ALSTON & BIRD LLP
One Atlantic Center
1201 West Peachtree Street
Atlanta, Georgia 30309-3424
404-881-7000
Fax: 404-881-7777
www.alston.com
PETER C. NOVEMBER DIRECT DIAL: 404-881-7872 E-MAIL: PNOVEMBER@ALSTON.COM
April 28, 2005
Mr. Jeffrey Riedler
Assistant Director
United States Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0306
Re: LHC Group, LLC
Supplemental Response to Form S-1/A
Filed April 7, 2005
File Number 333-120792
Dear Mr. Riedler:
At the request and on behalf of our client, LHC Group, Inc. (the
"Company"), we hereby file this letter in response to the comment letter dated
April 27, 2005 from the Staff with regard to the above referenced registration
statement (the "Registration Statement"). Unless the context requires otherwise,
references to we, our, us, LHC or the Company in this letter refer to LHC Group,
Inc.
COMMENT
FORM S-1/A
Applicability of ASR to the Beta, HTAT and St. Landry's Contingent Put Options
1. We note that the Beta and HTAT equity derivatives become
exercisable in the event that LHC Group LLC undertakes an
initial public offering or is "sold, merged or otherwise
acquired." Please confirm our understanding, if true, that
during the April 25, 2005 conference call you represented that
a legal standpoint the condition "sold, merged or otherwise
acquired" would be met in the event more than 50% of the
voting power of the company is transferred.
Bank of America Plaza 90 Park Avenue 3201 Beechleaf Court, 601 Pennsylvania Avenue,
101 South Tryon Street, New York, NY 10016 Suite 600 N.W.
Suite 4000 212-210-9400 Raleigh, NC 27604-1062 North Building, 10th Floor
Charlotte, NC 28280-4000 Fax: 212-210-9444 919-862-2200 Washington, DC 20004-2601
704-444-1000 Fax: 919-862-2260 202-756-3300
Fax: 704-444-1111 Fax: 202-756-3333
Mr. Jeffrey Riedler
April 28, 2005
Page 2
RESPONSE
We confirm that from a legal standpoint, we believe that the condition
"sold, merged or otherwise acquired" would be met in the event more than 50% of
the voting power of LHC Group is transferred.
COMMENT
2. We note that the St. Landry option is exercisable if LHC Group
LLC "undertakes and initial public offering or is acquired by
a publicly traded company.'" Please confirm our understanding,
if true, that during the April 25, 2005 conference call, you
represented that from a legal standpoint the condition
"acquired by a publicly traded company" would be met in the
event more than 50% of the voting power of the company is
transferred.
RESPONSE
We confirm that from a legal standpoint, we believe the condition
"acquired by a publicly traded company" would be met in the event more than 50%
of the voting power of LHC Group is transferred.
COMMENT
3. If the answer to the two previous questions that a more than
50% ownership transfer makes these options exercisable, it
appears that these puts are mandatorily redeemable under the
guidance provided in ASR 268 because the change of control
provision is outside the control of the company and its board.
Please provide to us an analysis of the application of ASR 268
and EITF D-98 as it relates to the measurement criteria for
these puts through the date of the completion of the initial
public offering.
RESPONSE
Beta Home Care, Inc. Analysis
In January 2004 we entered into a joint venture with Beta Home Care,
Inc. ("Beta") for the ownership and operation of a home nursing agency (the
"Beta Joint Venture"). In conjunction with this transaction, we amended the
operating agreement for the Beta Joint Venture and granted Beta a right to
exchange its minority interest holdings in the Beta Joint Venture for shares of
LHC Group's common stock upon either of the following events: (i) if LHC Group
undertakes an initial public offering, or (ii) if LHC Group is sold, merged or
otherwise acquired. On September 14, 2004, we entered into an Exchange Agreement
with Beta pursuant to which it was agreed that in the event LHC Group closes an
initial public offering, Beta would be required to exercise its conversion
Mr. Jeffrey Riedler
April 28, 2005
Page 3
option and established that the consideration to be received by Beta upon
conversion would be 450,000 shares of LHC Group's common stock and the cash
equivalent of 153,772 shares of LHC Group's common stock.
Based on discussions with the Staff, we believe that it is necessary to
analyze the proper accounting treatment for this conversion option by analyzing
the conversion option under both the initial public offering scenario and the
scenario involving the sale, merger or other acquisition of LHC Group. It is our
understanding that based on assertions from us, the Staff does not believe that
the conversion option is a freestanding instrument under SFAS No. 150 or an
embedded derivative under SFAS No. 133. Further, the Staff does not believe that
the concept of freestanding contained within EITF 00-6 would apply to the
conversion option. Accordingly, the conversion option would not be accounted for
using the guidance provided in EITF 00-6. Therefore, we will limit our analysis
to the application of ASR 268 and EITF Topic D-98.
ASR 268 requires a public entity's stock subject to redemption
requirements that are outside the control of the issuer to be excluded from the
caption "stockholders' equity" and presented separately in the issuer's balance
sheet. Since the decision by LHC Group to complete an initial public offering is
within the control of the Board of Directors of LHC Group, we believe that the
conversion option in the context of our initial public offering would not be
subject to ASR 268. Based on conversation with the Staff, we believe the Staff
has adopted this same position.
In the context of a sale, merger or other acquisition of LHC Group, we
understand the Staff believes that management does not control a sale in all
situations. For example, if a third party were to acquire a majority of the
outstanding shares of LHC Group's common stock directly from its stockholders
(which transaction we believe would trigger the conversion rights), that
transaction would not be required under Delaware law to be approved by the Board
of Directors of LHC Group. As we have previously indicated, in the case of LHC
Group we believe this type of transaction would be in the control of the
management of LHC Group by reason of management owning approximately 59.8% of
LHC Group's common stock. However, we understand the Staff does not concur with
this position.
Assuming that a sale, merger or other acquisition of LHC Group is not
within the control of LHC Group, then ASR 268 would apply to the conversion
option as it relates to a sale, merger or other acquisition of LHC Group. If ASR
268 applies, we would then look to the guidance provided in EITF Topic D-98.
Under EITF Topic D-98, once it becomes probable that the minority interest would
become redeemable, the minority interest should be adjusted to its current
redemption amount. Between January 1, 2004 and the date of this letter, LHC
Group has not engaged in any discussions with any third party regarding the
acquisition of LHC Group. There have been no letters of intent signed by LHC
Group related to such a transaction and LHC Group has not engaged any investment
or other advisors to assist LHC Group in any sale, merger or other acquisition
Mr. Jeffrey Riedler
April 28, 2005
Page 4
of LHC Group. Further, the Board of Directors of LHC Group has not approved or
otherwise directed management to explore such a transaction. Therefore, we do
not believe that at anytime since January 1, 2004 the sale, merger or other
acquisition of LHC Group has been probable. Therefore, under the guidance
provided by EITF Topic D-98 the minority interest related to the Beta Joint
Venture should not yet be adjusted to its current redemption amount.
Since the minority interest will not have been adjusted to its
redemption value, upon completion of our initial public offering and the closing
of the transactions set forth in the Exchange Agreement with Beta, we will apply
purchase accounting under Statement 141 without any need to unwind any previous
fair value adjustments.
HTAT Analysis
In April 2004 we entered into a joint venture for the ownership and
operation of an outpatient rehabilitation clinic with four individual minority
interest holders (the "HTAT Holders") who collectively own 49% of the equity
joint venture interests (the "HTAT Joint Venture"). The operating agreement for
the HTAT Joint Venture granted the HTAT Holders a right to exchange their
minority interest holdings in the HTAT Joint Venture for shares of LHC Group's
common stock upon either of the following events: (i) if LHC Group undertakes an
initial public offering, or (ii) if LHC Group is sold, merged or otherwise
acquired. On November 23, 2004, we entered into an Exchange Agreement with the
HTAT Holders pursuant to which it was agreed that in the event LHC Group closes
an initial public offering, the HTAT Holders would be required to exercise their
conversion option and established that the consideration to be received by the
HTAT Holders upon conversion would be 68,034 shares of LHC Group's common stock.
For the reason articulated above, we will analyze the proper accounting
treatment for the conversion feature under both the initial public offering
scenario and the sale of LHC Group scenario using the guidance set forth in ASR
268 and EITF Topic D-98. The Board of Directors of LHC Group can control whether
LHC Group completes an initial offering. Thus, ASR 268 would not apply to the
conversion option for the HTAT Joint Venture in the context of an initial public
offering. Although for the reasons set forth above we believe there is a strong
argument to be made that management can control a sale of LHC Group, we will
assume that ASR 268 would apply to the conversion option in the HTAT Joint
Venture in the context of a sale of LHC Group. As stated above, we do not
believe a sale of LHC Group has been probable since the formation of the HTAT
Joint Venture in April 2004. Accordingly, under the guidance set forth in EITF
Topic D-98, the minority interest for the HTAT Joint Venture should not have
been adjusted to its redemption value. Since the minority interest will not have
been adjusted to its redemption value, upon completion of our initial public
offering and the closing of the transactions set forth in the Exchange Agreement
with the HTAT Holders, we will apply
Mr. Jeffrey Riedler
April 28, 2005
Page 5
purchase accounting under Statement 141 without any need to unwind any previous
fair value adjustments.
St. Landry's Analysis
In April 2004 we entered into a joint venture for the ownership and
operation of a long-term acute care hospital with individual minority interest
holders (the "St. Landry's Holders") who collectively own 5% of the equity joint
venture interests (the "St. Landry's Joint Venture"). The operating agreement
for the St. Landry's Joint Venture granted the St. Landry's Holders a right to
exchange their minority interest holdings in the St. Landry's Joint Venture for
shares of LHC Group's common stock upon either of the following events: (i) if
LHC Group undertakes an initial public offering, or (ii) if LHC Group is
acquired by a publicly traded company. Since the St. Landry's Holders are
physicians, their ownership of shares of LHC's common stock is contingent upon
compliance with the federal Stark law. Therefore, the conversion feature may
only be exercised by the St. Landry's Holders in the event that we (or our
successor) have $75 million of stockholders' equity following our initial public
offering. Based on the anticipated initial public offering price, we are
reasonably certain that following our initial public offering we will not have
$75 million in stockholders' equity. Thus, the St. Landry's Holders will not
have the right to exercise their conversion rights in connection with our
initial public offering.
In addition to the conversion option, the St. Landry's Holders have
also been granted a right to require us to redeem their minority interest
holdings in the equity joint venture in cash by delivering notice to us at
anytime after 30 days following our initial public offering. The purchase price
is equal to the product of the number of shares of our common stock the
redeeming member would have received upon exercise of the conversion option and
the average trading price of our common stock during the 30 days preceding the
exercise of the redemption right.
For the reason articulated above, we will analyze the proper accounting
treatment for the conversion/redemption feature under both the initial public
offering scenario and the acquisition of LHC Group by a public company scenario
using the guidance set forth in ASR 268 and EITF Topic D-98. Again for the
reasons set forth above, we believe that LHC Group can control whether it
completes an initial public offering. Thus, ASR 268 would not apply to the
conversion option for the St. Landry's Joint Venture in the context of an
initial public offering. It should be noted that the redemption feature in
operating agreement for the St. Landry's Joint Venture is only available
following an initial public offering and not following an acquisition of LHC
Group by a public company. Since the Board of Directors of LHC Group controls
whether or not we complete an initial public offering, the redemption feature
would not be covered by ASR 268 prior to the completion of our initial public
offering.
Mr. Jeffrey Riedler
April 28, 2005
Page 6
Although we believe a strong argument can be made that management can
control a sale of LHC Group, we will assume that ASR 268 would apply to the
conversion option in the St. Landry's Joint Venture in the context of an
acquisition of LHC Group by a public company. As discussed above, we do not
believe the acquisition of LHC Group by a public company has been probable since
the formation of the St. Landry's Joint Venture in April 2004. Accordingly,
under the guidance set forth in EITF Topic D-98, the minority interest for the
St. Landry's Joint Venture should not have been adjusted to its redemption
value.
If the St. Landry's Holders do not exercise their redemption rights
upon completion of our initial public offering, then under EITF Topic D-98 we
would be required to adjust the minority interest in St. Landry's to its
redemption value beginning in our first quarter as a public company. We would
propose to account for this as described in Response 1(a) in our letter dated
April 19, 2005. We would be willing to discuss this accounting treatment with
you prior to filing our first Form 10Q.
COMMENT
Requirement to Provide Article 11 of Regulation S-X Pro Forma Financial
Information
4. Please provide a robust discussion of the whether the company
believes that it is probable that the St. Landry's will redeem
their minority interest holdings upon the completion of the
initial public offering. Please base this analysis of
probability on the terms described in Financial Reporting
Codification 506.02.c.ii.
RESPONSE
The probability analysis requested by the Staff is only relevant if the
redemption of the interests held by the St. Landry's Holders would either
individually, or in the aggregate when combined with the redemption of the
interests held by Beta and the HTAT Holders, require us under Article 11 of
Regulation S-X to include pro-forma financial information in our Registration
Statement. As noted in our response to comment no. 5, pro-forma financial
information would not be required for the St. Landry's redemption under either
scenario.
COMMENT
5. Refer to comment 11 of the April 19, 2005 response letter.
Based one this response, it appears that the company evaluated
the need to provide pro forma financial information on each
step acquisition separately. If the company determined that
the St. Landry's step acquisition is probable, it appears that
each of these step acquisition: should be viewed as related
Mr. Jeffrey Riedler
April 28, 2005
Page 7
businesses because they will occur based on the outcome of a
single event, initial public offering. Please provide to us an
analysis that addresses whether St. Landry's, Beta, and HTAT
should be considered related businesses. If the St. Landry's
step acquisition is not probable, address this issue for the
HTAT and Beta step acquisitions. Specifically address the
criteria, discussed in Rule 3-05(a)(3)(iii) of Regulation S-X.
RESPONSE
Pursuant to Article 11 of Regulation S-X pro-forma financial
information is required for a single transaction if one of the following three
conditions is satisfied: (i) if LHC Group makes an investment in the acquisition
that exceeds 20% of LHC Group's consolidated total assets as of the end of the
most recently completed fiscal year; (ii) if the assets of the entity being
acquired exceeds 20% of the total consolidated assets of LHC Group (after
intercompany eliminations) as of the end of the most recently completed fiscal
year; or (iii) if the income from continuing operations of the acquired entity
exceeds 20% of the consolidated income of LHC Group as of the end of the most
recently completed fiscal year. If LHC Group engages in the acquisition of
related businesses, as that term is defined in Rule 3-05(a)(3) of Regulation
S-X, then for purposes of determining whether on an aggregate basis pro-forma
financial information is required the reference to 20% in each of the three
tests mentioned above should be changed to 50%. Set forth below is our analysis
of the three pro-forma financial information tests with respect to Beta, HTAT
and St. Landry's, both individually and on an aggregate basis.
Significance Test
----------------------------------------------
Assets Investment Income
------ ---------- ------
Beta 17.1% 17.1% 10.6%
HTAT 1.9 1.9 0.9
St. Landry 2.7 2.7 0.9
----- ----- -----
Combined 21.7% 21.7% 12.4%
===== ===== =====
As none of the individual significance tests are greater than 20% and
in the aggregate none of the tests exceeds 50%, we do not believe pro forma
financial statements are required under Article 11 of Regulation S-X.
Mr. Jeffrey Riedler
April 28, 2005
Page 8
COMMENT
APPENDIX B ADDITIONAL DISCLOSURE
6. We note the proposed disclosure that the company included in
its March 25, 2005 letter as Appendix B. Related to this
disclosure, we have the following comments:
a) Related to the $1.1 million that the company would be required
to pay related to the St. Landry agreement, consider
disclosing the number of shares and the stock price used to
calculate this amount.
b) Consider disclosing this amount in the table at the end of the
note instead of the $0 disclosed there.
c) The paragraph that describes the company's accounting will
need to be adjusted to reflect the results of its analysis
based on our discussions and the company's analysis requested
in other comments.
d) Please clearly indicate that the put options related to the
HTAT and Beta agreements are still outstanding related to the
change of control provision and that they are only replaced
related to the IPO contingency. It should be clear that there
are three puts and two forwards outstanding related to these
minority interests.
e) Consider disclosing the reasons for entering into these
exchange agreements as well as a discussion of how the
settlement amounts were determined.
f) The table indicates that the amounts disclosed in the last two
columns represent the "fair value" of these instruments. Is it
more appropriate to disclose these as the anticipated
settlement amounts?
g) Along the same thought it seems that the put option values for
Beta and HTAT would not be "N/A" but some other amount given
that the put options are still outstanding.
RESPONSE
In Amendment No. 3 to the Registration Statement we will include the
additional disclosure referenced in our March 25, 2005 letter, which disclosure
will contain the revisions suggested by the Staff in this comment no. 6.
COMMENT
ACCOUNTING FOR THE EXCHANGE AGREEMENTS
7. Did the Beta and HTAT forwards issued in the respective
exchange agreement is have a fair value at the date you
executed the exchange agreement equal to the written put
rights given up by the holders of those puts? Please fully
explain your response.
Mr. Jeffrey Riedler
April 28, 2005
Page 9
RESPONSE
We have asserted throughout our discussions with the Staff that the put
options were "fair value puts." That is consistent with our intent and belief
that the formula in the put option would result in a fair value price for the
minority interest when the option was exercised. It is acknowledged that a
strict application of the formula does not result in a fair value price when
that formula is applied at a point in time prior to that in which we had an
expectation of the option being exercisable. In the case of applying the formula
prior to the date when the option becomes exercisable, the formulaic price in
the put option would result in a price different than fair value for the
minority interest. This difference is further discussed below for each minority
interest.
The Staff's primary concern is whether there was an exchange of value
between us and the minority interest holder on the date the exchange agreements
were substituted for the put options. We believe there was no exchange of value
on that date. It was the intent and desire of both us and the minority interest
holders simply to remove the optionality of the sale/purchase of the minority
interest on the occurrence of an initial public offering and thus provide
certainty that the sale/purchase would occur. It was also the intent and desire
of both parties that the formula in the exchange agreement clarify and replicate
in value (but not necessarily in verbiage) the "fair value price" in the put
option. As such, the settlement price inherent in the exchange agreement
admittedly did not equal the settlement price derived by a then-current
application of the formula in the put option, but was instead calculated to
replicate the formulaic put price given an expectation of when the put would
have been exercised. Therefore, as the result of the negotiations, both parties
believed there was "equal value" before and after the substitution - that is,
the settlement price under the exchange agreement formula would result in the
same value that would have been expected by the application of the formula in
the put agreement for the transaction given the expectation of when such a
transaction would occur.
With respect to HTAT, the settlement price inherent in the exchange
agreement of $680,000 (approximately 68,000 shares at an assumed initial public
offering price of $10 per share) did not equal the settlement price of $0
derived by a then-current application of the conversion formula in the put
option. At that point in time, there was no value to the minority interest
holders due to the HTAT Joint Venture's lack of maturity as an operating unit
(i.e., lack of trailing 12 months EBITDA as well as negative EBITDA as of that
date). Our expectation was that the HTAT Joint Venture's contribution to LHC
Group would increase as it matured. This expectation was factored into our
replication of the formulaic put price at a point in time when our initial
public offering was expected to have occurred. In other words, at the time we
determined the amount to be paid under the exchange agreement, we estimated the
EBITDA of the HTAT Joint Venture and of LHC Group on the estimated date of our
initial public offering. We then used those EBITDA estimates to determine the
consideration payable under the exchange agreement. Under the strict application
of the formula we would have used the EBITDA
Mr. Jeffrey Riedler
April 28, 2005
Page 10
for the preceding 12 months as of the date we entered into the exchange
agreement, which would not have reflected the fair value at the point in the
future when the option was actually exercised upon completion of our initial
public offering.
With respect to the Beta Joint Venture, the settlement price inherent
in the exchange agreement of $6 million did not equal the settlement price of
$7.4 million derived by a then-current strict application of the conversion
formula in the put option. The differential between these amounts was due to
several factors. First, our expectation was that Beta's contribution to LHC
Group would decrease over the passage of time due to its maturity as an
operating unit and constraints on its future growth and the expected growth of
other operating units. This expectation of declining contribution to LHC Group
was factored into our replication of the formulaic put price at a point in time
that it would have been exercised. In addition, under the put option's
conversion formula the minority interest holders were to receive only restricted
shares of LHC Group as consideration. Under the exchange agreement, the nature
of the consideration received was changed slightly to include cash of $1.5
million and $4.5 million of restricted shares. Accordingly, Beta was willing to
take a reduction in its aggregate purchase price in exchange for receiving cash
(which provides more assurance of liquidity) as opposed to restricted shares of
LHC Group.
Focusing on the fair value of the put agreement and the fair value of
the exchange agreement (as opposed to the value of the specifically calculated
settlement amounts under the formulae in those agreements), we continue to
believe that fair values of those contracts at the date of the substitution
would be equal and essentially $0. The agreements would result in fair value
transactions in the timeframe they would be expected to be exercised - and an
agreement or ability to do something at fair value generally has a fair value of
$0. Any differential resulting from comparing the formula price (strike price)
to current market price for the minority interest (that is, the intrinsic value
to the contract on a valuation date) would have to be considered in conjunction
with the other elements of fair value when determining the fair value of the
overall agreement, including discounting and the probability of the resolution
of any contingencies. In other words, we believe that a probability factor of
essentially 0% related to the resolution of the contingencies within our control
associated with our initial public offering was applied resulting in a fair
value of $0 for either agreement.
If you have questions or comments about the matters discussed herein,
please call the undersigned at (404) 881-7872 or Steve Pottle at (404) 881-7554.
Sincerely yours,
/s/ Peter C. November
Peter C. November