<PAGE>
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A*
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1997
OR
[ ] TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number 001-12621
GRANCARE, INC.
(Exact name of registrant as specified in its charter)
Delaware 95-4336136
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
One Ravinia Drive, Suite 1500
Atlanta, Georgia 30346
(Address of principal executive offices) (Zip Code)
(770) 393-0199
(Registrant's telephone number, including area code)
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 x No
---------- ----------
There were 24,106,947 shares outstanding of registrant's Common Stock, par value
$0.001 per share, as of August 11, 1997.
* The purpose of filing this Form 10-Q/A is to correct certain information in
the Income (loss) before extraordinary charge item in the Condensed
Consolidated Statements of Income and certain information in the Operating
expense discussion in Management's Discussion and Analysis of Financial
Condition and Results of Operations appearing in the Form 10-Q initially filed
with respect to the quarterly period ended June 30, 1997.
================================================================================
<PAGE>
GRANCARE, INC.
INDEX
-----
Page No.
--------
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited):
Condensed Consolidated Balance Sheets-
June 30, 1997 and December 31, 1996............... 3
Condensed Consolidated Statements of Income-
Three Months Ended June 30, 1997 and 1996 and
Six Months Ended June 30, 1997 and 1996........... 5
Condensed Consolidated Statement of Shareholders'
Equity - Six Months Ended June 30, 1997........... 6
Condensed Consolidated Statements of Cash Flows-
Six Months Ended June 30, 1997 and 1996........... 7
Notes to Condensed Consolidated Financial
Statements........................................ 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations for the
Three and Six Months Ended June 30, 1997.......... 11
Signatures.................................................... 19
2
<PAGE>
PART I - FINANCIAL INFORMATION
For financial reporting purposes, the reporting entity is the successor to
GranCare, Inc., a California corporation (the "Predecessor"). Effective
February 12, 1997, Vitalink Pharmacy Services, Inc. ("Vitalink") acquired the
Predecessor's institutional pharmacy business ("TeamCare" or the "Institutional
Pharmacy Business") through the merger (the "Vitalink Merger") of the
Predecessor with and into Vitalink. Immediately prior to the Vitalink Merger,
all of the Predecessor's non-institutional pharmacy businesses, including its
skilled nursing, home health care, assisted living and contract management
businesses and related assets (collectively, the "Skilled Nursing Business"),
were transferred to GranCare, Inc., a Delaware corporation (the "Successor")
(then a wholly owned subsidiary of the Predecessor) and all of the then
outstanding stock of the Successor was distributed (the "Distribution") to the
shareholders of the Predecessor. While the Successor is not the successor to
the Predecessor for Securities and Exchange Commission reporting purposes, it is
the successor to the Predecessor for financial reporting purposes. Accordingly,
unless the context otherwise requires, "GranCare" and the "Company" refer to
GranCare, Inc., a California corporation, and its subsidiaries for periods on or
prior to February 12, 1997 and to GranCare, Inc., a Delaware corporation, and
its subsidiaries for periods subsequent to February 12, 1997.
ITEM 1. FINANCIAL STATEMENTS
--------------------
GRANCARE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars In Thousands)
<TABLE>
<CAPTION>
June 30, December 31,
1997 1996
----------- ------------
(Unaudited) (Note)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.......................................... $ 19,778 $ 14,512
Accounts receivable, less allowance for doubtful accounts
(1997 - $14,918 and 1996 - $11,209)............................... 234,435 233,335
Inventories........................................................ 1,838 17,312
Notes receivable................................................ 24,520 24,520
Prepaid expenses and other current assets.......................... 17,502 18,786
Deferred income taxes.............................................. 5,887 9,239
--------- --------
Total current assets.............................................. 303,960 317,704
Property and equipment.............................................. 254,773 271,536
Less accumulated depreciation...................................... (57,798) (64,387)
--------- --------
196,975 207,149
Other assets:
Investments, at fair value......................................... 38,175 38,933
Goodwill, less accumulated amortization
(1997 - $6,010 and 1996 - $10,332)................................ 59,550 133,152
Other intangibles, less accumulated amortization
(1997 - $5,378 and 1996 - $9,700)................................. 9,497 11,613
Other.............................................................. 29,752 39,488
--------- --------
Total assets........................................................ $637,909 $748,039
========= ========
</TABLE>
Note: The balance sheet at December 31, 1996 has been derived from the audited
financial statements at that date.
See Notes to Condensed Consolidated Financial Statements.
3
<PAGE>
GRANCARE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars In Thousands)
<TABLE>
<CAPTION>
June 30, December 31,
1997 1996
----------- -------------
(Unaudited) (Note)
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses..................................... $ 82,555 $ 79,824
Accrued wages and related liabilities..................................... 16,405 21,541
Interest payable.......................................................... 4,968 8,235
Notes payable and current maturities of long-term debt.................... 3,115 7,535
-------- --------
Total current liabilities................................................ 107,043 117,135
Long-term debt............................................................. 361,996 382,242
Deferred income taxes...................................................... 17,531 23,084
Other...................................................................... 10,889 11,278
Shareholders' equity:
Common stock; $0.001 par value; 50,000,000 shares authorized
(shares issued: 1997-24,088,697)......................................... 24 -
Paid in capital........................................................ 124,970 -
Common stock; no par value; 50,000,000 shares authorized
(shares issued: 1996-23,677,825)......................................... - 123,378
Equity component of minimum pension liability............................. (542) (542)
Unrealized gain on investments net of income taxes (1997 -
$4,554 and 1996 - $4,573)................................................ 6,831 6,885
Retained earnings......................................................... 9,167 84,579
-------- --------
140,450 214,300
-------- --------
Total liabilities and shareholders' equity................................. $637,909 $748,039
======== ========
</TABLE>
Note: The balance sheet at December 31, 1996 has been derived from the audited
financial statements at that date. See Notes to Condensed Consolidated Financial
Statements.
4
<PAGE>
GRANCARE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(Dollars And Shares In Thousands, Except Per Share Data)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- ---------------------
1997 1996 1997 1996
--------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues:
Net patient revenues............................ $197,925 $245,427 $420,851 $474,254
Investment and other revenue.................... 1,416 1,844 3,006 3,028
-------- -------- -------- --------
Net revenues................................. 199,341 247,271 423,857 477,282
Expenses:
Operating expenses.............................. 187,016 218,646 390,870 423,721
Depreciation and amortization................... 5,262 6,514 11,013 12,672
Interest expense and financing charges.......... 7,782 8,918 16,319 17,067
Nonrecurring costs-merger and other costs....... --- --- 28,300 ---
-------- -------- -------- --------
Total expenses............................... 200,060 234,078 446,502 453,460
-------- -------- -------- --------
Income (loss) before income taxes and
extraordinary charge...................... (719) 13,193 (22,645) 23,822
Income taxes...................................... (273) 5,013 (893) 9,052
-------- -------- -------- --------
Income (loss) before extraordinary charge......... (446) 8,180 (21,752) 14,770
Extraordinary charge - loss on early
extinguishment of debt, net of income tax benefit
of $2,961........................................ --- --- 4,831 ---
-------- -------- -------- --------
Net income (loss)........................... $ (446) $ 8,180 $(26,583) $ 14,770
========= ======== ======== ========
Net income (loss) per common and common
equivalent share:
Primary:
Income (loss) before extraordinary charge.. $ (0.02) $ 0.34 $ (0.91) $ 0.62
Extraordinary charge....................... --- --- (0.20) ---
-------- -------- -------- --------
Net income (loss).......................... $ (0.02) $ 0.34 $ (1.11) $ 0.62
========= ======== ======== ========
Fully diluted:
Income (loss) before extraordinary charge.. $ (0.02) $ 0.33 $ (0.91) $ 0.61
Extraordinary charge....................... --- --- (0.20) ---
-------- -------- -------- --------
Net income (loss).......................... $ (0.02) $ 0.33 $ (1.11) $ 0.61
========= ======== ======== ========
Weighted average number of common and
common equivalent shares outstanding:
Primary.................................... 24,028 24,077 23,925 23,932
========= ======== ======== ========
Fully diluted.............................. 24,028 26,570 23,925 26,484
========= ======== ======== ========
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
5
<PAGE>
GRANCARE, INC.
CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(Dollars In Thousands)
<TABLE>
<CAPTION>
Equity
Component of
Common Minimum Unrealized
Common Stock, Stock, Paid in Pension Gain on Retained
No Par $0.001 Par Capital Liability Investments Earnings Total
-------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balances at January 1, 1997........ $ 123,378 $-- $ -- ($542) $6,885 $ 84,579 $214,300
TeamCare Merger transactions:
Conversion of Common Stock....... (123,378) 24 123,354 -- -- -- --
Dividend of TeamCare............. -- -- -- -- -- (48,829) (48,829)
Issuance of 410,872 shares of
common -- -- 1,616 -- -- -- 1,616
stock on exercise of options.......
Unrealized loss on investments..... -- -- -- -- (54) -- (54)
Net income (loss).................. -- -- -- -- -- (26,583) (26,583)
-------------------------------------------------------------------------------------------------
Balances at June 30, 1997.......... $ -- $24 $124,970 ($542) $6,831 $ 9,167 $140,450
=================================================================================================
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
6
<PAGE>
GRANCARE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars In Thousands)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
-----------------------------------------------
1997 1996
--------------------- ----------------------
OPERATING ACTIVITIES
<S> <C> <C>
Net income (loss)................................................. $ (26,583) $ 14,770
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Provision for doubtful accounts.................................. 10,381 3,607
Depreciation and amortization.................................... 11,013 12,672
Gain on sale of assets........................................... (187) (114)
Non-cash one-time charges........................................ 5,916 ---
Amortization of deferred financing costs......................... 310 468
Changes in assets and liabilities net of
effect of acquisitions:
Accounts receivable............................................. (59,406) (44,728)
Other current assets............................................ (1,212) (4,096)
Other noncurrent assets......................................... (767) (3,641)
Accounts payable and accrued expenses........................... 17,830 1,682
Accrued wages and related liabilities........................... (987) (469)
Interest payable................................................ (3,133) 1,433
Income taxes payable............................................ --- 1,928
Other noncurrent liabilities.................................... 96 76
--------------------- ----------------------
Net cash used in operating activities......................... (46,729) (16,412)
INVESTING ACTIVITIES
Acquisition of businesses, net of cash acquired................... 163 (5,929)
Purchases of property and equipment............................... (11,758) (16,364)
Net proceeds from disposition of TeamCare......................... 88,233 ---
Proceeds from disposition of property and equipment............... --- 994
Net purchases and sales of investments............................ 586 (5,119)
Other............................................................. (546) (1,400)
--------------------- ----------------------
Net cash provided by (used in) investing activities............. 76,678 (27,818)
FINANCING ACTIVITIES
Proceeds from exercise of warrants and options.................... 1,616 1,992
Long-term debt payments........................................... (262,794) (4,571)
Proceeds from long-term debt borrowings........................... 239,000 42,250
Payment of debt issuance costs.................................... (2,505) (250)
--------------------- ----------------------
Net cash (used in) provided by financing activities............. (24,683) 39,421
--------------------- ----------------------
Net increase (decrease) in cash and cash equivalents.............. 5,266 (4,809)
Cash and cash equivalents at beginning of period.................. 14,512 17,738
--------------------- ----------------------
Cash and cash equivalents at end of period........................ $ 19,778 $ 12,929
===================== ======================
</TABLE>
See Notes to Condensed Consolidated Financial Statements
7
<PAGE>
GRANCARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note A - Basis of Presentation
- ------------------------------
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with the instructions to Form 10-Q and Rule 10-
01 of Regulation S-X. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the three and six month periods ended June
30, 1997 are not necessarily indicative of the results that may be expected for
the year ending December 31, 1997. For further information, refer to the
consolidated financial statements and the footnotes thereto included in the
Company's annual report on Form 10-K for the year ended December 31, 1996.
Note B - Vitalink Merger
- ------------------------
GranCare entered into an Amended and Restated Agreement and Plan of
Merger with Vitalink Pharmacy Services, Inc. (Vitalink) dated as of September 3,
1996. The form of the transactions were: (1) GranCare's skilled nursing
facilities, along with its contract management and home health businesses were
reorganized into New GranCare, Inc. (New GranCare) and all of the shares of New
GranCare distributed to the GranCare shareholders in a tax-free spin off (the
Distribution); (2) GranCare (then consisting solely of the institutional
pharmacy and related business known as TeamCare) merged into and was acquired by
Vitalink (Vitalink Merger) through a tax-free exchange of shares of common stock
of Vitalink for shares of common stock of GranCare; and (3) New GranCare became
a public company upon consummation of the Distribution. Notwithstanding the
legal structure of the transactions, for accounting/financial reporting purposes
such transactions have been treated as the spin-off of TeamCare in the form of a
dividend and the reorganization/recapitalization of GranCare into New GranCare
as New GranCare has continued the majority of the GranCare businesses. No gain
has been recognized as a result of the distribution for the difference between
the market value of the Vitalink Common Stock received and the carrying value of
the net assets of TeamCare. New GranCare continued to reflect the historical
cost basis of assets and liabilities of GranCare. These transactions were
approved by the GranCare shareholders on February 8, 1997 and the transactions
closed on February 12, 1997 (the Closing Date); the spin-off of TeamCare was
reflected in the first quarter of 1997.
In addition, as a consequence of the Vitalink Merger, the Company
redeemed its 6 1/2% Convertible Subordinated Debentures (the Debentures) due
January 15, 2003 effective as of the Closing Date. GranCare deposited the
redemption price and accrued interest on each outstanding Debenture with the
trustee for the Debentures and interest ceased to accrue as of February 12,
1997. GranCare also completed a tender offer for its 9 3/8% Senior
Subordinated Notes (Senior Notes) due 2005. GranCare accepted $98 million
aggregate principal amount of Senior Notes (representing 98% of the outstanding
Senior Notes) for purchase pursuant to GranCare's cash tender offer at a
purchase price of $1,090 per $1,000 principal amount plus accrued and unpaid
interest up to, but not including, the payment date.
In February 1997, the Company recognized a merger charge and
extraordinary charge related to debt extinguishment in connection with the
aforementioned transactions. The components of the merger charge and
extraordinary charge recognized in New GranCare's operations in the first
quarter of 1997 consist of the following:
8
<PAGE>
DOLLARS IN THOUSANDS
--------------------
<TABLE>
<CAPTION>
Shared transaction costs:
<S> <C>
Redemption premium - $100 million Senior
Subordinated Notes.................................................... $ 9,000
Redemption premium - $60 million Convertible
Subordinated Debentures............................................... 2,430
Investment banker fees................................................ 4,200
Consent fee paid to HRPT.............................................. 5,500
Other professional fees and merger related costs...................... 5,470
--------
Total shared costs........................................................... 26,600
Less costs to be paid by Vitalink............................................ (13,300)
--------
GranCare portion of shared transaction costs................................. 13,300
Other transaction related costs:
Consent fee paid to HRPT.............................................. 4,500
Write-off to deferred financing fees.................................. 5,441
Amounts payable under GranCare Shareholder Value Program............
4,500
Amounts payable under Restricted Stock Plan........................... 2,200
Other employee severance and other related costs...................... 6,059
--------
36,000
Less: Income taxes......................................................... (6,000)
--------
Total costs, net of income taxes............................................. $ 30,000
========
</TABLE>
Excluding TeamCare, the Vitalink Merger and extraordinary charges, GranCare's
total net revenues, pre-tax income and primary earnings per share for the six
month periods ended June 30, 1997 and 1996, respectively, would have been
$403,060,000, $5,166,000 and $0.13 and $365,790,000, $6,333,000 and $0.26.
Note C - Contingent Earn-Out Provision
- --------------------------------------
The purchase agreement with respect to the 1994 acquisition of Long Term
Care Pharmaceutical Services Corporation I and Long Term Care Pharmaceutical
Services Corporation III (collectively, "LTC"), contained a contingent earnout
provision for the two year period ended June 30, 1996. In April 1997, the
Company paid the seller of LTC $5.4 million in settlement of the earnout
provision. Of this settlement, Vitalink is obligated to fund $2.5 million.
This settlement has been reflected in the accompanying financial statements as
an increase to GranCare's investment in TeamCare thereby increasing the amount
of the dividend recorded in connection with the TeamCare spin-off.
Note D - Non-Recurring Charge
- -----------------------------
During the third quarter of 1996, the Company recorded exit and other
one-time costs of $18.4 million as a charge to operations. Approximately $10.6
million of this charge relates to management's decision to close five Indiana
facilities which are operated under long term operating leases, as these
facilities did not fit the Company's operating strategies. The $10.6 million
reflects the remaining net book value of leasehold improvements at the dates of
closure and the remaining rent due to the landlord for periods after the dates
of closure. On March 6, 1997, the Company modified its plan from closing five
Indiana facilities to terminating most of its lease obligations and operations
in Indiana involving a total of 18 facilities. This modification did not
significantly impact the exit costs previously accrued in the third quarter of
1996. Management completed the lease terminations effective April 1, 1997.
Approximately $3 million of the charge relates to the write-off of notes
receivable for loans made by the Company to a sublease lessee to fund working
capital. Accounts receivable from the facility under lease serve as collateral
for the working capital loans. During the third quarter of 1996, the loans to
the lessee began to significantly exceed the collateral, indicating that the
loan would not be recoverable. Accordingly, the Company decided to terminate
the sublease arrangement and to write off the loans which it concluded would not
be recoverable. In addition, in the third quarter of 1996, the Company recorded
9
<PAGE>
$4.8 million of other charges which included $2.9 million of additional bad debt
expense related to TeamCare. The charge for bad debt expense was necessary to
provide for the increased risk of collection resulting from the deterioration in
the financial condition of certain customers in the third quarter of 1996.
Note E - Third Party Settlement Appeal
- --------------------------------------
During the fourth quarter of 1996, the Company received final settlement
on its 1994 cost reports for its California long-term health care facilities.
The final settlements made by the intermediary for seven facilities included
disallowances of a portion of speech and occupational therapy costs ($1.8
million) based on their interpretation of the Medicare prudent buyer concept.
In addition, the intermediary has reopened the 1993 cost reports for two
additional facilities ($0.7 million) for the same issue. The Company has
furnished therapy services to patients under arrangements with outside therapy
contractors. The contracts with the outside contractors contain indemnification
clauses regarding denial of payment for services provided. The intermediary
asserts that the Company did not act as a prudent buyer of therapy services as
the Company should have hired therapists instead of contracting for their
services. In the absence of prudent buyer documentation to the contrary, the
intermediary determined reasonable costs for therapy services based on
internally developed survey data and other factors. The Company, in conjunction
with a therapy company and another long-term care company, has filed an
expedited group appeal to the Provider Reimbursement Review Board regarding
these 1994 audit adjustments. A hearing took place during the Company's second
quarter. The Company is awaiting the outcome of this hearing. Management
(based on the advise of outside counsel) believes that it has a strong position
in this matter and will ultimately prevail; therefore no accrual for losses has
been made. It is possible that the intermediary will attempt to apply the same
interpretation for other Company facilities and for other periods. If the
hearing results in an unfavorable outcome to the Company and if the Company does
not ultimately prevail on this matter, it could have a material adverse impact
on net income of a particular future quarter or year.
Note F - Credit Facility
- ------------------------
In connection with the Vitalink Merger described in Note B, the Company
replaced its existing credit facility with a new credit facility in the
aggregate amount of $300,000,000 (the New Credit Facility). The New Credit
Facility consists of two components: a $200,000,000 5-year revolving credit
facility (which includes a $40,000,000 sub-limit for the issuance of standby
letters of credit) and a $100,000,000 5-year term loan. Borrowings for working
capital and general corporate purposes may not exceed $75,000,000. The first
$25,000,000 of exposure for letters of credit issued under the letter of credit
sub-facility will correspondingly reduce availability under the working capital
sub-facility. The revolving credit portion of the New Credit Facility will
mature in five years. The term loan portion of the New Credit Facility will be
amortized in ten quarterly installments of $7,000,000 each commencing February
12, 1999, thereafter increasing to $10,000,000 per quarter. All remaining
principal and accrued and unpaid interest shall be due and payable in full on
the fifth anniversary of the closing date of the New Credit Facility. Interest
on outstanding borrowings shall accrue, at the option of the Company, at the
base rate or at the Eurodollar rate plus, in each case, an applicable margin.
Note G - Taxes
- --------------
For the six-months ended June 30, 1997, the provision for income taxes is
affected by $19.0 million of merger expenses that are not tax deductible for
income tax purposes. Without the effect of such non-deductible expenses, the
effective tax rate for the 1997 period is approximately 39% compared to 38% for
the same period in 1996.
Note H - FASB Statement No. 128
- -------------------------------
During the first quarter of 1997, the FASB released FASB Statement No. 128
(Statement No. 128), Earnings Per Share. As required, the Company intends to
adopt Statement No. 128 in the fourth quarter of 1997 and will restate earnings
per share for prior periods in conformity with the new rules.
10
<PAGE>
Note I - Related Party Transaction
- ----------------------------------
Effective April 1, 1997, the Company acquired Connerwood Healthcare, Inc.
("Connerwood"), a long-term care company operating seven skilled nursing
facilities in Indiana. These facilities were subleased to Connerwood in 1993
and have been managed by the Company since that date. Four of the seven
facilities acquired were subsequently divested in conjunction with the Indiana
lease termination described in Note D.
Note J - Change in Accounting Estimate
- --------------------------------------
Since December 31, 1996, and to a greater extent in the second quarter of
1997, the Company has experienced delays in its collection of certain third
party and other accounts receivable. In recognition of these delays, the Company
has increased its allowance for doubtful accounts. The effect of this change in
accounting estimate for the three and six months ended June 30, 1997 was to
increase operating expenses by $8.0 million and net loss by $4.9 million, or
$0.20 per share.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
-----------------------------------------------------------------------
OF OPERATIONS
-------------
RECENT DEVELOPMENTS
On May 8, 1997, the Company announced the execution of an agreement and plan
of merger pursuant to which the Company would be merged (the "LCA Merger") into
a wholly-owned subsidiary of Living Centers of America, Inc. ("LCA") immediately
following a leveraged recapitalization of LCA by Apollo Management, L.P.
("Apollo") and certain other related transactions (collectively, the
"Transactions"). The Company believes that the post-merger company and its
subsidiaries (the "Companies") would be one of the largest long term care
providers in the country in terms of the number of licensed beds, operating over
330 facilities with more than 38,000 licensed beds in 21 states. In addition to
operating skilled nursing facilities, the Companies would provide pharmacy and
rehabilitation services, assisted living, contract management and geriatric
specialty healthcare services nationwide. Vitalink and Manor Care, Inc.
("ManorCare") have obtained a preliminary injunction prohibiting the Company
from consummating the LCA Merger. The Company remains committed to consummating
the LCA Merger on the terms set forth in the merger agreement; however, due to
the uncertainties of litigation, no assurance can be given that the Company will
prevail in having the injunction lifted on appeal or in the ultimate disposition
of this matter. See "Part II - Item 1. Legal Proceedings". Consummation of the
LCA Merger is subject to numerous conditions including obtaining certain
regulatory approvals and approval of the Transactions by the shareholders of LCA
and the Company.
GENERAL
On February 12, 1997, the Company completed the Vitalink Merger, the practical
effect of which was to transfer on a tax advantaged basis the Company's
Institutional Pharmacy Business to Vitalink and distribute the consideration for
such transfer to the Company's shareholders. For financial reporting purposes,
the Company is the successor to GranCare, Inc., a California corporation.
The Company was incorporated in September 1987. Since inception, the Company
has grown rapidly through acquisitions of long-term care facilities and
specialty medical businesses such as institutional pharmacy operations. During
1996 the Company acquired RN Health Care Services, Inc., a home health agency in
Michigan, Jennings Visiting Nurse Association, Inc., a home health agency in
Indiana, Emery Pharmacy, a provider of institutional pharmacy services in
upstate New York and RX Corporation, a provider of institutional pharmacy
services in southern California.
11
<PAGE>
The Company's revenues and profitability are affected by ongoing efforts of
third-party payors to contain health care costs by limiting reimbursement rates,
increasing case management review and negotiating reduced contract pricing.
Government payors, such as state-administered Medicaid programs and, to a lesser
extent, the federal Medicare program, generally provide more restricted coverage
and lower reimbursement rates than private pay sources. For the three-month
period ended June 30, 1997, the percentage of the Company's total gross patient
revenues derived from Medicaid and Medicare programs were 34% and 46%,
respectively.
The Company derives its revenues by providing (i) skilled nursing, (ii)
pharmacy (through January 31, 1997), therapy, subacute and other specialty
medical services and (iii) contract management of specialty medical programs for
acute care hospitals. In general, the Company generates higher revenues and
profitability from the provision of specialty medical services than from routine
skilled nursing care, and the Company believes that this trend will continue.
The Company seeks to enhance its operating margins by increasing the proportion
of its revenues derived from specialty medical services.
In April 1997, the Company disposed of 18 underperforming facilities that no
longer fit within the Company's strategic focus. The Company continues to
evaluate certain long-term care facilities which are underperforming or do not
fit within the Company's long-term strategic plans. All or a portion of these
facilities may be divested in the future whether or not the Transactions are
consummated.
RESULTS OF OPERATIONS
The following tables set forth, as a percentage of patient revenues, certain
income data for the periods indicated:
REVENUE COMPOSITION/PERCENTAGE OF PATIENT REVENUES (1)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------------- ----------------------------
1997 1996 1997 1996
------------- ----------- -------------- ----------
<S> <C> <C> <C> <C>
Skilled Nursing and Subacute Care:
Routine services.......................................... 56.2% 59.6% 56.3% 60.8%
Specialty Medical:
Therapy, subacute and other ancillary services............. 39.4 35.6 39.4 34.5
Contract Management........................................ 4.4 4.8 4.3 4.7
-------------- ----------- ------------ -------------
Subtotal.................................................. 43.8% 40.4% 43.7% 39.2%
-------------- ----------- ------------ -------------
Total...................................................... 100.0% 100.0% 100.0% 100.0%
============== =========== ============ =============
</TABLE>
Revenues Per Patient Day Derived from Skilled Nursing and Subacute Care (1)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- --------------------
1997 1996 1997 1996
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Routine skilled nursing $ 94.49 $ 90.05 $ 93.24 $ 89.09
Specialty medical services (2) 66.15 53.75 65.32 50.51
--------- --------- --------- ---------
Total $160.64 $143.80 $158.56 $139.60
========= ========= ========= =========
</TABLE>
(1) Excluding TeamCare for all periods presented.
(2) Excludes other specialty medical revenue from beds not operated by the
Company.
The Company's net revenues for the three and six month periods ended June 30,
1997 were $199.3 and $423.9 million, respectively, compared to $247.3 and $477.3
million for the same periods in 1996, a decrease of $48.0 and $53.4 million,
respectively, or 19.4% and 11.2%.
12
<PAGE>
Excluding the Institutional Pharmacy Business, the Company's net revenues for
the three and six month periods ended June 30, 1997 were $199.3 and $403.0
million, respectively, compared to $188.2 and $365.7 million for the same
periods in 1996, an increase of $11.1 and $37.3 million, respectively, or 5.9%
and 10.2% These increases are partially offset by April 1997 divestiture of
certain underperforming businesses. Same-store growth increased,
$10.7 and $23.8 million for the three and six month periods ended June
30, 1997, from increases in specialty medical services provided and an increase
in average daily rates due to an improved payor mix. Specialty medical revenues
increased $11.3 and $32.8 million over the same periods in 1996. This was the
result of growth in the number of Medicare residents which utilize higher margin
ancillary services (physical, respiratory, occupational and speech therapy).
Included in net revenues for the three and six month periods ended June 30, 1997
and 1996 were $1.5 million and $2.4 million, respectively, compared to $2.0 and
$2.4 for the same periods in 1996, relating to routine cost limit exceptions.
While the Company has applied for these exceptions, and has only recognized a
portion of the estimated recovery, there can be no assurance that the actual
revenues from routine cost limit exceptions will equal those amounts recognized
by the Company in the three and six month periods ended June 30, 1997 and 1996.
Operating expenses (excluding rent and property expenses) for the three and
six month periods ended June 30, 1997 were $175.2 and $365.3 million,
respectively, compared to $204.4 and $396.0 million for the same periods in
1996, a decrease of $29.2 and $30.7 million, respectively.
Excluding the Institutional Pharmacy Business, operating expenses (excluding
rent and property expenses) for the three and six month periods ended June 30,
1997 were $175.2 and $347.1 million, respectively, compared to $155.7 and $304.1
million for the same periods in 1996, an increase of $19.5 and $43.0 million,
respectively, or 12.6% and 14.1%. $11.5 and $21.5 million of the increase for
the three and six month periods ended June 30, 1997, respectively, was
attributable to acquisitions, as well as costs associated with an increase of
specialty medical services provided. On a same-store basis, operating expenses
increased $10.6 and $22.1 million for the three and six month periods ended June
30, 1997, respectively, over the same periods in 1996. $8.0 million of the
increase for the three and six months ended June 30, 1997 was attributable to
the Company's change in accounting estimate in the second quarter of 1997
related to its estimation of allowances for doubtful accounts. These increases
are partially offset by the divestiture of certain businesses in 1997.
Specialty medical services result in the incurrence of additional costs from the
higher staffing levels required to provide the higher acuity care. The
additional ancillary services (physical, respiratory, occupational and speech
therapy) utilized generate additional costs in line with the growth realized in
the specialty medical revenues. This increase was partially offset by a
reduction in costs from more appropriate staffing given patient acuity levels at
skilled nursing facilities and an increased use of third-party vendors for
therapy services.
Rent and property expenses for the three and six month periods ended June 30,
1997 were $11.8 and $25.6 million, respectively, compared to $14.2 and $27.7
million for the same periods in 1996, a decrease of $2.4 and $2.1 million,
respectively, or 16.9% and 7.6%.
Excluding the Institutional Pharmacy Business, rent and property expenses for
the three and six month periods ended June 30, 1997 were $11.8 and $25.1
million, respectively, compared to $12.9 and $25.2 million for the same periods
in 1996, a decrease of $1.1 and $0.1 million, respectively. This decrease was
primarily the result of rent and property expenses attributable to businesses
divested in 1997 offset in part by scheduled increases in rental expense.
Depreciation and amortization expenses for the three and six month periods
ended June 30, 1997 were $5.3 and $11.0 million, respectively, compared to $6.5
and $12.7 million for the same periods in 1996, a decrease of $1.2 and $1.7
million, respectively, or 18.5% and 13.4%.
Excluding the Institutional Pharmacy Business, depreciation and amortization
expenses for the three and six month periods ended June 30, 1997 were $5.3 and
$10.5 million, respectively, compared to $4.8 and $9.5 million for the same
periods in 1996, a decrease of $0.5 and $1.0 million, respectively, or 10.4%
and 10.5%. This decrease was primarily the result of depreciation and
amortization expenses attributable to businesses divested in 1997 offset by
additions to property and equipment.
13
<PAGE>
Interest expense and financing charges for the three and six month periods
ended June 30, 1997 were $7.8 and $16.3 million, respectively, compared to $8.9
and $17.1 million for the same periods in 1996, a decrease of $1.1 and $0.8
million, respectively, or 12.4% and 4.7%.
Excluding the Institutional Pharmacy Business, interest expense and financing
charges for the three and six month periods ended June 30, 1997 were $7.8 and
$15.3 million, respectively, compared to $8.8 and $16.8 million for the same
periods in 1996, a decrease of $1.0 and $1.5 million, respectively, or 11.4% and
8.9%. This decrease was due primarily from a reduction in indebtedness related
to debt extinguished in the Vitalink Merger offset in part by interest on
additional indebtedness to fund working capital.
During the first quarter of 1997, in conjunction with the Vitalink Merger, the
Company recorded merger and other one-time costs of $36.0 million (See Note B of
Notes to Condensed Consolidated Financial Statements). Of this aggregate
charge, $28.3 million is reflected as a charge to operations with the remaining
$7.7 million pertaining to costs associated with the early extinguishment of
debt being reflected as an extraordinary charge. The components of the merger
charge and extraordinary charge recognized in the first quarter of 1997 consist
of the following:
<TABLE>
<CAPTION>
DOLLARS IN THOUSANDS
--------------------
Shared transaction costs:
<S> <C>
Redemption premium - $100 million Senior
Subordinated Notes.................................................... $ 9,000
Redemption premium - $60 million Convertible
Subordinated Debentures............................................... 2,430
Investment banker fees................................................ 4,200
Consent fee paid to HRPT.............................................. 5,500
Other professional fees and merger related costs...................... 5,470
--------
Total shared costs........................................................... 26,600
Less costs to be paid by Vitalink............................................ (13,300)
--------
GranCare portion of shared transaction costs................................. 13,300
Other transaction related costs:
Consent fee paid to HRPT.............................................. 4,500
Write-off to deferred financing fees.................................. 5,441
Amounts payable under GranCare Shareholder Value Program............
4,500
Amounts payable under Restricted Stock Plan........................... 2,200
Other employee severance and other related costs 6,059
--------
36,000
Less: Income taxes......................................................... (6,000)
--------
Total costs, net of income taxes............................................. $ 30,000
========
</TABLE>
Income taxes for the three and six month periods ended June 30, 1997 were
$(0.3) and $(3.9) million compared to $5.0 and $9.1 million for the same periods
in 1996. Income taxes in 1997 are affected by approximately $19.0 million in
non-deductible merger expenses.
Excluding the Institutional Pharmacy Business, income taxes for the three
and six month periods ended June 30, 1997 were $(0.3) and $(4.0) million,
respectively, compared to $2.2 and $3.9 million for the same periods in 1996.
As a result of the foregoing, net income (loss) for the three and six
month periods ended June 30, 1997 was $(0.4) and $(26.6) million compared to
$8.2 and $14.8 million for the same periods in 1996. Excluding the
Institutional Pharmacy Business, net income (loss) for the three and six month
periods ended June 30, 1997 was $(0.4) and $(26.8) million compared to $3.8 and
$6.3 million for the same periods in 1996.
14
<PAGE>
During the fourth quarter of 1996, the Company received final settlement
on its 1994 cost reports for its California long-term health care facilities.
The final settlements made by the intermediary for seven facilities included
disallowances of a portion of speech and occupational therapy costs ($1.8
million) based on their interpretation of the Medicare prudent buyer concept.
In addition, the intermediary has reopened the 1993 cost reports for two
additional facilities ($0.7 million) for the same issue. The Company has
furnished therapy services to patients under arrangements with outside therapy
contractors. The contracts with the outside contractors contain indemnification
clauses regarding denial of payment for services provided. The intermediary
asserts that the Company did not act as a prudent buyer of therapy services as
the Company should have hired therapists instead of contracting for their
services. In the absence of prudent buyer documentation to the contrary, the
intermediary determined reasonable costs for therapy services based on
internally developed survey data and other factors. The Company, in conjunction
with a therapy company and another long-term care company, has filed an
expedited group appeal to the Provider Reimbursement Review Board regarding
these 1994 audit adjustments. A hearing took place during the Company's second
quarter. The Company is awaiting the outcome of this hearing. Management
(based on the advise of outside counsel) believes that it has a strong position
in this matter and will ultimately prevail; therefore no accrual for losses has
been made. It is possible that the intermediary will attempt to apply the same
interpretation for other Company facilities and for other periods. If the
hearing results in an unfavorable outcome to the Company and if the Company does
not ultimately prevail on this matter, it could have a material adverse impact
on net income of a particular future quarter or year.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary source of liquidity at June 30, 1997 was $19.8
million in cash and cash equivalents compared to $14.5 million at December 31,
1996, an increase of $5.3 million. The increase in cash and cash equivalents
was due primarily to proceeds from the disposition of TeamCare and long-term
debt borrowings offset by an increase in accounts receivable. Payments received
by the Company from the Medicaid and Medicare programs are the Company's largest
source of cash from operations.
Accounts receivable at June 30, 1997 were $234.4 million compared to
$233.3 million at December 31, 1996, an increase of $1.1 million.
Excluding the Institutional Pharmacy Business, accounts receivable at
June 30, 1997 were $234.4 million compared to $184.3 million at December 31,
1996, an increase of $50.1 million or 27.2%. Since December 31, 1996, and to a
greater extent in the second quarter of 1997, the Company experienced delays in
its payments for services rendered under the Medicare program. In the State of
Michigan the Medicare fiscal intermediary placed a number of facilities under
focus review. This delays the payment cycle because under focus review each
claim must receive a medical review. The Company has not received a material
number of denials for services rendered, only a delay in payment which is in the
60-90 day range. In addition, as a consequence of the Vitalink Merger,
terminating Medicare cost reports were required to be filed for all of the
Company facilities and certain other businesses. Normally, cost reports are
filed based on the fiscal year end, but as a result of the Vitalink Merger, they
were filed for a thirteen month period ended January 31, 1997, which has delayed
the cost settlements, the difference between audited costs and interim rates, by
30-60 days. In addition, as a consequence of filing thirteen month cost
reports, the Company has not received 1997 Medicare rate increases, and as such,
differences between interim and expected rates have continued to increase
settlement balances. Finally, the Company has continued to experience
significant growth in Medicare business (41% for 1996 to 46% six months ended
June 30, 1997). Final cost settlements, based on the difference between audited
costs and interim rates, are paid following final cost report audits by Medicare
fiscal intermediaries. Because of the cost report and audit process, final
settlement may not occur until up to 24 months after services are provided. The
Company accounts for such open cost reports by recording appropriate reserves to
offset potential audit adjustments. Specialty medical services generally
increase the amount of payments received on a delayed basis. The Company
receives payment for skilled nursing services based on rates set by individual
state Medicaid programs. Although payment cycles for these programs vary,
payments generally are made within 30 to 60 days of services provided, except in
Illinois, where the Medicaid program delays payments for 120 days. The federal
Medicare program, a cost-reimbursement system, pays interim rates, based on
estimated costs of services, on a 30 to 45-day basis. The Company has
implemented certain policies and procedures to assist in the collection of
accounts receivable and to help mitigate the impact of the delays noted above.
However, in recognition of the delays, the Company has increased its allowance
for doubtful accounts to provide for potential losses. This change in accounting
15
<PAGE>
estimate resulted in an $8.0 million increase in the allowance for doubtful
accounts at June 30, 1997, and a corresponding charge to operations in the
second quarter of 1997.
While federal regulations do not provide states with grounds to curtail
payments under their Medicaid reimbursement programs due to state budget
deficiencies or delays in enactment of new budgets, states have nevertheless
curtailed payments in such circumstances in the past. In particular, some
states have delayed the payment of significant amounts owed to health care
providers such as the Company for health care services provided under their
respective Medicaid programs.
In addition to principal and interest payments on its long-term
indebtedness, the Company has significant rent obligations relating to its
leased facilities, as well as property expenses (principally property taxes and
insurance) relating to all of its facilities. The Company's estimated principal
payments, cash interest payments, rent and property expense obligations for 1997
are approximately $83.2 million.
Excluding the Institutional Pharmacy Business, the Company's estimated
principal payments, cash interest payments, rent and property expense
obligations for calendar year 1997 are approximately $81.7 million.
The Company's operations require capital expenditures for renovations of
existing facilities in order to continue to meet regulatory requirements, to
upgrade facilities for the treatment of subacute patients and to accommodate the
addition of specialty medical services, and to improve the physical appearance
of its facilities for marketing purposes. The Company estimates that capital
expenditures for the year ending December 31, 1997, will be approximately $35.0
million.
The Company maintained a $150.0 million credit facility (the "Predecessor
Credit Facility") with a syndicate of banks for whom First Union acted as lead
bank, which was used for working capital, other general corporate purposes and
acquisitions. In order to complete the Vitalink Merger and related
transactions, the Company replaced the Predecessor Credit Facility with a new
credit facility in the aggregate amount of $300.0 million, with First Union and
The Chase Manhattan Bank each committing to $150.0 million (the "Credit
Facility"). The Credit Facility consists of two components: a $200.0 million
5-year revolving credit facility (which includes a $40.0 million sub-limit for
the issuance of standby letters of credit and a $5.0 million swing-line
commitment from First Union) and a $100.0 million 5-year term loan. Borrowings
for working capital and general corporate purposes may not exceed $75.0 million.
The first $25.0 million of exposure for letters of credit issued under the
letter of credit sub-facility will correspondingly reduce availability under the
working capital sub-facility. As of June 30, 1997, the Company had
approximately $50.0 million outstanding under the working-capital sub-facility
and $25.0 million in letters of credit. While the Company currently has no
availability under the working capital sub facility, the Company believes that
its cash from operations will be sufficient to meet the Company's working
capital requirements in the future. The revolving credit portion of the Credit
Facility matures in February 2002. The term loan portion of the Credit Facility
will be amortized in ten quarterly installments of $7.0 million each commencing
in February 1999, thereafter increasing to $10.0 million per quarter. All
remaining principal and accrued and unpaid interest shall be due and payable in
full in February 2002. Interest on outstanding borrowing shall accrue, at the
option of the Company, at the base rate or at the Eurodollar rate plus, in each
case, an applicable margin. As of June 30, 1997, approximately $236.0 million
was outstanding under the Credit Facility. On April 18, 1997, the Company
amended the Credit Facility in order to provide the Company with greater
flexibility to pursue potential acquisitions. The Credit Facility contains
restrictions on the ability of the Company to pay dividends to its stockholders
upon the failure to satisfy certain financial covenants.
In connection with the Vitalink Merger, the Company completed a tender
offer for its Senior Subordinated Notes due 2005 (the "Notes"), substantially
all of which were purchased in the tender offer with funds provided by Vitalink.
The remaining Notes became obligations of Vitalink in connection with the
Merger. Also in connection with the Vitalink Merger, the Company redeemed all
of its outstanding 6 1/2% Convertible Debentures due 2003 (the "Convertible
Debentures"). Accordingly, neither the Notes nor the Convertible Debentures
remain obligations of the Company following the Vitalink Merger.
In April 1997, the Company paid the seller of Long Term Care
Pharmaceutical Services Corporation I and Long Term Care Pharmaceutical Services
Corporation III (collectively, "LTC") $5.4 million in settlement of a contingent
earnout provision in the purchase agreement relating to the Company's 1994
16
<PAGE>
acquisition of LTC. Pursuant to the documents entered into in connection with
the Vitalink Merger, Vitalink is obligated to fund $2.5 million of this payment.
The Company previously announced a pending acquisition with respect to
the purchase of 18 nursing facilities and ancillary businesses from an
affiliated group in the State of Alabama. The Company now believes that such
acquisition will not be consummated.
In conjunction with a 1990 acquisition, the Company borrowed $15.0
million under a promissory note agreement with Health and Retirement Properties
Trust ("HRPT"). The note is secured by mortgages on two facilities and
1,000,000 shares of HRPT common stock owned by the Company. The HRPT note had a
balance of $8.7 million, with an interest rate of 13.75% at December 31, 1994.
During 1995, the Company renegotiated the note with HRPT, whereby the principal
balance of the promissory note was increased to $11.5 million, resulting in
additional proceeds to the Company. Minimum interest on the note is 11.5% per
year payable monthly in arrears. Additional interest became payable commencing
on January 1, 1996, in an amount equal to 75% of the percentage increase in the
Consumer Price Index, with certain defined limitations. Principal payments will
begin two years after the date of the note on a 30-year direct reduction basis,
with the remaining balance due December 31, 2010.
The Company has operating leases for 24 facilities, including land,
buildings, and equipment from HRPT under two Master Lease Documents. Subsequent
to December 31, 1994, the existing Master Lease Documents were amended. Under
the amended lease arrangements, minimum rent for the aggregate facilities is the
annual sum of $11,550,000, payable in equal monthly installments. In addition,
commencing January 1, 1996, the amended lease agreement provides for additional
rent to be paid monthly, in advance, based on 75% of the increase in the
Consumer Price Index multiplied by the minimum rent due, provided, however, that
the maximum rent (minimum rent plus additional rent) each January shall be
limited to a 2% increase over the total monthly rent paid in the prior December.
The operating leases for 17 facilities expire on December 28, 2010, and there
are two 10 year renewal options. The leases for seven facilities expire in June
2006 and there are two 10 1/2 year renewal options. The Company has subleased
six of the 24 facilities to unrelated parties.
The Company is a beneficial owner of 1,000,000 shares of stock of HRPT,
which are held in trust and pledged as collateral for the obligations of two of
the Company's subsidiaries under mortgages notes and lease obligations with
HRPT. The pledge agreement strictly limits the Company's ability to sell the
shares until its obligations to HRPT are satisfied, which will not be until the
year 2010. As a result, these shares cannot be sold to meet other financial
obligations. In addition, such mortgage notes and lease obligations contain
provisions that restrict, upon the occurrence of an event of default thereunder,
the ability of such subsidiaries to make dividends, loans or advances to the
Company. In accordance with FASB Statement No. 115, "Accounting for Certain
Investments in Debt and Equity Securities," the HRPT stock is carried at fair
market value, with unrealized gains and losses reported as a separate component
of equity.
The Company maintains a captive insurance subsidiary to provide
reinsurance for its obligations under workers' compensation and general and
professional liability plans. These obligations are funded with long-term fixed
income investments, which are not available to satisfy other obligations of the
Company.
A wholly-owned subsidiary of the Company, Professional Health Care
Management, Inc. ("PHCMI"), is the borrower under a $58.8 million mortgage note
(the "Omega Loan") executed on August 14, 1992, in favor of Omega Healthcare
Investors, Inc. ("Omega"), and under the related Michigan loan agreement dated
as of June 7, 1992. All $58.8 million is outstanding at the present time.
Proceeds of the Omega Loan were used by PHCMI to acquire 17 skilled nursing
facilities in the State of Michigan ("the "PHCMI Facilities"). With the
exception of four PHCMI Facilities since divested, PHCMI owns and leases the
PHCMI Facilities to various of its wholly-owned subsidiaries under separate
lease agreements (the "PHCMI Subsidiary Leases"). The Omega Loan is secured by
a mortgage and security agreement executed by PHCMI with respect to the PHCMI
Facilities. PHCMI has assigned its interest in the PHCMI Subsidiary Leases to
Omega as additional security for the Omega Loan. In addition, in February 1997,
the PHCMI subsidiaries executed and delivered guarantees of the Omega Loan and
pledged their personal property assets to Omega as security for such guarantees.
17
<PAGE>
The Omega Loan bears interest at a rate which is adjusted based on either
(a) changes in the Consumer Price Index, or (b) a percentage of the change in
gross revenues of PHCMI and its subsidiaries from year to year, divided by $58.8
million, whichever produces the higher interest rate, but in any event subject
to a maximum rate not to exceed 10.5% of the interest rate in effect for the
Omega Loan for the prior calendar year. The current interest rate is 14.5% per
annum. The Omega Loan currently requires monthly, interest-only payments. The
Omega Loan may be prepaid within the first 180-days following August 14, 2002,
upon 30 days' notice. Prepayment at any other time will result in a prepayment
penalty in the nature of a "make whole" premium. Beginning October 1, 2002,
quarterly amortizing installments of principal in the amount of $1,470,000 each
will also become due and payable on the first day of each calendar quarter. The
entire outstanding principal amount of the Omega Loan is due and payable on
August 13, 2007.
In addition to the interest on the Omega Loan described in the preceding
paragraph, as a condition to obtaining Omega's consent to the Vitalink Merger,
the Credit Facility and other transactions related thereto, PHCMI agreed to pay
additional interest to Omega in the amount of $20,500 per month, through and
including July 1, 2002. If the principal balance of the Omega Loan for any
reason becomes due and payable prior to that date, there will be added to the
indebtedness owed by PHCMI (i) the sum of $1,000,000, plus (ii) interest thereon
at 11% per annum to the prepayment date, less (iii) the amount of such
additional interest paid to Omega prior to the prepayment date.
As substitute collateral for the four divested PHCMI Facilities, and as
consideration for granting its consent to such divestiture, Omega required
GranCare to cause First Union to issue its letter of credit in favor of Omega in
the amount of $9.0 million pursuant to the Credit Facility (the "Omega Letter of
Credit"). The Omega Letter of Credit can be drawn upon following the occurrence
of any event of default under the Omega loan documents, if the Omega Letter of
Credit is not renewed or extended at least 30 days prior to its scheduled
expiration date (currently March 22, 1998), or if certain representations,
warranties or covenants of PHCMI under the Omega loan documents are breached and
such breaches are not cured within the prescribed time after notice.
The Omega Loan Agreement obligates PHCMI, among other things, to maintain
a minimum tangible net worth of at least $10.0 million, increased or decreased
by 25% of PHCMI's net income (but in no event less than $10.0 million). The
Company has agreed to contribute additional equity to PHCMI if, as and when
necessary to assure that such minimum tangible net worth test is met. As of
December 31, 1996, PHCMI's tangible net worth exceeded the current minimum
adjusted tangible net worth requirement.
Capital Resources. The Company believes that its existing working
capital and available borrowings under the Credit Facility will be sufficient to
fund the fixed obligations, capital expenditures and other obligations referred
to above, as well as to repay certain indebtedness when due, and further expand
GranCare's business (other than the LCA Merger). Additionally, in connection
with the Vitalink Merger, Vitalink assumed (as part of the Vitalink Merger)
certain items of GranCare's consolidated indebtedness aggregating approximately
$108.0 million (which included GranCare's obligations in respect of the Notes).
However, in the event that the Company continues to grow through acquisitions,
the Company may need to raise additional capital, either through borrowings,
sale-leaseback financings or the sale of debt or equity, to finance the
acquisition price and any additional working capital and capital expenditure
requirements related to such acquisitions. At this time, the Company believes
that any additional required financing may be obtained at market rates on terms
that are acceptable to the Company, although no assurance can be given regarding
the terms that are available of additional financing in the future.
18
<PAGE>
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.
Date: August 29, 1997 GRANCARE, INC.
/s/ Keith J. Yoder
------------------
Keith J. Yoder
Chief Financial Officer
(Duly Authorized Officer and Principal Financial
and Accounting Officer)
19
