952

Supplemental disclosures of cash flow informationCash paid during the year for interest $ 3,792,313 $ 3,532,595

Supplemental disclosures of non-cash flow activityConversion of Omnicare accounts payable to long-term debt $ - $ 75,176Conversion of line of credit to long-term debt - 1,980,000Allocation of goodwill to identifiable intangible assets - 258,000Assets acquired under capital lease agreements 3,650,111 -Due to seller on acquisition 1,239,632 -


6.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTSDecember 31, 2012 and 2011

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization: United Surgeons, LLC d/b/a Unity Medical and Surgical Hospital, LLC ("UMASH"), asubsidiary of Physician’s ASC Management, LLC (“PAM” or "Parent"), operates a 29 bed outpatient /inpatient surgical hospital located in Mishawaka, Indiana. UMASH obtained hospital licensure inNovember 2009. Unity Medical Associates, LLC, i-Spine, LLC, and Patel Family Medicine, LLC providepatient services.

Basis of Consolidation: The accompanying consolidated financial statements include the accounts ofUMASH and their wholly owned subsidiaries (collectively “the Company”), and have been prepared inconformity with accounting principles generally accepted in the United States of America. All materialintercompany accounts and transactions have been eliminated in consolidation.

Industry: The Company derives a significant portion of its revenue from third-party payer programs. Thereceipt of future revenues by the Company is subject to, among other factors, federal and state policiesaffecting the health care industry, economic conditions that may include an inability to control expenses inperiods of inflation, increased competition, market pressures on premium rates and other conditionswhich are impossible to predict.

Use of Estimates: The preparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assetsand liabilities at the date of the financial statements and reported amounts of revenues and expensesduring the reporting period. Estimates associated with the allowances for contractual adjustments anduncollectible patient accounts, third party settlements, and medical malpractice are particularlysusceptible to material change in the near term.

Total patient accounts receivable concentrations by payer at December 31 are as follows:

2012 2011

Medicare %40.2 %20.5Blue Cross 37.0 39.6Commercial, self pay and other 22.8 39.9

%100.0 %100.0

The Company does not perform credit evaluations of its payers, but does inquire of patients regardingtheir access to insurance and ability to pay. The Company does not require collateral from its patients,third-party payers or others.

Cash: The Company maintains cash balances with financial institutions which, at times, may exceedfederally insured limits.

(Continued)

7.



NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Patient Receivables and Allowances: Patient receivables represent charges to patients, primarily on openaccount. The Company does not accrue interest on any of its patient receivables. Adjustments to patientaccounts are made in amounts estimated to maintain an adequate allowance to cover contractualallowances and anticipated losses. Patient receivables represent estimated net realizable amounts frompatients, third-party payers and others. Estimated contractual adjustments, based on existing contractualrelationships, are recorded at the time charges are posted and are adjusted to reflect actual contractualadjustments as claims are settled.

Management periodically reviews patient receivables and records an allowance for uncollectible accountsbased on current circumstances. Allowance estimates are based on historical experience and otherrelevant factors. Accounts are charged against the allowance when all attempts to collect the receivablehave failed. Patient receivables are shown net of allowances of $10,967,926 and $7,431,629 on theconsolidated balance sheets at December 31, 2012 and 2011, respectively.

Settlements: Settlements under cost reimbursement agreements with third-party payers are estimatedand recorded in the period in which the related services are rendered and are adjusted in future periodsas final settlements are determined. Final determination of amounts earned under the Medicare andMedicaid programs often occur in subsequent years because of audits by the programs, rights of appeal,and the application of numerous technical provisions. An estimated Medicare and Medicaid settlementreceivable of $1,777,775 is recorded at December 31, 2011 in third party settlements on the consolidatedbalance sheets. An estimated Medicare and Medicaid settlement payable of $1,055,954 is recorded atDecember 31, 2012 in third party settlements on the consolidated balance sheets.

Inventories: Inventories consist primarily of medical and pharmaceutical supplies and are stated at thelower of cost (first-in, first-out) or market value.

Property and Equipment: Property and equipment are stated at cost. Depreciation of property andequipment is provided using the straight-line method over the estimated useful lives of the assets andincludes depreciation on assets leased under capital lease arrangements. When properties are retired orotherwise disposed of, the appropriate accounts are relieved of cost and accumulated depreciation, andany resulting gain or loss is recognized.

The assets' estimated lives used in computing depreciation are as follows:

Buildings 24 yearsFurniture, fixtures and office equipment 3 - 7 yearsSoftware, computer and medical equipment 3 - 7 yearsLeasehold improvements Lesser of life of lease or economic

useful life

On an on-going basis, long-lived assets, such as property and equipment, are reviewed for impairmentwhenever events or changes in circumstances indicate that the carrying amount of an asset may not berecoverable. If the carrying amount of an asset exceeds its estimated discounted future cash flows, animpairment charge is recognized by the amount by which the carrying amount of the asset exceeds thefair value of the asset. As of December 31, 2012 and 2011, no such impairment existed.

(Continued)

8.




Goodwill: Goodwill represents the excess of costs over the estimated fair value of the net assets ofbusinesses acquired. Goodwill assets have indefinite useful lives and will not be amortized but will besubject to annual impairment tests based on their estimated fair values. Management believes nogoodwill was impaired at December 31, 2011, however, management did not provide a goodwillimpairment analysis. During 2012, management identified goodwill impairment and recorded a goodwillimpairment loss. See Note 8 for additional details.

Intangible Assets: Intangible assets consist of customer relationships, trade name and non-competitionagreements. These assets are amortized, straight-line over their period of expected benefits, which isestimated to range from 2 - 7 years. The assets are presented net of accumulated amortization of$69,000 at December 31, 2011 and the Company recorded $69,000 of amortization expense in 2011.Management believes no intangible assets were impaired at December 31, 2011, however, managementdid not provide an impairment analysis. During 2012, management identified intangible asset impairmentand expensed the remaining unamortized asset amounts of $197,100 as amortization expense. OnDecember 31, 2012, UMASH entered into a business acquisition to acquire the interests of i-Spine, LLC(see Note 2). As part of the acquisition the Company identified a non-compete agreement in the amountof $2,000,000. Amortization expense is estimated to be $666,666 each year from 2013 through 2015.

Revenue Recognition: Revenue is recorded when medical services are rendered. Management fee andcontracted service revenues are recorded as services are rendered. Provisions for estimated third-partypayer settlements and adjustments are made in the period the related services are rendered andadjusted in future periods as final settlements are determined.

Other Revenue: The American Recovery and Reinvestment Act of 2009 included provisions forimplementing health information technology under the Health Information Technology for Economic andClinical Health Act (HITECH). These provisions were designed to increase the use of electronic healthrecords (EHR) technology and establish the requirements for a Medicare and Medicaid incentivepayments program beginning in 2011 for eligible hospitals and providers that adopt and meaningfully usecertified EHR technology. Eligibility for annual Medicare incentive payments is dependent on providersdemonstrating meaningful use of EHR technology in each period over a four-year period. Initial Medicaidincentive payments are available to providers that adopt, implement, or upgrade certified EHRtechnology; but providers must demonstrate meaningful use of such technology in subsequent years toqualify for additional incentive payments. Medicaid EHR incentive payments are fully funded by thefederal government and administered by the states; however, the states are not required to offer EHRincentive payments to providers.

Using the grant accounting method of revenue recognition, the Company recognized $1,237,400 ofrevenue for HITECH incentives from Medicare during the year ended December 31, 2012. The Companyhas demonstrated meaningful use of certified EHR technology or has completed attestations to theiradoption or implementation of certified EHR technology. Such revenue is included within other income onthe consolidated statements of operations and changes in members’ deficit at December 31, 2012.

Medical Malpractice: The Indiana Medical Malpractice Act limits the maximum recovery for professionalliability to $750,000 per occurrence, $250,000 of which would be paid through the Company’s malpracticeinsurance coverage, and the balance would be paid by the State of Indiana Patient Compensation Fund.The Company maintains professional liability insurance coverage on a claims-incurred basis. Premiumsare expensed in the period to which they relate.

(Continued)

9.




Fair Value of Financial Instruments: The Company's carrying amount for its financial instruments, whichinclude cash, patient accounts receivable, accounts payable, and long-term debt approximates fair value.

Income Taxes: A tax position is recognized as a benefit only if it is "more likely than not" that the taxposition would be sustained in a tax examination, with a tax examination being presumed to occur. Theamount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized onexamination. For tax positions not meeting the "more likely than not" test, no tax benefit is recorded.

The Company recognizes interest and penalties related to unrecognized tax benefits in interest andincome tax expense, respectively. The Company has no amounts accrued for interest or penalties as ofDecember 31, 2012 and 2011. Due to its pass-through status, the Company is not subject to U.S. federalincome tax or state income tax. The Company is no longer subject to examination by U.S. federal andState of Indiana taxing authorities for years before January 1, 2009. The Company does not expect thetotal amount of unrecognized tax benefits to significantly change in the next 12 months.

NOTE 2 - BUSINESS ACQUISITIONS

To pursue the strategy of increasing market presence by expanding their service base, the Companyentered into the following business acquisitions:

On February 1, 2012, pursuant to an Asset Purchase Agreement, UMASH acquired certain assets ofMcClure Investments, LLC. The purchase price was $190,000. The excess of the purchase price overthe fair value of the net identifiable tangible and intangible assets was allocated to goodwill. Thefollowing table presents the allocation of the purchase price based on fair value:

Property and equipment $ 59,000Inventory 28,000Goodwill 103,000

Total purchase allocation $ 190,000

In conjunction with the Asset Purchase Agreement, the owner of McClure Investments, LLC became anemployee of UMASH.

The purchased goodwill primarily represents the acquired business intangible assets that do not qualifyfor separate recognition, its market position and the expectation of future earnings growth.

(Continued)

10.



NOTE 2 - BUSINESS ACQUISITIONS (Continued)

On December 31, 2012, pursuant to a Unit Purchase Agreement, UMASH acquired the businessoperations of i-Spine, LLC. The purchase price was $3,239,632 and was funded through $2,000,000 oflender proceeds with the remaining balance of $1,239,632 due to seller at December 31, 2012. Theremaining balance has a fixed interest rate of 6.00% and is due in full on or before December 31, 2013.This amount was repaid in full during November of 2013. The excess of the purchase price over the fairvalue of the net identifiable tangible and intangible assets was allocated to goodwill. The following tablepresents the allocation of the purchase price based on fair value:

Cash $ 121,225Accounts receivable 652,600Prepaid assets 10,120Property and equipment 1,090Goodwill 493,725Non-compete agreement 2,000,000Accounts payable and accrued payroll (39,128)

Total purchase price $ 3,239,632

The Company determined the fair value of the non-compete agreement by applying an income basedapproach which included discounting future estimated cash flows.

The Company incurred acquisition costs of $25,000 which were expensed as professional fees on theconsolidated statement of operations in 2012.

The purchased goodwill primarily represents the acquired business intangible assets that do not qualifyfor separate recognition, its market position and the expectation of future earnings growth.

NOTE 3 - PROPERTY AND EQUIPMENT

Property and equipment consist of the following at December 31:

2012 2011

Building $ 14,379,799 $ 14,379,799Furniture, fixtures and office equipment 1,543,997 1,407,297Software, computer and medical equipment 11,783,521 7,944,377Leasehold improvements 790,475 772,936

28,497,792 24,504,409Accumulated depreciation (8,259,508) (6,103,929)

$ 20,238,284 $ 18,400,480

Depreciation expense for December 31, 2012 and 2011 was $2,243,120 and $1,929,969, respectively.

(Continued)

11.



NOTE 4 - LINES OF CREDIT

The Company maintains a due on demand line of credit with Lake City Bank with available credit of$7,000,000. The line of credit had principal outstanding of $7,000,000 and $6,445,668 at December 31,2012 and 2011, respectively. Interest accrues daily at bank prime rate or a minimum rate of 4.00%.Interest was at 4.00% at December 31, 2012 and 2011, respectively. The line of credit is secured bysubstantially all of the assets of the Company, is guaranteed by certain members, and expires on October25, 2015.

The Company maintained a due on demand line of credit with Lake City Bank with available credit of$2,000,000. The line of credit had no principal outstanding at December 19, 2012 or December 31, 2011.Interest accrued daily at bank prime rate or a minimum rate of 4.00%. Interest was 4.00% at December19, 2012 and December 31, 2011, respectively. The line of credit was secured by substantially all of theassets of the Company, was guaranteed by certain members, and expired on December 19, 2012.

On December 27, 2012, the Company obtained a due on demand line of credit with Lake City Bank withavailable credit of $1,500,000. The line of credit had principal outstanding of $1,200,000 at December31, 2012. Interest accrues daily at bank prime rate or a minimum rate of 4.00%. Interest was 4.00% atDecember 31, 2012. The line of credit is secured by substantially all of the assets of the Company, isguaranteed by certain members, and expires on January 5, 2018.

The above lines of credit are subject to certain financial and non-financial covenants. The Company wasnot in compliance with the covenants as of December 31, 2012 (see Note 5).

NOTE 5 - LONG-TERM DEBT

Long-term debt consists of the following at December 31:

2012 2011Lake City Bank – note payable in monthlyinstallments of $177,022 including fixed interest at6.00%, maturing in October 2015, and is subjectto prepayment penalties. The note is secured bysubstantially all assets of the Company. $ 5,811,704 $ 7,246,070

Lake City Bank – note payable in monthlyinstallments of $37,820 including fixed interest at5.50%, maturing in December 2016, and issubject to prepayment penalties. The note issecured by substantially all assets of theCompany. 1,687,995 1,980,000

Lake City Bank – note payable due in fullincluding fixed interest at 4.00%, maturing inMarch 2013. The note is secured by substantiallyall assets of the Company and a personalguarantee of a seller. In March 2013 the note wasextended through October 2013. On December27, 2013 this note was included in the loanagreement restructuring (Note 11). 2,000,000 -

(Continued)

12.



NOTE 5 - LONG-TERM DEBT (Continued)

2012 2011Lake City Bank – note payable in monthlyinstallments of $7,542 including fixed interest at4.00%, maturing in December 2015, and issubject to prepayment penalties. The note issecured by substantially all assets of theCompany. $ 500,000 $ -

Lake City Bank – note payable in monthlyinstallments of $5,049 including fixed interest at5.75%, maturing in December 2017, and issubject to prepayment penalties. The note issecured by substantially all assets of theCompany. 350,000 -

Omnicare – note payable in monthly installmentsof $2,250 including fixed interest at 6.00%,maturing in June 2014. The note is secured bysubstantially all assets of the Company. 37,533 61,489

Hill-Rom – installment note payable in monthlyinstallments of $10,866 including fixed interest at6.70%, maturing in September 2012. The note issecured by the assets financed by the notepayable. This note was paid in full in September2012. - 105,400

10,387,232 9,392,959Current portion of long-term debt (4,787,835) (2,214,076)

Long-term debt, net of current portion $ 5,599,397 $ 7,178,883

Principal maturities of outstanding debt at December 31, 2012, over the next five years are as follows:

2013 $ 4,787,8352014 2,527,7482015 2,302,6522016 582,6042017 186,393

The Company is required to maintain certain financial and non-financial covenants with Lake City Bank.As of December 31, 2012, the Company was not in compliance. On August 6, 2013, the Companyobtained a waiver from Lake City Bank curing covenant non-compliance.

See Note 11 for details on the Lake City Bank debt restructuring in 2013.

(Continued)

13.



NOTE 6 - LEASES

The Company entered into non-cancelable operating leases for medical and office equipment and spacethrough December 2018. Total rent expense in 2012 and 2011 was $883,629 and $735,839,respectively.

Future payments under operating leases with initial non-cancelable terms of one year or more consistedof the following:

2013 $ 465,4482014 370,0442015 276,7012016 115,8512017 22,433Thereafter 13,200

$ 1,263,677

The Company has a capital lease with Unity Realty, LLC (“UR”), a party related through commonownership, for the building, and also maintains capital leases for certain medical and office equipmentwith unrelated various parties. Following is a summary of the capital leases at December 31:

2012 2011

Buildings $ 14,379,799 $ 14,379,799Furniture, fixtures and office equipment 11,036 -Software, computer and medical equipment 4,119,631 674,121

18,510,466 15,053,920Accumulated depreciation (3,386,619) (2,407,422)

$ 15,123,847 $ 12,646,498

Future minimum payments under capital leases are as follows:

2013 $ 3,724,3992014 3,708,6422015 3,497,2402016 2,606,1962017 2,671,784Thereafter 64,078,423

80,286,684Amount representing interest (61,769,634)Present value of net minimum lease

payments (including current portion of$524,844) $ 18,517,050

Interest expense in excess of capital lease payments of $488,857 and $486,609, relative to the UR lease,was recognized on the consolidated statement of operations and changes in members’ deficit in interestexpense for 2012 and 2011.

(Continued)

14.



NOTE 7 - FAIR VALUE MEASUREMENTS

The Company applies fair value techniques to value potential impairment losses related to goodwill on anon-recurring basis. Fair value is defined as the price that would be received by the Company for anasset, or paid by the Company to transfer a liability (as exit price), in an orderly transaction betweenmarket participants on the measurement date in the Company's principal or most advantageous marketfor the asset or liability. The fair value hierarchy requires the Company to maximize the use of observableinputs and minimize the use of unobservable inputs when measuring fair value. Unobservable inputs areinputs that reflect the Company's own assumptions based on market data and on assumptions thatmarket participants would use in pricing the asset or liability developed based on the best informationavailable in the circumstances. The hierarchy places the highest priority on unadjusted quoted marketprices in active markets for identical assets or liabilities (Level 1 measurements) and gives the lowestpriority to unobservable inputs (Level 3 measurements). The three levels of inputs within the fair valuehierarchy are defined as follows:

Level 1 Inputs: Quoted prices (unadjusted) for identical assets or liabilities in active markets that theentity has the ability to access as of the measurement date.

Level 2 Inputs: Significant other observable inputs other than Level 1 prices such as quoted prices forsimilar assets or liabilities; quoted prices in markets that are not active; or other inputs that areobservable or can be corroborated by observable market data.

Level 3 Inputs: Significant unobservable inputs that reflect a reporting entity's own assumptions aboutthe assumptions that market participants would use in pricing an asset or liability.

In many cases, a valuation technique used to measure fair value includes inputs from multiple levels ofthe fair value hierarchy. The lowest level of significant input determines the placement of the entire fairvalue measurement in the hierarchy.

The Company uses the combination of a discounted cash flow model and a market multiple analysismethod to determine the current fair value of goodwill. The discounted cash flow model was preparedusing management’s future revenue and expense projections based on the Company’s current operatingplan. As such, a number of significant assumptions and estimates are involved in the forecasted revenuegrowth, price changes, gross profits, operating expenses and operating cash flows.

Significant inputs and management assumptions were used in the fair value techniques associated withvaluing potential impairment losses related to the Company's goodwill. As such, significant fair valueinputs generally cannot be verified and involve significant management judgments (Level 3 inputs).

(Continued)

15.



NOTE 8 - GOODWILL

The Company recognized $1,667,108 and $0 of impairment loss in 2012 and 2011, respectively.Management indicated the impairment loss resulted from a continued decline in operating results. Thechanges in the carrying amount of goodwill is as follows:

Balance at January 1, 2011 $ 1,822,108Provisional goodwill allocated to identified intangible assets (258,000)Acquired -Impairment -Balance as of December 31, 2011 1,564,108Acquired 596,725Impairment (1,667,108)

Balance as of December 31, 2012 $ 493,725

NOTE 9 - RELATED PARTY TRANSACTIONS

Medical Director Agreements: The Company entered into medical director agreements ("MDA") withindividuals who are members of PAM. The MDAs automatically renew for one year periods unlessterminated according to the terms of the MDAs. Expenses under the MDAs for 2011 was $121,325. Theagreement was terminated prior to 2012. No expenses were recorded during 2012.

Management Agreement: The Company entered into a management agreement with PAM through May2016 for provision of development, administrative and management services, as described in themanagement agreement. The Company pays PAM $672,000 annually, increasing by 5% per year (theincrease has been waived by PAM since inception of the agreement). The management agreement wasterminated in September 2012. Management fees for 2012 and 2011 were $504,000 and $672,000,respectively.

Lease Agreement: The Company entered into a net lease for the building with UR, a related partythrough common ownership (see Note 5). The term of the lease is for 300 months beginning in October2009. The UR lease is guaranteed by the members of PAM in direct proportion to their membership inPAM.

Employee Lease Agreement: The Company had an Employee Lease Agreement with Physician'sManagement/Employee Leasing Company, LLC ("PMEL”). The initial term of the lease was for five yearsbeginning in February 2008, and provided for automatic renewal terms of one year each, unless notice toterminate was given. PMEL provided employee services for the Company's staffing needs, and theCompany had agreed to reimburse PMEL for wages, benefits, and various employment liability coverage.The agreement was terminated in December 15, 2012, at which point the Company became theemployer of all employees previously employed as part of the agreement. The Company incurred$10,174,314 and $7,159,586 in expenses for leased employees of PMEL in 2012 and 2011, respectively.

In the normal course of business, the Company incurs expenses on behalf of affiliated entities, orprovides services to related parties, and recognizes a receivable in affiliate receivables. See Note 11 foradditional details.

(Continued)

16.



NOTE 9 - RELATED PARTY TRANSACTIONS (Continued)

Affiliate Receivables: Following is the composition of affiliate receivables at December 31:

2012 2011Related parties through common ownership:

Physician's Hospital, LLC d/b/a RiverCrest SpecialtyHospital $ 219,752 $ 612,459

Doctors Hospital - Grand Forks, LLC 259,050 190,977Northern Indiana Rehab Hospital, LLC d/b/a Doctor's

Hospital & Neuromuscular Center 673,388 286,006Michiana Multi-Specialty Medical Group 63,624 59,432Other related parties 18,797 13,327

Related party through common control:Knox Winamac Community Health Center, Inc. 131,514 128,291

Total affiliate receivables $ 1,366,125 $ 1,290,492

Affiliate Payables: Following is the composition of affiliate payables at December 31:

2012 2011Related parties through common ownership:

Due to members $ - $ 26,391Doctor's Behavioral Hospital, LLC 29,909 -Doctor's Development Company, LLC 400,000 -Physician's Management/Employee Leasing Company,

LLC 249,642 125,029

Total affiliate payables $ 679,551 $ 151,420

Due from Parent: Following is the composition of due from Parent at December 31:

2012 2011Due from Parent:

Physician ASC Management, LLC $ 325,342 $ -

The Company has certain transactions with its Parent under a management agreement and from time totime receivables from the Parent, and therefore, the Parent is considered a variable interest entity to theCompany. Since the Company does not have the power to direct the activities of the Parent and doesnot have the obligation to absorb losses of the Parent in excess of the amounts due from them, theCompany's maximum exposure to loss is the amount owed from them of $325,342 and $0 at December31, 2012 and 2011, respectively.

Management has determined that the repayment of this receivable is dependent upon future distributionsreceived from the Company, and therefore, has classified these receivables in members' deficit.

(Continued)

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NOTE 10 - CONTINGENCIES AND COMMITMENTS

Litigation: The Company is, at times, involved in professional liability claims arising from the use of thehospital, and from provision of medical services in the physician practices, which are defended andhandled in the ordinary course of business. At December 31, 2012 and 2011, management believes thatthe Company does not have any significant malpractice claims or other litigation in which the ultimateresolution is probable and could have a material financial impact, and therefore has not reflected anyliabilities, or corresponding receivables, in the consolidated balance sheets.

NOTE 11 - SUBSEQUENT EVENTS

On January 10, 2013, the Company obtained a note payable from Lake City Bank in the amount of$700,000. The loan is due in monthly installments of $10,200, including fixed interest at 5.75%, maturingin December 2017.

On December 27, 2013, the Company and Lake City Bank entered into a Loan Restructuring Agreement.Under this agreement the outstanding notes payable and line of credit agreements were consolidated.This resulted in one note payable in the amount of $17,713,967 to be repaid in monthly payments of$328,564 including interest at 4.25% through the earlier of December 2018, the expiration of theagreement, or when repaid. The outstanding lines of credit were consolidated into one line of credit withavailable credit of $3,000,000 at an interest rate of 4.25%. The line of credit expires in December of 2018.This agreement is secured by all assets of the Company and the personal guarantees of certainmembers.

During December 2013, and in conjunction with the December 27, 2013 Loan Restructuring Agreementwith Lake City Bank, the Company entered into certain settlement agreement and general releases withmembers of PAM and UMASH. These settlement agreements also impacted certain affiliated entityownership and related party relationships. In conjunction with certain settlement agreement and generalleases, certain affiliate receivables and payables due to and from the Company were forgiven. Theamounts of the affiliate receivables and payables that were forgiven in 2013 were $1,284,240 and$679,551 as of December 31, 2012, respectively.

In 2013 the Company successfully implemented significant operational improvements, completedstrategic changes in PAM and UMASH member ownership and restructured the Company's outstandingdebt borrowings with Lake City Bank. The Company reported net income in 2013 on net revenues of$46,000,000. In addition the Company was in compliance with the Lake City Bank financial basedcovenants at December 31, 2013. The Company however, was not in compliance with all of the non-financial covenants at December 31, 2013. On March 26, 2014, the Company obtained a waiver fromLake City Bank curing the 2013 covenant non-compliance.

Management has performed an analysis of the activities and transactions subsequent to December 31,2012 to determine the need for any adjustments to and/or disclosures within the audited financialstatements for the year ended December 31, 2012. Management has performed their analysis throughMay 29, 2014, the date the financial statements were available for issuance and has determined that allmaterial subsequent events have been properly disclosed.

18.

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