10-Q 1 f10q_051316p.htm FORM 10-Q



UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

[X]

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2016

 

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: 001-36724

 

The Joint Corp.

(Exact name of registrant as specified in its charter)

 

Delaware 90-0544160

(State or other jurisdiction of incorporation or

organization)

(IRS Employer Identification No.)

 

16767 N. Perimeter Drive, Suite 240, Scottsdale

Arizona

85260
(Address of principal executive offices) (Zip Code)

 

(480) 245-5960

(Registrant’s telephone number, including area code)

 

N/A

(Former name, former address and former fiscal year, if changed since last report)

 

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 filing requirements for the past 90 days.   Yes þ   No  o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Date 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 (or for such shorter period that the registrant was required to submit and post such files).   Yes þ     No o

 

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

 

 
 

Large accelerated filer ¨ Accelerated filer ¨
Non-accelerated filer ¨ Smaller reporting company þ

 

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

 

As of May 6, 2016, the registrant had 12,672,552 shares of Common Stock ($0.001 par value) outstanding.

 

 

 

 

 

 

 

 
 

THE JOINT CORP.

FORM 10-Q

 

TABLE OF CONTENTS

 

     

PAGE NO.

 

PART I FINANCIAL INFORMATION  
       
  Item 1. Unaudited Financial Statements:  
    Condensed Consolidated Balance Sheets as of March 31, 2016 and December 31, 2015 1
    Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2016 and 2015 2
    Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2016 and 2015 3
    Notes to Unaudited Condensed Consolidated Financial Statements 5
       
  Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 19
       
  Item 4. Controls and Procedures 28
       
Part I, Item 3 – Not applicable  
     
PARTII OTHER INFORMATION  
       
  Item 1. Legal Proceedings 28
       
  Item 1A. Risk Factors 29
       
  Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 29
       
  Item 6. Exhibits 29
       
  SIGNATURES 29
       
  EXHIBIT INDEX 30
       
Part II, Items 3, 4, and 5 - Not applicable  

 

 

 
 

PART I:  FINANCIAL INFORMATION

 

ITEM 1.      UNAUDITED FINANCIAL STATEMENT

 

THE JOINT CORP. AND SUBSIDIARY

CONDENSED CONSOLIDATED BALANCE SHEETS

 

   March 31,
2016
  December 31,
2015
ASSETS  (unaudited)   
Current assets:          
Cash and cash equivalents  $10,367,496   $16,792,850 
Restricted cash   457,267    385,282 
Accounts receivable, net   1,645,429    743,239 
Income taxes receivable   38,960    70,981 
Notes receivable - current portion   48,763    60,908 
Deferred franchise costs - current portion   630,900    605,850 
Prepaid expenses and other current assets   445,030    366,033 
Total current assets   13,633,845    19,025,143 
Property and equipment, net   7,968,588    7,138,746 
Notes receivable, net of current portion and reserve   10,710    15,823 
Deferred franchise costs, net of current portion   1,342,148    1,534,700 
Intangible assets, net   2,607,342    2,542,269 
Goodwill   2,466,937    2,466,937 
Deposits and other assets   642,049    638,710 
Total assets  $28,671,619   $33,362,328 
           
LIABILITIES AND STOCKHOLDERS' EQUITY          
Current liabilities:          
Accounts payable  $1,564,406   $1,996,971 
Accrued expenses   288,424    375,529 
Co-op funds liability   104,532    201,078 
Payroll liabilities   663,442    1,493,375 
Notes payable - current portion   461,350    451,850 
Deferred rent - current portion   279,251    334,560 
Deferred revenue - current portion   2,714,134    2,579,423 
Other current liabilities   96,290    54,596 
Total current liabilities   6,171,829    7,487,382 
Notes payable, net of current portion   -    130,000 
Deferred rent, net of current portion   1,140,780    457,290 
Deferred revenue, net of current portion   3,799,867    4,369,702 
Other liabilities   206,744    238,648 
Total liabilities   11,319,220    12,683,022 
Commitments and contingencies          
Stockholders' equity:          
Series A preferred stock, $0.001 par value; 50,000 shares authorized, 0 issued and outstanding, as of March 31, 2016, and December 31, 2015   -    - 
Common stock, $0.001 par value; 20,000,000 shares authorized, 13,118,336 shares issued and 12,584,336 shares outstanding as of March 31, 2016 and 13,070,180 shares issued and 12,536,180 outstanding as of December 31, 2015   13,118    13,070 
Additional paid-in capital   35,465,555    35,267,376 
Treasury stock (534,000 shares as of March 31, 2016 and December 31, 2015, at cost)   (791,638)   (791,638)
Accumulated deficit   (17,334,636)   (13,809,502)
Total stockholders' equity   17,352,399    20,679,306 
Total liabilities and stockholders' equity  $28,671,619   $33,362,328 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

1
 

THE JOINT CORP. AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

 

   Three Months Ended
March 31,
   2016  2015
Revenues:          
Royalty fees  $1,368,831   $1,015,513 
Franchise fees   514,800    348,000 
Revenues and management fees from company clinics   1,658,553    387,453 
Advertising fund revenue   265,721    285,516 
IT related income and software fees   221,134    203,975 
Regional developer fees   147,537    217,500 
Other revenues   88,460    49,941 
Total revenues   4,265,036    2,507,898 
Cost of revenues:          
Franchise cost of revenues   694,735    507,566 
IT cost of revenues   45,228    37,695 
Total cost of revenues   739,963    545,261 
Selling and marketing expenses   738,683    967,024 
Depreciation and amortization   575,544    122,596 
General and administrative expenses   5,696,507    2,788,240 
Total selling, general and administrative expenses   7,010,734    3,877,860 
Loss from operations   (3,485,661)   (1,915,223)
           
Other income, net   4,924    11,500 
           
Loss before income tax expense   (3,480,737)   (1,903,723)
           
Income tax expense   (44,397)   - 
           
Net loss and comprehensive loss  $(3,525,134)  $(1,903,723)
           
Loss per share:          
Basic and diluted loss per share  $(0.28)  $(0.20)
           
Basic and diluted weighted average shares   12,567,901    9,662,502 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

2
 

THE JOINT CORP. AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

 

   Three Months Ended
March 31,
   2016  2015
Cash flows from operating activities:          
Net loss  $(3,525,134)  $(1,903,723)
Adjustments to reconcile net loss to net cash used in operating activities:          
Provision for bad debts   -    847 
Regional developer fees recognized upon acquisition of development rights   -    (159,500)
Net franchise fees recognized upon termination of franchise agreements   (41,100)   - 
Depreciation and amortization   575,544    122,596 
Gain on sale of property and equipment   -    (11,500)
Stock based compensation expense   197,669    132,287 
Changes in operating assets and liabilities, net of effects from acquisitions:          
Restricted cash   (71,985)   (113,985)
Accounts receivable   (902,190)   (71,611)
Income taxes receivable   32,021    - 
Prepaid expenses and other current assets   (78,997)   295,599 
Deferred franchise costs   121,602    74,550 
Deposits and other assets   (3,339)   (8,401)
Accounts payable   (1,229,146)   (16,876)
Accrued expenses   (234,291)   321,085 
Co-op funds liability   (96,546)   111,957 
Payroll liabilities   (829,933)   9,523 
Other liabilities   9,790    (12,117)
Deferred rent   628,181    (14,794)
Deferred revenue   (311,874)   (98,998)
Net cash used in operating activities   (5,759,728)   (1,343,061)
           
Cash flows from investing activities:          
Cash paid for acquisitions   -    (1,830,000)
Reacquisition and termination of regional developer rights   (275,000)   (545,000)
Purchase of property and equipment   (287,942)   (14,021)
Proceeds received on sale of property and equipment   -    11,500 
Payments received on notes receivable   17,258    6,729 
Net cash used in investing activities   (545,684)   (2,370,792)
           
Cash flows from financing activities:          
Issuance of common stock, offering costs adjustment   (1,042)   - 
Proceeds from exercise of stock options   1,600    - 
Repayments on notes payable   (120,500)   - 
Net cash used in financing activities   (119,942)   - 
           
Net decrease in cash   (6,425,354)   (3,713,853)
Cash at beginning of period   16,792,850    20,796,783 
Cash at end of period  $10,367,496   $17,082,930 

 

3
 

Supplemental disclosure of cash flow information:

 

During the three months ended March 31, 2016 and 2015, cash paid for income taxes was $3,625 and $0, respectively. During the three months ended March 31, 2016 and 2015, cash paid for interest was $2,648 and $0, respectively.

 

Supplemental disclosure of non-cash activity:

 

As of March 31, 2016, we had property and equipment purchases of $796,581 and $147,186 which were included in accounts payable and accrued expenses, respectively.

 

In connection with our reacquisition and termination of regional developer rights during the three months ended March 31, 2016 and 2015, we had deferred revenue of $36,250 and $572,750, respectively, representing license fees collected upon the execution of the regional developer agreements.  We netted these amounts against the aggregate purchase price of the acquisitions (Note 5).

 

In connection with our acquisitions of franchises during the three months ended March 31, 2015, we acquired $525,000 of property and equipment, intangible assets of $329,000 and assumed deferred revenue associated with membership packages paid in advance of $104,936 in exchange for $1,830,000 in cash and notes payable issued to the sellers for an aggregate amount of $255,000. Additionally, at the time of these transactions, we carried deferred revenue of $348,000, representing franchise fees collected upon the execution of franchise agreements, and deferred costs of $155,900, related to our acquisition of undeveloped franchises. We netted these amounts against the aggregate purchase price of the acquisitions (Note 2).

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

4
 

THE JOINT CORP. AND SUBSIDIARY

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Note 1:      Nature of Operations and Summary of Significant Accounting Policies

 

Basis of Presentation

 

These unaudited financial statements represent the condensed consolidated financial statements of The Joint Corp. and its wholly owned subsidiary The Joint Corporate Unit No. 1, LLC (collectively, the “Company”). These unaudited condensed consolidated financial statements should be read in conjunction with The Joint Corp. and Subsidiary consolidated financial statements and the notes thereto as set forth in The Joint Corp.’s Form 10-K, which included all disclosures required by generally accepted accounting principles. In the opinion of management, these unaudited condensed consolidated financial statements contain all adjustments necessary to present fairly our financial position on a consolidated basis and the consolidated results of operations and cash flows for the interim periods presented. The results of operations for the periods ended March 31, 2016 and 2015 are not necessarily indicative of expected operating results for the full year. The information presented throughout the document as of and for the periods ended March 31, 2016 and 2015 is unaudited.

 

Principles of Consolidation

 

The accompanying condensed consolidated financial statements include the accounts of The Joint Corp. and its wholly owned subsidiary, The Joint Corporate Unit No. 1, LLC, which was dormant for all periods presented.

 

All significant intercompany accounts and transactions between The Joint Corp. and its subsidiary have been eliminated in consolidation.

 

Comprehensive Loss

 

Net loss and comprehensive loss are the same for the three months ended March 31, 2016 and 2015.

 

Nature of Operations

 

The Joint Corp. (“The Joint”), a Delaware corporation, was formed on March 10, 2010 for the principal purpose of franchising chiropractic clinics, selling regional developer rights and supporting the operations of franchised chiropractic clinics at locations throughout the United States of America. The franchising of chiropractic clinics is regulated by the Federal Trade Commission and various state authorities.

 

The following table summarizes the number of clinics in operation under franchise agreements for the three months ended March 31, 2016 and 2015:

 

5
 

   Three Months Ended
March 31,
Franchised clinics:  2016  2015
Clinics open at beginning of period   265    242 
Opened during the period   14    13 
Acquired during the period   -    (10)
Closed during the period   (2)   (4)
Clinics in operation at the end of the period   277    241 

 

   Three Months Ended
March 31,
Company-owned or managed clinics:  2016  2015
Clinics open at beginning of period   47    4 
Opened during the period   7    - 
Acquired during the period   -    10 
Closed during the period   -    (2)
Clinics in operation at the end of the period   54    12 
           
Total clinics in operation at the end of the period   331    253 
           
Clinics licenses sold but not yet developed   146    254 

 

Variable Interest Entities

 

An entity deemed to hold the controlling interest in a voting interest entity or deemed to be the primary beneficiary of a variable interest entity (“VIE”) is required to consolidate the VIE in its financial statements. An entity is deemed to be the primary beneficiary of a VIE if it has both of the following characteristics: (a) the power to direct the activities of a VIE that most significantly impact the VIE's economic performance and (b) the obligation to absorb the majority of losses of the VIE or the right to receive the majority of benefits from the VIE. Investments where the Company does not hold the controlling interest and are not the primary beneficiary are accounted for under the equity method.

 

Certain states in which the Company manages clinics regulate the practice of chiropractic care and require that chiropractic services be provided by legal entities organized under state laws as professional corporations or PCs. Such PCs are VIEs. In these states, the Company has entered into management services agreements with PCs under which the Company provides, on an exclusive basis, all non-clinical services of the chiropractic practice.  The Company has analyzed its relationship with the PCs and has determined that the Company does not have the power to direct the activities of the PCs. As such, the activity of the PCs is not included in the Company’s condensed consolidated financial statements

 

Cash and Cash Equivalents

 

The Company considers all highly liquid instruments purchased with an original maturity of three months or less to be cash equivalents. The Company continually monitors its positions with, and credit quality of, the financial institutions with which it invests. As of the balance sheet date and periodically throughout the period, the Company has maintained balances in various operating accounts in excess of federally insured limits. The Company has invested substantially all of its cash in short-term bank deposits. The Company had no cash equivalents as of March 31, 2016 and December 31, 2015.

 

Restricted Cash

 

Restricted cash relates to cash franchisees and corporate clinics contribute to the Company’s National Marketing Fund and cash franchisees provide to various voluntary regional Co-Op Marketing Funds. Cash contributed by franchisees to the National Marketing Fund is to be used in accordance with the Company’s Franchise Disclosure Document with a focus on regional and national marketing and advertising.

 

6
 

Concentrations of Credit Risk

 

From time to time, the Company grants credit in the normal course of business to franchisees related to the collection of royalties, and other operating revenues. The Company periodically performs credit analysis and monitors the financial condition of the franchisees to reduce credit risk. As of March 31, 2016 and December 31, 2015, three PC entities and six franchisees represented 36% and 31%, respectively, of outstanding accounts receivable. The Company did not have any customers that represented greater than 10% of its revenues during the three months ended March 31, 2016 and 2015.

 

Accounts Receivable

 

Accounts receivable represent amounts due from franchisees for initial franchise fees, royalty fees, marketing and advertising expenses, working capital advances due from PCs, and tenant improvement allowances due from landlords. The Company considers a reserve for doubtful accounts based on the creditworthiness of the entity. The provision for uncollectible amounts is continually reviewed and adjusted to maintain the allowance at a level considered adequate to cover future losses. The allowance is management’s best estimate of uncollectible amounts and is determined based on specific identification and historical performance that the Company tracks on an ongoing basis. The losses ultimately could differ materially in the near term from the amounts estimated in determining the allowance. As of March 31, 2016 and December 31, 2015, the Company had an allowance for doubtful accounts of $142,661.

 

Deferred Franchise Costs

 

Deferred franchise costs represent commissions that are paid in conjunction with the sale of a franchise and are expensed when the respective revenue is recognized, which is generally upon the opening of a clinic.

 

Property and Equipment

 

Property and equipment are stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of three to seven years. Leasehold improvements are amortized using the straight-line method over the shorter of the lease term or the estimated useful life of the assets.

 

Maintenance and repairs are charged to expense as incurred; major renewals and improvements are capitalized. When items of property or equipment are sold or retired, the related cost and accumulated depreciation are removed from the accounts and any gain or loss is included in income.

 

Software Developed

 

The Company capitalizes certain software development costs. These capitalized costs are primarily related to proprietary software used by clinics for operations and by the Company for the management of operations. Costs incurred in the preliminary stages of development are expensed as incurred. Once an application has reached the development stage, internal and external costs, if direct, are capitalized as assets in progress until the software is substantially complete and ready for its intended use. Capitalization ceases upon completion of all substantial testing. The Company also capitalizes costs related to specific upgrades and enhancements when it is probable the expenditures will result in additional functionality. Software developed is recorded as part of property and equipment. Maintenance and training costs are expensed as incurred. Internal use software is amortized on a straight line basis over its estimated useful life, generally five years.

 

Intangible Assets

 

Intangible assets consist primarily of re-acquired franchise and regional developer rights and customer relationships.  The Company amortizes the fair value of re-acquired franchise rights over the remaining contractual terms of the re-acquired franchise rights at the time of the acquisition, which range from six to eight years. In the case of regional developer rights the Company amortizes the acquired regional developer rights over seven years. The fair value of customer relationships is amortized over their estimated useful life of two years.

 

7
 

Goodwill

 

Goodwill consists of the excess of the purchase price over the fair value of tangible and identifiable intangible assets acquired in the acquisitions discussed in Note 2.  Goodwill and intangible assets deemed to have indefinite lives are not amortized but are subject to annual impairment tests. As required, the Company performs an annual impairment test of goodwill as of the first day of the fourth quarter or more frequently if events or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. No impairments of goodwill were recorded for the three months ended March 31, 2016 and 2015.

 

Long-Lived Assets

 

The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recovered. The Company looks primarily to estimated undiscounted future cash flows in its assessment of whether or not long-lived assets have been impaired. No impairments of long-lived assets were recorded for the three months ended March 31, 2016 and 2015.

 

Advertising Fund

 

The Company has established an advertising fund for national/regional marketing and advertising of services offered by its clinics. The monthly marketing fee was increased to 2% in January 2015. The Company segregates the marketing funds collected which are included in restricted cash on its consolidated balance sheets. As amounts are expended from the fund, the Company recognizes advertising fund revenue and a related expense. Amounts collected in excess of marketing expenditures are included in restricted cash on the Company’s condensed consolidated balance sheets. 

 

Co-Op Marketing Funds

 

Some franchises have established regional Co-Ops for advertising within their local and regional markets. The Company maintains a custodial relationship under which the marketing funds collected are segregated and used for the purposes specified by the Co-Ops’ officers. The marketing funds are included in restricted cash on the Company’s condensed consolidated balance sheets.

 

Deferred Rent

 

The Company leases office space for its corporate offices and company-owned and managed clinics under operating leases, which may include rent holidays and rent escalation clauses.  It recognizes rent holiday periods and scheduled rent increases on a straight-line basis over the term of the lease.  The Company records tenant improvement allowances as deferred rent and amortizes the allowance over the term of the lease, as a reduction to rent expense.

 

Revenue Recognition

 

The Company generates revenue through initial franchise fees, regional developer fees, royalties, advertising fund revenue, IT related income, and computer software fees, and from its company-owned and managed clinics.

 

Franchise Fees. The Company requires the entire non-refundable initial franchise fee to be paid upon execution of a franchise agreement, which typically has an initial term of ten years. Initial franchise fees are recognized as revenue when the Company has substantially completed its initial services under the franchise agreement, which typically occurs upon opening of the clinic.  The Company’s services under the franchise agreement include: training of franchisees and staff, site selection, construction/vendor management and ongoing operations support. The Company provides no financing to franchisees and offers no guarantees on their behalf.

 

8
 

Regional Developer Fees. During 2011, the Company established a regional developer program to engage independent contractors to assist in developing specified geographical regions. Under this program, regional developers pay a license fee ranging from $7,250 to 25% of the then current franchise fee for each franchise they receive the right to develop within the region. Each regional developer agreement establishes a minimum number of franchises that the regional developer must develop. Regional developers receive fees ranging from $14,500 to $19,950, which are collected upon the sale of franchises within their region, and a royalty of 3% of sales generated by franchised clinics in their region. Regional developer license fees are non-refundable and are recognized as revenue when the Company has performed substantially all initial services required by the regional developer agreement, which generally is considered to be upon the opening of each franchised clinic. Upon the execution of a regional developer agreement, the Company estimates the number of franchised clinics to be opened, which is typically consistent with the contracted minimum. When the Company anticipates that the number of franchised clinics to be opened will exceed the contracted minimum, the license fee on a per-clinic basis is determined by dividing the total fee collected from the regional developer by the revised number of clinics expected to be opened within the region. Certain regional developer agreements provide that no additional fee is required for franchises developed by the regional developer above the contracted minimum, while other regional developer agreements require a supplemental payment. The Company reassesses the number of clinics expected to be opened as the regional developer performs under its regional developer agreement. When a material change to the original estimate becomes apparent, the fee per clinic is revised on a prospective basis, and the unrecognized fees are allocated among, and recognized as revenue upon the opening of, the expected remaining unopened franchised clinics within the region. The regional developer’s services under regional developer agreements include site selection, grand opening support for the clinics, sales support for identification of qualified franchisees, general operational support and marketing support to advertise for ownership opportunities. Several of the regional developer agreements grant the Company the option to repurchase the regional developer’s license.

 

Revenues and Management Fees from Company Clinics.  The Company earns revenues from clinics that it owns and operates or manages throughout the United States.  In those states where the Company owns and operates the clinic, revenues are recognized when services are performed. The Company offers a variety of membership and wellness packages which feature discounted pricing as compared with its single-visit pricing.  Amounts collected in advance for membership and wellness packages are recorded as deferred revenue and recognized when the service is performed.  In other states where state law requires the chiropractic practice to be owned by a licensed chiropractor, the Company enters into a management agreement with the doctor’s PC.  Under the management agreement, the Company provides administrative and business management services to the doctor’s PC in return for a monthly management fee.  When the collectability of the full management fee is uncertain, the Company recognizes management fee revenue only to the extent of fees expected to be collected from the PCs.

 

Royalties.  The Company collects royalties, as stipulated in the franchise agreement, equal to 7% of gross sales, and a marketing and advertising fee currently equal to 2% of gross sales. Certain franchisees with franchise agreements acquired during the formation of the Company pay a monthly flat fee. Royalties are recognized as revenue when earned. Royalties are collected bi-monthly two working days after each sales period has ended.

 

IT Related Income and Software Fees.  The Company collects a monthly computer software fee for use of its proprietary chiropractic software, computer support, and internet services support. These fees are recognized on a monthly basis as services are provided. IT related revenue represents a flat fee to purchase a clinic’s computer equipment, operating software, preinstalled chiropractic system software, key card scanner (patient identification card), credit card scanner and credit card receipt printer. These fees are recognized as revenue upon receipt of equipment by the franchisee.

 

Advertising Costs

 

The Company incurs advertising costs in addition to those included in the advertising fund. The Company’s policy is to expense all operating advertising costs as incurred. Advertising expenses were $422,098 and $268,506 for three months ended March 31, 2016 and 2015, respectively.

 

9
 

Income Taxes

 

The Company accounts for income taxes in accordance with ASC 740 that requires the recognition of deferred income taxes for differences between the basis of assets and liabilities for financial statement and income tax purposes. The differences relate principally to depreciation of property and equipment and treatment of revenue for franchise fees and regional developer fees collected. Deferred tax assets and liabilities represent the future tax consequence for those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. Deferred taxes are also recognized for operating losses that are available to offset future taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.

 

The Company accounts for uncertainty in income taxes by recognizing the tax benefit or expense from an uncertain tax position only if it is more likely than not that the tax position will be sustained upon examination by the taxing authorities, based on the technical merits of the position. The Company measures the tax benefits and expenses recognized in the condensed consolidated financial statements from such a position based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate resolution.

 

At March 31, 2016 and December 31, 2015, the Company maintained a liability for income taxes for uncertain tax positions of approximately $49,300 and $66,000, respectively, of which $32,000 and $33,000, respectively, represent penalties and interest and are recorded in the  “other liabilities” section of the accompanying condensed consolidated balance sheets. Interest and penalties associated with tax positions are recorded in the period assessed as general and administrative expenses. The Company’s tax returns for tax years subject to examination by tax authorities include 2011 through the current period for state and 2012 through the current period for federal reporting purposes.

 

Loss per Common Share

 

Basic loss per common share is computed by dividing the net loss by the weighted-average number of common shares outstanding during the period. Diluted loss per common share is computed by giving effect to all potentially dilutive common shares including preferred stock, restricted stock, and stock options.

 

   Three Months Ended
March 31,
   2016  2015
       
Net loss  $(3,525,134)  $(1,903,723)
           
Weighted average common shares outstanding - basic   12,567,901    9,662,502 
Effect of dilutive securities:          
Stock options   -    - 
Weighted average common shares outstanding - diluted   12,567,901    9,662,502 
           
Basic and diluted loss per share  $(0.28)  $(0.20)

 

The following table summarizes the potential shares of common stock that were excluded from diluted net loss per share, because the effect of including these potential shares was anti-dilutive:

 

   Three Months Ended
March 31,
   2016  2015
Unvested restricted stock   292,466    522,356 
Stock options   768,625    366,995 
Warrants   90,000    90,000 

 

10
 

Stock-Based Compensation

 

The Company accounts for share based payments by recognizing compensation expense based upon the estimated fair value of the awards on the date of grant. The Company determines the estimated grant-date fair value of restricted shares using quoted market prices and the grant-date fair value of stock options using the Black-Scholes option pricing model. In order to calculate the fair value of the options, certain assumptions are made regarding the components of the model, including the estimated fair value of underlying common stock, risk-free interest rate, volatility, expected dividend yield and expected option life. Prior to the IPO, the grant date fair value was determined by the Board of Directors. Changes to the assumptions could cause significant adjustments to the valuation. The Company recognizes compensation costs ratably over the period of service using the straight-line method.

 

Use of Estimates

 

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Items subject to significant estimates and assumptions include the allowance for doubtful accounts, share-based compensation arrangements, fair value of stock options, useful lives and realizability of long-lived assets, classification of deferred revenue and deferred franchise costs, uncertain tax positions, realizability of deferred tax assets, impairment of goodwill and intangible assets and purchase price allocations.

 

Recent Accounting Pronouncements

 

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers”, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard becomes effective for the Company on January 1, 2018. The Company is evaluating the effect that ASU 2014-09 will have on its consolidated financial statements and related disclosures. The Company has not yet selected a transition method nor has it determined the effect of the standard on its ongoing financial reporting.

 

In August 2014, the FASB issued ASU No. 2014-15, “Presentation of Financial Statements - Going Concern: Disclosures about an Entity’s Ability to Continue as a Going Concern.” The new standard requires management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date the financial statements are issued. An entity must provide certain disclosures if conditions or events raise substantial doubt about the entity’s ability to continue as a going concern. The new guidance is effective for our December 31, 2016 Form 10-K, and interim periods thereafter. The Company does not expect any changes to its consolidated financial position, results of operations and cash flows as a result of adoption of this standard, however, additional disclosures might be required in our financial statements.

 

In January 2016, the FASB issued ASU No. 2016-01, “Financial Instruments - Overall (Subtopic 825-10),” Recognition and Measurement of Financial Assets and Financial Liabilities, which addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. ASU 2016-01 will be effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, and early adoption is not permitted. The Company is currently evaluating the effect of adoption of this standard, if any, on its consolidated financial position, results of operations and cash flows.

 

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842).” The ASU requires that substantially all operating leases be recognized as assets and liabilities on our balance sheet, which is a significant departure from the current standard, which classifies operating leases as off balance sheet transactions and accounts for only the current year operating lease expense in the statement of operations. The right to use the leased property is to be capitalized as an asset and the expected lease payments over the life of the lease will be accounted for as a liability. The effective date is for fiscal years beginning after December 31, 2018. While we have not quantified the impact this proposed standard would have on our financial statements, if our current operating leases are instead recognized on the balance sheet, it will result in a significant increase in the asset and liabilities reflected on our balance sheet and in the interest expense and depreciation and amortization expense reflected in our statement of operations, while reducing the amount of rent expense. This could potentially decrease the Company’s reported net income.

 

11
 

In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation: Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”), which amends ASC Topic 718, Compensation – Stock Compensation (“ASC 718”). The standard is intended to simplify several areas of accounting for share-based compensation arrangements, including the accounting for income taxes, classification of excess tax benefits on the statement of cash flows, forfeitures, statutory tax withholding requirements, classification of awards as either equity or liabilities, and classification of employee taxes paid on the statement of cash flows when an employer withholds shares for tax-withholding purposes. ASU 2016-09 is effective for our interim and annual reporting periods beginning January 1, 2017. Early adoption is permitted. The Company is currently evaluating the method of adoption and impact the update will have on its consolidated financial statements and related disclosures.

 

Note 2:      Acquisitions

 

Franchises acquired during 2015

 

During the year ended December 31, 2015, the Company continued to execute its growth strategy and entered into a series of unrelated transactions with existing franchisees to re-acquire an aggregate of 24 developed and 35 undeveloped franchises throughout Arizona, California, and New York for an aggregate purchase price of $5,725,875, subject to certain adjustments, consisting of cash of $4,925,525 and notes payable of $800,350. Of the 24 developed franchises, the Company is operating 22 as company-owned or managed clinics and has closed the remaining two clinics. The 35 undeveloped franchises have been terminated and the Company may relocate them. At the time these transactions were consummated, the Company carried a deferred revenue balance of $1,005,500, representing franchise fees collected upon the execution of the franchise agreements, and deferred franchise costs of $493,500, related to undeveloped franchises.  The Company accounted for the franchise rights associated with the undeveloped franchises as a cancellation, and the respective deferred revenue and deferred franchise costs were netted against the aggregate purchase price.  The remaining $5,213,875 was accounted for as consideration paid for the acquired franchises.

 

Additionally, in January 2015, in connection with the default by a franchisee under its franchise agreement, the Company assumed substantially all of the assets of a clinic in Tempe, Arizona in exchange for $25,000.  The Company has accounted for this as a business combination.  The Company completed its valuation of the fair value of the assets acquired, including intangible assets, in September 2015. Because the net assets acquired exceeded the consideration paid, the Company recognized a bargain purchase gain of $233,804 during the year ended December 31, 2015.

 

The Company also recognized a bargain purchase gain of $27,343 related to the acquisition of two developed franchises and seven undeveloped franchises in San Diego, California. Total bargain purchase gain for the year ended December 31, 2015 was $261,147.

 

The Company incurred $393,069 of transaction costs related to these acquisitions for the year ended December 31, 2015 which are included in general and administrative expenses in the accompanying statements of operations.

 

Purchase Price Allocation

 

The purchase price allocations for these acquisitions are complete with the exception of the acquisition completed on December 29, 2015. For that transaction the balances are preliminary and subject to further adjustment upon finalization of the opening balance sheet. The following summarizes the aggregate fair values of the assets acquired and liabilities assumed during 2015 as of the acquisition date:

 

Property and equipment  $1,504,169 
Intangible assets   1,942,180 
Favorable leases   521,825 
Goodwill   1,830,833 
Total assets acquired   5,799,007 
Unfavorable leases   (49,077)
Deferred membership revenue   (106,908)
Net assets acquired   5,643,022 
Deferred tax liability   (168,000)
Bargain purchase gain   (261,147)
Net purchase price  $5,213,875 

 

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Intangible assets in the table above consist of reacquired franchise rights of $1,458,667 and customer relationships of $483,513, and will be amortized over their estimated useful lives ranging from six to eight years and two years, respectively.

 

Goodwill recorded in connection with these acquisitions was attributable to the workforce of the clinics and synergies expected to arise from cost savings opportunities. All of the recorded goodwill is tax-deductible. 

 

Pro Forma Results of Operations (Unaudited)

 

The following table summarizes selected unaudited pro forma condensed consolidated statements of operations data for the three months ended March 31, 2016 and 2015 as if the acquisitions had been completed on January 1, 2015.

 

   Pro Forma for the Three Months Ended March 31,
   2016  2015
Revenues, net  $-   $3,287,078 
Net loss  $-  $(2,208,422)

 

This selected unaudited pro forma consolidated financial data is included only for the purpose of illustration and does not necessarily indicate what the operating results would have been if the acquisitions had been completed on that date. Moreover, this information is not indicative of what the Company’s future operating results will be. The information for 2015 and 2016 prior to the acquisitions is included based on prior accounting records maintained by the acquired companies. In some cases, accounting policies differed materially from accounting policies adopted by the Company following the acquisitions. For 2016, this information includes actual data recorded in its financial statements for the period subsequent to the date of the acquisitions. The Company’s consolidated statement of operations for the three months ended March 31, 2015 includes net revenue and net income of approximately $387,000 and $4,000, respectively, attributable to the 2015 acquisitions.

 

The pro forma amounts included in the table above reflect the application of accounting policies and adjustment of the results of the clinics to reflect the additional depreciation and amortization that would have been charged assuming the fair value adjustments to property and equipment and intangible assets had been applied from January 1, 2015, together with the consequential tax impacts.

 

Note 3:      Notes Receivable

 

Effective July 2012, the Company sold a company-owned clinic, including the license agreement, equipment, and customer base, in exchange for a $90,000 unsecured promissory note. The note bears interest at 6% per annum for fifty-four months and requires monthly principal and interest payments over forty-two months, beginning August 2013 and maturing January 2017.

 

Effective July 2015, the Company entered into two license transfer agreements, in exchange for $10,000 and $29,925 in separate unsecured promissory notes.  The non-interest bearing notes require monthly principal payments over 24 months, beginning on September 1, 2015 and maturing on August 1, 2017.

 

Effective July 2015, the Company entered into a license transfer agreement, in exchange for $29,925 in an unsecured promissory note.  The note bears interest at 4.0% per annum, and requires monthly principal payments over 12 months, beginning on August 1, 2015 and maturing on July 1, 2016.

 

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The outstanding balance of the notes as of March 31, 2016 and December 31, 2015 were $59,473 and $76,731, respectively.

 

Note 4:     Property and Equipment

 

Property and equipment consists of the following:

 

   March 31,  December 31,
   2016  2015
           
Office and computer equipment  $1,097,836   $963,299 
Leasehold improvements   7,121,020    4,672,582 
Software developed   693,385    691,827 
    8,912,241    6,327,708 
Accumulated depreciation   (1,500,305)   (1,098,438)
    7,411,936    5,229,270 
Construction in progress   556,652    1,909,476 
   $7,968,588   $7,138,746 

 

Depreciation expense was $401,867 and $85,929 for the three months ended March 31, 2016 and 2015, respectively.

 

Note 5:      Intangible Assets

 

On January 1, 2016, the Company entered into an agreement under which it repurchased the regional development rights to develop franchises in San Bernardino and Riverside Counties in California. The total consideration for the transaction was $275,000, paid in cash. The Company carried a deferred revenue balance associated with these transactions of $36,250, representing license fees collected upon the execution of the regional developer agreements.  The Company accounted for the development rights associated with the unsold or undeveloped franchises as a cancellation, and the respective deferred revenue was netted against the aggregate purchase price or recognized as revenue to the extent deferred revenue was in excess of the cash consideration paid.  

 

Intangible assets consist of the following:

 

   As of March 31, 2016
 
 
 
 
Gross Carrying
Amount
 
 
Accumulated
Amortization
 
 
Net Carrying
Value
Amortized intangible assets:               
Reacquired franchise rights  $1,539,667   $237,050   $1,302,617 
Customer relationships   555,512    259,939    295,573 
Reacquired development rights   1,162,000    152,848    1,009,152 
   $3,257,179   $649,837   $2,607,342 
                
Unamortized intangible assets:               
Goodwill             2,466,937 
Total intangible assets            $5,074,279 

 

Amortization expense was $173,677 and $36,667 for the three months ended March 31, 2016 and 2015, respectively.

 

14
 

Estimated amortization expense for 2016 and subsequent years is as follows:

 

2016 (remaining)  $521,027 
2017   504,203 
2018   385,113 
2019   385,113 
2020   385,113 
Thereafter   426,773 
Total  $2,607,342 

 

Note 6:     Notes Payable

 

During, 2015, the Company delivered 12 notes payable totaling $800,350 as a portion of the consideration paid in connection with the Company’s various acquisitions. Interest rates range from 1.5% to 5.25% with maturities through February of 2017. Repayments during the three months ended March 31, 2016 totaled $120,500.

 

Maturities of our notes payable are as follows as of March 31, 2016:

 

2016  $331,350 
2017   130,000 
Total  $461,350 

 

Note 7:     Equity

 

Public Offerings of Common Stock

 

The Company completed its initial public offering (“IPO”) of 3,000,000 shares of common stock at a price to the public of $6.50 per share on November 14, 2014, whereupon it received aggregate net proceeds of approximately $17,065,000 after deducting underwriting discounts, commissions and other offering expenses. The Company’s underwriters exercised their option to purchase 450,000 additional shares of common stock to cover over-allotments on November 18, 2014, pursuant to which it received aggregate net proceeds of approximately $2,710,000, after deducting underwriting discounts, commissions and expenses.  Also, in conjunction with the IPO, the Company issued warrants to the underwriters for the purchase of 90,000 shares of common stock, which can be exercised between November 10, 2015 and November 10, 2018 at an exercise price of $8.125 per share.

 

On November 25, 2015 the Company closed its follow-on offering of 2,272,727 shares of common stock, at a price to the public of $5.50 per share. On December 30, 2015 the Company’s underwriters exercised their over-allotment option to purchase an additional 340,909 shares of common stock at a public offering price of $5.50 per share After giving effect to the exercise of the over-alllotment option, the total number of shares offered and sold in the Company’s follow-on public offering increased to 2,613,636 shares. With the exercise of the over-allotment option, the Company received aggregate net proceeds of approximately $13.0 million.

 

Stock Options

 

In the three months ended March 31, 2016, the Company granted 295,000 stock options to employees and certain non-employee members of its board of directors with exercise prices ranging from $3.07 - $4.11.

 

15
 

The fair value of the Company’s common stock prior to its IPO was estimated by the Board of Directors at or about the time of grant for each share-based award. At each grant, the board considered a number of factors in establishing a value for the Company’s common stock including its EBITDA, assessments of an amount its shareholders would accept in the private sale of the Company, discussions with its investment bankers regarding pricing of the Company’s common stock in an initial public offering and the probability of successfully completing an IPO. Although the methods for determining the fair value of the Company’s common stock are not complex, the board’s estimate of the fair value of the common stock did involve subjectivity, especially assessments of value in a private sale and estimates of value in the public stock market.

 

Upon the completion of the Company’s IPO, its stock trading price became the basis of fair value of its common stock used in determining the value of share based awards. To the extent the value of the Company’s share based awards involves a measure of volatility, it will rely upon the volatilities from publicly traded companies with similar business models until its common stock has accumulated enough trading history for it to utilize its own historical volatility. The expected life of the options granted is based on the average of the vesting term and the contractual term of the option. The risk-free rate for periods within the expected life of the option is based on the U.S. Treasury 10-year yield curve in effect at the date of the grant.

 

The Company has computed the fair value of all options granted during the three months ended March 31, 2016 and 2015, using the following assumptions:

 

    Three Months Ended March 31,
    2016   2015
Expected volatility   44% to 45%     47%  
Expected dividends     None       None  
Expected term (years)     7       6.25 
Risk-free rate   1.50% to 1.68%   1.45% to 1.74%
Forfeiture rate     20%       20%  

 

The information below summarizes the stock options:

 

   Number of
Shares
  Weighted
Average
Exercise
Price
  Weighted
Average
Fair
Value
  Weighted
Average
Remaining
Contractual Life
Outstanding at December 31, 2015   477,459   $4.30   $2.01    8.7 
Granted at market price   295,000    4.09           
Exercised   (1,334)   1.20           
Cancelled   (2,500)   7.81           
Outstanding at March 31, 2016   768,625   $4.21   $1.98    9.1 
Exercisable at March 31, 2016   196,046   $2.85   $1.26    8.1 

 

The intrinsic value of the Company’s stock options outstanding was $453,986 at March 31, 2016.

 

For the three months ended March 31, 2016 and 2015, stock based compensation expense for stock options was $107,506, and $43,529, respectively.   Unrecognized stock-based compensation expense for stock options as of March 31, 2016 was $1,055,308, which is expected to be recognized ratably over the next 3.4 years.

 

Restricted Stock

 

The information below summaries the restricted stock activity:

 

Restricted Stock Awards  Shares
Outstanding  at December 31, 2015   670,375 
Restricted stock awards granted   - 
Awards forfeited or exercised   - 
Outstanding  at March 31, 2016   670,375 

 

16
 

For the three months ended March 31, 2016 and 2015, stock based compensation expense for restricted stock was $90,163, and $88,758, respectively. Unrecognized stock based compensation expense for restricted stock awards as of March 31, 2016 was $700,543 to be recognized ratably over the next 2.3 years.

 

Note 8:      Income Taxes

 

During the three months ended March 31, 2016, the Company recorded income tax expense of approximately $44,000 due to state tax expense as a result of current year state income taxes and a lower estimate of income tax refunds available through net operating loss (NOL) carrybacks.

 

Note 9:      Related Party Transactions

 

The Company entered into consulting and legal agreements with certain common stockholders related to services performed for the operations and transaction related activities of the Company.  Amounts paid to or for the benefit of these stockholders was approximately $110,000 and $209,000 for the three months ended March 31, 2016 and 2015, respectively.

 

Note 10:      Commitments and Contingencies

 

Operating Leases

 

The Company leases its corporate office space and the space for each of the company-owned or managed clinics in the portfolio.

 

Total rent expense for the three months ended March 31, 2016 and 2015 was $752,495 and $118,000, respectively.

 

Future minimum annual lease payments are as follows:

 

2016 (remaining)  $2,161,327 
2017   2,878,355 
2018   2,361,373 
2019   2,069,390 
2020   1,847,278 
Thereafter   8,818,859 
   $20,136,582 

 

Litigation

 

In the normal course of business, the Company is party to litigation from time to time.

 

On July 7, 2015, a group of six franchisees, who formerly owned a total of 8 franchise licenses that were terminated by the Company due to defaults in performance, commenced a collective arbitration proceeding before the American Arbitration Association in San Diego, California. The claimants’ demand for arbitration asserts claims for breach of contract, promissory fraud, negligent misrepresentation, breach of the implied covenant of good faith and fair dealing, wrongful termination of franchise agreements and “wrongful competition” pursuant to unspecified state business practices, unfair competition and franchise statutes. The claimants also seek “a preliminary and permanent injunction prohibiting the Company from seeking to operate corporate clinics within 25 miles of any franchise clinic.” Although commenced in California, the arbitration proceeding has been moved to Arizona, pursuant to the franchise agreements in dispute, which include clauses that make it mandatory for any arbitration proceeding to be conducted in Phoenix, Arizona. The Company has also asserted counterclaims against each of the claimants for unpaid termination fees due to the premature termination of their licenses. In April 2016, one of the franchisee’s claims was voluntarily dismissed, thereby leaving a total of five claimants with a collective total of 16 former licenses remaining as part of the arbitration proceeding. The Company does not believe that any of the claimants’ affirmative claims, either collectively or individually, have any legal merit and intends to vigorously defend the arbitration proceeding.

 

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Note 11:      Segment Reporting

 

An operating segment is defined as a component of an enterprise for which discrete financial information is available and is reviewed regularly by the Chief Operating Decision Maker (“CODM”), to evaluate performance and make operating decisions. We have identified our CODM as the Chief Executive Officer.

 

The Company operates two business segments. The Corporate Clinics segment is comprised of the operating activities of the company-owned or managed clinics. As of March 31, 2016, we operated or managed 54 clinics under this segment. The Franchise Operations segment is comprised of the operating activities of the franchise business unit. As of March 31, 2016, the franchise system consisted of 277 clinics in operation. Corporate is a non-operating segment that develops and implements strategic initiatives and supports our operating segments by centralizing key administrative functions such as finance and treasury, information technology, insurance and risk management, litigation and human resources. Corporate also provides the necessary administrative functions to support the Company as a publicly traded company. A portion of the expenses incurred by Corporate are allocated to the operating segments.

 

The tables below present financial information for our two reportable operating segments (in thousands):

 

   Three Months Ended
March 31,
   2016  2015
Revenues:          
Corporate clinics  $1,659   $387 
Franchise operations   2,606    2,121 
Total revenues  $4,265   $2,508 
           
Segment operating income (loss):          
Corporate clinics  $(1,684)  $4 
Franchise operations   1,067    675 
Total segment operating income (loss)  $(617)  $679 
           
Depreciation and amortization:          
Corporate clinics  $493   $59 
Franchise operations   -    - 
Corporate administration   83    64 
Total depreciation and amortization  $576   $123 
           
Reconciliation of total segment operating income (loss) to consolidated earnings (loss) before income taxes (in thousands):          
Total segment operating income (loss)  $(617)  $679 
Unallocated corporate   (2,869)   (2,594)
Consolidated loss from operations   (3,486)   (1,915)
Other income (expense), net   5    11 
Loss before income tax (expense) benefit  $(3,481)  $(1,904)

 

18
 

   March 31,
2016
  December 31,
2015
Segment assets:      
Corporate clinics  $14,212   $12,426 
Franchise operations   2,428    2,580 
Total segment assets  $16,640   $15,006 
           
Unallocated cash and cash equivalents  $10,825   $17,178 
Unallocated property and equipment   785    802 
Other unallocated assets   422    376 
Total assets  $28,672   $33,362 

 

“Unallocated cash and cash equivalents” relates primarily to corporate cash and cash equivalents, “unallocated property and equipment” relates primarily to corporate fixed assets, and “other unallocated assets” relates primarily to deposits, prepaid and other assets.

 

Note 12:      Subsequent Events

 

On April 29, 2016, the Company entered into an Asset and Franchise Purchase Agreement under which (i) the Company repurchased from the seller three operating franchises in Albuquerque, New Mexico and (ii) the parties terminated a fourth franchise agreement for an undeveloped franchise (together, the “Repurchase Transaction”). The Company intends to operate the operating franchises as Company-owned clinics. The total consideration for the repurchase transaction was $430,000, $344,000 of which was funded with cash, and $86,000 of which was funded with a promissory note.

 

On May 6, 2016, the Company entered into an Asset and Franchise Purchase Agreement under which the Company repurchased from the seller three operating franchises, two of which are located in Riverside County, California and one of which is located in San Bernardino County, California. The Company intends to operate the three franchises to manage three related clinics. The total consideration for the repurchase transaction was $595,000, $ 495,000 of which was paid in cash and $100,000 of which was funded with a promissory note.

 

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

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and related notes included in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and notes thereto as of and for the year ended December 31, 2015 and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in our Annual Report on Form 10-K.

 

Forward-Looking Statements

 

The information in this discussion contains forward-looking statements and information within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, (“the Exchange Act”), which are subject to the “safe harbor” created by those sections. These forward-looking statements include, but are not limited to, statements concerning our strategy, future operations, future financial position, future revenues, projected costs, prospects and plans and objectives of management; and accounting estimates and the impact of new or recently issued accounting pronouncements. The words “anticipates,” “believes,” “estimates,” “expects,” “intends,” “may,” “plans,” “projects,” “will,” “should,” “could,” “predicts,” “potential,” “continue,” “would” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements that we make. The forward-looking statements are applicable only as of the date on which they are made, and we do not assume any obligation to update any forward-looking statements. All forward-looking statements in this Form 10-Q are made based on our current expectations, forecasts, estimates and assumptions, and involve risks, uncertainties and other factors that could cause results or events to differ materially from those expressed in the forward-looking statements. In evaluating these statements, you should specifically consider various factors, uncertainties and risks that could affect our future results or operations as described from time to time in our SEC reports, including those risks outlined under “Risk Factors” which are contained in Item 1A of our Form 10-K for the year ended December 31, 2015. These factors, uncertainties and risks may cause our actual results to differ materially from any forward-looking statement set forth in this Form 10-Q. You should carefully consider these risk and uncertainties and other information contained in the reports we file with or furnish to the SEC before making any investment decision with respect to our securities. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by this cautionary statement. Some of the important factors that could cause our actual results to differ materially from those projected in any forward-looking statements include, but are not limited to, the following:

 

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  we may not be able to successfully implement our growth strategy if we or our franchisees are unable to locate and secure appropriate sites for clinic locations, obtain favorable lease terms, and attract patients to our clinics;

 

  we have limited experience operating company-owned or managed clinics, and we may not be able to duplicate the success of some of our franchisees;

 

  we may not be able to acquire operating clinics from existing franchisees or develop company-owned or managed clinics on attractive terms;

 

  any acquisitions that we make could disrupt our business and harm our financial condition;

 

  we may not be able to continue to sell franchises to qualified franchisees;

 

  we may not be able to identify, recruit and train enough qualified chiropractors to staff our clinics;

 

  new clinics may not be profitable, and we may not be able to maintain or improve revenues and franchise fees from existing franchised clinics;

 

  the chiropractic industry is highly competitive, with many well-established competitors;

 

  recent administrative actions and rulings regarding the corporate practice of medicine and joint employer responsibility may jeopardize our business model;

 

  we may face negative publicity or damage to our reputation, which could arise from concerns expressed by opponents of chiropractic and by chiropractors operating under traditional service models;

 

  legislation and regulations, as well as new medical procedures and techniques could reduce or eliminate our competitive advantages;

 

  we face increased costs as a result of being a public company; and

 

  we have identified material weaknesses in our internal control over financial reporting, and our business and stock price may be adversely affected if we do not adequately address those weaknesses.

 

Additionally, there may be other risks that are otherwise described from time to time in the reports that we file with the Securities and Exchange Commission. Any forward-looking statements in this report should be considered in light of various important factors, including the risks and uncertainties listed above, as well as others.

 

20
 

Overview

 

The principal business of The Joint Corp., a Delaware corporation, is to develop, own, operate, support and manage chiropractic clinics through direct ownership, management arrangements, franchising and the sale of regional developer rights throughout the United States.

 

As used in this Form 10-Q:

 

  · “we,” “us,” and “our” refer to The Joint Corp.

 

  · a “clinic” refers to a chiropractic clinic operating under our “Joint” brand, which may be (i) owned by a franchisee, (ii) owned by a professional corporation or limited liability company and managed by a franchisee; (iii) owned directly by us; or (iv) owned by a professional corporation or limited liability company and managed by us.

 

  · when we identify an “operator” of a clinic, a party that is “operating” a clinic, or a party by whom a clinic is “operated,” we are referring to the party that operates all aspects of the clinic in certain jurisdictions, and to the party that manages all aspects of the clinic other than the practice of chiropractic in certain other jurisdictions.

 

  · when we describe our acquisition or our opening of a clinic, we are referring to our acquisition or opening of the entity that operates all aspects of the clinic in certain jurisdictions, and to our acquisition or opening of the entity that manages aspects of the clinic other than the practice of chiropractic in certain other jurisdictions.

 

We seek to be the leading provider of chiropractic care in the markets we serve and to become the most recognized brand in our industry through the rapid and focused expansion of chiropractic clinics in key markets throughout North America and abroad.

 

Key Performance Measures.  We receive both weekly and monthly performance reports from our company-owned or managed and our franchised clinics which include key performance indicators including gross clinic revenues, total royalty income, number of open clinics and patient office visits. We believe these indicators provide us with useful data with which to measure our performance and to measure our franchisees’ and clinics’ performance.

 

Key Clinic Development Trends.   As of March 31, 2016, we or our franchisees operated 331 clinics. Of the 331 clinics in operation, we now operate 54 as company-owned or managed clinics as of March 31, 2016. Of the 54 company-owned or managed clinics, 28 were constructed and developed by us, and 26 were acquired from franchises.

 

Our future growth strategy will continue to focus on acquiring and developing clinics that are owned and managed by us, and to grow through the sale and development of additional franchises.

 

We also believe that the development timeline to open company-owned or managed clinics can be shorter than the timeline for franchised clinics, which is generally between nine and 14 months. Our estimated development timelines for company-owned or managed clinics is approximately five months. While there may be material variances among franchisees in customer acquisition and compliance with operating standards, these variances can be reduced at company-owned or managed clinics. In addition, we believe that our revenue from company-owned or managed clinics will exceed revenue that would be generated through royalty income from a franchise-only system. The development timeline for franchised clinics applies both to clinics franchised directly with us and for clinics franchised through a regional developer. In addition, our regional developers are required, under their respective regional developer agreements, to obtain franchises and open the minimum number of clinics prescribed in their regional developer agreement within a negotiated time period, which takes into account the number of clinics, as well as the size, geography and demographics pertaining to each relevant region. This negotiated time period may differ among regional developers

 

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We may encounter difficulty in finding suitable locations for our planned company-owned or managed clinics, and our franchisees may encounter difficulty in finding and funding suitable locations for their franchised clinics. In addition, we and our franchisees may not be able to secure the services of chiropractors who share our vision and philosophy regarding the practice of chiropractic and are therefore appropriate candidates to provide services at a Joint clinic. Our ability to take full advantage of advertising and public awareness initiatives will depend on the speed with which we can develop either company-owned or franchised clinics in clusters with sufficient density to justify the use of mass media and other strategic media.

 

Recent Developments

 

On November 25, 2015 we closed on our follow-on public offering of 2,272,727 shares of our common stock, at a price to the public of $5.50 per share. On December 30, 2015 our underwriters exercised their over-allotment option to purchase an additional 340,909 shares of common stock at a public offering price of $5.50 per share. After giving effect to exercise of the over-allotment option exercise, the total number of shares offered and sold in our follow-on public offering increased to 2,613,636 shares. With the exercise of the over-allotment option, we received aggregate net proceeds of approximately $13.0 million.

 

During the three months ended March 31, 2016, we opened seven company-owned or managed clinics and terminated regional developer rights in one territory. As of March 31, 2016 we had 54 company-owned or managed clinics. As part of our company-owned or managed clinic strategy, we may seek to reacquire additional franchises as circumstances permit. We are in process of negotiating lease agreements for additional company-owned or managed clinics which we expect to open later in the year.

 

Development of company-owned or managed clinics is important to our growth strategy, and we have used and will use a significant amount of the proceeds from our securities offerings to pursue this strategy. We believe we can leverage the experience we have gained in supporting our demonstrated franchisee growth and our senior management’s experience in rapidly and effectively growing other well-known high velocity specialty retail concepts to successfully develop and profitably operate or manage company-owned or managed clinics. Since commencing operations as a franchisor of chiropractic clinics, we have gained significant experience in identifying the business systems and practices that are required to profitably operate our clinics, validate our model and demonstrate proof of concept.

 

We believe that we can more effectively apply our business systems and practices to company-owned or managed clinics than in our franchised clinics, as a result, to collect more revenue per clinic than would otherwise be available to us solely through the collection of royalty fees, franchise sales fees, and regional developer fees. We intend to develop company-owned or managed clinics in geographic clusters where we are able to increase efficiencies through a consolidated real estate penetration strategy, leverage aggregated advertisement and marketing, and attain general corporate and administrative operating efficiencies. We believe that our management’s experience in this area readily translates to our business model.

 

During the three months ended March 31, 2016, we terminated 3 franchise licenses that were in default of various obligations under their respective franchise agreements. In conjunction with these terminations, during the three months ended March 31, 2016, we recognized $87,000 of revenue and $45,900 of costs, which were previously deferred.

 

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Factors Affecting Our Performance

 

Our quarterly operating results may fluctuate significantly as a result of a variety of factors, including the timing of new clinic openings, markets in which they are contained and related expenses, general economic conditions, consumer confidence in the economy, consumer preferences, and competitive factors.

 

Significant Accounting Polices and Estimates

  

There were no additional changes in our significant accounting policies and estimates during the three months ended March 31, 2016 from those set forth in “Significant Accounting Policies and Estimates” in our Annual Report on Form 10-K for the year ended December 31, 2015.

 

Results of Operations

 

The following discussion and analysis of our financial results encompasses our consolidated results and results of our two business segments: Corporate Clinics and Franchise Operations.

 

Total Revenues

 

Components of revenues for the three months ended March 31, 2016 as compared to the three months ended March 31, 2015, are as follows:

 

   Three Months Ended      
   March 31,      
   2016  2015  Change from
Prior Year
  Percent Change
from Prior Year
Revenues:                    
Royalty fees  $1,368,831   $1,015,513   $353,318    34.8%
Franchise fees   514,800    348,000    166,800    47.9%
Revenues and management fees from company-owned or managed clinics   1,658,553    387,453    1,271,100    328.1%
Advertising fund revenue   265,721    285,516    (19,795)   (6.9)%
IT related income and software fees   221,134    203,975    17,159    8.4%
Regional developer fees   147,537    217,500    (69,963)   (32.2)%
Other revenues   88,460    49,941    38,519    77.1%
                     
Total revenues  $4,265,036   $2,507,898   $1,757,138    70.1%

 

The reasons for the significant changes in our components of total revenues are as follows:

 

Consolidated Results

 

 

·

Total revenues increased by $1.8 million primarily due to 42 additional Company-owned or managed clinics, and continued expansion and performance of our franchise base.

 

Franchise Operations

 

 

·

Royalty fees have increased due to an increase in the number of franchised clinics in operation during the current quarter along with continued growth of existing clinics.  As of March 31, 2016 and 2015, there were 277 and 241 franchise clinics in operation, respectively.  
 

·

Franchise fees are recognized when a clinic is opened. Franchise fees have increased due to the recognition of $87,000 of revenues from terminated franchise licenses, as well as additional clinic openings during the three months ended March 31, 2016 as compared to the three months ended March 31, 2015. For the three months ended March 31, 2016 and 2015, 14 and 13 new clinics opened respectively.
  · Regional developer fees decreased due to revenue recognition on the termination of regional developer rights during the three months ended March 31, 2015.
 

·

IT related income and software fee and other revenues increased due to an increase in our clinic base as described above.

 

Corporate Clinics

 

 

·

Revenue and management fees from company-owned or managed clinics increased due to the number of company-owned or managed clinics in operation during the current quarter compared to prior year.  As of March 31, 2016 and 2015, there were 54 and 12 company-owned or managed clinics in operation, respectively.

 

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Cost of Revenues

 

   Three Months Ended March 31,  Change from  Percent Change
from Prior Year
   2016  2015  Prior Year  from Prior Year
Cost of Revenues  $739,963   $545,261   $194,702    35.7%

 

The total cost of revenues increased due to increased regional developer royalties of $83,000 triggered by an increase of royalty revenues of approximated 35% during the quarter, regional commissions on franchise license transfers of $55,000, and $45,000 in regional developer commissions recognized in conjunction with franchise license terminations.

 

Selling and Marketing Expenses

 

   Three Months Ended March 31,  Change from  Percent Change
from Prior Year
   2016  2015  Prior Year  from Prior Year
Selling and Marketing Expenses  $738,683   $967,024   $(228,341)   (23.6)%

 

Selling and marketing expenses decreased for the three months ended March 31, 2016, as compared to the three months ended March 31, 2015, due to the timing of national marketing fund expenditures.

 

Depreciation and Amortization Expenses

 

   Three Months Ended March 31,  Change from  Percent Change
from Prior Year
   2016  2015  Prior Year  from Prior Year
Depreciation and Amortization Expenses  $575,544   $122,596   $452,948    369.5%

 

Depreciation and amortization expenses increased for the three months ended March 31, 2016 as compared to the three months ended March 31, 2015, primarily due to property and equipment additions of $1,231,709 relating to the development of our greenfield clinics and intangible asset additions of $275,000 relating to our acquisitions of franchises and regional developer rights.

 

General and Administrative Expenses

 

   Three Months Ended March 31,  Change from  Percent Change
from Prior Year
   2016  2015  Prior Year  from Prior Year
General and Administrative Expenses  $5,696,507   $2,788,240   $2,908,267    104.3%

 

General and administrative expenses increased during the three months ended March 31, 2016 compared to the three months ended March 31, 2015, primarily due to the following:

 

 

·

An increase of approximately $1.4 million of payroll related expense of which $1.2 million relates to additional headcount from 42 additional company-owned or managed clinics.
 

·

An increase of approximately $0.9 million in occupancy costs due to the acquisition and development of additional company-owned or managed clinics.
 

·

An increase of approximately $0.3 million in other miscellaneous unallocated expenses.

 

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Profit (Loss) from Operations

 

    Three Months Ended March 31,   Change from   Percent Change
    2016   2015   Prior Year   from Prior Year
Loss from Operations   $ (3,485,661)     $ (1,915,223)     $ (1,570,438)       82.0 %

 

Consolidated Results

 

Consolidated loss from operations increased by $1.6 million primarily driven by the $1.7 million loss in the corporate clinic segment.

 

Franchise Operations

 

Our franchise operations segment had net income from operations of $1.1 million for the three months ended March 31, 2016, an increase of $0.4 million, compared to net income from operations of $0.7 million for the same period ended March 31, 2015. This increase was primarily driven by:

 

  · An increase of approximately $0.5 million in franchise related revenues, driven by an approximate 35% increase in royalty revenues, offset by a decrease in regional developer fees due to the termination of regional developer rights during the three months ended March 31, 2015.
  · An increase in $0.1 million of operating expenses, primarily driven by an increase in franchise support headcount to manage our national expansion, offset by decrease in national marketing fund expenses due to timing of marketing expenditures.

 

Corporate Clinics

 

Our corporate clinics segment had loss from operations of $1.7 million for the three months ended March 31, 2016, and increase of $1.7 million compared to near breakeven results for the same period ended March 31, 2015. This increase was primarily driven by:

 

  · An increase of approximately $1.2 million of payroll related expense due to increased headcount from 42 additional company-owned or managed clinics.
  · An increase of approximately $0.9 million in occupancy costs due to the acquisition and development of additional company-owned or managed clinics.
  · An increase of approximately $0.4 million in depreciation and amortization related to the development and acquisition of 54 company-owned or managed clinics.
  · An increase in revenues of approximately $1.3 million from company-owned or managed clinics.

 

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Income Tax Expense

 

   Three Months Ended March 31,  Change from  Percent Change
from Prior Year
   2016  2015  Prior Year  from Prior Year
Income Tax Expense  $(44,397)  $-   $(44,397)   N/A 

 

Changes in our income tax expense related primarily to state income tax and valuation allowance. For the three months ended March 31, 2016, and 2015 the effective rate was 1.27% and 0%, respectively.  The difference is due to state income taxes relating to Voluntary Disclosure Agreements (“VDAs”) with various taxing jurisdictions as well as adjustment to expected federal income tax refunds.

 

Liquidity and Capital Resources

 

Sources of Liquidity

 

Since 2012, we have financed our business primarily through existing cash on hand and cash flows from operations until 2014 when we completed an initial public offering.

 

On November 14, 2014, we closed on our initial public offering (“IPO”) of 3,000,000 shares of common stock at a price to the public of $6.50 per share. As a result of the IPO, we received aggregate net proceeds, after deducting underwriting discounts, commissions and other offering expenses, of approximately $17,065,000.  On November 18, 2014, our underwriters exercised their option to purchase 450,000 additional shares of common stock to cover over-allotments, pursuant to which we received aggregate net proceeds of approximately $2,710,000, after deducting underwriting discounts, commissions and expenses.

 

On November 25, 2015 we closed on our follow-on public offering of 2,272,727 shares of our common stock at a price to the public of $5.50 per share. We granted the underwriters a 45-day option to purchase up to 340,909 additional shares of common stock to cover over-allotments, if any. On December 30, 2015 our underwriters exercised their over-allotment option to purchase an additional 340,909 shares of common stock at a public offering price of $5.50 per share. After giving effect to the exercise of the over-allotment option, the total number of shares offered and sold in our follow-on public offering increased to 2,613,636 shares. With the exercise of the over-allotment option, we received aggregate net proceeds of approximately $13.0 million.

 

We intend to use a significant amount of the net proceeds from our public offerings for the development of company-owned clinics.  We may accomplish this by developing new clinics, by repurchasing existing franchises or by acquiring existing chiropractic practices. In addition, we may use proceeds from our offerings to repurchase existing regional developer licenses.  Other than to pursue this growth strategy, we have not allocated a specific amount of our net proceeds from our public offerings to any particular purpose. The net proceeds we actually expend for the development of company-owned clinics and the acquisition of additional franchises or regional developer licenses may vary significantly depending on a number of factors, including the timing of our identification and leasing of suitable sites for company-owned clinics and, in respect of the acquisition of franchises or regional developer licenses, our ability to enter into a binding acquisition agreement on favorable terms and the negotiated purchase price. In addition, the net proceeds we actually expend for general corporate purposes may vary significantly depending on a number of factors, including future revenue growth and our cash flows. As a result, we will retain broad discretion over the allocation of the net proceeds from our public offerings. Pending use of the net proceeds from our public offerings, we are holding the net proceeds in cash or short-term bank deposits.

 

As of March 31, 2016, we had cash and short-term bank deposits of $10,367,496. We believe cash is sufficient to execute on our development strategy to develop company-owned or managed clinics and reacquire select franchise clinics for the foreseeable future.

 

Analysis of Cash Flows

 

Net cash used in operating activities increased by $4,416,667 to $5,759,728 for the three months ended March 31, 2016, compared to $1,343,061 for the three months ended March 31, 2015.  The increase in cash used in operating activities was attributable primarily to increased expenses caused by increased operating losses and working capital requirements of our 54 company-owned or managed clinics and the addition of senior level and support staff in the latter part of 2015.

 

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Net cash used in investing activities was $545,684 and $2,370,792 during the three months ended March 31, 2016, and 2015, respectively.  For the three months ended March 31, 2016, this includes the purchase of regional developer rights of $275,000, purchases of fixed assets of $287,942 and payments received on notes receivable of $17,258.   For the three months ended March 31, 2015 this includes acquisitions of franchises of $1,830,000, reacquisition and termination of regional developer rights of $545,000, purchases of fixed assets of $14,021, proceeds received on sale of property and equipment of $11,500, and payments received on notes receivable of $6,729.

 

Net cash used in financing activities was $119,942 and $0 for the three months ended March 31, 2016, and 2015, respectively. For the three months ended March 31, 2016, this includes repayments on notes payable of $120,500 and offering costs adjustment of $1,042, partially offset by proceeds from exercise of stock options of $1,600.

 

Recent Accounting Pronouncements

 

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers”, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard becomes effective for us on January 1, 2018. We are currently evaluating the effect that ASU 2014-09 will have on our consolidated financial statements and related disclosures. We have not yet selected a transition method nor have we determined the effect of the standard on our ongoing financial reporting.

 

In August 2014, the FASB issued ASU No. 2014-15, “Presentation of Financial Statements - Going Concern: Disclosures about an Entity’s Ability to Continue as a Going Concern.” The new standard requires management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date the financial statements are issued. An entity must provide certain disclosures if conditions or events raise substantial doubt about the entity’s ability to continue as a going concern. The new guidance is effective for our December 31, 2016 Form 10-K, and interim periods thereafter. The Company does not expect any changes to its consolidated financial position, results of operations and cash flows as a result of adoption of this standard, however, additional disclosures might be required in our financial statements.

 

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments - Overall (Subtopic 825-10), Recognition and Measurement of Financial Assets and Financial Liabilities, which addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. ASU 2016-01 will be effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, and early adoption is not permitted. We are currently evaluating the effect of adoption of this standard, if any, on our consolidated financial position, results of operations or cash flows.

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). The changes require that substantially all operating leases be recognized as assets and liabilities on our balance sheet, which is a significant departure from the current standard, which classifies operating leases as off balance sheet transactions and accounts for only the current year operating lease expense in the statement of operations. The right to use the leased property is to be capitalized as an asset and the expected lease payments over the life of the lease will be accounted for as a liability. The effective date is for fiscal years beginning after December 31, 2018. While we have not quantified the impact this proposed standard would have on our financial statements, if our current operating leases are instead recognized on the balance sheet, it will result in a significant increase in the liabilities reflected on our balance sheet and in the interest expense and depreciation and amortization expense reflected in our statement of operations, while reducing the amount of rent expense. This could potentially decrease our reported net income.

 

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In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation: Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”), which amends ASC Topic 718, Compensation – Stock Compensation (“ASC 718”). The standard is intended to simplify several areas of accounting for share-based compensation arrangements, including the accounting for income taxes, classification of excess tax benefits on the statement of cash flows, forfeitures, statutory tax withholding requirements, classification of awards as either equity or liabilities, and classification of employee taxes paid on the statement of cash flows when an employer withholds shares for tax-withholding purposes. ASU 2016-09 is effective for our interim and annual reporting periods beginning January 1, 2017. Early adoption is permitted. We are currently evaluating the method of adoption and impact the update will have on our consolidated financial statements and related disclosures.

 

Off-Balance Sheet Arrangements

 

During the three months ended March 31, 2016, we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance sheet arrangements.

 

ITEM 4. CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, have evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), as of the end of the period covered by this Quarterly Report on Form 10-Q.  Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of such date, our disclosure controls and procedures were not effective.

 

We continue to implement certain controls over the Company’s financial reporting. Our initiatives include additional resources to oversee financial reporting, the enhancement of segregation of duties, and the engagement of third party consultants to aid in designing and implementing processes and procedures to compile, reconcile and review accounts in a timely manner. However, even with these improvements one or more material weaknesses or significant deficiencies could be present and result in errors in our financial statements.

 

Changes in Internal Control over Financial Reporting

 

We are currently in the process of addressing and remediating the control weaknesses described above which include additional resources to oversee financial reporting, the enhancement of segregation of duties, and the engagement of third party consultants to aid in designing and implementing processes and procedures to compile, reconcile and review accounts in a timely manner. We believe that these, and other internal control changes that we will implement in the second quarter of 2016 will remediate our existing deficiencies.  

 

PART II OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

In the normal course of business, we are party to litigation from time to time.

 

On July 7, 2015, a group of six franchisees, who formerly owned a total of 8 franchise licenses that were terminated by the Company due to defaults in performance, commenced a collective arbitration proceeding before the American Arbitration Association in San Diego, California. The claimants’ demand for arbitration asserts claims for breach of contract, promissory fraud, negligent misrepresentation, breach of the implied covenant of good faith and fair dealing, wrongful termination of franchise agreements and “wrongful competition” pursuant to unspecified state business practices, unfair competition and franchise statutes. The claimants also seek “a preliminary and permanent injunction prohibiting the Company from seeking to operate corporate clinics within 25 miles of any franchise clinic.” Although commenced in California, the arbitration proceeding has been moved to Arizona, pursuant to the franchise agreements in dispute, which include clauses that make it mandatory for any arbitration proceeding to be conducted in Phoenix, Arizona. The Company has also asserted counterclaims against each of the claimants for unpaid termination fees due to the premature termination of their licenses. In April 2016, one of the franchisee’s claims was voluntarily dismissed, thereby leaving a total of five claimants with a collective total of 16 former licenses remaining as part of the arbitration proceeding. The Company does not believe that any of the claimants’ affirmative claims, either collectively or individually, have any legal merit and intends to vigorously defend the arbitration proceeding.

 

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ITEM 1A. RISK FACTORS

 

There have been no material changes from the risk factors disclosed in Item 1A of our Form 10-K for the year ended December 31, 2015. 

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

Use of Proceeds from Registered Securities

 

None.

 

ITEM 6. EXHIBITS

 

The Exhibit Index immediately following the Signatures to this Form 10-Q is hereby incorporated by reference into this Form 10-Q.

 

 

 

THE JOINT CORP.

 

SIGNATURES

 

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

 

  THE JOINT CORP.
       
Dated: May 13, 2016 By:

/s/ John B. Richards

 
    John B. Richards  
    Chief Executive Officer
    (Principal Executive Officer)
       
  By:

/s/ Francis T. Joyce

 
    Francis T. Joyce  
    Chief Financial Officer and Treasurer
    (Principal Financial Officer)

 

 

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EXHIBIT INDEX

 

Exhibit

Number

  Description of Document
     
     
31.1   Certification of Principal Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, (filed herewith).
     
31.2   Certification of Principal Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, (filed herewith).
     
32   Certifications of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished herewith).
     
101.INS   XBRL Instance Document.
     
101.SCH   XBRL Taxonomy Extension Schema Document.
     
101.CAL   XBRL Taxonomy Extension Calculation Linkbase Document.
     
101.DEF   XBRL Taxonomy Extension Definition Linkbase Document.
     
101.LAB   XBRL Taxonomy Extension Label Linkbase Document.
     
101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document.

 

 

 

 

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