FPCG First Physicians Capital Group Inc (CE)

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of First Physicians Capital Group, Inc., f/k/a Tri-Isthmus Group, Inc., a Delaware corporation (the “Company,” “we,” “us,” or “our,” depending on the context), as of March 31, 2014 and for the three and six month periods ended March 31, 2014 and March 31, 2013, have been prepared on substantially the same basis as our annual consolidated financial statements and should be read in conjunction with our Annual Report on Form 10-K (the “Form 10-K”), filed with the United States Securities and Exchange Commission (the “SEC”) on April 4, 2014, and any amendments thereto, for the Fiscal Year Ended September 30, 2013 (the “Fiscal Year Ended September 30, 2013”). In the opinion of management, the accompanying condensed consolidated financial statements reflect all adjustments of a normal recurring nature considered necessary to present fairly the financial information included herein.

The consolidated financial statements include our accounts and the accounts of our subsidiaries. All significant inter-company balances and transactions have been eliminated.

The results as of September 30, 2013 have been derived from our audited consolidated financial statements for the fiscal year ended as of such date.

The unaudited consolidated results for interim periods are not necessarily indicative of expected results for the full fiscal year.

Future Funding

We have an accumulated deficit of approximately $79.3 million as of March 31, 2014. This deficit has been funded primarily through the issuance of promissory notes, the sale of preferred and common stock, and cash generated from operations.

At March 31, 2014, we had current liabilities of $6.6 million and current assets of $19.7 million.

Critical Accounting Policies

For critical accounting policies affecting us, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” of our Annual Report on Form 10-K for the Fiscal Year Ended September 30, 2013. Critical accounting policies affecting us have not changed materially since September 30, 2013.

Fair Value of Financial Instruments

Carrying amounts of certain of our financial instruments, including accounts receivable, accounts payable and accrued expenses approximate fair value due to their short maturities. Carrying value of notes receivable and long-term debt approximate fair values as they bear market rates of interest. None of our financial instruments are held for trading purposes.

Revenue Recognition

The Company has contracted billing rates for its management services which it bills as gross revenue as services are delivered. Gross billed revenues are then reduced by the Company’s estimate of allowances based on expected collections, which includes the provision for doubtful accounts, to arrive at net revenues. Net revenues may not represent amounts ultimately collected. The Company adjusts current period revenue for differences in estimated revenue recorded in prior periods and actual cash collections.

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The Company computes its estimate of bad debt by taking into account collections received for the services performed and also estimating amounts collectible for the services performed within the last twelve months.

2. Discontinued Operations

As of March 31, 2014 and September 30, 2013, the remaining operating liabilities of RHA Tishomingo, RHA Anadarko, RHA Stroud, SPMC, Del Mar, Point Loma, and SPA, have been recorded as liabilities of discontinued operations. We have reclassified the results of operations of RHA Tishomingo, RHA Anadarko, RHA Stroud, SPMC, Del Mar, Point Loma, and SPA for all periods presented, to discontinued operations. As of March 31, 2014 and September 30, 2013, there was $557,000 of current liabilities classified as liabilities of discontinued operations. In fiscal year 2011, a deferred gain of $4.0 million was recorded related to the sale-leaseback of the RHA Anadarko and RHA Stroud assets, and is being amortized on a straight-line basis over the 20 year lease term. The Company recognized $51,000 and $101,000 of gain during each of the three and six month periods, respectively, ended March 31, 2014 and 2013, which is included in income from discontinued operations on the accompanying Consolidated Statements of Operations.

3. Income Per Share

The following table shows the calculation of income per share for the three and six month periods ended March 31, 2014 and 2013 (in thousands, except for per share data):

For the three and six month periods ended March 31, 2014 and 2013, the Company had stock options outstanding to purchase up to 150,000 and 6,760,000 shares of common stock, respectively, and warrants outstanding to purchase up to 6,730,879 and 360,000 shares of common stock, respectively, which had strike prices above market value and so are considered “out-of-the-money.” As a result, they were excluded from the computation of diluted earnings per share.

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FIRST PHYSICIANS CAPITAL GROUP, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED

For the three and six month periods ended March 31, 2014 and 2013, the following potential shares of common stock outstanding were included in the computation of diluted earnings per share: 67,600 Series 1-A Convertible Preferred Stock convertible into 33,493 shares of common stock, 3,900 Series 2-A Convertible Preferred Stock convertible into 1,872 shares of common stock, 9,000 Series 5-A Convertible Preferred Stock convertible into 28,800,000 shares of common stock and 4,875 Series 6-A Convertible Preferred Stock convertible into 15,600,000 shares of common stock, and $1,350,000 of convertible debt from our bridge financings convertible into 2,160,000 shares of common stock.

For the three month periods ended March 31, 2014 and 2013, interest expense of $34,000 related to the convertible debt was added back to net income attributable to continuing operations for the computation of diluted earnings per share. For the six month periods ended March 31, 2014 and 2013, interest expense of $68,000 related to the convertible debt was added back to net income attributable to continuing operations for the computation of diluted earnings per share.

4. Accounts Receivable

Accounts receivable consisted of the following (in thousands):

5. Long Term Debt

Beginning in November 2013, we entered into a staggered bridge financing transaction (the “2013 Bridge Financing”) whereby we entered into four promissory notes, with interest of 10% per annum, in the aggregate principal amount of $650,000 (the “2013 Bridge Notes”). The 2013 Bridge Notes mature June 30, 2014. The 2013 Bridge Loans funded as follows: $450,000 and $200,000 in November 2013 and January 2014, respectively. Three of the investors, SMP Investments I, LLC (“SMP”), Anthony J. Ciabottoni, and William A. Houlihan each hold a 10% or greater voting interest and are considered related parties. The fourth investor, Blue Ridge Investments, LLC is wholly owned by Richardson Sells, a member of the Board, and is therefore also considered a related party. SMP, Anthony J. Ciabottoni, William A. Houlihan and Blue Ridge Investments, LLC contributed $300,000, $125,000, $125,000, and $100,000, respectively.

In January 2014, each 2009 Bridge Lender agreed to extend the maturity of their respective notes with the same terms and conditions contained in the originally executed notes and related extensions until June 30, 2014. In April 2014, the Company paid all outstanding principal and accrued interest related to these notes. For additional information, see Note 9. Three of the 2009 Bridge Lenders, SMP, Anthony Ciabattoni, and William A. Houlihan, each hold a 10% or greater voting interest and are considered related parties to this transaction.

Long-term debt consists of the following (in thousands):

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6. Warrants

On January 17, 2014, the Company issued warrants to SMP for the purchase of up to 8,500,000 shares of common stock at an initial exercise price of $0.01 per share. The warrants are exercisable for a period of five years from the date of issuance and were issued as consideration for the extension of the maturity date of the SMP promissory note associated with the 2009 Bridge Lenders (see Note 5). SMP holds a 10% or greater voting interest and is considered a related party. On March 27, 2014, SMP exercised its warrant to purchase 8,500,000 shares of common stock for an aggregate purchase price of $85,000. The $85,000 proceeds were received previously by the company in fiscal year 2013, and were recorded as a liability until such time as the Company was able to accept the warrants.

On January 1, 2014, the Company issued warrants to purchase an aggregate of 2,278,079 shares of common stock with an exercise price of $0.3125. These warrants are exercisable for a period of five years from date of issuance. SMP, Anthony J. Ciabattoni, and William A. Houlihan received warrants to purchase up to 850,080, 425,600 and 470,400 shares of common stock, respectively. The warrant issuance was related to the 2011 Bridge Financing and the warrants were issued at such time as the Company was able to legally issue warrants. Three of the warrant recipients, SMP, Anthony J. Ciabattoni, and William A. Houlihan, a member of the Company’s Board, each hold a 10% or greater voting interest and are considered related parties and received in aggregate 1,746,080 of the warrants.

On January 1, 2014, the Company issued warrants to purchase an aggregate of 4,092,800 shares of common stock with an exercise price of $0.3125. These warrants are exercisable for a period of five years from date of issuance. SMP, Anthony J. Ciabattoni, and William A. Houlihan received warrants to purchase up to 1,984,400, 1,388,800 and 720,000 shares of common stock, respectively. The warrant issuance was related to the 2012 Bridge Financing and the warrants were issued at such time as the Company was able to legally issue warrants. The warrant recipients, SMP, Anthony J. Ciabattoni, and William A. Houlihan, each hold a 10% or greater voting interest and are considered related parties.

The following warrants were outstanding and exercisable as of the following as of March 31, 2014:

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7. Stock Options

A summary of our options activity and related information at March 31, 2014 and September 30, 2013 is as follows:

The following options were outstanding as of March 31, 2014:

8. Preferred Stock

Series 7-A Convertible Preferred Stock

On December 5, 2013, the Company filed a Certificate of Designation of Rights and Preferences of Series 7-A Convertible Preferred Stock (the “7-A Certificate”) authorizing the issuance of up to 7,000 Series 7-A Convertible Preferred Stock (“7-A Preferred”).

Under the terms of the 7-A Certificate, in the event of any liquidation or dissolution, either voluntary or involuntary, the holders of the 7-A Preferred shall be entitled to receive, pari passu with the Series 6-A Convertible Preferred Stock (“6-A Preferred”) and the Series 5-A Convertible Preferred Stock (“5-A Preferred”), after distribution of all amounts due to the holders of the Series 1-A Convertible Preferred Stock (“1-A Preferred”) and Series 2-A Convertible Preferred Stock (“2-A Preferred”), but prior and in preference to any distribution of any of the assets or surplus funds to the holders of the Common Stock by reason of their ownership thereof, a preference amount per share consisting of the sum of (A) the original issue price, which initially is $1,000 (as adjusted for stock splits, stock dividends, combinations and the like), plus (B) an amount equal to all declared but unpaid dividends on such shares, if any.

Each share of 7-A Preferred shall be convertible at any time after the date of issuance of such shares, into such number of fully paid shares of Common Stock as is determined by dividing the original issue price by the then-applicable conversion price in effect on the date the certificate evidencing such share is surrendered for conversion. Each share of 7-A Preferred, subject to the surrendering of the certificates of the 7-A Preferred, shall be

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FIRST PHYSICIANS CAPITAL GROUP, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED

automatically converted into shares of Common Stock at the then-applicable conversion price, upon the election of the holders of not less than a majority of the outstanding shares 7-A Preferred electing to effect such conversion. Under certain circumstances, such as the sale of the Company or the sale of the Company’s shares in a public offering, each at a valuation of greater than $100,000,000, the Company can elect to convert all Series 7-A into Common Stock. The initial conversion price per share is $0.3125. The holder of each share of 7-A Preferred shall have the right to that number of votes equal to the number of shares of Common Stock, which would be issued upon conversion of the 7-A Preferred.

The Company, at its option and upon the approval of a majority of the holders of the shares of Series 7-A Preferred Stock then-outstanding, may redeem any or all of the outstanding shares of Series 7-A Preferred Stock at any time upon five (5) business days’ prior written notice to each holder of shares of Series 7-A Preferred Stock, at a price per share equal to the (i) redemption price (as provided in the Certificate of Designation) then in effect plus (ii) an amount equal to any declared but unpaid dividends on such share. In the event the Company elects to redeem less than all of the outstanding shares of Series 7-A Preferred Stock, the Company shall redeem shares of Series 7-A Preferred Stock on a pro rata basis among all holders of Series 7-A Preferred Stock, based on the number of shares of Series 7-A Preferred Stock held by each holder relative to the total number of shares of Series 7-A Preferred Stock outstanding as of the time of such redemption.

The holders of 7-A Preferred shall be entitled to receive (out of any assets legally available), if declared by our Board of Directors, noncumulative dividends pari passu with the 6-A Preferred and the 5-A Preferred stockholders, of $100 per share annually. No dividend may be declared and paid upon shares of 7-A Preferred in any fiscal year of the Company unless dividends have first been paid upon or declared and set aside for payment to the holders of shares of the Company’s 1-A Preferred and 2-A Preferred. Under certain circumstances, such as stock splits or issuances of Common Stock at a price less than the issuance price of the 7-A Preferred, the 7-A Preferred is entitled to conversion price adjustments. Shares of 7-A Preferred have an initial conversion price of $0.3125 per share. Shares of 7-A Preferred Stock are subject to redemption at our option and upon approval of the majority of the holders of the outstanding 7-A Preferred.

As part of the consideration for entering into the 2011 Bridge Financing, all of the 2011 Bridge Lenders were granted the option to exchange their current holdings if any, of 5-A Preferred, 6-A Preferred and common stock (collectively the “Exchanged Securities”), into 7-A Preferred. Upon election to exchange, each lender would receive the number of 7-A Preferred equal to the initial consideration paid for their Exchanged Securities divided by $1,000. In connection with the exchange, each 2011 Bridge Lender shall receive warrants to purchase a number of shares of common stock of the Company in an amount equal to 1,120 multiplied by the aggregate number of shares of 7-A Preferred issued. Such issued warrants shall have an exercise price of $0.3125, and shall expire five years from date of issuance. The Company has received notification from all the 2011 Bridge Lenders of their intent to exchange, as appropriate, their holdings of Exchanged Securities to 7-A Preferred, which will result in the issuance of an aggregate of 5,998 shares of 7-A Preferred and warrants to purchase up to 6,717,760 shares of common stock. The Company expects to complete the exchange during the fiscal quarter ending June 30, 2014. Three of the 2011 Bridge Lenders, SMP, Anthony J. Ciabattoni, and William A. Houlihan, a member of the Company’s Board each hold a 10% or greater voting interest and are considered related parties. SMP, Anthony J. Ciabattoni, and William A. Houlihan will receive 2,713, 1,560 and 317 shares of 7-A Preferred, respectively, and warrants to purchase up to 3,038,560, 1,747,200 and 415,520 shares of common stock, respectively.

9. Subsequent Events

Bridge Financing

On April 7, 2014, the Company paid all outstanding principal and accrued interest related to the 2009 and 2013 Bridge Financing notes, and the outstanding accrued interest related to the 2011 and 2012 Bridge Financing notes. The total amount paid was $2,463,874 consisting of $2,000,000 on principal and $463,874 of interest. Three of the bridge lenders, SMP, Anthony J. Ciabottoni, and William A. Houlihan (a member of the board) each hold a 10% or greater voting interest and are considered related parties. A fourth lender, Blue Ridge Investments, LLC is wholly owned by Richardson Sells, a member of the Board, and is therefore also considered a related party. SMP, Anthony J. Ciabottoni, William A. Houlihan and Blue Ridge Investments, LLC received payments of $930,059, $1,187,701, $209,024, and $101,056, respectively. The Company also paid an outstanding note payable in the amount of $100,000 plus interest of $28,812, to Anthony Ciabottoni who holds a 10% or greater voting interest and is considered a related party.

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FIRST PHYSICIANS CAPITAL GROUP, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED

Warrant Exercise

In April 2014, we accepted two warrant exercises in the amount of 150,000 and 210,000 shares of Common Stock, at an exercise price of $0.625 and $0.50 per share, respectively, for an aggregate purchase price of $198,000 from two investors. The $198,000 proceeds, consisting of $138,000 cash and $60,750 in consulting fees owed, had been received by the Company in fiscal year 2012, and were recorded as a liability until the Company accepted the warrants in April 2014.

Change in Management

On March 24, 2014, the Board appointed Adrian B. Reeder to the position of Chief Financial Officer of the Company effective April 7, 2014 to serve until his successor is duly appointed and qualified or until his earlier resignation or removal.

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