Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis should be read in conjunction with, and is qualified in its entirety by, our audited annual financial statements and the related notes thereto, each of which appear elsewhere in this Annual Report. This discussion contains certain forward-looking statements that involve risks and uncertainties in this Annual Report. Actual results could differ materially from those projected in the forward-looking statements. The Management Discussion and Analysis of Financial Condition and Results of Operations below is based upon only the financial performance of Ethema Health Corporation.
Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). These accounting principles require us to make certain estimates, judgments, and assumptions. We believe that the estimates, judgments and assumptions upon which we rely are reasonable based upon information available to us at the time that these estimates, judgments, and assumptions are made. These estimates, judgments, and assumptions can affect the reported amounts of assets and liabilities as of the date of the consolidated financial statements as well as the reported amounts of revenues and expenses during the periods presented. Our consolidated financial statements would be affected to the extent there are material differences between these estimates. This discussion and analysis should be read in conjunction with the company’s consolidated financial statements and accompanying notes to the consolidated financial statements for the year ended December 31, 2024.
Results of operations for the year ended December 31, 2024 and the year ended December 31, 2023.
Revenue
Revenue was $6,017,204 and $5,344,976 for the years ended December 31, 2024 and 2023, respectively, an increase of $672,228 or 12.6%.
Revenue from patient treatment was $6,017,204 and $5,164,454 for the years ended December 31, 2024 and 2023, respectively, an increase of $852,750 or 16.5%. The increase is due to organic growth in the number of in-network patients at the facility and an increase in advertising spend to attract patients to the facility.
Revenue from rental income was $0 and $180,522 for the years ended December 31, 2024 and 2023, respectively, a decrease of $180,522 or 100.0%. The Company disposed of its real property owning subsidiary, Cranberry Cove Holdings, to a related party, Leonite Capital, LLC on June 30, 2023.
Operating Expenses
Operating expenses was $7,350,333 and $5,886,896 for the years ended December 31, 2024 and 2023, respectively, an increase of $1,463,437 or 24.9%. The increase in operating expenses is attributable to:
General and administrative expenses was $1,550,799 and $1,041,501 for the years ended December 31, 2024 and 2023, respectively, an increase of $509,298 or 48.9%. The increase is primarily attributable to due to an increase in advertising and marketing costs of $228,767, we spent more funds on advertising to attract new patients to our West Palm Beach facility during the current year, and increases in general operating expenses resulting from the increased patient count, including an increase in food costs of $47,739, an increase in small equipment purchases of $37,596, an increase in client supplies of $20,248, an increase in utilities of $35,450 and an increase in travel costs of $34,160, in addition, property taxes increased by $73,082 due to the increased property value in West Palm Beach and, the balance of $38,256 consisting of increase in numerous individually insignificant costs, related to the increase in the number of patients passing through the facility during the current period.
Rent expense was $1,304,127 and $614,793 for the years ended December 31, 2024 and 2023 an increase of $689,334 or 112.1%. The increase is primarily due to an increase in rental which arose on the acquisition of the west Palm Beach building in August 2023 from our landlord and the immediate disposal of the building to a third party, resulting in the cancellation of the old lease which expired in January 2027 and entering into a new 20 year lease expiring in August 2043, at an increased rental expense of $410,204 over the prior year, including a significant rent smoothing adjustment of $223,851 during the current year, in addition, we acquired the business of Boca Cove Detox during the current year and incurred a rental expense of $221,275 for the use of this facility. We only began generating revenue from this facility in January 2025, after obtaining the necessary licensing and approval from the health care insurance providers.
Management fees were $0 and $368,003 for the years ended December 31, 2024 and 2023, respectively, a decrease of $368,003 or 100.0%. In the prior year management fees included a once off charge of $185,503 related to a fee charged by Leon Developments to Cranberry Cove prior to its disposal to a related party, Leonite Capital on June 30, 2023. In addition, the Company paid management fees of $182,500 to the minority stockholder of ATHI during the prior year.
Professional fees were $955,801 and $707,413 for the years ended December 31, 2024 and 2023, respectively, an increase of $248,388 or 35.1%. The increase is primarily due to an increase in contractor fees incurred by our in-house billing company of $182,434 during the current year as we bolster this department to improve our collections from insurance providers. In addition we incurred professional fees related to corporate activity on closing the acquisition of Boca Cove Detox and the acquisition of the business of Edgewater Recovery in Kentucky which closed on January 7, 2025.
Salaries and wages were $3,072,654 and $2,656,267 for the years ended December 31, 2024 and 2023, respectively, an increase of $416,387 or 15.7%. T he increase is due to acquisition of Boca Cove Detox which was fully staffed in anticipation of receiving our licenses and approvals from healthcare providers in the third quarter of 2024, this was only obtained in January 2025. In addition we increased our headcount due to the increased patient count during the current year.
Depreciation and amortization expense was $466,952 and $498,919 for the years ended December 31, 2024 and 2023, respectively, a decrease of $31,967 or 6.4%. The decrease is primarily due to the disposal of Cranberry Cove Holdings to Leonite Capital, a related party, on June 30, 2023. Cranberry Cove assets included buildings and leasehold improvements which were being depreciated prior to disposal.
Operating loss
The operating loss was $1,333,129 and $541,920 for the years ended December 31, 2024 and 2023, respectively, an increase in loss of $791,209 or 146.0%. The increase in loss is due to the increase in operating expenses of $1,463,437, discussed in detail above, offset by the increase in revenue of $672,228, discussed in detail above.
Other income
Other income was $110,000 and $0 for the years ended December 31, 2024 and 2023, respectively. Other income consisted of management fees provided to Edgewater Recovery, prior to acquisition by the Company.
Other expense
Other expense was $1,160 and $0 for the years ended December 31, 2024 and 2023, respectively, an increase of $1,160 or 100.0%.
Gain on disposal of property
Gain on disposal of property was $0 and $2,484,172 for the years ended December 31, 2024 and 2023, respectively, a decrease of $2,484,172 or 100.0%. In the prior year, the Company exercised its option to acquire the property located at 950 Evernia Street, West Palm Beach, Florida, in which its treatment center operations are located, and subsequently disposed of the property to a third party, realizing a profit on disposal of $2,484,172, after transaction costs.
Loss on debt extinguishment
Loss on debt extinguishment was $0 and $277,175 for the years ended December 31, 2024 and 2023, respectively, a decrease of $277,175 or 100.0%. In the prior year, the loss on debt extinguishment was related primarily to replacement warrants issued to Leonite Capital as part of the debt settlement agreement reached with Leonite.
Extension fee on property purchase
The extension fee on the property purchase was $0 and $140,000 for the years ended December 31, 2024 and 2023, respectively, a decrease of $140,000 or 100%. In the prior year, the extension fee was levied by the landlord of our West Palm Beach facility to afford us additional time to structure the acquisition of the facility, which we in turn disposed of to a third party lender.
Penalty on convertible notes
The penalty on convertible notes was $0 and $34,688 for the years ended December 31, 2024 and 2023, respectively, a decrease of $34,688 or 100.0%. In the prior year, the penalty on convertible note was agreed upon with one of our lenders whose notes were in default and was subsequently settled after June 30, 2023.
Interest income
Interest income was $2,292 and $676 for the years ended December 31, 2024 and 2023 respectively. Interest income represent interest earned on positive bank balances.
Interest expense
Interest expense was $565,343 and $500,226 for the years ended December 31, 2024 and 2023, respectively, an increase of $65,117 or 13.0%, primarily due to the increase in short term note funding of $1,912,000 less repayments of $752,680, the additional funds were raised to fund the acquisition of Boca Cove Detox and for general working capital purposes.
Debt discount
Debt discount was $416,120 and $281,354 for the years ended December 31, 2024 and 2023, respectively, an increase of $134,766 or 47.9%. The increase is primarily due to the increase in short term note funding issued at a discount and the increased utilization of receivables funding during the current year resulting in increased amortization of debt discount associated with this funding.
Foreign exchange movements
Foreign exchange movements were $37,523 and $(95,032) for the years ended December 31, 2024 and 2023, respectively. Foreign exchange movements represents the realized exchange gains and (losses) on monetary assets and liabilities settled during the current year as well as mark to market unrealized gains and losses on monetary assets and liabilities reflected on the balance sheet and denominated in Canadian Dollars.
Net (loss) income before income taxes
Net (loss) income before income taxes was $(2,165,937) and $614,453 for the years ended December 31, 2024 and 2023, respectively, an increase of $2,780,390 or 452.5%. The increase is primarily due to the increase in operating loss as discussed above, the increase in interest expense and debt discount, the prior period gain on sale of property, offset by the other income earned for managing the Edgewater facility, a decrease in the prior year loss on debt extinguishment and the prior year extension fee on the property purchase, all discussed in detail above.
Income taxes
Income taxes were $0 and $391,962 for the years ended December 31, 2024 and 2023, respectively a decrease of $391,962 or 100.0%. Losses were made in the current year, resulting in an increase in the NOL valuation allowance. In the prior year, we completed tax returns for our operating subsidiaries, which resulted in the reversal of previously provided for income taxes, primarily related to accelerated depreciation allowances on property and equipment and the reversal of the deferred tax liability related to intangible assets.
Net (loss) income
Net (loss) income was $(2,165,937) and $1,006,415 for the years ended December 31, 2024 and 2023, respectively, an increase of $3,172,352 or 315.2%. The increase is due to the increase in loss before income taxes and the prior period reversal of income tax charges and deferred tax balances, discussed above.
Liquidity and Capital Resources
Cash used in operating activities was $0.46 million and $0.53 million for the years ended December 31, 2024 and 2023, respectively a decrease of $0.07 million or 13.2%. The decrease is primarily due to the following:
The increase in net loss of $(3.2) million, as discussed above;
The decrease in non-cash movements of $2.5 million, primarily due to the prior year gain on disposal of property of $2.5 million, as discussed above;
The decrease in working capital movements of $0.8 million, primarily due to an increase in the movement of accounts receivable of $0.1 million, increase in the movement of accounts payable and accrued liabilities of $0.2 million, the increase in movement of operating lease liabilities of $0.3 million, and the increase in the movement of taxes payable of $0.2 million due to the reversal of tax provisions in the prior year.
Cash used in investing activities was $1.0 million and cash provided by investing activities was $2.5 million for the years ended December 31, 2024 and 2023, respectively. In the current year, the Company acquired the business of the Boca Cove detox facility for $0.2 million and the payment of property deposits related to this facility of $0.1 million, we also acquired the minority stockholders interest in ATHI for a cash payment of $0.6 million and purchased additional property and equipment of $0.1 million at our west Palm Beach facility. In the prior year, the Company exercised its option to acquire 950 Evernia Street, where it conducts its treatment facility for net proceeds of $5.2 million, net of $0.4 million of deposits previously paid. Upon acquisition, we immediately sold the property for net proceeds of $8.1 million, after fees and expenses related to the disposal, and paid a rental deposit of $0.4 million related to the lease entered into on the property disposed of.
Cash provided by financing activities was $1.7 million and cash used in financing activities was $(2.1) million and for the years ended December 31, 2024 and 2023, respectively. In the current year, we raised $1.9 million in short term notes, and repaid $0.8 million, realizing a net $1.1 million, We repaid $0.1 million on the promissory note due on the acquisition of ATHI, we received subscription receipts of $0.2 million, we also raised a total of $0.7 million and repaid $0.6 million in receivables funding, we received a net advance from related parties of $0.2 million, these proceeds were used to acquire Boca Cove Detox and the minority stockholders interest and for general working capital purposes. In the prior year, the net proceeds realized on the acquisition and immediate sale of the property, discussed under investing activities was used to repay convertible notes of $(1.0) million, the net repayment of promissory notes of $(0.1) million and the payment of third party loans of $(0.3) million. The Company also repaid net receivables funding of $(0.4) million, mortgage loans of $(0.1) million and related party loans of $(0.2) million during the prior year.
Over the next twelve months we estimate that the company will require approximately $3.8 million in funding to repay its obligations other than convertible notes. We will need funding for working capital as we continue to seek additional opportunities for addiction treatment in the US markets. There is no assurance that the Company will be successful with future financing ventures, and the inability to secure such financing may have a material adverse effect on the Company’s financial condition. In the opinion of management, the Company’s liquidity risk is assessed as high.
Going Concern
The accompanying consolidated financial statements have been prepared on a going-concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. For the year ended December 31, 2024, we incurred operating losses of $1.3 million and had a negative cash flow from operating activities of 0.5 million. As of December 31, 2024, we had an accumulated deficit of $44.4 million, working capital deficiency of $9.1 million and total liabilities in excess of total assets of $7.5 million. These matters raise substantial doubt about our ability to continue as a going concern.
Management believes that current available resources will not be sufficient to fund our planned expenditures over the next 12 months. Accordingly, we will be dependent upon the raising of additional capital through placement of common shares, and/or debt financing in order to implement our business plan and generating sufficient revenue in excess of costs. If we raise additional capital through the issuance of equity securities or securities convertible into equity, stockholders will experience dilution, and such securities may have rights, preferences or privileges senior to those of the holders of common stock or convertible senior notes. If we raise additional funds by issuing debt, we may be subject to limitations on our operations, through debt covenants or other restrictions. If we obtain additional funds through arrangements with collaborators or strategic partners, we may be required to relinquish its rights to certain geographical areas, or techniques that it might otherwise seek to retain. There is no assurance that we will be successful with future financing ventures, and the inability to secure such financing may have a material adverse effect on our financial condition.
Based on the uncertainties described above, we believe our business plan does not alleviate the existence of substantial doubt about our ability to continue as a going concern within one year from the date of the issuance of these consolidated financial statements. The accompanying consolidated financial statements do not include any adjustments to the amounts and classifications of assets and liabilities that might be necessary should we be unable to continue as a going concern.
Critical accounting policies
Revenue recognition
We recognize revenue in terms of ASC 606 which requires us to exercise more judgment and recognize revenue using a five-step process as described under our accounting policies in note 2 to the consolidated financial statements.
We derive substantially all of our revenue from payors that receive discounts from established billing rates. The various managed care contracts under which these discounts must be calculated are complex, subject to interpretation and adjustment, and may include multiple reimbursement mechanisms for different types of services provided in the Company’s inpatient facilities and cost settlement provisions. Management estimates the transaction price on a payor-specific basis given its interpretation of the applicable regulations or contract terms. The services authorized and provided and related reimbursement are often subject to interpretation that could result in payments that differ from the Company’s estimates. Additionally, updated regulations and contract renegotiations occur frequently, necessitating regular review and assessment of the estimation process by management.
Settlements with third-party payors are estimated and recorded in the period in which the related services are rendered and are adjusted in future periods as final settlements are determined. In the opinion of management, adequate provision has been made for any adjustments and final settlements.
Allowance for credit losses
In conjunction with Revenue recognition, we recognize revenue based on historical collections received from healthcare providers, recognizing only a percentage of revenues actually billed. Effectively recognizing revenue net of any expected billing differentials. Based on our collection experience, the percentage of revenue recognized is adjusted on a periodic basis, thereby taking into account expected credit losses in the revenue recognition process. The revenue we recognize is already net of expected credit losses.
Leases
We account for leases in terms of ASC 842. In terms of ASC 842, the Company assesses whether any asset based leases entered into for periods longer than twelve months meet the definition of financial leases or operation leases, by evaluating the terms of the lease, including the following; the duration of the lease; the implied interest rate in the lease; the cash flows of the lease; and whether the Company intends to retain ownership of the asset at the end of the lease term.
Leases which imply that we will not acquire the asset at the end of the lease term are classified as operating leases, our right to use the asset is reflected as a non-current right of use asset with a corresponding operational lease liability raised at the date of lease inception. The right of use asset and the operational lease liability are amortized over the right of use period using the effective interest rate implied in the operating lease agreement.
Long Lived Assets
The Company evaluates the carrying value of its long-lived assets for impairment by comparing the expected undiscounted future cash flows of the assets to the net book value of the assets when events or circumstances indicate that the carrying amount of a long-lived asset may not be recoverable. If the expected undiscounted future cash flows are less than the net book value of the assets, the excess of the net book value over the estimated fair value will be charged to earnings.
Fair value is based upon discounted cash flows of the assets at a rate deemed reasonable for the type of asset and prevailing market conditions, appraisals, and, if appropriate, current estimated net sales proceeds from pending offers.
Critical Accounting Estimates
Preparation of our consolidated financial statements in accordance with U.S. generally accepted accounting principles (“GAAP”) requires us to make estimates and assumptions that affect the reported amounts of certain assets, liabilities, revenues and expenses, as well as related disclosure of contingent assets and liabilities. Our estimates are based on our historical experience, information received from third parties and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimated under different assumption or conditions. Significant accounting policies are fundamental to understanding our financial condition and results as they require the use of estimates and assumptions which affect the financial statements and accompanying notes. See Note 2 - Summary of Significant Accounting Policies of the Notes to the Consolidated Financial Statements included in Part II, Item 8 of this Annual Report for further information.
The Critical accounting policies that involved significant estimation include the following:
Revenue recognition
Management constantly monitors the level of billings and collections on those billings and makes an estimation of the percentage of billings that will ultimately be recorded as revenue. The various managed care contracts under which these discounts must be calculated are complex, subject to interpretation and adjustment, and may include multiple reimbursement mechanisms for different types of services provided in the Company’s inpatient facilities and cost settlement provisions. Management estimates the transaction price on a payor-specific basis given its interpretation of the applicable regulations or contract terms. The services authorized and provided and related reimbursement are often subject to interpretation that could result in payments that differ from the Company’s estimates.
Since we already make adjustments for expected collections we are constantly taking into account any expected credit losses.
Leases
On August 4, 2023, we entered into an acquisition and immediate disposal transaction with two unrelated third parties for the building which we currently operate our West Palm Beach treatment facility, see note 5 to the consolidated financial statements.
Simultaneously with the acquisition and disposal, on August 4, 2023, we entered into a long term lease for 950 Evernia Street, West Palm Beach, Florida with an initial term of twenty years, and two ten year extension options. The lease is absolutely net and the lease cost for the initial year is $748,000 paid monthly. The lease increases at a rate of 2.75% per year for a total term lease obligation of $19,655,717 over the initial twenty-year term. Due to the initial lease term of twenty years, we are not certain that the extension periods will be exercised at this point in time and accordingly, these have been excluded from the present value of the minimum future lease payments.
To determine the present value of minimum future lease payments for operating leases at August 4, 2023, we were required to estimate a rate of interest that we would have to pay to borrow on a collateralized basis over a similar term in a similar economic environment (the "incremental borrowing rate" or "IBR"). Wey determined the appropriate IBR by identifying a reference rate and making adjustments that take into consideration financing options and certain lease-specific circumstances. For the reference rate, the Company used the Fannie Mae, in excess of $3,000,000 rate based on an 80% value to loan ratio, averaging the 15 and 30 year indicative rates, resulting in a rate of 7.70%. We determined that 7.70% per annum was an appropriate incremental borrowing rate to apply to its real estate operating lease.
The present value of the future minimum lease payments was valued at $9,333,953 on August 4, 2023.
On May 1, 2024 the Company, through its subsidiary Evernia Health Center LLC, entered into a Definitive Agreement whereby the Company would assume the lease for suites 100,101, 201, 202 and 203 located at 899 Meadows Road, Boca Raton, Florida (the “Leased Premises”) upon the assignment of the lease from the property owner. The lease was assigned on June 10, 2024.
The assigned lease has a remaining term of 3 years, expiring on June 30, 2027, with an initial monthly lease cost of $21,843 from July 1, 2024 to December 31, 2024, escalating by 2.9% per annum, each annual period being a calendar year.
To determine the present value of minimum future lease payments for operating leases at June 10, 2024, the Company was required to estimate a rate of interest that it would have to pay to borrow on a collateralized basis over a similar term in a similar economic environment (the "incremental borrowing rate" or "IBR").
The Company determined the appropriate IBR by identifying a reference rate and making adjustments that take into consideration financing options and certain lease-specific circumstances. For the reference rate, the Company used the Bank rate 3/1 adjustable-rate mortgage which represents the average rate for several mortgage lenders in the market of 6.36%. The Company determined that 6.36% per annum was an appropriate incremental borrowing rate to apply to its real estate operating lease.
The present value of the future minimum lease payments was valued at $744,256 on June 10, 2024.
Long-lived assets
We have significant long-lived assets, including property and equipment, intangible assets, right-of-use assets and deposits. The Company evaluates the carrying value of its long-lived assets for impairment by comparing managements estimates of undiscounted future cash flows of the assets to the net book value of the assets when events or circumstances indicate that the carrying amount of a long-lived asset may not be recoverable. This requires significant estimation of future revenue streams, based on management’s understanding of the business which may not be accurate and may require re-estimation at a future date. If the expected undiscounted future cash flows are less than the net book value of the assets, the excess of the net book value over the estimated fair value will be charged to earnings.
Fair value is based upon discounted cash flows of the assets at a rate deemed by management to be reasonable for the type of asset and prevailing market conditions, appraisals, and, if appropriate, current estimated net sales proceeds from pending offers.
