<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JUNE 18, 1998
REGISTRATION NO. 333-
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
---------------------
NETCARE HEALTH SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
---------------------
<TABLE>
<S> <C> <C>
DELAWARE 8062 62-1624835
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) Identification No.)
</TABLE>
424 CHURCH STREET, SUITE 2100
NASHVILLE, TENNESSEE 37219
(615) 742-8500
(Address, including zip code and telephone number, including
area code, of registrant's principal executive offices)
---------------------
MICHAEL A. KOBAN, JR.
PRESIDENT AND CHIEF EXECUTIVE OFFICER
424 CHURCH STREET, SUITE 2100
NASHVILLE, TENNESSEE 37219
(615) 742-8500
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
---------------------
COPIES TO:
<TABLE>
<S> <C>
MORTON A. PIERCE, ESQ. MICHAEL W. BLAIR, ESQ.
DEWEY BALLANTINE LLP DEBEVOISE & PLIMPTON
1301 AVENUE OF THE AMERICAS 875 THIRD AVENUE
NEW YORK, NEW YORK 10019 NEW YORK, NEW YORK 10022
(212) 259-8000 (212) 909-6000
</TABLE>
---------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after this Registration Statement becomes effective.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box: [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ]
------------------
If this Form is a post effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
------------------
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
------------------
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
---------------------
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
============================================================================================================
PROPOSED MAXIMUM
TITLE OF EACH CLASS OF SECURITIES AGGREGATE AMOUNT OF
TO BE REGISTERED OFFERING PRICE(1) REGISTRATION FEE
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Common Stock, $.01 par value................................ $115,000,000 $33,925
- ------------------------------------------------------------------------------------------------------------
Preferred Stock Purchase Rights............................. (2) NA
============================================================================================================
</TABLE>
(1) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457(o).
(2) To be issued pro rata to holders of the registrant's Common Stock for no
consideration.
---------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
================================================================================
<PAGE> 2
EXPLANATORY NOTE
This registration statement contains two forms of Prospectus: one to be
used in connection with a United States and Canadian offering of the
registrant's Common Stock (the "U.S. Prospectus") and one to be used in
connection with a concurrent international offering of the Common Stock (the
"International Prospectus" and, together with the U.S. Prospectus, the
"Prospectuses"). The International Prospectus will be identical to the U.S.
Prospectus except that it will have a different front cover page, underwriting
section and back cover page. The U.S. Prospectus is included herein and is
followed by the alternate pages to be used in the International Prospectus. The
front cover page, underwriting section and back cover page for the International
Prospectus included herein have all been labeled "Alternate Page for
International Prospectus."
<PAGE> 3
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF ANY OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.
SUBJECT TO COMPLETION
PRELIMINARY PROSPECTUS DATED JUNE 18, 1998
PROSPECTUS
SHARES
NETCARE HEALTH SYSTEMS, INC.
COMMON STOCK
------------------------
All of the shares of Common Stock offered hereby are being
sold by NetCare Health Systems, Inc. ("NetCare or the "Company"). Of the
shares of Common Stock offered hereby, shares are being offered for sale
initially in the United States and Canada by the U.S. Underwriters and
shares are being offered for sale initially in a concurrent offering
outside the United States and Canada by the International Managers. The initial
public offering price and the underwriting discount per share will be identical
for both Offerings. See "Underwriting."
Prior to the Offerings, there has been no public market for the Common
Stock. It is currently estimated that the initial public offering price will be
between $ and $ per share. For a discussion relating to factors to
be considered in determining the initial public offering price, see
"Underwriting." Application has been made to list the Common Stock on the New
York Stock Exchange under the symbol "NHS."
SEE "RISK FACTORS" BEGINNING ON PAGE 7 FOR A DISCUSSION OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE COMMON STOCK OFFERED
HEREBY.
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS
THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
=====================================================================================================================
PRICE TO UNDERWRITING PROCEEDS TO
PUBLIC DISCOUNT(1) COMPANY(2)
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Per Share................................ $ $ $
- ---------------------------------------------------------------------------------------------------------------------
Total(3)................................. $ $ $
=====================================================================================================================
</TABLE>
(1) The Company has agreed to indemnify the several Underwriters against certain
liabilities, including certain liabilities under the Securities Act of 1933,
as amended. See "Underwriting."
(2) Before deduction of expenses payable by the Company, estimated at
$ .
(3) The Company has granted the U.S. Underwriters and the International Managers
options to purchase up to an additional shares and
shares of Common Stock, respectively, in each case, exercisable within 30
days after the date hereof, solely to cover over-allotments, if any. If such
options are exercised in full, the total Price to Public, Underwriting
Discount and Proceeds to Company will be $ , $ and
$ respectively. See "Underwriting."
------------------------
The shares of Common Stock are offered by the several Underwriters, subject
to prior sale, when, as and if issued to and accepted by them, subject to
approval of certain legal matters by counsel for the Underwriters and certain
other conditions. The Underwriters reserve the right to withdraw, cancel or
modify such offer and to reject orders in whole or in part. It is expected that
delivery of the shares of Common Stock will be made in New York, New York, on or
about , 1998.
------------------------
MERRILL LYNCH & CO.
BEAR, STEARNS & CO. INC.
CREDIT SUISSE FIRST BOSTON
SALOMON SMITH BARNEY
------------------------
The date of this Prospectus is , 1998.
<PAGE> 4
[PHOTOGRAPHS OF THE COMPANY'S HOSPITALS LOCATED IN DAHLONEGA, GEORGIA AND TRACE,
MISSISSIPPI AND AN ARCHITECTUAL RENDERING OF THE COMPANY'S HOSPITAL LOCATED IN
DENTON, TEXAS]
CERTAIN PERSONS PARTICIPATING IN THE OFFERINGS MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN, OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK.
SUCH TRANSACTIONS MAY INCLUDE STABILIZING, THE PURCHASE OF COMMON STOCK TO COVER
SYNDICATE SHORT POSITIONS AND THE IMPOSITION OF PENALTY BIDS. FOR A DESCRIPTION
OF THESE ACTIVITIES, SEE "UNDERWRITING."
<PAGE> 5
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by, and should be read
in conjunction with, the more detailed information and the Consolidated
Financial Statements and the related Notes thereto appearing elsewhere in this
Prospectus. Unless otherwise indicated, all information in this Prospectus (i)
has been adjusted to give effect to the Recapitalization (as defined below); and
(ii) assumes no exercise of the Underwriters' over-allotment option. Prospective
investors should consider carefully, among other things, the information set
forth under "Risk Factors." Unless the context otherwise requires, references in
this Prospectus to "NetCare" or the "Company" shall mean NetCare Health Systems,
Inc. and its predecessors, together with its direct and indirect subsidiaries.
THE COMPANY
OVERVIEW
NetCare was initially funded in March 1996 to acquire and operate acute
care community hospitals in non-urban markets. Since then, NetCare has acquired
and currently operates ten general acute care hospitals in growing, non-urban
communities in Georgia, Mississippi, Texas and California. These facilities,
together with their medical staffs, provide a wide range of inpatient and
outpatient acute care services and a variety of specialty services, including
skilled nursing services, rehabilitation services and psychiatric services. The
Company also operates four nursing homes associated with its hospitals. The
Company had total revenue of $130.3 million for the year ended December 31, 1997
from the seven hospitals and related businesses then operated by the Company,
approximately 92% of which was derived from hospital and hospital-related
activities. On a pro forma basis, after giving effect to the acquisition of the
three hospitals acquired in 1998 as if such acquisitions occurred on January 1,
1997, the Company had total revenue of $162.8 million for the year ended
December 31, 1997.
The Company's objective is to be a leading provider of high quality health
care services in growing non-urban markets. The Company believes that these
markets are attractive because there are generally only one or two hospitals in
each non-urban community, resulting in less direct competition for
hospital-based services. The smaller populations and relative dominance of the
acute care hospitals in these markets generally also limit the entry of
alternative non-hospital providers, such as outpatient surgery centers or
rehabilitation or diagnostic imaging centers, as well as managed care plans. In
addition, the Company believes that non-urban communities are generally
characterized by a high level of patient and physician loyalty that fosters
cooperative relationships among the local hospital, physician and patients. As a
result, the local hospital is viewed as a key part of the local community. All
of NetCare's facilities are located in growing, non-urban markets. Nine of
NetCare's ten hospitals are the only hospitals in their respective communities
and the tenth hospital is one of only two hospitals in its community. The
hospitals have general service area populations ranging from 15,000 to more than
110,000 and the average annual population growth rate of these communities since
1990 is 2.3%, more than twice the national average annual population growth rate
of 1.1% for the same period, according to data supplied by Health InfoTechnics,
LLC.
The Company's senior management has significant experience acquiring and
operating community hospitals. As part of the management of Healthtrust,
Inc.-- The Hospital Company, NetCare's senior management implemented a growth
plan which included the acquisition of more than 20 community hospitals and the
operation of over 100 hospitals between 1987 and 1995.
BUSINESS STRATEGY
The key elements of the Company's business strategy include:
- Increasing Revenue at Existing Facilities. The Company increases revenue
at existing facilities by providing a broader range of services in a more
attractive care setting, and by supporting and recruiting physicians. The
Company's hospitals are expanding the breadth of services offered to
include more complex services such as cardiology, orthopedics, and
oncology, and investing in technology and the physical plant at the
facilities. The Company also provides the resources and capital needed to
support
<PAGE> 6
the physicians currently in the communities it serves and works with
local hospital boards, management teams and medical staffs to determine
the number and type of additional physicians needed. The Company
aggressively recruits additional primary care physicians and specialists
to its communities to meet those needs. By taking these actions, the
Company believes each of its hospitals can increase its share of the
health care dollars spent by local residents and limit patient migration
to larger urban facilities. Total revenue for hospitals operated by
NetCare for a full year in 1997 increased 10.3% from 1996 to 1997.
- Growing through Acquisitions. NetCare intends to grow through the
acquisition of additional hospitals in its target communities. NetCare
intends to acquire at least one or two hospitals each year that fit the
Company's acquisition criteria. The Company pursues acquisition
candidates that: (i) have a minimum general service area population of
10,000 with a stable or growing population base; (ii) are the sole or a
primary provider of acute care services in the community; and (iii) have
financial performance that the Company believes will benefit from
management's operating skills. According to Company estimates, there are
currently more than 900 acute care hospitals that have two or fewer
hospital competitors within a twenty mile radius of their local community
campus. As these hospitals experience limited management and financial
resources, payment reductions, increasingly complex regulations and
larger urban competitors, the Company believes that their owners may turn
to companies, such as NetCare, that have the management expertise and
financial resources necessary to preserve the local availability of
health care in their community.
- Reducing Costs. In order to improve efficiencies and increase operating
margins following the acquisition of a hospital, the Company implements
cost reduction programs which include: (i) redesigning the manner in
which clinical and administrative work is performed; (ii) adjusting
staffing levels according to patient volumes; (iii) capitalizing on
purchasing efficiencies and terminating or renegotiating certain vendor
contracts; and (iv) installing a standardized management information
system resulting in more efficient billing and collection procedures. In
addition, each of the Company's hospitals and their local management
teams is supported by the Company's reimbursement, regulatory and
compliance expertise and by NetCare's senior management team which has an
average of 15 years of experience in the health care industry. The
operating margins for the hospitals operated by NetCare for a full year
in 1997 improved from 13.1% in 1996 to 15.5% in 1997.
- Focusing on the Community. Since the Company believes that the provision
of health care is essentially a local business, the Company emphasizes
local hospital initiatives, responsibility and accountability.
Decentralized hospital management teams work closely with local
physicians, community leaders and residents to identify and then meet the
health care needs of the community. The Company also generally affiliates
with tertiary care hospitals or systems in nearby urban markets for
services which cannot effectively be provided locally and sponsors local
preferred provider options and contracting opportunities to employers in
partnership with other local providers and managed care plans. The
Company believes that its community focus will limit patient migration to
larger urban facilities and thereby increase the Company's market share
and revenue.
BACKGROUND
NetCare was formed in November 1995 and was initially funded in March 1996
by Charterhouse Equity Partners II, L.P. ("Charterhouse Equity Partners"),
certain former executives of Healthtrust, Inc. -- The Hospital Company and
certain other investors. In August 1996, NetCare acquired Southern Health
Corporation ("Southern Health"), an owner and operator of four non-urban
community hospitals and three associated nursing homes in Georgia ranging from
approximately 45 miles to 100 miles north of Atlanta, Georgia and one hospital
and associated nursing home in northeastern Mississippi, approximately 35 miles
southeast of Tupelo, Mississippi. In November 1996, NetCare acquired Denton
Community Hospital, located in Denton, Texas, approximately 35 miles northwest
of Dallas. In January 1997, NetCare acquired Stone County Hospital, located in
Wiggins, Mississippi, approximately 30 miles north of Gulfport, Mississippi. In
April 1998, NetCare acquired Central Texas Hospital, located in Cameron, Texas,
approximately 70 miles northeast of Austin, Texas, through the assumption of a
lease and in May 1998, NetCare acquired Holly
2
<PAGE> 7
Springs Memorial Hospital, located in Holly Springs, Mississippi, approximately
30 miles southeast of Memphis, Tennessee. In June 1998, the Company acquired San
Clemente Hospital and Medical Center, located in San Clemente, California,
approximately 65 miles south of Los Angeles, California.
The Company's principal executive offices are located at 424 Church Street,
Suite 2100, Nashville, Tennessee 37219, and its telephone number is (615)
742-8500.
THE RECAPITALIZATION
Prior to the Offerings (as defined below), all of the outstanding Common
Stock of the Company has been owned by NetCare Health Systems LLC ("NetCare
LLC"). The members of NetCare LLC are Charterhouse Equity Partners, Chef
Nominees Limited ("Chef" and, together with Charterhouse Equity Partners, "CEP
II") and NetCare Management LLC ("Management LLC"). The members of Management
LLC are senior management and employees of the Company and certain other
investors. Immediately prior to the consummation of the Offerings (i) Management
LLC will be liquidated and members of Management LLC will receive member
interests in NetCare LLC in accordance with the terms of the limited liability
company agreement of Management LLC; (ii) an amendment to the Company's
Certificate of Incorporation providing for, among other things, an increase in
the authorized number of shares of Common Stock and the authorization of the
preferred stock, par value $ per share of the Company (the "Preferred Stock")
will become effective; (iii) the Company will effect a [ ]-for-one stock split
with respect to the then outstanding Common Stock; and (iv) NetCare LLC will be
liquidated and the Common Stock of the Company then held by NetCare LLC will be
distributed to the former members of NetCare LLC in accordance with the terms of
the limited liability company agreement of NetCare LLC (collectively, the
"Recapitalization").
THE OFFERINGS
The offering of shares of the Company's Common Stock, par
value $.01 per share (the "Common Stock"), in the United States and Canada (the
"U.S. Offering") and the offering of shares of the Common Stock outside the
United States and Canada (the "International Offering") are collectively
referred to herein as the "Offerings."
Common Stock offered by the Company..... shares
Common Stock to be outstanding after the
Offerings............................... shares (1)
Use of Proceeds......................... The net proceeds to be received by
the Company from the Offerings will
be used to repay certain
indebtedness and for general
corporate purposes. See "Use of
Proceeds."
Proposed New York Stock Exchange
Symbol.................................. "NHS"
- ---------------
(1) Excludes shares of Common Stock issuable upon the exercise of
options to be issued upon consummation of the Offerings pursuant to the
Company's 1998 Long-Term Equity Incentive Plan and Directors' Stock Option
Plan at an exercise price equal to the initial public offering price. See
"Management."
RISK FACTORS
See "Risk Factors" beginning on page 7 of the Prospectus for certain
factors relating to an investment in the Common Stock.
3
<PAGE> 8
SUMMARY SUPPLEMENTAL FINANCIAL DATA
(IN THOUSANDS)
The financial impact of the Company's recent acquisitions makes it
difficult to draw meaningful comparisons between the Company's financial
statements for the periods presented. Therefore, the following table presents
the Company's (i) historical results of operations for the year ended December
31, 1997; and (ii) supplemental results of operations for the years ended
December 31, 1996 and 1995 giving effect to all acquisitions (Southern Health,
Denton Community Hospital and Stone County Hospital) completed prior to December
31, 1997 as if they had occurred as of January 1, 1995. The supplemental
financial information for 1996 and 1995 does not purport to be indicative of
what actually would have occurred if the acquisitions had been in effect for the
entire period presented and is not intended to be a projection of future results
or trends. The following should be read in conjunction with the related
historical financial statements of the Company and Management's Discussion and
Analysis of Financial Condition and Results of Operations included in this
Prospectus.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1995 1996 1997
-------- -------- --------
<S> <C> <C> <C>
Total revenue................................. $119,556 $118,211 $130,341
Operating expenses............................ 112,362 111,744 117,897
Interest expense.............................. 6,383 6,929 6,681
-------- -------- --------
Income (loss) before income taxes............. 811 (462) 5,763
Income tax provision.......................... (704) (220) (2,387)
-------- -------- --------
Net income (loss)................... $ 107 $ (682) $ 3,376
======== ======== ========
</TABLE>
4
<PAGE> 9
SUMMARY HISTORICAL AND PRO FORMA FINANCIAL AND STATISTICAL DATA
(IN THOUSANDS, EXCEPT PER SHARE AND STATISTICAL DATA)
The following table presents (i) summary combined financial and statistical
data of Southern Health (as predecessor of the Company) for periods prior to the
Southern Health acquisition and summary consolidated financial and statistical
data of the Company for periods subsequent to its date of inception; and (ii)
pro forma financial data of the Company. The Company had no operations prior to
the acquisition of Southern Health. The unaudited pro forma summary financial
data set forth below has been prepared based upon the historical financial
statements of the Company, San Clemente Hospital and Medical Center, Central
Texas Hospital and Holly Springs Memorial Hospital (hereafter, with the
exception of the Company, collectively referred to as the "Acquired
Facilities"). The pro forma statements of operations and data give effect to:
(i) the acquisition of the Acquired Facilities; (ii) the Recapitalization; (iii)
the sale of the Common Stock in the Offerings; and (iv) the application of the
estimated net proceeds thereof as described in "Use of Proceeds" as if all such
transactions had occurred on January 1 of the respective period. The pro forma
balance sheet data as of March 31, 1998 gives effect to: (i) the acquisition of
the Acquired Facilities; (ii) the Recapitalization; (iii) the sale of Common
Stock in the Offerings; and (iv) the application of the estimated net proceeds
thereof as described in "Use of Proceeds," as if all such transactions had
occurred on March 31, 1998. The pro forma financial information is not
necessarily indicative of actual results that would have been achieved had the
transactions been consummated at the beginning of the periods presented or of
future results. The following should be read in conjunction with the related
historical financial statements of the Company, Southern Health, and San
Clemente and the related Notes thereto, Management's Discussion and Analysis of
Financial Condition and Results of Operations and the Unaudited Pro Forma
Condensed Consolidated Financial Statements and the related Notes thereto
included in this Prospectus.
<TABLE>
<CAPTION>
SOUTHERN HEALTH CORPORATION
(PREDECESSOR)(1) COMPANY (SUCCESSOR)(1)
------------------------------ --------------------------------------------------------------------
PERIOD FROM
MARCH 11, YEAR ENDED
PERIOD 1996 DECEMBER 31, THREE MONTHS ENDED MARCH 31,
YEAR ENDED JULY 1, (DATE OF -------------------- -----------------------------
JUNE 30, 1996 TO INCEPTION) TO
----------------- AUGUST 15, DECEMBER 31, PRO FORMA PRO FORMA
1995(2) 1996 1996 1996(3) 1997 1997 1997 1998 1998
------- ------- ---------- ------------- -------- --------- ------- ------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Total revenue............. $51,198 $65,572 $8,845 $31,424 $130,341 $162,799 $32,448 $34,631 $42,609
Operating expenses........ 46,892 60,680 8,737 31,483 117,897 154,405 28,635 30,449 39,802
Interest expense.......... 1,702 3,055 371 2,013 6,681 1,363 1,540 1,631 297
------- ------- ------ ------- -------- -------- ------- ------- -------
Income (loss) before
income taxes and
extraordinary charge.... 2,604 1,837 (263) (2,072) 5,763 7,031 2,273 2,551 2,510
Income tax benefit
(provision)............. (1,217) (1,183) 97 204 (2,387) (2,870) (909) (1,188) (1,243)
------- ------- ------ ------- -------- -------- ------- ------- -------
Income (loss) before
extraordinary charge.... 1,387 654 (166) (1,868) 3,376 4,161 1,364 1,363 1,267
Extraordinary charge on
early extinguishment of
debt, net of taxes(4)... -- -- -- 525 -- -- -- -- --
------- ------- ------ ------- -------- -------- ------- ------- -------
Net income
(loss).......... $ 1,387 $ 654 $ (166) $(2,393) $ 3,376 $ 4,161 $ 1,364 $ 1,363 $ 1,267
======= ======= ====== ======= ======== ======== ======= ======= =======
Basic earnings per
share(5)................ -- -- -- -- $ [ ] $ [ ] -- $ [ ] $ [ ]
Weighted average
shares(5)............... -- -- -- -- [ ] [ ] -- [ ] [ ]
</TABLE>
<TABLE>
<CAPTION>
MARCH 31, 1998
-------------------------
PRO FORMA
ACTUAL AS ADJUSTED
-------- --------------
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents................................... $ 930 $ 10,402
Working capital............................................. 10,256 29,988
Total assets................................................ 150,551 172,301
Long-term debt, less current maturities..................... 71,045 2,545
Members'/Stockholders' equity............................... 51,135 149,635
</TABLE>
5
<PAGE> 10
<TABLE>
<CAPTION>
SOUTHERN HEALTH CORPORATION
(PREDECESSOR)(1) COMPANY (SUCCESSOR)(1)
------------------------------- ------------------------------------------------
PERIOD FROM
MARCH 11,
PERIOD 1996 THREE MONTHS
YEAR ENDED JULY 1, (DATE OF ENDED
JUNE 30, 1996 TO INCEPTION) TO YEAR ENDED MARCH 31,
------------------ AUGUST 15, DECEMBER 31, DECEMBER 31, -----------------
1995(2) 1996 1996 1996(3) 1997 1997 1998
-------- ------- ---------- ------------- ------------ ------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
STATISTICAL DATA:
Hospitals owned or leased (at
end of period)................ 5 5 5 6 7 7 7
Licensed beds (at end of
period)....................... 275 275 275 385 435 435 435
Admissions...................... 7,145 7,910 908 3,374 14,326 3,686 3,594
Adjusted Admissions(6).......... 11,255 13,213 1,671 5,793 23,286 5,763 5,747
Patient days.................... 28,782 34,323 3,668 14,128 59,521 16,200 15,942
Average length of stay
(days)(7)..................... 4.0 4.3 4.0 4.2 4.2 4.4 4.4
Net patient revenue (in
thousands).................... $ 49,782 $64,602 $8,698 $ 30,532 $128,517 $31,988 $34,267
Gross outpatient service revenue
(in thousands)................ $ 22,782 $33,465 $4,670 $ 17,141 $ 73,053 $17,228 $19,544
Gross outpatient service revenue
(% of gross patient service
revenue)...................... 37.2 39.8 45.1 40.7 36.5 34.4 35.5
EBITDA (in thousands) (8)....... $ 6,975 $ 8,251 $ 490 $ 2,120 $ 20,032 $ 5,560 $ 5,983
CASH PROVIDED BY (USED IN):
Operating activities............ $ 4,151 $ 2,307 $ (292) $ (3,409) $ 3,899 $ 1,658 $ 2,589
Investing activities............ $(13,001) $(3,892) $ (240) $(96,328) $ (3,231) $(1,564) $(2,053)
Financing activities............ $ 10,710 $ 569 $ (502) $ 93,388 $ (642) $ (121) $ (101)
</TABLE>
- ---------------
(1) The financial statements of the Company and Southern Health for the periods
presented are not strictly comparable due to the significant effect that
acquisitions have had on such statements. See Note 2 to the Consolidated
Financial Statements of the Company and Note 3 to the Southern Health
Combined Financial Statements.
(2) Includes the results of operations of Chatuge Regional Hospital from
September 22, 1994 (date of acquisition) and the results of operations of
Chestatee Regional Hospital from January 31, 1995 (date of acquisition).
(3) Includes the results of operations of Southern Health from August 16, 1996
(date of acquisition) and the results of operations of Denton Community
Hospital from November 13, 1996 (date of acquisition).
(4) Represents the extraordinary charge resulting from the write-off of the
unamortized loan costs related to the early extinguishment of the
outstanding principal balance under the Southern Health Amended and Restated
Credit Agreement. See Note 3 to the Consolidated Financial Statements of the
Company.
(5) The computation of historical earnings per share is based upon the assumed
conversion of members' equity into weighted average shares of Common
Stock, which includes shares issued to NetCare LLC. The computation of
pro forma earnings per share is based upon weighted average shares
of Common Stock outstanding, which includes shares issued to NetCare
LLC and of the shares being sold in the Offerings, the proceeds of
which will be used to repay $82,650 of debt and pay $1,000 in expenses of
the Offerings. If all the shares sold in the Offerings were included in the
above calculation, there would be weighted average shares of Common
Stock outstanding with basic earnings per share of $ . The Company
had no potential dilutive shares of Common Stock at December 31, 1997 or
March 31, 1998.
(6) Adjusted admissions are calculated as total admissions for the period
multiplied by the ratio of total patient revenue divided by total inpatient
revenue.
(7) Average length of stay is calculated based on the number of patient days
divided by the number of admissions.
(8) As calculated herein, EBITDA represents income (loss) from continuing
operations before income taxes, interest expense, depreciation and
amortization. EBITDA is not a measure of financial performance under
generally accepted accounting principles and should not be considered an
alternative (i) to net income as a measure of operating performance or (ii)
to cash flows from operating, investing, or financing activities as a
measure of liquidity. The Company includes EBITDA to provide additional
information with respect to the ability of the Company to meet its future
debt service, capital expenditure and working capital requirements. Given
that EBITDA is not a measurement determined in accordance with generally
accepted accounting principles and is thus susceptible to varying
calculations, EBITDA as presented may not be comparable to other similarly
titled measures of other companies.
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RISK FACTORS
In addition to the other information contained in this Prospectus,
prospective investors should consider carefully the following information
relating to the Company and the Common Stock before making an investment in the
Common Stock offered.
RISKS OF ACQUISITION STRATEGY
A key element of the Company's growth strategy is expansion through the
acquisition of acute care hospitals in growing non-urban markets. There can be
no assurance that suitable acquisitions, for which other health care companies
(including those with greater financial resources than the Company) may be
competing, can be accomplished on terms favorable to the Company or that
financing, if necessary, can be obtained for such acquisitions. Expenses arising
from the Company's efforts to complete acquisitions or otherwise increase its
market penetration could have a material adverse effect on the Company's
business, financial condition or results of operations. In addition, certain of
the facilities that the Company has acquired have had operating losses. There
can be no assurance that the Company will be able to operate profitably any
hospital or other facility it may acquire, effectively integrate the operations
of such acquisitions or otherwise achieve the intended benefits of its growth
strategy. The failure by the Company to manage its growth effectively could have
a material adverse effect on the Company's business, financial condition or
results of operations. See Note 6 to the Consolidated Financial Statements of
the Company.
Hospital acquisitions generally require a longer period to complete than
acquisitions in many other businesses and are subject to additional uncertainty.
In recent years, the legislatures and attorneys general of several states have
increased their level of interest in transactions involving the sale of
hospitals by not-for-profit entities. Although the level of interest varies from
state to state, the trend is to provide for increased governmental review, and
in some cases approval, of transactions in which a not-for-profit entity sells a
health care facility. Although the Company has not yet been adversely affected
as a result of these trends, such heightened scrutiny may increase the cost and
difficulty or prevent the completion of transactions with not-for-profit
organizations in certain states in the future. See "Business -- Acquisition
Program" and "Business -- Competition."
NEED FOR ADDITIONAL CAPITAL; POTENTIAL FUTURE INDEBTEDNESS
The Company's acquisition program requires substantial capital resources.
In addition, the operations of its existing hospitals require capital
expenditures for renovation and expansion and the addition of costly medical
equipment and technology utilized in the hospitals. The Company may incur
indebtedness and may issue, from time to time, debt or equity securities to fund
any such expenditures. There can be no assurance that sufficient financing will
be available on terms satisfactory to the Company or that the unavailability of
such financing will not have a material adverse effect on the business,
financial condition or results of operations of the Company. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources" and "Business -- Business
Strategy."
Substantially all of the net proceeds of the Offerings will be used to
repay in full amounts outstanding under the Existing Credit Facility (as defined
below). In connection with the Recapitalization and the Offerings, the Company
expects to enter into a new $200 million credit facility with a group of lenders
(the "New Credit Facility"). Following the Offerings, pursuant to its growth
strategy, the Company intends to continue to pursue acquisitions of additional
hospitals in target communities which it intends to finance with borrowings
under the New Credit Facility and through the incurrence of other additional
indebtedness. See "Capitalization," "Pro Forma Condensed Consolidated Financial
Statements" and "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources."
The degree to which the Company becomes leveraged following consummation of
the Offerings could have important consequences to holders of the Common Stock,
including the following: (i) the Company's ability to obtain additional
financing in the future for working capital, capital expenditures, acquisitions,
general corporate purposes or other purposes may be impaired; (ii) a substantial
portion of the Company's cash flow from operations may have to be dedicated to
the payment of principal and interest on its
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indebtedness, thereby reducing the funds available to the Company for its
operations; (iii) certain of the Company's borrowings may be at variable rates
of interest, which would make the Company vulnerable to increases in interest
rates; and (iv) such indebtedness, including the New Credit Facility, is
expected to contain numerous financial and other restrictive covenants
(including restrictions on payments of dividends, incurrences of indebtedness
and sale of assets), the failure to comply with which may result in an event of
default which, if not cured or waived, could cause such indebtedness to be
declared immediately due and payable. Any substantial increase in the Company's
debt levels or the inability of the Company to borrow funds at favorable
interest rates or to comply with the financial or other restrictive covenants
could have a material adverse effect on the Company's business, financial
condition or results of operations. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Liquidity and Capital
Resources."
CONCENTRATION OF OPERATIONS
Four of the Company's hospitals are located in Georgia. For the fiscal year
ended December 31, 1997, 43.4% of the Company's net operating revenue and 30.8%
of the Company's income from continuing operations before income taxes, interest
expense, depreciation and amortization was generated by the Company's Georgia
hospitals. In addition, for the fiscal year ended December 31, 1997, 35.2% of
the Company's net operating revenue and 48.5% of the Company's income from
continuing operations before income taxes, interest expense, depreciation and
amortization was generated by Denton Community Hospital. Accordingly, any change
in the current demographic, economic, competitive and regulatory conditions in
Georgia or Denton, Texas could have a material adverse effect on the business,
financial condition or results of operations of the Company.
DEPENDENCE ON PHYSICIANS
Since physicians generally control the majority of hospital admissions, the
success of the Company, in part, is dependent upon the number and quality of
physicians on its hospitals' medical staffs, the admissions practices of such
physicians and the maintenance of good relations between the Company and such
physicians. Hospital physicians are generally not employees of the Company, and
most staff physicians have admitting privileges at other hospitals. Only a
limited number of physicians are interested in practicing in the non-urban
communities in which the Company's hospitals are located, and the loss of
physicians in these communities, the inability of the Company to recruit
physicians to these communities or the inability of the Company to maintain good
relations with the physicians on its hospitals' staffs could have a material
adverse effect on the Company's business, financial condition or results of
operations. The operations of the Company's hospitals could also be materially
adversely affected by the shortage of nurses and certain other health care
professionals in these communities. See "Business -- Employees and Medical
Staff."
DEPENDENCE ON MANAGEMENT
The Company's success is largely dependent on the skills, experience and
efforts of its senior management and key members of its local management staffs.
The loss of service of one or more members of the Company's senior management or
of a significant portion of its local management staff could have a material
adverse effect on the Company's business, financial condition or results of
operations. The Company does not maintain key man life insurance policies on any
of its officers. See "Management."
LIMITED OPERATING HISTORY
NetCare was established in November 1995, initially funded in March 1996
and acquired its first facilities in August 1996. Accordingly, NetCare has only
a limited operating history upon which an evaluation of the Company's prospects
can be made. Such prospects must be considered in light of the risks, expenses
and difficulties frequently encountered by companies in an early stage of
development, particularly those companies operating in evolving markets. To
address these risks, the Company must, among other things, respond to
competitive developments, continue to attract, retain and motivate qualified
physicians, management personnel and other health care personnel, successfully
implement its acquisition and development
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strategies and obtain funds for such strategies, and manage the effects of
existing or future government regulation and managed care initiatives. There can
be no assurance that the Company will be able to sustain profitability or a
positive cash flow from its operations. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
EFFECT OF REIMBURSEMENT AND PAYMENT POLICIES; HEALTH CARE REFORM LEGISLATION
The Company's hospitals derive a substantial portion of their revenue from
the Medicare and Medicaid programs. Such programs are highly regulated and are
subject to frequent and substantial changes. In recent years, changes in
Medicare and Medicaid programs have resulted in limitations on, and reduced
levels of, payment and reimbursement for a substantial portion of hospital
procedures and costs. The federal Balanced Budget Act of 1997, which establishes
a plan to balance the federal budget by fiscal year 2002, includes significant
additional reductions in spending levels for the Medicare and Medicaid programs.
These include, among others, payment reductions directly affecting hospitals,
establishment of prospective payment systems for skilled nursing facilities and
home health agencies under Medicare, and repeal of the federal payment standard
(the so-called "Boren Amendment") for hospitals and nursing facilities under
Medicaid. In addition, a number of states are considering legislation designed
to reduce their Medicaid expenditures and to provide universal coverage and
additional care and/or to impose additional taxes on hospitals to help finance
or expand the states' Medicaid systems. Significant additional reductions in
payment levels or changes to the timeliness of payments could have a material
adverse effect on the business, financial condition or results of operations of
the Company.
A number of related legislative proposals have been introduced or proposed
in Congress and in some state legislatures that would effect major changes in
the health care system, either nationally or at the state level. Among the
proposals under consideration or already enacted are price controls on
hospitals, insurance market reforms to increase the availability of group health
insurance coverage to small businesses, and requirements that all businesses
offer health insurance coverage to their employees. While the Company
anticipates that payments to hospitals will be reduced as a result of future
federal and state legislation, it is uncertain at this time what health care
reform legislation may ultimately be enacted or whether other changes in the
administration or interpretation of governmental health care programs will
occur. There can be no assurance that future health care legislation or other
changes in the administration or interpretation of governmental health care
programs will not have a material adverse effect on the Company's business,
financial condition or results of operations. See "Business -- Health Care
Reform, Regulation and Licensing."
HEALTH CARE INDUSTRY INVESTIGATIONS
Significant media and public attention has recently been focused on the
hospital industry (and, to a somewhat lesser extent, on the long-term care and
home health industries) due to ongoing investigations reportedly related to
certain referral, cost reporting and billing practices, laboratory and home
health care services and physician ownership and joint ventures involving
hospitals. The alleged practices have been the subject of federal and state
investigations, as well as other proceedings.
As part of its operations, the Company has significant Medicare and
Medicaid billings. The Company monitors its billing practices and facility
operations to maintain compliance with prevailing industry interpretations of
applicable law, and believes that its current practices are consistent with
current industry practices. The applicable laws are complex and constantly
evolving, however, and there can be no assurance that the government
investigations will not result in interpretations which are inconsistent with
industry practices, including the Company's practices. In public statements
surrounding the current investigations, governmental authorities have taken
positions on a number of issues, including some for which little judicial or
other official interpretation has previously been available, such as the
legality of physician ownership in health care facilities in which they perform
services. Certain of these positions appear to be inconsistent with practices
that have been common within the industry and which have not previously been
challenged in this manner. Moreover, in certain instances, government
investigations that have in the past been conducted under the civil provisions
of federal law, are now being conducted as criminal investigations under the
Medicare fraud and abuse laws. None of the Company's hospitals has physician
investors and only three of the
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Company's hospitals operate home health agencies. However, there can be no
assurance that the Company or other hospital operators will not be the subject
of investigations or inquiries. The positions taken by authorities in the
current investigations or in any future investigations of the Company or other
providers could have a material adverse effect on the Company's business,
financial condition or results of operations. See "-- Health Care Regulation,"
and "Business -- Health Care Reform, Regulation and Licensing."
HEALTH CARE REGULATION
The health care industry is subject to extensive federal, state and local
laws and regulations relating to issues such as licensure, conduct of
operations, ownership of facilities, addition of facilities and services, and
prices for services, that are extremely complex and for which, in many
instances, the industry has the benefit of little or no regulatory or judicial
interpretation. In particular, Medicare and Medicaid anti-kickback amendments
codified under Section 1128B(b) of the Social Security Act (the "Anti-kickback
Amendments") prohibit certain business practices and relationships that might
affect the provision and cost of health care services reimbursable under
Medicare, Medicaid and other federal health care programs, including the payment
or receipt of remuneration for the referral, or arranging for the referral, of
patients whose care will be paid for by Medicare or other governmental programs.
Sanctions for violating the Anti-kickback Amendments include criminal penalties
and civil sanctions, including civil money penalties and possible exclusion from
government programs such as Medicare and Medicaid. Pursuant to the Medicare and
Medicaid Patient and Program Protection Act of 1987, the Department of Health
and Human Services ("HHS") has issued regulations that describe some of the
conduct and business relationships permissible under the Anti-kickback
Amendments ("Safe Harbors"). The fact that a given business arrangement does not
fall within a Safe Harbor does not render the arrangement per se illegal.
However, business arrangements of health care service providers that fail to
satisfy the applicable Safe Harbor criteria risk increased scrutiny by
enforcement authorities. The Health Insurance Portability and Accountability Act
of 1996, which became effective January 1, 1997, amends, among other things,
Title XI (42 U.S.C. 1301 et seq.) to broaden the scope of certain fraud and
abuse laws to include all health care services, whether or not they are
reimbursed under a federal program and creates new enforcement mechanisms to
combat fraud and abuse, including an incentive program under which individuals
can receive up to $1,000 for providing information on Medicare fraud and abuse
that leads to the recovery of at least $100 of Medicare funds. The Balanced
Budget Act of 1997 also expands numerous health care fraud provisions. See
"-- Health Care Industry Investigations."
The Company provides financial incentives to recruit physicians into the
communities served by its hospitals, including loans and minimum revenue
guarantees. Although HHS has proposed a Safe Harbor for certain physician
recruitment, no Safe Harbor for physician recruitment is currently in force. The
Company also enters into certain employment agreements, leases and other
agreements with physicians. There can be no assurance that regulatory
authorities who enforce the Anti-kickback Amendments will not determine that the
Company's physician recruiting activities or other physician arrangements
violate the Anti-kickback Amendments or other federal laws. Such a determination
could subject the Company to liabilities under the Social Security Act,
including criminal penalties, civil money penalties and/or exclusion of the
Company from participation in Medicare, Medicaid or other federal health care
programs, any of which could have a material adverse effect on the Company's
business, financial condition or results of operations. See "Business -- Health
Care Reform, Regulation and Licensing."
In addition, Section 1877 of the Social Security Act (commonly known as the
"Stark Law") was amended, effective January 1, 1995, to significantly broaden
the scope of prohibited physician referrals under the Medicare and Medicaid
programs to providers of designated health services with which they have
ownership or certain other financial arrangements (the "Self-Referral
Prohibitions"). Certain exceptions are available for employment agreements,
leases, physician recruitment, and certain other physician arrangements. Final
implementing regulations have not yet been issued, and there can be no assurance
that the Company's physician arrangements will be found to be in compliance with
the Stark Law, as such law ultimately may be interpreted. Many states have
adopted or are considering similar fraud and abuse and physician self-referral
legislation, some of which extends beyond the Medicare and Medicaid programs to
prohibit the payment or receipt of remuneration for the referral of patients and
physician self-referrals
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regardless of the source of the payment for the care, and some of which is more
stringent than federal law. The Company's participation in and development of
financial relationships with physicians and others could be adversely affected
by these amendments and similar state enactments. See "Business -- Health Care
Reform, Regulation and Licensing."
Both federal and state government agencies have announced heightened and
coordinated civil and criminal enforcement efforts. One federal initiative,
Operation Restore Trust, is focused on investigating health care providers in
the home health, hospice and nursing home industries as well as on medical
suppliers to these providers in 17 states, including California, Texas and
Georgia, three of the four states in which the Company provides home health care
or nursing home care. In addition, the Office of the Inspector General ("OIG")
of HHS and the Department of Justice have from time to time established
enforcement initiatives that focus on specific billing practices or other
suspected areas of abuse. Current initiatives include a focus on hospital
billing for outpatient charges associated with inpatient services, as well as
hospital laboratory billing practices. The Company is cooperating with the
government agencies which are responsible for such initiatives. See
"Business -- Healthcare Reform, Regulation and Licensing" and Note 6 to the
Consolidated Financial Statements of the Company.
Some states require state approval for the purchase, construction and
expansion of health care facilities, including findings of need for additional
or expanded health care facilities or services. Certificates of Need ("CONs"),
which are issued by governmental agencies with jurisdiction over health care
facilities, may be required for capital expenditures exceeding a prescribed
amount, changes in bed capacity or services and certain other matters. Following
a number of years of decline, the number of states requiring CONs is increasing.
Two states in which the Company currently owns hospitals, Georgia and
Mississippi, require CONs. There can be no assurance that the Company will be
able to obtain required CONs in the future or that the failure of the Company to
obtain any required CONs will not have a material adverse effect on the
business, financial condition or results of operations of the Company.
The laws, rules and regulations described above are complex and subject to
interpretation. In the event of a determination that the Company is in violation
of such laws, rules or regulations, or if further changes in the regulatory
framework occur, any such determination or changes could have a material adverse
effect on the Company's business, financial condition or results of operations.
See "Business -- Health Care Reform, Regulation and Licensing."
PROFESSIONAL LIABILITY
As is typical in the health care industry, the Company is subject to claims
and legal action by patients and others in the ordinary course of business. The
Company maintains professional malpractice liability insurance and general
liability insurance in amounts that management believes to be sufficient for its
operations, although some claims may exceed the scope of coverage in effect.
While the Company's professional and other liability insurance has been adequate
in the past to provide for liability claims, there can be no assurance that such
insurance will continue to be available for the Company to maintain adequate
levels of insurance. If payments with respect to malpractice liability or other
insurance increase in the future or if the Company is unable to maintain
adequate levels of insurance, the business, financial condition or results of
operations of the Company could be adversely affected. See
"Business -- Professional Liability."
COMPETITION
Competition among hospitals and other health care providers in the United
States has intensified in recent years as hospital occupancy rates have declined
as a result of cost containment pressures, changing technology, changes in
government regulation and reimbursement, changes in practice patterns (e.g.,
shifting from inpatient to outpatient treatments), the impact of managed care
organizations and other factors. The Company's hospitals face competition from
larger tertiary care centers, outpatient service providers and other local
non-urban hospitals, which provide similar services to those offered by the
Company's hospitals. Some of the hospitals that compete with the Company are
owned by governmental agencies or not-for-profit corporations supported by
endowments and charitable contributions, and can finance capital expenditures on
a
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tax-exempt basis. In addition, the Company faces competition for acquisitions
from for-profit hospital management companies, as well as not-for-profit
entities. The Company and its hospitals must also compete with other hospitals
and health care providers to attract quality physicians to their staffs. Some of
the Company's competitors are larger, may be more established and may have more
capital and other resources than the Company. Denton Regional Medical Center,
which competes with the Company's Denton Community Hospital and is located
approximately two miles from Denton Community Hospital, is being replaced by a
new facility to be located approximately seven miles from Denton Community
Hospital. There can be no assurance that the failure of the Company or its
hospitals to adequately compete will not have an adverse impact on the business,
financial condition or results of operations of the Company. See "-- Risks of
Acquisition Strategy," "Business -- Competition" and "Business -- Acquisition
Program."
EFFECTIVE CONTROL BY CEP II
Upon completion of the Offerings, CEP II will beneficially own % of
the outstanding shares of Common Stock. In addition, the Company will enter into
an agreement with CEP II providing that for as long as CEP II beneficially owns
30% or more of the outstanding voting stock of the Company, CEP II may require
the Company to appoint designees of CEP II as directors such that designees of
CEP II will constitute a majority of the members of the Board of Directors. As a
result of such concentration of ownership and such agreement, CEP II will have
the ability to exert significant influence on the policies and affairs of the
Company and corporate actions requiring stockholder approval, including the
election of the members of the Board of Directors. This concentration of
ownership and the agreement described above could have the effect of delaying,
deferring or preventing a change of control of the Company, including any
business combination with an unaffiliated party, and could also affect the price
that investors might be willing to pay in the future for shares of Common Stock.
See "Management," "Certain Relationships and Related Transactions" and
"Principal Stockholders."
HOLDING COMPANY STRUCTURE
The Company is a holding company and has no significant operations other
than those incidental to its ownership of the capital stock of its subsidiaries.
As a holding company, the Company's results of operations depend on the results
of operations of its subsidiaries. Moreover, the Company is dependent on
dividends or other intercompany transfers of funds from its subsidiaries to meet
its debt service and other obligations and, to the extent that the Company
intends to declare cash dividends on the Common Stock in the future, to fund the
payment of cash dividends. Claims of creditors of the Company's subsidiaries,
including trade creditors, will generally have priority as to the assets of such
subsidiaries over the claims of the Company. In addition, the New Credit
Facility may be collateralized by the assignment of the common stock of the
Company's subsidiaries.
CERTAIN ANTI-TAKEOVER EFFECTS
Certain provisions of the Company's Certificate of Incorporation and Bylaws
may have the effect, either alone or in combination with each other, of making
more difficult or discouraging a tender offer or takeover attempt that is
opposed by the Company's Board of Directors. These provisions include (i) a
provision requiring that the Company's Board of Directors be divided into three
classes, each serving a staggered three-year term; (ii) certain restrictions on
the persons eligible to call a special meeting of stockholders; (iii) a
prohibition on actions by written consent of the holders of Common Stock; (iv)
certain limitations on the size of the Company's Board of Directors; (v) removal
of directors for cause only; and (vi) the ability of the Company's Board of
Directors to authorize the issuance of preferred stock in series. The Company
has also adopted a stockholder rights plan which could substantially deter a
takeover attempt on terms the Company's Board of Directors determines are
unacceptable. See "Description of Capital Stock."
NO PRIOR PUBLIC MARKET; POSSIBLE VOLATILITY OF STOCK PRICE
Prior to the Offerings, there has been no public market for the Common
Stock. The initial public offering price of the Common Stock will be determined
by negotiations between the Company and the U.S.
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Representatives and the Lead Managers and may not be indicative of the market
price for shares of the Common Stock after the Offerings. See "Underwriting."
There can be no assurance that an active trading market will develop or be
maintained or as to the price at which the Common Stock will trade if and when
such a market develops. The Company has applied to list the Common Stock on the
New York Stock Exchange. The market price of the Common Stock may be subject to
significant fluctuations in response to variations in the Company's operating
results and other factors, including future acquisitions or divestitures of
hospitals, market rates of interest, developments affecting the health care
industry generally, the enactment of health care reform, reductions in payment
rates and changes in governmental regulation. In addition, the stock market in
recent years has experienced price and volume fluctuations that often have been
unrelated or disproportionate to the operating performance of companies, and the
price of the Common Stock could be affected by such fluctuations.
ABSENCE OF DIVIDENDS
The Company does not anticipate paying cash dividends in the foreseeable
future. In addition, the terms of the New Credit Facility are expected to
restrict the payment of cash dividends, and any future indebtedness incurred to
refinance the Company's existing indebtedness or to fund future growth may
prohibit or limit the Company's ability to pay dividends. See "Dividend Policy."
SUBSTANTIAL DILUTION
The assumed initial public offering price of $ per share will exceed
the net tangible book value per share of the Common Stock after the Offerings by
$ per share. Purchasers of the Common Stock in the Offerings will experience
immediate and substantial dilution in the amount of $ per share, and present
stockholders will experience an immediate and substantial increase in net
tangible book value in the amount of $ per share of Common Stock. The net
tangible book value of the Company at March 31, 1998, on a pro forma basis after
giving effect to the Recapitalization, was $103.0 million or $ per share of
Common Stock. See "Dilution."
SHARES ELIGIBLE FOR FUTURE SALE; REGISTRATION RIGHTS
Upon consummation of the Offerings, there will be
outstanding shares of Common Stock. All of the shares sold in the Offerings will
be freely tradable without restriction under the Securities Act, except to the
extent acquired by affiliates of the Company. The remaining
shares of Common Stock are "restricted securities" as that term is defined in
Rule 144 under the Securities Act. Subject to certain exceptions, the Company,
the Company's executive officers and directors and CEP II, who in the aggregate
will hold approximately shares of Common Stock, have agreed that
for a period of 180 days following the date of this Prospectus they will not
offer, pledge, sell, contract to sell, or otherwise transfer or dispose of,
shares of Common Stock without the prior written consent of Merrill Lynch. Upon
expiration of the 180-day period, shares of Common Stock will be
eligible for sale pursuant to Rule 144 under the Securities Act, subject in some
cases to compliance with Rule 144 volume limitations, of which
shares are held by CEP II and executive officers and directors of the Company.
Sales of a substantial amount of such shares, or the perception that such sales
will occur, could have a significant adverse effect on the market price of the
Common Stock and could impair the Company's ability to raise additional capital
through the sale of equity securities. See "Description of Capital Stock" and
"Shares Eligible for Future Sale."
In connection with the Recapitalization and the Offerings, the Company will
enter into a Registration Rights Agreement with its current stockholders. Under
the terms of the Registration Rights Agreement, such stockholders are entitled
to certain "piggy-back" and demand registration rights pursuant to which such
stockholders may have shares of Common Stock owned by them registered under the
Securities Act for sale to the public. In addition, the Company expects to
register the issuance of up to shares of Common Stock authorized
under its 1998 Long-Term Equity Incentive Plan, Directors' Stock Option Plan and
Directors' Stock Unit Plan following the Offerings. See "Management -- Long-Term
Equity Incentive Plan" and "Certain Relationships and Related
Transactions -- Registration Rights Agreement."
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YEAR 2000 COMPLIANCE
The Company has made and will continue to make certain investments in its
software systems and applications to ensure that the Company is year 2000
compliant. The financial impact to the Company to ensure year 2000 compliance
has not been and is not anticipated to be material to its business, financial
condition or results of operations. As part of its operations, the Company
transacts business with several governmental agencies and has significant
Medicare and Medicaid billings. There can be no assurance that the fiscal
intermediaries and governmental agencies with which the Company transacts
business, and which are responsible for payment to the Company under the
Medicare and Medicaid programs, as well as other payors, will not experience
problems in year 2000 compliance that could adversely affect the business,
financial condition or results of operations of the Company.
USE OF PROCEEDS
The net proceeds to the Company from the Offerings are estimated to be
$92.0 million ($106.0 million if the Underwriters' over-allotment option is
exercised in full), after deduction of the estimated underwriting discounts and
commissions and estimated expenses of the Offerings payable by the Company
(assuming a public offering price of $ per share).
The Company intends to use $82.7 million of the net proceeds from the
Offerings to repay outstanding indebtedness under the Existing Credit Facility,
which bears interest at a floating rate based upon the Federal Funds Effective
Rate or LIBOR, currently an effective rate of 7.625%. Borrowings under the
revolving loan portion and term loan portion of the Existing Credit Facility
mature on May 13, 2003.
The Company intends to use the balance of the proceeds for working capital
and other general corporate purposes, including the possible acquisition of
other hospitals. Pending such uses, the Company intends to invest the net
proceeds of the Offerings in short-term, interest-bearing investment grade debt
securities, certificates of deposit, commercial paper, time deposits or direct
or guaranteed obligations of the United States.
Although the Company has had preliminary discussions from time to time
regarding possible acquisition opportunities, the Company has no agreements,
understandings or commitments with respect to any such opportunities, other than
as described elsewhere in this Prospectus, nor has the Company allocated any
portion of the net proceeds hereunder for any specific acquisition. There can be
no assurance that any future acquisition will be consummated.
DIVIDEND POLICY
The Company currently intends to retain its earnings for use in its
business and therefore does not anticipate declaring or paying any cash
dividends in the foreseeable future. The New Credit Facility is expected to
restrict the payment of dividends by the Company (other than dividends paid in
the Company's stock). Any future determination to declare or pay cash dividends
will be made by the Board of Directors in light of the Company's earnings,
financial position, capital requirements, credit agreements and such other
factors as the Board of Directors deems relevant at such time. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources" and Note 3 to the Consolidated
Financial Statements of the Company.
14
<PAGE> 19
CAPITALIZATION
The following table sets forth as of March 31, 1998 (i) the actual
capitalization of the Company after giving effect to the Recapitalization, (ii)
the capitalization of the Company on a pro forma basis to reflect the
acquisition of the Acquired Facilities as if they had occurred on March 31,
1998, and (iii) the capitalization of the Company on a pro forma basis further
adjusted to reflect the sale of shares of Common Stock offered hereby (based on
an assumed offering price of $ per share) and the application of the
estimated net proceeds therefrom, as if they occurred on March 31, 1998.
<TABLE>
<CAPTION>
MARCH 31, 1998
----------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
-------- --------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Cash and cash equivalents................................... $ 930 $ 1,052 $ 10,402
======== ======== ========
Current maturities of long-term debt(1)..................... 9,175 9,175 675
======== ======== ========
Long-term debt, less current maturities(1).................. 71,045 76,695 2,545
Stockholders' equity:
Preferred Stock, $ par value,
shares authorized; no shares issued and outstanding.... -- -- --
Common Stock, $.01 par value, authorized;
shares issued and outstanding;
shares pro forma and
shares pro forma as adjusted........................... -- -- --
Additional paid-in capital................................ 51,135 57,635 149,635
Retained earnings......................................... -- -- --
-------- -------- --------
Total stockholders' equity............................. 51,135 57,635 149,635
-------- -------- --------
Total capitalization................................... $122,180 $134,330 $152,180
======== ======== ========
</TABLE>
- ---------------
(1) For information regarding the Company's long-term debt, see Note 3 to the
Consolidated Financial Statements of the Company.
15
<PAGE> 20
DILUTION
The net tangible book value of the Company at March 31, 1998 was $11.0
million, or $ per share of Common Stock. Net tangible book value per share
of Common Stock represents the amount of total assets less total liabilities,
minority interests and intangible assets, divided by the number of shares of
Common Stock outstanding at March 31, 1998. After giving effect to the sale by
the Company of the shares of Common Stock offered hereby (at an assumed initial
public offering price of $ per share) and the application of the net
proceeds as set forth under "Use of Proceeds," the pro forma net tangible book
value of the Company at March 31, 1998 would have been $103.0 million, or
$ per share of Common Stock. This represents an immediate increase in net
tangible book value of $ per share of Common Stock to existing stockholders
and an immediate dilution of $ per share of Common Stock to investors
purchasing Common Stock in the Offerings, as illustrated by the following table:
<TABLE>
<S> <C> <C>
Assumed initial public offering price....................... $
Net tangible book value per share of Common Stock prior to
the Offerings(1)(2).......................................
Increase in net tangible book value per share of Common
Stock attributable to new investors.......................
----------
Pro forma net tangible book value per share of Common Stock
after the Offerings.......................................
----------
Dilution per share of Common Stock to new investors(3)...... $
==========
</TABLE>
The following table summarizes as of March 31, 1998 certain differences
between the existing stockholders and the new investors with respect to the
number of shares of Common Stock purchased from the Company, the total
consideration paid and the average price per share paid by the existing
stockholders and new investors (based on an assumed initial public offering
price of $ per share), in each case on pro forma basis after giving effect
to the sale by the Company of shares of Common Stock in the
Offerings and the application of the estimated net proceeds thereof to the
repayment of debt, as described in "Use of Proceeds."
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
----------------- -------------------- PRICE PER
NUMBER PERCENT AMOUNT PERCENT SHARE
------- ------- --------- -------- ---------
<S> <C> <C> <C> <C> <C>
Existing stockholders(1)........................... % $ % $
New investors......................................
------- ----- -------- -----
Total.................................... % $ % $
======= ===== ======== =====
</TABLE>
- ---------------
(1) Excludes shares of Common Stock issuable upon the exercise of
outstanding options to be issued upon consummation of the Offerings pursuant
to the Company's 1998 Long-Term Equity Incentive Plan and Directors' Stock
Option Plan at a weighted average exercise price of $ per share. See
"Management -- Long-Term Equity Incentive Plan" and "Management -- Director
Compensation."
(2) Assumes conversion of Members' Equity into weighted average shares
of Common Stock, which includes shares issued to NetCare LLC.
(3) Dilution is determined by subtracting pro forma net tangible book value per
common share after giving effect to the Offerings from the initial public
offering price per share. Dilution to new investors will be $ if the
Underwriters' over-allotment option is exercised in full.
16
<PAGE> 21
SELECTED FINANCIAL AND OTHER DATA
(IN THOUSANDS EXCEPT PER SHARE AND STATISTICAL DATA)
The following selected financial data of (i) Southern Health (as
predecessor of the Company) for each of the years in the four year period ended
June 30, 1996 and for the period from July 1, 1996 through August 15, 1996; and
(ii) the Company for the year ended December 31, 1997 and for the period from
March 11, 1996 (date of inception) to December 31, 1996, are derived from (i)
the audited combined financial statements of Southern Health; and (ii) the
audited consolidated financial statements of the Company which are included
elsewhere in this Prospectus. The financial data for the three-month periods
ended March 31, 1998 and 1997 are derived from unaudited financial statements.
The unaudited financial statements include all adjustments, consisting of normal
recurring accruals, which the Company considers necessary for a fair
presentation of the financial position and the results of operations for these
periods. Operating results for the three months ended March 31, 1998 are not
necessarily indicative of the results that may be expected for the entire year
ending December 31, 1998.
All the information contained in the following tables should be read in
conjunction with "Capitalization," "Management's Discussion and Analysis of
Financial Condition and Results of Operations," the Unaudited Pro Forma
Condensed Consolidated Financial Statements and the related Notes thereto of the
Company and the audited combined financial statements and related notes of
Southern Health and the audited consolidated financial statements and the
related Notes thereto of the Company included in this Prospectus.
<TABLE>
<CAPTION>
SOUTHERN HEALTH (PREDECESSOR)(1)(2)
-----------------------------------------------------
PERIOD
YEAR ENDED JUNE 30, JULY 1, 1996
------------------------------------- TO AUGUST 15,
1993(3) 1994(3) 1995(4) 1996 1996
------- ------- ------- ------- -------------
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Total revenue.................. $37,646 $35,593 $51,198 $65,572 $8,845
Operating expenses............. 35,393 31,826 46,892 60,680 8,737
Interest expense............... 1,178 1,104 1,702 3,055 371
------- ------- ------- ------- ------
Income (loss) before income
taxes and extraordinary
charge....................... 1,075 2,663 2,604 1,837 (263)
Income tax benefit
(provision).................. (261) (808) (1,217) (1,183) 97
------- ------- ------- ------- ------
Income (loss) before
extraordinary charge......... $ 814 1,855 1,387 654 (166)
Extraordinary charge on early
extinguishment of debt, net
of taxes(6).................. -- -- -- -- --
------- ------- ------- ------- ------
Net income (loss)...... $ 814 $ 1,855 $ 1,387 $ 654 $ (166)
======= ======= ======= ======= ======
Basic earnings per share(7).... -- -- -- -- --
Weighted average shares(7)..... -- -- -- -- --
<CAPTION>
COMPANY (SUCCESSOR)(1)(2)
--------------------------------------------------
THREE MONTHS
PERIOD ENDED
MARCH 11, 1996 YEAR ENDED MARCH 31,
TO DECEMBER 31, DECEMBER 31, -----------------
1996(5) 1997 1997 1998
--------------- ------------ ------- -------
<S> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Total revenue.................. $31,424 $130,341 $32,448 $34,631
Operating expenses............. 31,483 117,897 28,635 30,449
Interest expense............... 2,013 6,681 1,540 1,631
------- -------- ------- -------
Income (loss) before income
taxes and extraordinary
charge....................... (2,072) 5,763 2,273 2,551
Income tax benefit
(provision).................. 204 (2,387) (909) (1,188)
------- -------- ------- -------
Income (loss) before
extraordinary charge......... (1,868) 3,376 1,364 1,363
Extraordinary charge on early
extinguishment of debt, net
of taxes(6).................. 525 -- -- --
------- -------- ------- -------
Net income (loss)...... $(2,393) $ 3,376 $ 1,364 $ 1,363
======= ======== ======= =======
Basic earnings per share(7).... -- $ [ ] -- $ [ ]
======== =======
Weighted average shares(7)..... -- [ ] -- [ ]
</TABLE>
<TABLE>
<CAPTION>
SOUTHERN HEALTH (PREDECESSOR)(1)(2) COMPANY (SUCCESSOR)(1)(2)
------------------------------------- --------------------------------
JUNE 30, DECEMBER 31, MARCH 31,
------------------------------------- ------------------- ----------
1993 1994 1995 1996 1996 1997 1998
------- ------- ------- ------- -------- -------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents................. $ 1,492 $ 619 $ 2,479 $ 1,463 $ 469 $ 495 $ 930
Working capital........................... (2,705) (1,342) 1,056 (109) 3,481 8,365 10,256
Total assets.............................. 16,888 20,335 35,694 37,771 142,908 149,530 150,551
Long-term debt, less current maturities... 9,410 11,690 24,066 33,245 73,895 71,571 71,045
Members'/Stockholders' equity (deficit)... (1,960) (101) 742 8,884 46,159 49,746 51,135
</TABLE>
(footnotes
on next page)
17
<PAGE> 22
- ---------------
(1) The Company was initially funded on March 11, 1996. On August 16, 1996, the
Company completed its acquisition of Southern Health. Since the Company had
no operations prior to the acquisition of Southern Health, the table
presents summary consolidated financial and statistical data of both
Southern Health and the Company.
(2) The financial statements of the Company and Southern Health for the periods
presented are not strictly comparable due to the significant effect that
acquisitions have had on such statements. See Note 2 to the Consolidated
Financial Statements of the Company and Note 3 to the Southern Health
Combined Financial Statements.
(3) Includes the results of operations of Mountainside Medical Center, North
Georgia Medical Center and Trace Regional Hospital.
(4) Includes the results of operations of Chatuge Regional Hospital from
September 22, 1994 (date of acquisition) and the results of operations of
Chestatee Regional Hospital from January 31, 1995 (date of acquisition).
(5) Includes the results of operations of Southern Health from August 16, 1996
(date of acquisition) and the results of operations of Denton Community
Hospital from November 13, 1996 (date of acquisition).
(6) Represents the extraordinary charge resulting from the write-off of the
unamortized loan costs related to the early extinguishment of the
outstanding principal balance under the Southern Health Amended and Restated
Credit Agreement. See Note 3 to the Consolidated Financial Statements of the
Company.
(7) The computation of historical earnings per share is based upon the assumed
conversion of members' equity into weighted average shares of Common
Stock, which includes shares issued to NetCare LLC. The Company had no
potential dilutive shares of Common Stock at December 31, 1997 or March 31,
1998.
18
<PAGE> 23
PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The unaudited pro forma condensed consolidated balance sheet as of March
31, 1998 gives effect to (i) the acquisition of the Acquired Facilities; (ii)
the Recapitalization; (iii) the sale of Common Stock in the Offerings; and (iv)
the application of the estimated net proceeds thereof, as described in "Use of
Proceeds," as if all such transactions had been completed as of March 31, 1998.
The unaudited pro forma consolidated statements of operations for the year ended
December 31, 1997 and the three months ended March 31, 1998 give effect to (i)
the acquisition of the Acquired Facilities; (ii) the Recapitalization; (iii) the
sale of the Common Stock in the Offerings; and (iv) the application of the
estimated net proceeds thereof, as described in "Use of Proceeds," as if all
such transactions had been completed as of January 1 of the respective periods.
The pro forma condensed consolidated financial information presented herein
does not purport to represent what the Company's results of operations or
financial position would have been had such transactions in fact occurred at the
beginning of the periods presented or to project the Company's results of
operation in any future period. The pro forma results of operations are not
necessarily indicative of the results that may be expected from the Acquired
Facilities. The unaudited pro forma condensed consolidated statements of
operations for the year ended December 31, 1997 and the three months ended March
31, 1998 do not reflect potential cost savings, synergies and efficiencies that
may in the future be achieved through the integration of the business and
operations of the Acquired Facilities with the Company. The unaudited pro forma
condensed consolidated financial statements should be read in conjunction with
the audited financial statements, including the notes thereto, included
elsewhere in this Prospectus.
19
<PAGE> 24
NETCARE HEALTH SYSTEMS, INC.
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1997
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
PRO FORMA PRO FORMA
HISTORICAL ADJUSTMENTS ADJUSTMENTS
----------------------------------------------------------- TO REFLECT TO REFLECT
NETCARE CENTRAL TEXAS HOLLY SPRINGS SAN CLEMENTE ACQUISITIONS SUBTOTAL OFFERINGS
----------- ------------- ------------- ------------- ------------ -------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Total revenue.......... $130,341 $3,646 $7,638 $ 21,174 -- $162,799 --
Operating expenses..... 117,897 3,903 7,987 27,889 (3,271)(1) 154,405 --(5)
Interest expense....... 6,681 15 56 1,657 (1,189)(2) 7,220 (5,857)(6)
Write down of
long-lived assets.... -- -- -- 18,631 (18,631)(3) -- --
-------- ------ ------ -------- ------- -------- -------
Income (loss) before
income taxes......... 5,763 (272) (405) (27,003) 23,091 1,174 5,857
Income tax benefit
(provision).......... (2,387) -- -- -- 1,743(4) (644) (2,226)(7)
-------- ------ ------ -------- ------- -------- -------
Net income
(loss)....... $ 3,376 $ (272) $ (405) $(27,003) $24,834 $ 530 $ 3,631
======== ====== ====== ======== ======= ======== =======
Basic earnings per
share(8)............. -- -- -- -- -- -- --
Weighted average
shares(8)............ -- -- -- -- -- -- --
<CAPTION>
COMBINED
PRO FORMA
---------
<S> <C>
Total revenue.......... $162,799
Operating expenses..... 154,405
Interest expense....... 1,363
Write down of
long-lived assets.... --
--------
Income (loss) before
income taxes......... 7,031
Income tax benefit
(provision).......... (2,870)
--------
Net income
(loss)....... $ 4,161
========
Basic earnings per
share(8)............. [ ]
--------
Weighted average
shares(8)............ [ ]
--------
</TABLE>
See accompanying notes to unaudited pro forma condensed consolidated statements
of operations.
20
<PAGE> 25
NETCARE HEALTH SYSTEMS, INC.
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED
STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 1998
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
PRO FORMA PRO FORMA
HISTORICAL ADJUSTMENTS ADJUSTMENTS
----------------------------------------------------------- TO REFLECT TO REFLECT
NETCARE CENTRAL TEXAS HOLLY SPRINGS SAN CLEMENTE ACQUISITIONS SUBTOTAL OFFERINGS
----------- ------------- ------------- ------------- ------------ -------- ---------------
<S> <C> <C> <C> <C> <C> <C> <C>
Total revenue........ $34,631 $ 824 $1,889 $ 5,265 $ -- $42,609 --
Operating expenses... 30,449 1,090 1,884 7,080 (887)(1) 39,616 186(5)
Interest expense..... 1,631 4 10 439 (319)(2) 1,765 (1,468)(6)
Write-down of long-
lived assets(3).... -- -- -- -- -- -- --
------- ------ ------ ------- ------- ------- --------
Income (loss) before
income taxes....... 2,551 (270) (5) (2,254) 1,206 1,228 1,282
Income tax benefit
(provision)........ (1,188) -- -- -- 503(4) (685) (558)(7)
------- ------ ------ ------- ------- ------- --------
Net income
(loss)..... $ 1,363 $ (270) $ (5) $(2,254) $ 1,709 $ 543 724
======= ====== ====== ======= ======= ======= ========
Basic earnings per
share(8)........... -- -- -- -- -- -- --
Weighted average
shares(8).......... -- -- -- -- -- -- --
<CAPTION>
COMBINED
PRO FORMA
---------
<S> <C>
Total revenue........ $42,609
Operating expenses... 39,802
Interest expense..... 297
Write-down of long-
lived assets(3).... --
-------
Income (loss) before
income taxes....... 2,510
Income tax benefit
(provision)........ (1,243)
-------
Net income
(loss)..... $ 1,267
=======
Basic earnings per
share(8)........... [ ]
=======
Weighted average
shares(8).......... [ ]
-------
</TABLE>
See accompanying notes to unaudited pro forma condensed consolidated statements
of operations.
21
<PAGE> 26
NETCARE HEALTH SYSTEMS, INC.
NOTES TO UNAUDITED PRO FORMA
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED ENDED
DECEMBER 31, MARCH 31,
1997 1998
------------ ------------
<C> <S> <C> <C>
</TABLE>
(1) Reflects the following adjustments to operating expenses as a result of the
acquisition of San Clemente Hospital and Medical Center:
<TABLE>
<S> <C> <C> <C>
(i) Elimination of salaries, wages and benefits associated
with a reduction in the number of employees at the
facility prior to the consummation of the acquisition..... $ (700) $ (175)
(ii) Elimination of the management fees charged by
Columbia/HCA.............................................. (1,499) (393)
(iii) Elimination of historical depreciation and inclusion of
depreciation based upon the new book basis of the
property, plant and equipment acquired.................... (1,072) (319)
-------- -------
$ (3,271) $ (887)
======== =======
</TABLE>
(2) Reflects the differences in interest expense resulting from the elimination
of historical interest expense and the inclusion of additional interest
expense associated with the debt borrowed to finance the acquisitions:
<TABLE>
<S> <C> <C> <C>
(i) San Clemente Hospital and Medical Center................. $ (1,379) $ (370)
(ii) Holly Springs Memorial Hospital. ........................ 190 51
-------- -------
$ (1,189) $ (319)
======== =======
(3) Reflects the elimination of the charge to operations related
to the write-down of long-lived assets for San Clemente
Hospital and Medical Center.................................. $(18,631) $ --
</TABLE>
(4) Reflects the following adjustments to income taxes (benefit) at an effective
tax rate of 38%:
<TABLE>
<S> <C> <C> <C>
(i) The tax benefit resulting from the loss from operations
of San Clemente Hospital and Medical Center, Central
Texas Hospital and Holly Springs Memorial Hospital....... $(10,518) $ (961)
(ii) The tax expense resulting from adjustments (1), (2) and
(3). .................................................... 8,775 458
-------- -------
$ (1,743) $ (503)
======== =======
(5) Reflects the amortization of the remaining unamortized
deferred compensation at March 31, 1998. Upon consummation
of the Offerings, all non-vested interests in the Company
granted to members of the Company's management would
immediately vest and the unamortized deferred compensation
would be charged to salaries, wages and benefits............ $ -- $ 186
(6) Reflects the reduction in interest expense as a result of
the reduction in debt from the proceeds of the Offerings.... $ (5,857) $(1,468)
(7) Reflects the adjustment to income taxes based on adjustment
(6) (at an effective tax rate of 38%). Adjustment (5) does
not result in an income tax benefit......................... $ 2,226 $ 558
</TABLE>
22
<PAGE> 27
(8) The computation of historical earnings per share is based upon the assumed
conversion of members' equity into weighted average shares of Common
Stock, which includes shares issued to NetCare LLC. The computation of
pro forma earnings per share is based upon weighted average shares of
Common Stock outstanding, which includes shares issued to NetCare LLC
and of the shares being sold in the Offerings, the proceeds of
which will be used to repay $82,650 of debt and pay $1,000 in expenses of
the Offerings. If all the shares sold in the Offerings were included in the
above calculation, there would be weighted average shares of Common
Stock outstanding with basic earnings per share of $ . The Company had
no potential dilutive shares of Common Stock at December 31, 1997 or March
31, 1998.
23
<PAGE> 28
NETCARE HEALTH SYSTEMS LLC
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
MARCH 31, 1998
(IN THOUSANDS)
<TABLE>
<CAPTION>
PRO FORMA
PRO FORMA ADJUSTMENTS
HISTORICAL ADJUSTMENTS TO REFLECT
------------------------------------------------------- TO REFLECT OFFERINGS AND
NETCARE CENTRAL TEXAS HOLLY SPRINGS SAN CLEMENTE ACQUISITIONS SUBTOTAL RECAPITALIZATION
-------- ------------- ------------- ------------ ------------ -------- ----------------
<S> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Current Assets:
Cash and cash
equivalents......... $ 930 $ -- $ 122 $ -- $ -- $ 1,052 92,000(5)
(82,650)(6)
Patient accounts
receivable, net of
allowance for
doubtful accounts... 22,902 399 1,413 5,136 (5,136)(1) 24,315 --
(399)(3)
Inventories........... 2,740 142 26 451 (142)(3) 3,217 --
Income tax
receivable.......... 3,822 -- -- -- -- 3,822 --
Prepaid expenses and
other current
assets.............. 2,205 14 -- 120 (14)(3) 2,325 --
-------- ------- ------- ------- -------- -------- -------
Total current
assets........ 32,599 555 1,561 5,707 (5,691) 34,731 9,350
Property, plant and
equipment, net...... 77,684 456 440 7,610 69(1) 87,952 --
2,149(2)
(456)(3)
Excess of purchase
price over net
assets acquired..... 38,588 -- -- -- -- 38,588 --
Other assets.......... 1,536 300 -- -- (300)(3) 1,536 --
Deferred income
taxes............... 144 -- -- -- -- 144 --
-------- ------- ------- ------- -------- -------- -------
Total Assets.... $150,551 $ 1,311 $ 2,001 $13,317 $ (4,229) 162,951 9,350
======== ======= ======= ======= ======== ======== =======
<CAPTION>
COMBINED
PRO FORMA
----------
<S> <C>
ASSETS
Current Assets:
Cash and cash
equivalents......... $ 10,402
Patient accounts
receivable, net of
allowance for
doubtful accounts... 24,315
Inventories........... 3,217
Income tax
receivable.......... 3,822
Prepaid expenses and
other current
assets.............. 2,325
--------
Total current
assets........ 44,081
Property, plant and
equipment, net...... 87,952
Excess of purchase
price over net
assets acquired..... 38,588
Other assets.......... 1,536
Deferred income
taxes............... 144
--------
Total Assets.... $172,301
========
</TABLE>
24
<PAGE> 29
<TABLE>
<CAPTION>
PRO FORMA
PRO FORMA ADJUSTMENTS
HISTORICAL ADJUSTMENTS TO REFLECT
------------------------------------------------------- TO REFLECT OFFERINGS AND
NETCARE CENTRAL TEXAS HOLLY SPRINGS SAN CLEMENTE ACQUISITIONS SUBTOTAL RECAPITALIZATION
-------- ------------- ------------- ------------ ------------ -------- ----------------
<S> <C> <C> <C> <C> <C> <C> <C>
LIABILITIES AND
STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable...... $ 3,186 614 867 $ 723 $ (723)(1) $ 3,186 --
(867)(2)
(614)(3)
Employee compensation
and benefits........ 3,834 -- 191 339 (89)(1) 4,084 --
(191)(2)
Accrued interest
payable............. 1,001 -- -- -- -- 1,001 --
Other accrued
liabilities......... 5,147 89 38 344 (344)(1) 5,147 --
(38)(2)
(89)(3)
Due to (from)
affiliates.......... -- -- 2,081 (818) (2,081)(2) -- --
818(1)
Current portion of
long-term debt...... 9,175 144 233 -- (233)(2) 9,175 (8,500)(6)
(144)(3)
-------- ------- ------- ------- -------- -------- -------
Total current
liabilities... 22,343 847 3,410 588 (4,595) 22,593 (8,500)
Long-term debt, less
current maturities.... 71,045 26 806 -- 3,000(1) 76,695 (74,150)(6)
2,650(2)
(806)(2)
(26)(3)
Third-party
settlements........... 6,028 -- -- 720 (720)(1) 6,028
Due to Columbia......... -- -- -- 18,902 (18,902)(1) --
Net assets (deficit).... -- -- -- (6,893) 6,893(1) -- --
Members' equity......... 51,135 -- -- -- 5,000(1) 57,635 (57,635)(4)
1,500(2)
Stockholder's equity:
Common stock.......... -- -- -- -- -- -- --
Additional paid-in
capital............. -- -- -- -- -- -- 57,635(4)
92,000(5)
Retained earnings
(deficit)........... -- 438 (2,215) -- 2,215(2) -- --
(438)(3)
-------- ------- ------- ------- -------- -------- -------
Total
stockholders'
equity........ -- 438 (2,215) -- 1,777 -- 149,635
-------- ------- ------- ------- -------- -------- -------
Total
liabilities
and
stockholders'
equity........ $150,551 $ 1,311 $ 2,001 $13,317 $ (4,229) $162,951 $ 9,350
======== ======= ======= ======= ======== ======== =======
<CAPTION>
COMBINED
PRO FORMA
----------
<S> <C>
LIABILITIES AND
STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable...... $ 3,186
Employee compensation
and benefits........ 4,084
Accrued interest
payable............. 1,001
Other accrued
liabilities......... 5,147
Due to (from)
affiliates.......... --
Current portion of
long-term debt...... 675
--------
Total current
liabilities... 14,093
Long-term debt, less
current maturities.... 2,545
Third-party
settlements........... 6,028
Due to Columbia......... --
Net assets (deficit)....
Members' equity......... --
Stockholder's equity:
Common stock.......... --
Additional paid-in
capital............. 149,635
Retained earnings
(deficit)........... --
--------
Total
stockholders'
equity........ 149,635
--------
Total
liabilities
and
stockholders'
equity........ $172,301
========
</TABLE>
See accompanying notes to unaudited pro forma condensed consolidated balance
sheet.
25
<PAGE> 30
NETCARE HEALTH SYSTEMS LLC
NOTES TO UNAUDITED PRO FORMA
CONDENSED CONSOLIDATED BALANCE SHEET
(IN THOUSANDS)
(1) Reflects the acquisition of San Clemente Hospital and Medical Center
including the borrowing of $3,000 under the Existing Credit Facility and
$5,000 in equity financing received from CEP II to be used for the purchase.
The Company purchased inventories, property, plant and equipment, and
assumed certain accrued employee benefits. The net effect of these
transactions result in (i) a decrease in accounts receivable of $5,136; (ii)
an increase in property, plant, and equipment of $69; (iii) a decrease in
accounts payable of $723; (iv) a decrease in employee compensation and
benefits of $89 (to reflect the agreed upon assumed obligations pursuant to
the acquisition agreement); (v) a decrease in other accrued liabilities of
$344; (vi) a decrease in due (from) affiliates of $818; (vii) a decrease in
third party settlements of $720; (viii) a decrease in due to Columbia of
$18,902; (ix) an increase in net assets (deficit) of $6,893; (x) an increase
in long-term debt of $3,000; and (xi) an increase in members' equity of
$5,000.
(2) Reflects the purchase of Holly Springs Memorial Hospital including the
borrowing of $2,650 under the Existing Credit Facility and $1,500 in equity
financing received from CEP II to be used for the purchase. The Company
purchased the accounts receivable, inventories and property, plant, and
equipment. The net effect of these transactions result in (i) an increase in
property, plant and equipment of $2,149 to adjust the recorded book value to
fair value; (ii) a decrease in accounts payable of $867; (iii) a decrease in
employee compensation and benefits of $191; (iv) a decrease in other accrued
liabilities of $38; (v) an increase in long-term debt of $1,611 (including
current portion); (vi) a decrease in due to affiliates of $2,081; (vii) an
increase in members' equity of $1,500; and (viii) a decrease in retained
deficit of $2,215.
(3) Reflects the acquisition of Central Texas Hospital. The Company assumed a
lease for this facility but did not purchase existing assets or liabilities.
This results in (i) a decrease in accounts receivable of $399; (ii) a
decrease in inventories of $142; (iii) a decrease in prepaid expenses and
other current assets of $14; (iv) a decrease in property, plant and
equipment of $456; (v) a decrease in other assets of $300; (vi) a decrease
in accounts payable of $614; (vii) a decrease in other accrued liabilities
of $89; (viii) a decrease in long-term debt (including current portion) of
$170; and (ix) a decrease in retained earnings of $438.
(4) Reflects the conversion of members' equity to Common Stock. This results in
a decrease in members' equity of $57,635 and an increase in paid in capital
of $57,635.
(5) Reflects the proceeds of the Offerings, net of estimated expenses ($1,000)
and underwriting commissions ($7,000). This results in an increase in cash
of $92,000 and an increase in paid in capital of $92,000.
(6) Reflects the use of the proceeds of the Offerings for the repayment of
$82,650 of debt. This results in a decrease in cash of $82,650 and a
decrease in debt of $82,650.
26
<PAGE> 31
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The Company is a health care services company focused on acquiring and
operating hospitals in growing non-urban communities throughout the United
States. The Company currently operates ten general acute care hospitals in four
states with a total of 600 licensed beds and four associated nursing homes with
a total of 338 licensed beds.
In August 1996, the Company purchased all of the outstanding stock of
Southern Health. Southern Health owned and operated five general acute care
hospitals and four associated nursing home facilities in the states of Georgia
and Mississippi. In November 1996, the Company acquired certain assets and
liabilities of Denton Community Hospital, located in Denton, Texas. In January
1997, the Company acquired certain assets and liabilities of Stone County
Hospital, located in Wiggins, Mississippi. In April, 1998, the Company acquired
Central Texas Hospital, located in Cameron, Texas, through the assumption of a
lease. In May 1998, the Company acquired Holly Springs Memorial Hospital,
located in Holly Springs, Mississippi. In June 1998, the Company acquired
certain assets and liabilities of San Clemente Hospital and Medical Center,
located in San Clemente, California. These acquisitions were recorded using the
purchase method of accounting and the results of operations are included in the
historical results of operations of the Company from the dates of the respective
acquisitions.
The financial impact of the Company's recent acquisitions makes it
difficult to draw meaningful comparisons between the Company's financial
statements for the fiscal periods presented. Therefore, the following discussion
includes an analysis of (i) the Company's historical results of operations for
1997, and supplemental results of operations for 1996 and 1995 giving effect to
all acquisitions completed prior to December 31, 1997 as if they had occurred as
of January 1, 1995; and (ii) the historical results of operations of the Company
(Successor) for periods following its date of inception and the historical
results of operations of Southern Health (Predecessor) for periods prior to such
acquisition.
GENERAL
An integral part of the Company's strategy is to acquire non-urban acute
care hospitals. See "Business -- Business Strategy." Due to the relatively small
number of hospitals owned, each hospital acquisition can materially affect the
overall operating margin of the Company. Upon the acquisition of a hospital, the
Company typically takes a number of steps to increase revenue and lower
operating costs. See "Business -- Operations." However, the impact of such
actions to lower operating costs may be offset by the costs associated with
implementing the Company's strategies to increase revenue by expanding services,
strengthening the medical staff and improving market position. The benefits of
these investments and of other activities to improve operating margins generally
do not occur immediately. Consequently, the financial performance of a
newly-acquired hospital may adversely affect overall operating margins in the
near term. As the Company makes additional hospital acquisitions, the Company
expects that this effect will be mitigated by the expanded financial base of
existing hospitals and the allocation of corporate overhead among a larger
number of hospitals.
The Company is continually involved in the investigation and evaluation of
potential acquisitions. In accordance with generally accepted accounting
principles, the Company capitalizes certain direct out-of-pocket expenditures
(such as legal and accounting fees) relating to potential or pending
acquisitions. Indirect acquisition costs, such as executive salaries, general
corporate overhead and other corporate services, are expensed as incurred. The
Company's policy is to charge against earnings any capitalized expenditures
relating to any potential or pending acquisition that the Company determines
will not be consummated. There can be no assurance that the Company in future
periods will not be required to incur a charge against earnings in accordance
with such policy, which charge, depending upon the magnitude thereof, could
adversely affect the Company's results of operations.
27
<PAGE> 32
Hospital revenue is received primarily from Medicare, Medicaid and
commercial insurance. The percentage of revenue received from the Medicare
program is expected to increase due to the general aging of the population. The
payment rates under the Medicare program for inpatients are based on a
prospective payment system, based upon the diagnosis of a patient. While these
rates have been adjusted annually, the adjustments have historically been less
than actual inflation. In addition, rather than paying standard rates, states,
insurance companies and employers are actively negotiating the amounts paid to
hospitals. The trend toward managed care, including health maintenance
organizations, preferred provider organizations and various other forms of
managed care, may affect the hospitals' ability to maintain their current rate
of net revenue growth.
Total revenue is comprised of net patient revenue from the Company's
hospitals and other revenue. Net patient revenue for the Company's hospitals is
reported net of contractual adjustments and policy discounts. The adjustments
principally result from differences between the hospitals' customary charges and
payment rates under the Medicare and Medicaid programs and managed care
programs. Other revenue includes interest income and other miscellaneous
revenue.
SUPPLEMENTAL RESULTS OF OPERATIONS
The following table and year-to-year analyses present, for the periods
indicated, historical operating results for 1997 and supplemental operating
results for 1996 and 1995. Such historical information for 1997 has been derived
from the consolidated statements of operations of the Company included elsewhere
in this Prospectus. The supplemental information for 1996 and 1995 represents
the results of operations as if all acquisitions which occurred prior to
December 31, 1997 (Southern Health, Denton Community Hospital, and Stone County
Hospital) had occurred as of January 1, 1995, after giving effect to certain
adjustments, including the depreciation and amortization of the assets acquired
based upon their fair values, changes in net interest expense resulting from
changes in consolidated debt and the elimination of the management fees charged
to Denton Community Hospital by its former owner. The supplemental information
for 1996 and 1995, however, does not reflect potential cost savings, synergies
and efficiencies that have been or may in the future be achieved through the
integration of the business and operations of Southern Health, Denton Community
Hospital and Stone County Hospital with the Company. The supplemental
information for 1996 and 1995 below does not purport to be indicative of what
actually would have occurred if the acquisitions had been in effect for the
entire period presented, and is not intended to be a projection of future
results or trends.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------------
1995 1996 1997
---------------- ---------------- ----------------
<S> <C> <C> <C> <C> <C> <C>
Net patient revenue...................... $117,190 98.0% $115,446 97.7% $128,517 98.6%
Other revenue............................ 2,366 2.0 2,765 2.3 1,824 1.4
-------- ----- -------- ----- -------- -----
Total revenue.................. 119,556 100.0 118,211 100.0 130,341 100.0
Expenses:
Salaries, wages and benefits........... 48,614 40.7 51,544 43.6 54,783 42.0
Supplies and other..................... 28,465 23.8 24,110 20.4 27,177 20.9
Provisions for bad debts............... 12,765 10.7 13,525 11.4 13,282 10.2
Purchased services..................... 7,896 6.6 7,984 6.8 8,450 6.5
Professional services.................. 4,461 3.7 3,754 3.2 3,690 2.8
Rent and lease expense................. 2,105 1.8 2,982 2.5 2,927 2.3
Depreciation and amortization.......... 8,056 6.7 7,845 6.6 7,588 5.8
Interest expense....................... 6,383 5.3 6,929 5.9 6,681 5.1
-------- ----- -------- ----- -------- -----
Income (loss) before income taxes........ 811 0.7% (462) (0.4)% 5,763 4.4%
Income tax provision..................... (704) 0.6% (220) (0.2)% (2,387) 1.8%
-------- ----- -------- ----- -------- -----
Net income (loss).............. $ 107 0.1% $ (682) (0.6)% $ 3,376 2.6%
======== ===== ======== ===== ======== =====
</TABLE>
28
<PAGE> 33
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
Total revenue was $130.3 million in 1997 compared to $118.2 million in
1996, an increase of $12.1 million, or 10.2%.
Net patient revenue totaled $128.5 million in 1997 compared to $115.4
million in 1996, an increase of $13.1 million, or 11.4%. This increase is
principally the result of an increase in hospital admissions to 14,326 in 1997
from 12,928 in 1996, an increase of 1,398, or 10.8%. Adjusted admissions
(adjusted to reflect outpatient activity) increased to 23,286 in 1997 from
21,622 in 1996, an increase of 1,664, or 7.7%.
Salaries, wages and benefits totaled $54.8 million in 1997 compared to
$51.5 million in 1996, an increase of $3.3 million, or 6.4%. The increase in
salaries, wages and benefits is primarily attributable to merit pay raises,
approximately $0.2 million in hospital executive severance payments and
relocation payments for newly hired hospital and corporate office executives and
an increase in bonus accruals from $0.2 million in 1996 to $0.8 million in 1997.
The increase in salaries, wages and benefits is lower than the rate of increase
in net operating revenue due primarily to favorable changes in work redesign,
nursing skill mixes and employee retention. Paid full-time equivalents remained
relatively consistent between 1997 (1,124) and 1996 (1,142).
Provision for bad debts totaled $13.3 million in 1997 compared to $13.5
million in 1996, a decrease of $0.2 million, or 1.5%. The improvement in the
provision for bad debts is primarily attributable to the enhancement of the
Company's internal collection procedures and to changes in the complement of
external collection agencies utilized by the Company.
Depreciation and amortization totaled $7.6 million in 1997 compared to $7.8
million in 1996, a decrease of $0.2 million, or 2.6%.
Interest expense totaled $6.7 million in 1997 compared to $6.9 million in
1996, a decrease of $0.2 million, or 2.9%. The decrease in interest expense is
principally the result of the decrease in the average interest rate on the
Company's long-term debt to 8.6% in 1997 from 8.9% in 1996.
Income tax expense totaled $2.4 million in 1997 compared to $0.2 million in
1996, an increase of $2.2 million. The Company's effective tax rate was 41.4%
and 47.6% for the years ended December 31, 1997 and 1996, respectively. In 1997,
the Company's income tax expense was favorably impacted by the reversal of a
deferred tax valuation allowance recorded in 1996. The reversal of the deferred
tax valuation allowance resulted in a decrease to income tax expense in 1997 of
$0.4 million and a corresponding decrease in the effective tax rate by 7.8%.
Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
Total revenue was $118.2 million in 1996 compared to $119.6 million in
1995, a decrease of $1.4 million, or 1.2%.
Net patient revenue totaled $115.4 million in 1996 compared to $117.2
million in 1995, a decrease of $1.8 million, or 1.5%. This decrease is
principally due to the decrease in patient volume at Denton Community Hospital,
where adjusted admissions (adjusted to reflect outpatient activities) decreased
from 6,940 in 1995 to 6,415 in 1996, representing a decrease of 525 adjusted
admissions, or 7.6%. In early 1996, Columbia/HCA, which then owned Denton
Community Hospital, determined that such facility would be excluded from a
significant managed care contract, thereby resulting in the decrease in adjusted
admissions.
Salaries, wages and benefits totaled $51.5 million in 1996 compared to
$48.6 million in 1995, an increase of $2.9 million, or 6.0%. Paid full time
equivalents decreased to 1,142 in 1996 from 1,198 in 1995, a decrease of 4.7%.
The increase in salaries, wages and benefits as a percentage of net operating
revenue is principally due to merit pay raises and Denton Community Hospital not
reducing its staffing levels in relation to the decrease in adjusted admissions.
Supplies and other totaled $24.1 million in 1996 compared to $28.5 million
in 1995, a decrease of $4.4 million, or 15.4%. The decrease in supplies and
other is primarily attributable to the decrease in patient volume and due to the
Company's efforts to consolidate vendors and negotiate contracts on a
consolidated basis.
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<PAGE> 34
Provision for bad debts totaled $13.5 million in 1996 compared to $12.8
million in 1995, an increase of $0.7 million, or 5.5%. The increase in the
provision for bad debts is primarily due to the increase in self-pay receivables
and the decrease in accounts receivable collections at Denton Community
Hospital, resulting from the decrease in the number of business office
collectors.
Depreciation and amortization totaled $7.8 million in 1996 compared to $8.1
million in 1995, a decrease of $0.3 million, or 3.7%.
Interest expense totaled $6.9 million in 1996 compared to $6.4 million in
1995, an increase of $0.5 million, or 7.8%. The increase in interest expense is
principally the result of the increase in the interest rates that would have
been charged under the Company's Existing Credit Facility. The effective
interest rates for 1996 and 1995 were 8.9% and 8.3%, respectively.
Income tax expense totaled $0.2 million in 1996 compared to $0.7 million in
1995, a decrease of $0.5 million. The Company's effective tax rate was 47.6% for
the year ended December 31, 1996 compared to 86.8% for the year ended December
31, 1995. Of such rates, 9.8% and 48.8%, respectively, relate to the tax effect
of non-deductible goodwill amortization attributable to the Southern Health
acquisition.
HISTORICAL RESULTS OF OPERATIONS
The following table and year-to-year analyses present, for the periods
indicated, historical information expressed as a percentage of net operating
revenue. Such historical information has been derived from the consolidated
statements of operations of the Company (Successor) for periods following the
acquisition of Southern Health and Southern Health (Predecessor) for the years
prior to the acquisition of Southern Health included elsewhere in this
Prospectus.
<TABLE>
<CAPTION>
COMPANY (SUCCESSOR)
SOUTHERN HEALTH --------------------------------------------------
CORPORATION PERIOD FROM
(PREDECESSOR) MARCH 11,
--------------- 1996
YEAR ENDED (DATE OF THREE MONTHS
JUNE 30, INCEPTION) TO YEAR ENDED ENDED MARCH 31,
--------------- DECEMBER 31, DECEMBER 31, ---------------
1995 1996 1996 1997 1997 1998
----- ----- ------------- ------------ ----- -----
<S> <C> <C> <C> <C> <C> <C>
Net patient revenue......... 97.2% 98.5% 97.2% 98.6% 98.6% 98.9%
Other revenue............... 2.8 1.5 2.8 1.4 1.4 1.1
----- ----- ----- ----- ----- -----
Total revenue..... 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Expenses:
Salaries, wages and
benefits............... 45.4 49.3 48.2 42.0 40.6 42.7
Supplies and other........ 22.2 21.9 21.0 20.9 20.0 19.9
Provisions for bad
debts.................. 6.9 4.4 11.3 10.2 11.1 8.9
Purchased services........ 5.1 5.4 5.8 6.5 6.1 5.8
Professional services..... 5.8 4.9 4.4 2.8 2.8 3.4
Rent and lease expense.... 0.9 1.5 2.5 2.3 2.2 2.1
Depreciation and
amortization........... 5.2 5.1 6.9 5.8 5.4 5.2
Interest expense.......... 3.3 4.7 6.4 5.1 4.8 4.7
----- ----- ----- ----- ----- -----
Income (loss) before
provision for income taxes
and extraordinary item.... 5.2% 2.8% (6.5)% 4.4% 7.0% 7.3%
Income tax benefit
(provision)............... 2.4% 1.8% (0.6)% 1.8% 2.8% 3.4%
----- ----- ----- ----- ----- -----
Income (loss) before
extraordinary charge...... 2.8% 1.0% (5.9)% 2.6% 4.2% 3.9%
Extraordinary charge on
early extinguishment of
debt, net of taxes........ -- -- (1.7)% -- -- --
----- ----- ----- ----- ----- -----
Net income
(loss).......... 2.8% 1.0% (7.6)% 2.6% 4.2% 3.9%
===== ===== ===== ===== ===== =====
</TABLE>
30
<PAGE> 35
Three Months Ended March 31, 1998 compared with Three Months Ended March 31,
1997 (Successor)
Total revenue was $34.6 million for the three months ended March 31, 1998
compared to $32.4 million for the three months ended March 31, 1997, an increase
of $2.2 million, or 6.8%.
Net patient revenue totaled $34.3 million for the three months ended March
31, 1998 compared to $32.0 million for the three month period ended March 31,
1997, an increase of $2.3 million, or 7.2%. This increase is principally the
result of the increase in outpatient revenue to $19.5 million for the three
month period ended March 31, 1998 from $17.2 million for the three month period
ended March 31, 1997 (a $2.3 million increase, or 13.4%). The increase in
outpatient revenue is primarily the result of the continued implementation of
new outpatient ancillary services. Inpatient admissions decreased to 3,594 for
the three months ended March 31, 1998 from 3,686 for the three months ended
March 31, 1997, a decrease of 2.5%.
Salaries, wages and benefits totaled $14.8 million for the three months
ended March 31, 1998 compared to $13.2 million for the three month period ended
March 31, 1997, an increase of $1.6 million, or 12.1%. This increase is
principally the result of the increase in employees classified as paid full-time
equivalents to 1,146 at March 31, 1998 from 1,097 at March 31, 1997 (an increase
of 49, or 4.5%) in response to the increased volume of outpatient services and
as a result of increased retention of the Company's work force.
Provision for bad debts totaled $3.1 million for the three months ended
March 31, 1998 compared to $3.6 million for the three months ended March 31,
1997, a decrease of $0.5 million, or 13.9%. The decrease results from the
Company's improved internal collection procedures and through changes in the
complement of external collection agencies utilized by the Company.
Interest expense totaled $1.6 million for the three months ended March 31,
1998 compared to $1.5 million for the three months ended March 31, 1997, an
increase of $0.1 million, or 6.7%. The Company's long-term debt totaled $80.2
million at March 31, 1998 compared to $80.8 million at March 31, 1997,
representing a decrease of $0.6 million, or 0.7%. The increase in interest
expense is principally the result of an increase in the effective interest rate
on the Company's revolving loans (9.25% and 9.0% in 1998 and 1997, respectively)
and the Company's term loans (7.4% and 7.0% in 1998 and 1997, respectively).
Income tax expense totaled $1.2 million for the three months ended March
31, 1998 compared to $0.9 million for the three months ended March 31, 1997, an
increase of $0.3 million, or 33.3%. The Company's effective tax rate was 46.6%
at March 31, 1998 compared to 40.0% at March 31, 1997. The increase in the
effective tax rate is attributable to the amortization of the excess of purchase
price over net assets acquired in connection with the acquisition of Southern
Health. The amortization expense associated with this acquisition is
non-deductible for income tax purposes. The allocation of the Southern Health
purchase price was finalized subsequent to the first quarter of 1997.
Year Ended December 31, 1997 Compared to Period from March 11, 1996 to
December 31, 1996 (Successor)
On August 16, 1996, the Company purchased Southern Health. Southern Health
owned and operated five general acute care hospitals and four associated nursing
home facilities. On November 13, 1996, the Company acquired certain assets and
liabilities of Denton Community Hospital. On January 1, 1997, the Company
acquired certain assets and liabilities of Stone County Hospital. The
acquisitions were recorded using the purchase method of accounting. The
historical financial information for 1996 includes the results of operations of
Southern Health and Denton Community Hospital from the dates of the respective
acquisitions. The historical financial information for 1997 includes the results
of operations of Southern Health, Denton Community Hospital and Stone County
Hospital for twelve months. Because of the significant increases in revenue and
expenses in 1997 compared to 1996 as a result of these acquisitions, there are
no meaningful comparisons between the December 31, 1997 and 1996 historical
results of operations. The expenses as a percentage of net operating revenue for
1997 generally indicated an improvement from 1996 primarily due to the expenses
recorded for the Company's corporate office during 1996 prior to the acquisition
of Southern Health. Prior to the acquisition of Southern Health, the Company did
not generate net operating revenue.
31
<PAGE> 36
In connection with the acquisition of Denton Community Hospital, the
Company entered into the Existing Credit Facility, under which the Company
initially borrowed $75.0 million. Of the $75.0 million initial borrowing under
the Existing Credit Facility (i) approximately $27.0 million was utilized to
extinguish a portion of the debt assumed in connection with the Southern Health
acquisition, (ii) approximately $45.0 million was utilized to purchase Denton
Community Hospital, and (iii) the remainder was utilized to extinguish existing
debt of the Company. In connection with the extinguishment of $27.0 million of
long-term debt from the proceeds of the Existing Credit Facility, the Company
recorded an extraordinary charge of $0.5 million (net of tax benefit of $0.3
million) in November 1996 due to the write-off of unamortized loan costs
associated with the $27 million in long-term debt. No extraordinary charges were
recorded in 1997.
Year Ended June 30, 1996 Compared to Year Ended June 30, 1995 (Predecessor)
In September 1994, Southern Health acquired certain assets of Chatuge
Regional Hospital and Nursing Home in Hiawassee, Georgia for $3.2 million. The
purchase was funded through a $2.8 million bank note with the balance paid in
cash. On January 31, 1995, Southern Health acquired certain assets of Chestatee
Regional Hospital in Dahlonega, Georgia for $6.7 million. The purchase was
funded through borrowings by Southern Health. The acquisitions were recorded
using the purchase method of accounting. The historical financial information
for 1995 includes the results of operations of Chatuge Regional Hospital (nine
months) and Chestatee Regional Hospital (five months) from the dates of the
respective acquisitions. The historical results of operations for 1996 includes
the results of operations of all five Southern Health hospitals and related
nursing homes for twelve months. Because of the significant increases in revenue
and expenses in 1996 compared to 1995 as a result of these acquisitions, there
are no meaningful comparisons between the June 30, 1996 and 1995 historical
information.
LIQUIDITY AND CAPITAL RESOURCES
Upon consummation of the Offerings, the Company will have less than $4
million of long-term debt outstanding. In connection with the Recapitalization
and the Offerings, it is anticipated that the Company will enter into the New
Credit Facility providing for aggregate commitments of up to $200 million,
consisting of a term facility and a revolving facility. The New Credit Facility
is expected to contain customary covenants similar to those contained in the
Existing Credit Facility.
At March 31, 1998, the Company had working capital of $10.3 million,
including cash and cash equivalents of $0.9 million. As with the hospital
industry in general, a major component of the Company's working capital is
accounts receivable arising from services provided to patients of its hospitals.
Payments on accounts receivable are made by third-party payors (Medicare,
Medicaid, and insurance plans) and directly by the patients. The Company
believes that the average collection period for its hospitals is consistent with
the industry average.
The Company's cash requirements, excluding acquisitions, have historically
been funded by cash generated from operations. Cash provided by operations was
$3.9 million for the year ended December 31, 1997. Cash provided by operations
was $1.7 million and $2.6 million for the three months ended March 31, 1997 and
1998, respectively.
Cash used in investing activities totaled $3.2 million for the year ended
December 31, 1997. Cash used in investing activities totaled $1.6 million and
$2.1 million for the three months ended March 31, 1997 and 1998, respectively.
These amounts related primarily to purchases of property and equipment in each
period.
Cash used in financing activities totaled $0.6 million for the year ended
December 31, 1997 and $0.1 million for each of the three month periods ended
March 31, 1997 and 1998. These amounts resulted from the net principal
repayments of the Company's long-term debt.
Capital expenditures for the Company's hospitals may vary from year to year
depending on facility improvements and service enhancements undertaken by the
hospitals. Capital expenditures for the three months ended March 31, 1998 were
$2.0 million. The Company expects to make capital expenditures in 1998 of
approximately $16.9 million, exclusive of any acquisitions. Planned capital
expenditures for 1998 include
32
<PAGE> 37
approximately $15.5 million of capital improvements at the Company's hospitals,
and approximately $1.4 million of capital expenditures for standardizing
management information systems for the Company's hospitals and the corporate
office.
The Company intends to purchase or lease additional acute care hospitals,
and is actively seeking such acquisitions. There can be no assurance that the
Company will not require additional debt or equity financing for any particular
acquisition, or that any needed financing will be available at all or on
favorable terms.
Under the Existing Credit Facility, the Company initially borrowed $75.0
million in the form of a term loan and may initially borrow, on a revolving
basis, an aggregate maximum principal amount of up to $50.0 million. Commencing
March 31, 2002 and each quarter thereafter, the aggregate maximum principal
amount available on a revolving basis under the Existing Credit Facility shall
be reduced. Amounts outstanding under the Existing Credit Facility totaled $77.0
million at both March 31, 1998 and December 31, 1997, of which $69.0 million
related to the term loan portion at March 31, 1998 and $71.0 million related to
the term loan portion at December 31, 1997.
Amounts borrowed in the form of term loans and revolving loans under the
Existing Credit Facility may be in the form of Eurodollar Loans, Alternate Base
Rate Loans, or a combination thereof. Interest on any Alternate Base Rate Loan
is equal to the Alternate Base Rate (the greater of the Federal Funds Effective
Rate plus 0.5%, or prime) plus the Alternate Base Rate margin (based upon the
Company's total debt ratio and interest coverage ratio and in any event no
greater than 0.75%). Interest on Eurodollar Loans is equal to the adjusted LIBOR
rate plus the LIBOR rate margin (based upon the Company's total debt ratio and
interest coverage ratio and in any event no greater than 1.75% and no less than
1%). The interest rate on the outstanding principal balance of Eurodollar Loans
and Alternate Base Rate Loans under the Existing Credit Facility at both March
31, 1998 and December 31, 1997 was approximately 7.6% and 9.3%, respectively.
The Existing Credit Facility contains various financial covenants which
include (i) limitations on additional debt; (ii) limitations on sales of assets,
mergers, consolidations and acquisitions; (iii) limitations on capital
expenditures; (iv) restrictions on payments of dividends; (v) maintenance of
certain financial ratios. The credit facility is collateralized by the
assignment of the Common Stock of the Company's subsidiaries.
Outstanding principal amounts under the term loan are payable in quarterly
installments. Outstanding principal amounts under the revolving loans are due
May 13, 2003. In addition, any outstanding principal amounts under the revolving
loans in excess of the aggregate maximum principal amount at the end of any
quarter are immediately payable. At March 31, 1998, the Company did not have
borrowings in excess of the aggregate maximum principal amount.
The Company believes that its future cash flow from operations, together
with borrowings available under the New Credit Facility and the net proceeds of
the Offerings, will be sufficient to fund the Company's operating expenses,
capital expenditures and debt service requirements for the foreseeable future.
The Company intends to pursue its acquisition strategy and in connection
therewith may pursue additional financings and incur additional indebtedness.
INFLATION
The health care industry is labor intensive. Wages and other expenses
increase on a regular basis, especially during periods of inflation and labor
shortages. In addition, suppliers pass along rising costs to the Company in the
form of higher prices. The Company has generally been able to offset increases
in operating costs by increasing charges for services and expanding services.
The Company has also implemented cost control measures to curb increases in
operating costs and expenses. In light of cost containment measures imposed by
government agencies and private insurance companies, the Company is unable to
predict its ability to offset or control future cost increases, or its ability
to pass on the increased costs associated with providing health care services to
patients with government or managed care payors, unless such payors
correspondingly increase reimbursement rates. See "Business -- Government
Reimbursement."
33
<PAGE> 38
YEAR 2000 COMPLIANCE
The Company has made and will continue to make certain investments in its
software systems and applications to ensure that the Company is year 2000
compliant. The financial impact to the Company to ensure year 2000 compliance
has not been and is not anticipated to be material to its business, financial
condition or results of operations. As part of its operations, the Company
transacts business with several governmental agencies and has significant
Medicare and Medicaid billings. There can be no assurance that the fiscal
intermediaries and governmental agencies with which the Company transacts
business, and which are responsible for payment to the Company under the
Medicare and Medicaid programs, as well as other payors, will not experience
problems in year 2000 compliance that could adversely affect the business,
financial condition or results of operations of the Company. See "Risk
Factors -- Year 2000 Compliance."
34
<PAGE> 39
BUSINESS
OVERVIEW
NetCare was initially funded in March 1996 to acquire and operate acute
care community hospitals in non-urban markets. Since then, NetCare has acquired
and currently operates ten general acute care hospitals in growing, non-urban
communities in Georgia, Mississippi, Texas and California. These facilities,
together with their medical staffs, provide a wide range of inpatient and
outpatient acute care services and a variety of specialty services, including
skilled nursing services, rehabilitation services and psychiatric services. The
Company also operates four nursing homes associated with its hospitals. The
Company had total revenue of $130.3 million for the year ended December 31, 1997
from the seven hospitals and related businesses then operated by the Company,
approximately 92% of which was derived from hospital and hospital-related
activities. On a pro forma basis, after giving effect to the acquisition of
three hospitals acquired in 1998 as if such acquisitions occurred on January 1,
1997, the Company had total revenue of $162.8 million for the year ended
December 31, 1997.
The Company's senior management has significant experience acquiring and
operating community hospitals. As part of the management of Healthtrust,
Inc.-- The Hospital Company, NetCare's senior management implemented a growth
plan which included the acquisition of more than 20 community hospitals and the
operation of over 100 hospitals between 1987 and 1995.
In August 1996, NetCare acquired Southern Health, an owner and operator of
four non-urban community hospitals and three associated nursing homes in Georgia
ranging from approximately 45 miles to 100 miles north of Atlanta, Georgia and
one hospital and associated nursing home in northeastern Mississippi,
approximately 35 miles southeast of Tupelo, Mississippi. In November 1996,
NetCare acquired Denton Community Hospital, located in Denton, Texas,
approximately 35 miles northwest of Dallas. In January 1997, NetCare acquired
Stone County Hospital, located in Wiggins, Mississippi, approximately 30 miles
north of Gulfport, Mississippi. In April 1998, NetCare acquired Central Texas
Hospital, located in Cameron, Texas, approximately 70 miles northeast of Austin,
Texas, through the assumption of a lease and in May 1998, NetCare acquired Holly
Springs Memorial Hospital, located in Holly Springs, Mississippi, approximately
30 miles southeast of Memphis, Tennessee. In June 1998, the Company acquired San
Clemente Hospital and Medical Center, located in San Clemente, California,
approximately 65 miles south of Los Angeles, California.
INDUSTRY OVERVIEW
Hospital Management Industry
According to Health Care Finance Administration statistics, aggregate
national health care expenditures were more than $1 trillion in 1996, the most
recent year for which such statistics are available. Over the last four decades,
a number of factors have contributed to the growth of health care expenditures,
including the introduction of Medicare and Medicaid, technological innovations
in the health care industry, the aging of the American population and general
inflation. Hospital care represents the largest single share of health care
expenditures, accounting for 34.6% of total national health care outlays, or
approximately $359 billion in 1996. The hospital industry is highly competitive
and in recent years has been characterized by increased competition for patients
and staff physicians, a shift from inpatient to outpatient care, increased
consolidation and reduced or discounted payments for services provided.
The shift to outpatient care, which has characterized the hospital industry
in recent years, has been primarily due to (i) advances in medical technologies
and pharmaceutical improvements, which allow more services to be provided on an
outpatient basis and (ii) cost containment pressures by Medicare, Medicaid,
health maintenance organizations (HMOs), preferred provider organizations (PPOs)
and insurers to reduce hospital stays and provide services, where possible, on a
less expensive outpatient basis. The hospital industry is significantly affected
by such cost containment pressures due to the fact that Medicare and Medicaid
combine for more than 40% of most hospitals' revenue and managed care
organizations, such as HMOs and PPOs, continue to represent an increasing
segment of health care payors. In response to the increased pressure from
federal and private health insurers to reduce inpatient care, many hospitals
have adopted competitive
35
<PAGE> 40
strategies that emphasize the use of alternative health care delivery systems
(such as home health services, outpatient surgery and emergency and diagnostic
centers) that eliminate or reduce lengths of hospital stays.
Due, in large part, to the shift from inpatient to outpatient care and cost
containment pressures from government and private third-party payors, the
hospital industry over the last decade has been characterized by excess
capacity. As a result, many hospitals have either closed or consolidated through
acquisitions and affiliations. Not-for-profit hospitals have increasingly been
acquired by for-profit institutions. Although the percentage of for-profit
hospitals has fluctuated in recent years due to the general consolidation within
the hospital industry, from 1993 to 1996 for-profit hospitals increased as a
percentage of the hospital industry from 13.6% to 14.7%.
The Non-Urban Health Care Market
The Company believes that growing, non-urban health care markets are
attractive to health care service providers as a result of favorable demographic
and economic trends. According to Health Care Finance Administration statistics
and Demographic U.S.A. County Statistics -- 1997, 34% of the United States
population lived in counties with populations of less than 150,000 in 1997. All
of NetCare's facilities are located in growing, non-urban markets. Nine of
NetCare's ten hospitals are the only hospitals in their respective communities
and the tenth hospital is one of only two hospitals in its community. The
hospitals have general service area populations ranging from 15,000 to more than
110,000 and the average annual population growth rate of these communities since
1990 is 2.3%, more than twice the national average annual population growth rate
of 1.1% for the same period, according to data supplied by Health InfoTechnics,
LLC.
Because non-urban service areas have smaller populations, there are
generally only one or two hospitals in each non-urban community, resulting in
less direct competition for hospital-based services. The Company believes that
the smaller populations and relative dominance of the one or two acute care
hospitals in these markets also limit the entry of alternate non-hospital
providers, such as outpatient surgery centers or rehabilitation or diagnostic
imaging centers, as well as managed care plans. In addition, the Company
believes that non-urban communities are generally characterized by a high level
of patient and physician loyalty that fosters cooperative relationships among
the local hospital, physician and patients. As a result, the local hospital is
viewed as a key part of the local community.
Although the characteristics of the non-urban health care market present a
number of opportunities, the Company believes that hospitals in such markets
have been under considerable pressure. The not-for-profit and governmental
entities that typically own and operate these hospitals may have limited access
to the capital required to keep pace with advances in medical technology and to
make needed capital improvements. Non-urban hospitals also frequently lack the
management resources necessary to control hospital expenses, recruit physicians,
expand health care services and comply with increasingly complex reimbursement
and managed care requirements. The increasingly dynamic and complex health care
regulatory environment compounds these pressures. Collectively, these factors
frequently lead to poor operating performance, a decline in the breadth of
services offered, dissatisfaction by community physicians and residents and the
perception of subpar quality of care in the community. As a result, patients
migrate to, are referred by local physicians to, or are lured by incentives from
managed care plans to travel to, hospitals in larger urban markets which may be
as far as 30 to 50 miles away. This patient migration further increases the
financial pressure on non-urban physicians and hospitals, thereby further
limiting their ability to address the issues which have led to this migration.
The Company believes that as a result of these pressures, not-for-profit and
governmental owners of non-urban hospitals who wish to preserve the local
availability of quality health care services have sought to sell or lease these
hospitals to companies, like NetCare, that have the access to capital and
management resources which can better serve the community and are committed to
the local delivery of health care.
BUSINESS STRATEGY
The key elements of the Company's business strategy include:
- Increasing Revenue at Existing Facilities. The Company seeks to provide
additional health care services and programs in response to the needs of
the community. The Company intends to continue to
36
<PAGE> 41
expand and improve the breadth of services offered so that each of the
Company's hospitals becomes the provider of choice for patients seeking
health care services in the community it serves. These services may
include specialty inpatient services, outpatient services, home health
care and mental health clinics. As a result of its efforts to date, the
Company believes that its hospitals are improving their ability to
provide high quality primary and emergency care, expanding their ability
to offer more complex hospital services such as diagnostic imaging,
radiology, cardiology, orthopedics and oncology and, in some markets,
offering cardiac catherization services, open heart surgery, certain
complex rehabilitation services and emergency air transport services. The
Company also makes capital investments in technology and the physical
plant at its facilities to further improve both the quality of health
care and the reputation of the hospital in the community. For example,
the Company is currently engaged in an expansion project at Denton
Community Hospital that is expected to be completed by December 31, 1998
and cost approximately $6.5 million. The project includes the creation of
open-heart surgery capabilities, the construction of additional surgical
suites, the addition of a skilled nursing facility and the expansion of
ambulatory surgery facilities. By providing a broader range of services
and a more attractive care setting, the Company believes each of its
hospitals can increase its share of the health care dollars spent by
local residents and limit patient migration to large urban facilities.
Total revenue for the hospitals operated by NetCare for a full year in
1997 increased 10.3% from 1996 to 1997.
In addition, the Company believes that supporting current physicians
and recruiting additional physicians to its local communities is an
essential element of increasing the quality and availability of health
care in the community through its hospitals and, therefore, of increasing
the Company's revenue. The Company intends to continue to provide the
resources and capital needed to support physicians currently in the
communities it serves to allow them more time to provide patient care.
The Company also works with local hospital boards, management teams and
medical staffs to determine the number and type of additional physicians
needed in the communities. The Company intends to aggressively recruit
additional primary care physicians and specialists to its communities to
meet those needs. In 1997, the Company added nine specialists and four
primary care physicians (net of departures) at the seven hospitals then
operated by the Company. The Company also looks to physicians to play an
active role in the governance of its hospitals. Physicians help develop
short and long-term plans for the hospitals and review and approve, as
appropriate, actions of the medical staff, including staff appointments,
credentialing, peer review and quality assurance.
- Growing through Acquisitions. NetCare intends to grow through the
acquisition of additional hospitals in its target communities. NetCare
intends to acquire at least one or two hospitals each year that fit the
Company's acquisition criteria. The Company pursues acquisition
candidates that (i) have a minimum general service area population of
10,000 with a stable or growing population base; (ii) are the sole or a
primary provider of acute care services in the community; and (iii) have
financial performance that the Company believes will benefit from
management's operating skills. The Company believes there are currently
more than 900 hospitals that have two or fewer hospital competitors
within a twenty mile radius of their local community campus. As these
hospitals experience limited management and financial resources, payment
reductions, increasingly complex regulations and larger urban
competitors, the Company believes that their owners may turn to
companies, such as NetCare, that have the management expertise and
financial resources necessary to preserve the local availability of
health care in their community.
- Reducing Costs. In order to improve efficiencies and increase operating
margins following the acquisition of a hospital, the Company implements
cost reduction programs which include (i) redesigning the manner in which
clinical and administrative work is performed; (ii) adjusting staffing
levels according to patient volumes; (iii) capitalizing on purchasing
efficiencies and, terminating or renegotiating certain vendor contracts;
and (iv) installing a standardized management information system
resulting in more efficient billing and collection procedures. The
Company also enforces strict protocols for compliance with the Company's
supply contracts. The Company believes that such programs, along with the
growth of the Company's net operating revenue, have contributed, in part,
to
37
<PAGE> 42
the improvement of the operating margins of the Company's hospitals. The
operating margins for the hospitals operated by NetCare for a full year
in 1997 improved from 13.1% in 1996 to 15.5% in 1997. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations."
- Focusing on the Community. Since the Company believes that the provision
of health care is essentially a local business, the Company emphasizes
local hospital initiatives, responsibility and accountability. Each
hospital's operating plan is developed by the local management team in
conjunction with the Company's senior management team and sets forth
revenue enhancement strategies and specific expense benchmarks.
Decentralized hospital management teams work closely with local
physicians, community leaders and residents to identify and then meet the
needs of the community. For example, the Company operates health clinics
in rural areas located in close proximity to certain of its hospitals to
provide previously unavailable primary care services in such areas and to
introduce the Company's services to a broader geographic area. In
addition the Company also generally affiliates with tertiary care
hospitals or systems in nearby urban markets for services which cannot
effectively be provided locally and sponsors local preferred provider
options and contracting opportunities to employers in partnership with
other local providers and managed care plans. The Company believes that
its community focus will limit patient migration to larger urban
facilities and thereby increase the Company's market share and revenue.
ACQUISITION PROGRAM
To further the Company's acquisition strategy, the Company actively seeks
out acquisition targets by identifying attractive markets and hospitals based on
demographic, economic and competitive factors and initiating meetings with the
hospital owners and community leaders to discuss the benefits to the community
of a possible acquisition by the Company. The Company also responds to requests
for proposals from entities which are seeking to sell or lease a hospital. The
Company believes that it generally takes several months to identify and evaluate
acquisition opportunities and, thereafter, four to six months to consummate an
acquisition after the hospital owner's decision to sell. After a potential
acquisition has been identified, the Company undertakes a thorough due diligence
review of the hospital to be acquired. The Company utilizes its experienced
personnel to conduct a formalized review of all aspects of the target's
operations, including Medicare reimbursement, purchasing, regulatory compliance,
litigation, capital requirements, and environmental issues. During the course of
its due diligence review, the Company prepares an operating plan for the
hospital to be acquired, identifies opportunities for operating efficiencies and
physician recruiting needs, and assesses productivity and management information
systems. Throughout the process, the Company works closely with community
decision-makers in order to enhance both the community's understanding of the
Company's philosophy and abilities and the Company's knowledge of the needs of
the community.
The competition to acquire non-urban hospitals is significant, and the
Company believes that often the acquiror will be selected for a variety of
reasons and not exclusively on the basis of price. The Company believes that its
goal of increasing the access to, and the quality of, health care in the local
communities served by its hospitals aligns its interests with those of the
communities. The Company believes that this commitment to maintaining the local
availability of health care services, together with the Company's reputation for
providing market-specific, high quality health care, its focus on physician
recruiting, its management's operating experience, its access to capital, and
its active approach to identifying acquisition targets, enable the Company to
compete successfully for acquisitions.
OPERATIONS
Following the acquisition of a hospital, the Company implements its
policies and procedures to improve the hospital's operating and financial
performance. The Company implements an operating plan designed to increase
revenue through the expansion of the breadth of services offered by the
hospitals and the recruitment of physicians to the community and reduce costs by
improving operating efficiency. Management believes that the long-term growth
potential of a hospital is dependent on the Company's ability to add appropriate
health care services and effectively recruit physicians.
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<PAGE> 43
Each hospital management team generally is comprised of a chief executive
officer, chief financial officer and chief nursing officer. The Company believes
that the quality of the local management team at each hospital is critical to
the hospital's success, because the management team is responsible for
implementing the elements of the Company's operating plan. The operating plan is
developed by the local management team in conjunction with the Company's senior
management team and sets forth revenue enhancement strategies and specific
expense benchmarks. The Company has implemented a performance-based compensation
program for each local management team based upon the achievement of the goals
set forth in the operating plan. See "Risk Factors -- Dependence on Management."
Each of the Company's hospitals and their local management teams is
supported by the Company's reimbursement, regulatory and compliance expertise
and by NetCare's senior management team which has an average of 15 years of
experience in the health care industry. While the local management team is
responsible for the day-to-day operations of the hospitals, the Company's
corporate staff provides support services to each hospital, including physician
recruiting, regulatory compliance, reimbursement expertise, information systems,
human resources, accounting, cash management and other finance activities, tax
and insurance support. Financial controls are maintained through utilization of
standardized policies and procedures. The Company promotes communication among
its hospitals so that local expertise and improvements can be shared throughout
the Company.
As part of the Company's efforts to improve access to high quality health
care in the communities it serves, the Company adds appropriate services at its
hospitals. The Company uses patient and physician surveys, analyses of local
demographics, the local managed care environment and competitive conditions for
such services and discussions with key individuals in the community to determine
which services are needed by the community. Services and care programs added may
include specialty inpatient services, such as cardiology, geriatric psychiatry,
skilled nursing, rehabilitation and subacute care, and outpatient services such
as same-day-surgery, radiology, laboratory, pharmacy services and physical
therapy. The Company may also add home health care services and mental health
clinics. Management believes the establishment and maintenance of quality
emergency room departments and obstetrics and gynecological services are
particularly important, because they are often the most visible services
provided to the community. The Company also makes capital investments in
technology and facilities to increase the quality and breadth of services
available in the communities. By increasing the services provided at the
Company's hospitals and upgrading the technology used in providing such
services, the Company believes that it improves the quality of care and the
hospitals' reputation in each community, which in turn may increase patient
census and revenue.
The Company works with local hospital boards, management teams and medical
staffs to determine the number and type of additional physicians needed in the
community. The Company intends to aggressively recruit additional primary care
physicians and specialists to meet the community's needs. The majority of
physicians who relocate their practices to the communities serviced by the
Company's hospitals are identified by the efforts of independent recruiting
firms. When recruiting a physician to a community, the Company may guarantee the
physician a minimum level of revenue during a limited initial period and assists
the physician with his or her transition to the community. The Company requires
the physician to repay some or all of the amounts expended for such assistance
in the event the physician leaves the community within a specified period.
Physicians affiliated with the Company hospital in a given community also are
made available to physicians considering relocation to the community. See "Risk
Factors -- Dependence on Physicians" and "-- Health Care Regulation" and
"Business -- Health Care Reform, Regulation and Licensing."
Hospitals and Nursing Homes
The Company currently operates ten general acute care hospitals in Georgia,
Mississippi, Texas and California, with a total of 600 licensed beds. Nine of
the Company's ten hospitals are the only hospital in their respective
communities and the tenth hospital is one of only two hospitals in its
community. Hospital and hospital-related activities represented approximately
92% of the Company's net operating revenue for the year ended December 31, 1997.
Management believes that the hospitals operated by the Company are suitable for
their respective uses.
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<PAGE> 44
The Company's hospitals offer a wide range of inpatient medical services
such as operating/recovery rooms, intensive care units, diagnostic services and
emergency room services, as well as outpatient services such as same-day
surgery, radiology, laboratory, pharmacy services and physical therapy. The
Company's hospitals also frequently provide certain specialty services which
include skilled nursing, geriatric psychiatry, and rehabilitation services. The
Company's hospitals do not provide highly specialized surgical services such as
organ transplants and are not engaged in extensive medical research or
educational programs.
The Company operates four nursing homes, with a total of 338 licensed beds,
which are associated with certain of the Company's owned and leased hospitals
located in Georgia and Mississippi. The Company's nursing home operations
represented approximately 8.3% of the Company's net operating revenue for the
year ended December 31, 1997. Historically, the Company acquired nursing homes
which were associated with hospitals targeted for acquisition by the Company
pursuant to its growth strategy. The Company has no plans to acquire nursing
homes which are not associated with hospitals targeted for acquisition by the
Company. In addition, three of the Company's hospitals, San Clemente Hospital
and Medical Center, Denton Community Hospital and Central Texas Hospital,
operate home health agencies.
Below is a table which sets forth certain information with respect to each
of the hospitals currently operated by the Company, followed by a brief
description of each of the hospitals. All growth rates noted below are for the
period from 1990 to 1997.
<TABLE>
<CAPTION>
DATE OF
FACILITY ACQUISITION LICENSED BEDS
- -------- ----------- -------------
<S> <C> <C>
GEORGIA
Chatuge Regional Hospital and Nursing Home 47 bed hospital
Hiawassee, Georgia................................... August 1996 112 bed nursing home
Chestatee Regional Hospital
Dahlonega, Georgia................................... August 1996 52 bed hospital
Mountainside Medical Center and Nursing Home 40 bed hospital
Jasper, Georgia...................................... August 1996 60 bed nursing home
North Georgia Medical Center and Gilmer Nursing Home, 52 bed hospital
Ellijay, Georgia..................................... August 1996 100 bed nursing home
MISSISSIPPI
Holly Springs Memorial Hospital
Holly Springs, Mississippi........................... May 1998 40 bed hospital
Stone County Hospital
Wiggins, Mississippi................................. January 1997 50 bed hospital
Trace Regional Hospital and Floy Dyer Nursing Home, 84 bed hospital
Trace, Mississippi................................... August 1996 66 bed nursing home
TEXAS
Denton Community Hospital
Denton, Texas........................................ November 1996 110 bed hospital
Central Texas Hospital
Cameron, Texas....................................... April 1998 44 bed hospital
CALIFORNIA
San Clemente Hospital and Medical Center
San Clemente, California............................. June 1998 81 bed hospital
</TABLE>
Chatuge Regional Hospital and Nursing Home is located approximately 100
miles north of Atlanta, Georgia and is the only hospital in the community. The
closest competing hospital is located approximately 20 miles away. The hospital
is a sole community provider as designated under Medicare and has a general
service area population of approximately 15,000 that increases substantially in
the summer months and has been growing at approximately 2.7% per year.
40
<PAGE> 45
Chestatee Regional Hospital is located approximately 45 miles north of
Atlanta, Georgia and is the only hospital in the community. The nearest
competitor is located approximately 20 miles away. The hospital's general
service area population is approximately 31,000 and has been growing at
approximately 4.5% per year.
Mountainside Medical Center and Nursing Home is located approximately 50
miles north of Atlanta, Georgia and is the only hospital in the community. The
hospital's primary competitor is located approximately 20 miles away. The
hospital's general service area population is approximately 25,000 and has been
growing at approximately 3.7% per year. The Company manages this facility for a
non-profit entity affiliated with the Company for a fee equal to its profits and
losses. The Company has agreed to purchase the facility from the non-profit
entity for a nominal purchase price following the satisfaction of the facility's
obligation to provide indigent care under the Hill-Burton funding program. The
Company believes such obligations will be satisfied and the acquisition
completed in 1998.
North Georgia Medical Center and Gilmer Nursing Home is located
approximately 75 miles north of Atlanta, Georgia and is the only hospital in the
community. The hospital's primary competitor is located approximately 30 miles
away. The hospital's general service area population is approximately 27,000 and
has been growing at more than 3.2% per year.
Holly Springs Memorial Hospital is located approximately 30 miles southeast
of Memphis, Tennessee and is the only hospital in the community. The hospital's
primary competitors are located approximately 30 miles away. The hospital's
general service area population is approximately 34,000 and has been growing at
approximately 1.0% per year. The Company leases this hospital for a term ending
in 2018.
Stone County Hospital is located approximately 30 miles north of Gulfport,
Mississippi. It is the only hospital in the community. The hospital's primary
competitors are located approximately 30 miles away. The hospital is a sole
community provider as designated under Medicare and the hospital's general
service area population is approximately 23,000 and has been growing at
approximately 2.8% per year.
Trace Regional Hospital and Floy Dyer Nursing Home is located approximately
35 miles southeast of Tupelo, Mississippi and is the only hospital in the
community. The hospital's primary competitor is located approximately 35 miles
away. The hospital's general service area population is approximately 32,000 and
has been growing at approximately 0.1% per year.
Denton Community Hospital is located approximately 35 miles northwest of
Dallas, Texas and is one of two hospitals in the community. The hospital's
general service area population is approximately 110,000 and has been growing at
approximately 2.4% per year.
Central Texas Hospital is located approximately 70 miles northeast of
Austin, Texas and is the only hospital in the community. The hospital's primary
competitors are a small hospital approximately 12 miles away and one larger
hospital located approximately 35 miles away. The hospital's general service
area population is approximately 24,000 and has been growing at approximately
0.7% per year. The Company leases this facility for an initial term ending in
2001 but with four additional renewal terms of five years each.
San Clemente Hospital and Medical Center is located approximately 65 miles
south of Los Angeles, California and is the only hospital in the community. The
hospital's primary competitors are located 12 to 15 miles away. The hospital's
general service area population is approximately 49,000 and has been growing at
approximately 1.9% per year.
The Company also subleases approximately 8,000 square feet of office space
in Nashville, Tennessee for its corporate headquarters under a three-year
sublease which expires on September 30, 2000 and contains customary terms and
conditions. See "Certain Relationships and Related Transactions."
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<PAGE> 46
Operating Statistics
The following table sets forth certain operating statistics for Southern
Health (as predecessor to the Company) and the Company for each of the periods
presented.
<TABLE>
<CAPTION>
COMPANY (SUCCESSOR)
--------------------------------------------------
PERIOD FROM
SOUTHERN HEALTH (PREDECESSOR) MARCH 11,
-------------------------------------- 1996 (DATE
PERIOD OF INCEPTION) THREE MONTHS ENDED
YEAR ENDED JUNE 30, JULY 1, 1996 TO TO YEAR ENDED MARCH 31,
------------------- AUGUST 15, DECEMBER 31, DECEMBER 31, -------------------
1995 1996 1996 1996 1997 1997 1998
-------- -------- ---------------- ------------- ------------ -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
STATISTICAL DATA:
Hospitals owned or
leased (at end of
period)............ 5 5 5 6 7 7 7
Licensed beds (at end
of period)......... 275 275 275 385 435 435 435
Admissions........... 7,145 7,910 908 3,374 14,326 3,686 3,594
Adjusted
Admissions(1)...... 11,255 13,213 1,671 5,793 23,286 5,763 5,747
Patient Days......... 28,782 34,323 3,668 14,128 59,521 16,200 15,942
Average length of
stay (days)(2)..... 4.0 4.3 4.0 4.2 4.2 4.4 4.4
Net patient revenue
(in thousands)..... $49,782 $64,602 $8,698 $30,532 $128,517 $31,988 $34,267
Gross outpatient
service revenue (in
thousands)......... $22,782 $33,465 $4,670 $17,141 $ 73,053 $17,228 $19,544
</TABLE>
- ---------------
(1) Adjusted admissions are calculated as total admissions for the period
multiplied by the ratio of total patient revenue divided by total inpatient
revenue.
(2) Average length of stay is calculated based on the number of patient days
divided by the number of admissions.
Sources of Revenue
The Company receives payments for patient care from private insurance
carriers, federal Medicare programs for elderly and disabled patients, HMOs,
preferred provider organizations ("PPOs"), state Medicaid programs, the Civilian
Health and Medical Program of the Uniformed Services ("CHAMPUS"), employers and
patients directly.
The following table sets forth the percentage of the patient days of the
hospitals of Southern Health (as predecessor to the Company) and the Company
from various payors for the periods indicated. The data for the periods
presented are not strictly comparable due to the significant effect that
acquisitions have had on the Company. See "Management's Discussion and Analysis
of Results of Operations and Financial Condition."
<TABLE>
<CAPTION>
COMPANY (SUCCESSOR)
-------------------------------------------------
PERIOD FROM
SOUTHERN HEALTH (PREDECESSOR) MARCH 11,
---------------------------------- 1996 (DATE
YEAR ENDED PERIOD OF INCEPTION) THREE MONTHS
JUNE 30, JULY 1, 1996 TO TO YEAR ENDED ENDED MARCH 31,
-------------- AUGUST 15, DECEMBER 31, DECEMBER 31, ----------------
1995 1996 1996 1996 1997 1997 1998
----- ----- ---------------- ------------- ------------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C>
Medicare............. 48.7% 49.8% 48.8% 47.1% 47.2% 49.2% 46.9%
Medicaid............. 14.5 13.7 13.5 10.0 7.9 8.2 7.7
Private and other
sources............ 36.8 36.5 37.7 42.9 44.9 42.6 45.4
----- ----- ----- ----- ----- ----- -----
Total...... 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
===== ===== ===== ===== ===== ===== =====
</TABLE>
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<PAGE> 47
Quality Assurance
The Company's hospitals implement quality assurance procedures to ensure a
consistently high level of care. Each hospital has a medical director who
supervises and is responsible for the quality of medical care provided. In
addition, each hospital has a medical advisory committee comprised of physicians
who review the professional credentials of physicians applying for medical staff
privileges at the hospital. Medical advisory committees also review and monitor
surgical outcomes along with procedures performed and the quality of the
logistical, medical and technological support provided to the physicians. All of
the Company's hospitals are Medicare and Medicaid certified or are accredited by
the Joint Commission on Accreditation of Health Care Organizations.
Regulatory Compliance Program
The Company has established a voluntary corporate compliance program (the
"Compliance Program") which is designed to prevent and detect, within the
Company, criminal conduct and conduct which is inconsistent with the Company's
ethical standards. The Compliance Program focuses on all areas of regulatory
compliance, including physician recruitment, reimbursement and cost reporting
practices, laboratory and home health care operations. The Compliance Program
provides specific standards of conduct relating to such matters as (i) financial
reporting and other business records; (ii) improper payments; (iii) health care
fraud and abuse; (iv) conflicts of interest; (v) political activity; (vi)
antitrust; (vii) insider trading and confidentiality; (viii) health, safety and
environmental requirements; (ix) personnel and work environment; and (x)
government investigations. Members of management oversee the monitoring,
reporting and enforcement procedures of the Compliance Program and report to the
Compliance Committee of the Board of Directors.
The Company has limited participation in certain of the programs which have
historically been the focus of investigation by the Office of the Inspector
General of the HHS. For example, the Company does not own or operate any
teaching hospitals, the Company's hospitals currently have no physician
investors and only three of the Company's hospitals operate home health agencies
(which have been operated by the Company only since March, April and June of
1998). See "Risk Factors -- Health Care Regulation" and "Risk Factors -- Health
Care Industry Investigations."
COMPETITION
The primary bases of competition among hospitals in non-urban markets are
the quality and scope of medical services, strength of referral network,
location, and, to a lesser extent, price. With respect to the delivery of
general acute care services, most of the Company's hospitals face less
competition in their immediate patient service areas than would be expected in
larger communities. While the Company's hospitals are generally the primary
provider of health care services in their respective communities, its hospitals
face competition from larger tertiary care centers and, in some cases, other
non-urban hospitals. Some of the hospitals that compete with the Company are
owned by governmental agencies or not-for-profit entities supported by
endowments and charitable contributions, and can finance capital expenditures on
a tax-exempt basis.
The Company faces competition for acquisitions from for-profit hospital
management companies, as well as not-for-profit entities. Some of the Company's
competitors have greater financial and other resources than the Company.
Increased competition for the acquisition of non-urban acute care hospitals
could have an adverse impact on the Company's ability to acquire such hospitals
on favorable terms. See "Risk Factors -- Competition."
EMPLOYEES AND MEDICAL STAFF
As of April 30, 1998, the Company had 1,210 "full-time equivalent"
employees. Of these employees, 18 are corporate personnel and the remaining
employees, most of whom are nurses and office personnel, are employed at the
Company's ten hospitals. None of the Company's employees is covered by a
collective bargaining agreement. The Company considers relations with its
employees to be good.
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<PAGE> 48
The Company employs physicians who have active practices in the communities
served by the Company's hospitals. As of April 30, 1998, the Company employed 26
practicing physicians. Also, certain of the Company's hospital services,
including emergency room coverage, radiology, pathology and anesthesiology
services, are provided through independent contractor arrangements with
physicians.
GOVERNMENT REIMBURSEMENT
Medicare payments for general hospital inpatient care are based on a
prospective payment system ("PPS"). Under the PPS, a hospital receives a mixed
amount for operating costs based on the established fixed payment amount per
discharge for categories of hospital treatment, commonly known as a diagnostic
related group ("DRG"), for each Medicare inpatient. DRG payments do not consider
a specific hospital's costs, but are adjusted for area wage differentials. The
DRG payments do not include reimbursement for capital costs, which are
reimbursed separately. Psychiatric services, long-term acute care,
rehabilitation, pediatric services and certain designated research hospitals,
and distinct parts of rehabilitation and psychiatric units within hospitals, are
currently exempt from the PPS and are reimbursed on a cost-based system, subject
to specific reimbursement caps (known as TEFRA limits). For the year ended
December 31, 1997, the Company had three units that were reimbursed under this
methodology.
For several years, the percentage increases to the DRG rates have been
lower than the percentage increases in the cost of goods and services purchased
by general hospitals. The index used to adjust the DRG rates is based on the
cost of goods and services purchased by hospitals as well as those purchased by
non-hospitals (the "Market Basket"). The historical Market Basket rates of
increase were 2.0%, 1.5% and 2.0% for federal fiscal years 1995, 1996 and 1997,
respectively. The Market Basket Rate of increase for federal fiscal year 1998
(October 1, 1997 through September 30, 1998) is 0%. The budgeted updates for
federal fiscal years 1999 through 2002 are Market Basket minus 1.9%, 1.8%, 1.1%
and 1.1% respectively. The Company anticipates that future legislation may
decrease the future rate of increase for DRG payments, but is unable to predict
the amount of the final reduction. Medicare reimburses general hospitals'
capital costs separately from DRG payments.
Outpatient services provided at general hospitals typically are reimbursed
by Medicare at the lower of customary charges or approximately 90% of actual
cost, subject to additional limits on the reimbursement of certain outpatient
services. Beginning January 1, 1999, outpatient services of a hospital will be
converted from this cost-based payment system to a prospective payment system.
The Company is unable to predict the effect, if any, that the new payment system
will have on the Company's financial results. After the fee schedule is
established for this new system, the fee schedule is to be updated by the Market
Basket minus 1.0% for each of federal fiscal years 2000 through 2002. Similarly,
therapy services will be converted to a prospective payment system on January 1,
1999 and payments for non-hospital-based therapy services will be subject to
caps in payment.
Skilled nursing facilities have historically been reimbursed by Medicare on
the basis of actual costs, subject to certain limits. The Balanced Budget Act
requires the establishment of a prospective payment system for Medicare skilled
nursing facilities under which facilities will be paid a federal per diem rate
for virtually all covered services. The new payment system will be phased in
over three cost reporting periods, starting with cost reporting periods
beginning on or after July 1, 1998. The law also institutes consolidated billing
for skilled nursing facility services, under which payments for most
non-physician Part B services for beneficiaries no longer eligible for Part A
skilled nursing facility care will be made to the facility, regardless of
whether the item or service was furnished by the facility, by others under
arrangement, or under any other contracting or consulting arrangement.
Consolidated billing is being implemented on a transition basis, effective for
items or services furnished on or after July 1, 1998 or January 1, 1999 at the
election of the provider. The Balanced Budget Act also requires HHS to establish
a PPS for home health services, to be implemented beginning October 1, 1999.
Prior to implementation, the Balanced Budget Act establishes certain interim
payment reforms for cost reporting periods beginning on or after October 1,
1997, including reduced home health limits, reducing per visit costs limits, and
agency-specific per beneficiary annual limits on an agency's costs.
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<PAGE> 49
Currently, physicians are paid by Medicare on a fee for service basis.
However, physicians working in rural health clinics are reimbursed at cost, but
such reimbursement is subject to a cap on payments if the rural health clinic is
not based at a rural hospital with less than 50 beds.
Each state has its own Medicaid program that is funded jointly by the state
and federal government. Federal law governs how each state manages its Medicaid
program, but there is wide latitude for states to customize Medicaid programs to
fit the needs and resources of their citizens. As a result, each states'
Medicaid plan has its own payment formula and recipient eligibility criteria.
Historically, federal law required state Medicaid programs to reimburse
hospitals and nursing facilities for the costs that are incurred by efficiently
and economically operated providers in order to meet quality and safety
standards (the so-called "Boren Amendment"). Effective for Medicaid services
provided on or after October 1, 1997, this payment standard was repealed. As a
result, states now have considerable flexibility in establishing payment rates.
The Medicaid program in California, known as Medi-Cal, reimburses hospital
inpatient cost on one of three methods: (i) cost-based, subject to various
limits known as MIRL/PIRL limits; (ii) negotiated rate per discharge or per diem
for hospitals under contract; or (iii) managed care initiatives, where payment
rates tend to be capitated and networks must be formed. The hospital operated by
the Company in California is cost-based for Medi-Cal. There can be no assurance
that this will remain the case in the future. In addition, California has
created a voluntary health insurance purchasing cooperative that seeks to make
health care coverage more affordable for businesses with five to fifty employees
and, effective January 1, 1995, began changing the payment system for
participants in Medi-Cal in certain counties from fee-for-service arrangements
to managed care plans. While San Clemente Hospital and Medical Center is not
located in a county currently targeted for conversion to managed care, if the
state is able to implement successfully managed care in these counties, this
initiative could be expanded throughout the state.
Most of the nursing home services provided in the Company's nursing homes
in Georgia are paid by Medicaid. Generally, each nursing home receives a
prospective payment based on the prior year's cost at that nursing home facility
increased by the state's market basket update factor for the year but subject to
a cap on payments. Each state has its own payment formula and the Company is
unable to predict what the payment rates will be in future years.
Medicare has special payment provisions for "Sole Community Hospitals" or
SCHs. An SCH is generally the only hospital in at least a 35-mile radius. Stone
County Hospital and Chatuge Regional Hospital currently qualify as SCHs under
Medicare regulations and Holly Springs Memorial Hospital is in the process of
obtaining SCH certification. Special payment provisions related to SCHs include
a higher DRG rate, which is based on a blend of hospital-specific costs and the
national DRG rate; and a 90% payment "floor" for capital costs thereby
guaranteeing the SCH capital reimbursement equal to 90% of capital cost. In
addition, the CHAMPUS program has special payment provisions for hospitals
recognized as SCHs for Medicare purposes.
In recent years, changes in Medicare and Medicaid programs have resulted in
limitations on, and reduced levels of, payment and reimbursement for a
substantial portion of hospital procedures and costs. The federal Balanced
Budget Act of 1997, which establishes a plan to balance the federal budget by
fiscal year 2002, includes significant additional reductions in spending levels
for the Medicare and Medicaid programs.
The Medicare, Medicaid and CHAMPUS programs are subject to statutory and
regulatory changes, administrative rulings, interpretations and determinations,
requirements for utilization review and new governmental funding restrictions,
all of which may materially increase or decrease program payments as well as
affect the cost of providing services and the timing of payment to facilities.
The final determination of amounts earned under the programs often requires many
years, because of audits by the program representatives, providers' rights of
appeal and the application of numerous technical reimbursement provisions.
Management believes that adequate provision has been made for such adjustments.
Until final adjustment, however, significant issues remain unresolved and
previously determined allowances could become either inadequate or more than
ultimately required.
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<PAGE> 50
HEALTH CARE REFORM, REGULATION AND LICENSING
Background
Health care, as one of the largest industries in the United States,
continues to attract much legislative interest and public attention. Medicare,
Medicaid, and other public and private hospital cost-containment programs,
proposals and initiatives to limit health care spending, proposals to limit
prices and industry competitive factors are among the many factors which are
highly significant to the health care industry. In addition, the health care
industry is governed by a framework of federal and state laws, rules and
regulations that are extremely complex and for which the industry has the
benefit of only limited regulatory or judicial interpretation. Although the
Company believes it is in compliance in all material respects with such laws,
rules and regulations, if a determination is made that the Company is or was in
violation of such laws, rules or regulations, the Company's business, financial
condition or results of operations could be materially adversely affected.
The Company's facilities also are affected by controls imposed by
government and private payors designed to reduce admissions and lengths of stay.
Such controls, including what is commonly referred to as "utilization review,"
have resulted in fewer of certain treatments and procedures being performed.
Utilization review entails the review of the admission and course of treatment
of a patient by a third party. Utilization review by third-party peer review
organizations ("PROs") is required in connection with the provision of care paid
for by Medicare and Medicaid. Utilization review by third parties is also
required under many managed care arrangements.
Many states have enacted, or are considering enacting, measures that are
designed to reduce their Medicaid expenditures and to make certain changes to
private health care insurance. Various states have applied, or have been granted
federal waivers from current Medicaid regulations to allow them to serve some of
their Medicaid participants through managed care providers. The Balanced Budget
Act allows states to mandate enrollment in managed care systems without seeking
approval from HHS for waivers from certain Medicaid requirements as long as
certain standards are met. Although historically these managed care programs
have exempted institutional care, no assurance can be given that these programs
ultimately will not change the reimbursement system for hospitals, long-term
care facilities and other providers to negotiated or capitated rates. These
programs also may attempt to include coverage for some people who presently are
uninsured, and generally could have the effect of reducing payments to
hospitals, physicians and other providers for the same level of service provided
under Medicaid.
Certificate of Need Requirements
Some states require approval for construction and expansion of health care
facilities, including findings of need for additional or expanded health care
facilities or services. Certificates of Need ("CONs"), which are issued by
governmental agencies with jurisdiction over health care facilities, are at
times required for capital expenditures exceeding a prescribed amount, changes
in bed capacity or services and certain other matters. Georgia and Mississippi,
states in which the Company operates seven of its hospitals, require CONs.
However, the states of Texas and California, in which the Company operates three
of its ten hospitals, do not currently require CONs for hospital construction or
changes in the mix of services. The Company is unable to predict whether it will
be able to obtain any CON that may be necessary to accomplish its business
objectives in any jurisdiction where such CONs are required.
Anti-kickback, Self-Referral and Other Regulations
Sections of the Anti-Fraud and Abuse Amendments to the Social Security Act,
commonly known as the "anti-kickback" statute (the "Anti-kickback Amendments"),
prohibit certain business practices and relationships that might affect the
provision and cost of health care services reimbursable under Medicare and
Medicaid, including the payment or receipt of remuneration for the referral, or
arranging for the referral, of patients whose care will be paid for by Medicare
or other government programs. Sanctions for violating the Anti-kickback
Amendments include criminal penalties and civil sanctions, including civil money
penalties and
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<PAGE> 51
possible exclusion from government programs such as Medicare and Medicaid.
Pursuant to the Medicare and Medicaid Patient and Program Protection Act of
1987, the HHS has issued regulations that create Safe Harbors under the
Anti-kickback Amendments. A given business arrangement which does not fall
within a Safe Harbor is not per se illegal; however, business arrangements of
health care service providers that fail to satisfy the applicable Safe Harbor
criteria risk increased scrutiny by enforcement authorities. The Health
Insurance Portability and Accountability Act of 1996, which became effective
January 1, 1997, broadened the scope of certain fraud and abuse laws to include
all health care services, whether or not they are reimbursed under a federal
program and creates new enforcement mechanisms to combat fraud and abuse,
including an incentive program, under which individuals can receive up to $1,000
for providing information on Medicare fraud and abuse that leads to the recovery
of at least $100 of Medicare funds. The Balanced Budget Act of 1997 also expands
numerous health care fraud provisions.
The Company provides financial incentives to recruit physicians into the
communities served by its hospitals, including loans and minimum revenue
guarantees. Although HHS has proposed a Safe Harbor for certain physician
recruitment, no Safe Harbor for physician recruitment is currently in force. The
Company believes that its recruitment policies are being conducted in accordance
with industry practice. The Company also enters into certain employment
agreements, leases and other agreements with physicians. The Company believes
that these arrangements do not violate the Anti-kickback Amendments. There can
be no assurance that regulatory authorities who enforce the Anti-kickback
Amendments will not determine that the Company's physician recruiting
activities, other physician arrangements, or group purchasing activities violate
the Anti-kickback Amendments or other federal laws. Such a determination could
subject the Company to liabilities under the Social Security Act, including
criminal penalties, civil money penalties and/or exclusion of the Company from
participation in Medicare/Medicaid or other federal health care programs, any of
which could have a material adverse effect on the Company's business, financial
condition or results of operations. See "Risk Factors -- Health Care Regulation"
and "Business -- Health Care Reform, Regulation and Licensing."
The Company's operations necessarily involve financial relationships with
physicians on the medical staff. Such arrangements include professional services
agreements for services at its hospitals and physician recruitment incentives to
encourage physicians to establish private practices in markets served by the
Company's owned or leased hospitals. Although the Company believes that these
arrangements are lawful, no safe harbor provisions currently apply to physician
recruitment arrangements not involving physician employment. Evolving
interpretations of current, or the adoption of new, federal or state laws or
regulations could affect these arrangements.
There is increasing scrutiny by law enforcement authorities, the HHS, OIG,
the courts, and Congress of arrangements between health care providers and
potential referral sources to ensure that the arrangements are not designed as a
mechanism to exchange remuneration for patient care referrals and opportunities.
Investigators have also demonstrated a willingness to look behind the
formalities of a business transaction to determine the underlying purpose of
payments between health care providers and potential referral sources.
Enforcement actions have increased, as evidenced by recent highly publicized
enforcement investigations of certain hospital activities. Although, to its
knowledge, except as described below, the Company is not currently the subject
of any investigation or inquiry there can be no assurance that the Company and
its providers will not be the subject of investigations or inquiries in the
future. See "Risk Factors -- Health Care Industry Investigations."
The OIG and the Department of Justice have from time to time established
enforcement initiatives that focus on specific billing practices or other
suspected areas of abuse. Current initiatives include a nationwide
Medicare/Medicaid audit project regarding hospital laboratory billing practices,
referred to as the "laboratory unbundling" project. Three of the Company's
hospitals have been audited by the federal government. The Department of Justice
has issued a notice of payment due for two of these facilities and has required
a self-audit for the third facility. The Company estimates the aggregate
potential liability for all facilities to be less than $500,000. See Note 6 to
the Consolidated Financial Statements of the Company.
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<PAGE> 52
Certain provisions of the Social Security Act restrict referrals by
physicians of Medicare and Medicaid patients for a broad range of designated
health services to providers with which they have ownership or certain other
financial arrangements (the "Stark Law"). A person making a referral, or seeking
payment for services referred, in violation of the Stark Law would be subject to
the following sanctions: (i) civil money penalties of up to $15,000 for each
service; (ii) assessments equal to twice the dollar value for each service;
and/or (iii) exclusion from participation in the Medicare program (which can
subject the person to exclusion from participation in state health care
programs). Further, if any physician or entity enters into an arrangement or
scheme that the physician or entity knows or should know has the principal
purpose of assuring referrals by the physician to a particular entity, and the
physician directly made referrals to such entity, then such physician or entity
could be subject to a civil money penalty of up to $100,000. Certain exceptions
are available for employment agreements, leases, physician recruitment, and
certain other physician arrangements. Final implementing regulations have not
yet been issued, and there can be no assurance that the Company's physician
arrangements will be found to be in compliance with the Stark Law, as such law
ultimately may be interpreted. Many states have adopted or are considering
similar fraud and abuse and physician self-referral legislation, some of which
extends beyond the Medicare and Medicaid program to prohibit the payment or
receipt of remuneration for the referral of patients and physician
self-referrals regardless of the source of the payment for the care, and some of
which is more stringent than federal law. The Company's contracts with
physicians on the medical staff of its hospitals and its participation in
certain other financial relationships with physicians could be adversely
affected by these federal and similar state enactments.
The Company is unable to predict the future course of federal, state and
local regulation or legislation, including Medicare and Medicaid statutes and
regulations. Further changes in the regulatory framework or in the
interpretation of these laws, rules and regulations could have a material
adverse effect on the Company's business, financial condition or results of
operations.
Environmental Regulations
The Company's health care operations generate medical waste that must be
disposed of in compliance with federal, state and local environmental laws,
rules and regulations. The Company's operations, as well as the Company's
purchases and sales of facilities, are also subject to various other
environmental laws, rules and regulations. The costs of compliance do not
currently materially affect the Company's capital expenditures, earnings or
competitive position.
Health Care Facility Licensing Requirements
The Company's health care facilities are subject to extensive federal,
state and local legislation and regulation. In order to maintain their operating
licenses, health care facilities must comply with strict standards concerning
medical care, equipment and hygiene. Various licenses and permits also are
required in order to dispense narcotics, operate pharmacies, handle radioactive
materials and operate certain equipment. The Company's health care facilities
hold all required governmental approvals, licenses and permits. All licenses,
provider numbers and other permits or approvals required to perform the
Company's business operations are held by subsidiaries of the Company. Each of
the Company's facilities that is eligible for accreditation is fully accredited
by the Joint Commission on Accreditation of Health Care Organizations or
Medicare and Medicaid certified.
Utilization Review Compliance and Hospital Governance
The Company's health care facilities are subject to and comply with various
forms of utilization review. In addition, under the Medicare prospective payment
system, each state must have a PRO to carry out a federally mandated system of
review of Medicare patient admissions, treatments and discharges in a general
hospital. Medical and surgical services and practices are extensively supervised
by committees of staff doctors at each health care facility, are overseen by
each health care facility's local governing board, the primary voting members of
which are physicians and community members, and are reviewed by the Company's
quality assurance personnel. The local governing boards also help maintain
standards for quality care, develop long-
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<PAGE> 53
range plans, establish, review and enforce practices and procedures and approve
the credentials and disciplining of medical staff members.
Governmental Developments Regarding Sales of Not-for-Profit Hospitals;
Hill-Burton Obligations
In recent years, the legislatures and attorneys general of several states
have shown a heightened level of interest in transactions involving the sale of
not-for-profit hospitals. Although the level of interest varies from state to
state, the trend is to provide for increased governmental review, and in some
cases approval, of transactions in which not-for-profit corporations sell a
health care facility. Although the Company has not yet been adversely affected
as a result of these trends, such increased scrutiny may increase the difficulty
or prevent the completion of transactions with not-for-profit organizations in
certain states in the future. In addition, to the extent the Company acquires a
not-for-profit hospital which has received funds under the federal Hill-Burton
program, the Company may be required to satisfy outstanding uncompensated care
requirements and community service obligations.
California Seismic Standards
California recently adopted a law requiring standards and regulations to be
developed to ensure hospitals meet seismic performance standards. Within three
years after adoption of the standards by the California Building Standards
Commission, owners of subject properties are to evaluate their facilities and
develop a plan and schedule for complying with the standards. To date, the
Commission has adopted evaluation criteria but has not yet adopted the retrofit
standards. Therefore, the Company is unable, at this time, to evaluate its
California facility to determine whether the requirements or the cost of
complying with these requirements will have a material adverse effect on the
Company's operations.
PROFESSIONAL LIABILITY
As part of its business, the Company is subject to claims of liability for
events occurring as part of the ordinary course of hospital operations. To cover
these claims, the Company maintains professional malpractice liability insurance
and general liability insurance in amounts which management believes to be
sufficient for its operations, although some claims may exceed the scope of the
coverage in effect. The Company also maintains umbrella coverage. At various
times in the past, the cost of malpractice and other liability insurance has
risen significantly. Therefore, there can be no assurance that such insurance
will continue to be available at a reasonable price for the Company to maintain
adequate levels of insurance.
LEGAL PROCEEDINGS
The Company is, from time to time, subject to claims and suits arising in
the ordinary course of business, including claims for damages for personal
injuries, breach of management contracts or for wrongful restriction of or
interference with physician's staff privileges. In certain of these actions,
plaintiffs request punitive or other damages that may not be covered by
insurance. The Company is currently not a party to any proceeding which, in
management's opinion, would have a material adverse effect on the Company's
business, financial condition or results of operations.
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MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The following table sets forth certain information concerning the Company's
directors and executive officers as of May 31, 1998.
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Michael A. Koban, Jr.............. 47 President, Chief Executive Officer and Director
Philip D. Wheeler................. 42 Executive Vice President, Chief Administrative Officer and
Director
Steven L. Blaine.................. 50 Executive Vice President, Chief Operating Officer and
Director
Thomas M. Moore................... 52 Vice President and Chief Development Officer
Glenn D. Davis.................... 39 Vice President, Treasurer and Chief Financial Officer
Lee R. Livin...................... 35 Vice President -- Financial Operations
Merril M. Halpern................. 64 Chairman of the Board of Directors
A. Lawrence Fagan................. 68 Director
Morton A. Pierce.................. 49 Director
</TABLE>
Mr. Koban has served as a Director of NetCare since November 1995 and as
President and Chief Executive Officer of NetCare since January 1996. From 1987
to 1995, he was employed at Healthtrust, Inc. -- The Hospital Company, first as
Vice President, Finance, and then, from 1993 to 1995, as Senior Vice
President -- Finance and Director. From 1976 to 1987, Mr. Koban worked in
various capacities for Hospital Corporation of America.
Mr. Wheeler has served as a Director of NetCare since November 1995 and as
Executive Vice President and Chief Administrative Officer of NetCare since
January 1996. From 1988 to 1995, Mr. Wheeler was Senior Vice President & General
Counsel for Healthtrust, Inc. -- The Hospital Company. From 1984-1988, he was
employed at Hospital Corporation of America.
Mr. Blaine has served as Executive Vice President, Chief Operating Officer
and as a Director of NetCare since January 1996. Prior to joining NetCare, he
was a Division President for Columbia/HCA Healthcare Corporation in 1995 and a
Regional Vice President for Healthtrust, Inc. -- The Hospital Company in 1994.
From 1981 to 1994, he was CEO of the 150-bed Davis Community Hospital in
Statesville, North Carolina.
Mr. Moore has served as Vice President and Chief Development Officer of
NetCare since January 1996. From 1990 to 1995, Mr. Moore was Director, Insurance
and Risk Management for Healthtrust, Inc. -- The Hospital Company. From 1984 to
1990, he was in private legal practice. Prior thereto he was a Development
Director for CIGNA Health Plans.
Mr. Davis has served as Vice President, Treasurer and Chief Financial
Officer of NetCare since January 1996. From 1987 to 1995, he was employed at
Healthtrust, Inc. -- The Hospital Company where, in November 1992, he was
appointed Treasurer. From 1981 to 1987, Mr. Davis held various financial
positions with Hospital Corporation of America.
Mr. Livin has served as Vice President -- Financial Operations of NetCare
since January 1, 1997. From 1996 to 1997 he was Chief Financial Officer of
Longview Regional Medical Center in Longview, Texas for Columbia/HCA Healthcare
Corporation and from 1993 to 1995 he was Chief Financial Officer of Medical
Center of Pampa in Pampa, Texas for Healthtrust, Inc. -- The Hospital Company.
Mr. Halpern has served as a Director of NetCare since March 1996. Since
1984, Mr. Halpern has been the Chairman and Chief Executive Officer of
Charterhouse Group International, Inc. ("CGI"), a firm specializing in private
equity investments. From 1973 to 1984 Mr. Halpern served as President and Chief
Executive Officer of CGI. Charterhouse Equity Partners is an affiliate of CGI.
Mr. Halpern is also a director of Insignia Financial Group, Inc., a real estate
management firm, and Microwave Power Devices, Inc., a manufacturer of power
amplifiers, primarily in the wireless telecommunications market.
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Mr. Fagan has served as a Director of NetCare since March 1996. Mr. Fagan
has been the President and Chief Operating Officer of CGI since January 1997 and
formerly served as Executive Vice President of CGI since 1984. Mr. Fagan is also
a director of Microwave Power Devices, Inc.
Mr. Pierce has served as a Director of NetCare since November 1995. Mr.
Pierce has been a member of the law firm of Dewey Ballantine LLP since 1986.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Compensation Committee is currently comprised of Messrs. Pierce,
Halpern and Fagan. Messrs. Halpern and Fagan are officers of CGI. Charterhouse
Equity Partners is an affiliate of CGI. CGI is party to a fee arrangement with
the Company which will terminate upon consummation of the Offerings. Mr. Pierce
is a member of the law firm of Dewey Ballantine LLP. Dewey Ballantine LLP has
provided legal services to the Company in the past on customary terms and is
acting as counsel to the Company in connection with the Offerings. See "Certain
Relationships and Related Transactions."
No executive officer of the Company served as a member of the Compensation
Committee or as a director of any other entity whose executive officer serves as
a director of the Company.
EXECUTIVE COMPENSATION
The following table summarizes the compensation paid by NetCare in 1997 to
(i) the Company's chief executive officer; and (ii) the Company's four other
most highly compensated executive officers at December 31, 1997 (collectively,
the "Named Executive Officers").
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL COMPENSATION
-------------------- ALL OTHER
NAME AND PRINCIPAL POSITION SALARY($) BONUS($) COMPENSATION($)(1)
- --------------------------- --------- -------- ------------------
<S> <C> <C> <C>
Michael A. Koban, Jr.............................. 182,500 74,000 4,314
President and Chief
Executive Officer
Philip D. Wheeler................................. 182,500 74,000 3,756
Executive Vice President
and Chief Administrative Officer
Steven L. Blaine.................................. 182,500 74,000 4,525
Executive Vice President
and Chief Operating Officer
Thomas M. Moore................................... 112,500 48,000 3,690
Vice President and Chief
Development Officer
Glenn D. Davis.................................... 112,500 48,000 2,700
Vice President and Chief
Financial Officer
</TABLE>
- ---------------
(1) Represents Company 401(k) retirement contributions and life insurance
premium payments, as follows:
<TABLE>
<CAPTION>
401(K) INSURANCE
OFFICER CONTRIBUTIONS PREMIUM
------- ------------- ---------
<S> <C> <C>
Michael A. Koban, Jr........................................ $4,163 $151
Philip D. Wheeler........................................... 3,468 288
Steven L. Blaine............................................ 4,163 362
Thomas M. Moore............................................. 2,700 990
Glenn D. Davis.............................................. 2,700 --
</TABLE>
LONG-TERM EQUITY INCENTIVE PLAN
Prior to consummation of the Offerings, the Board of Directors adopted and
the stockholders of the Company approved the NetCare Health Systems, Inc. 1998
Long-Term Equity Incentive Plan (the "Plan").
Reservation of Shares. The Company will reserve for issuance under the
Plan a number of shares of the Company's Common Stock equal to 10% of the total
number of shares of Common Stock to be outstanding
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<PAGE> 56
immediately following consummation of the Offerings. The shares of Common Stock
to be issued under the Plan will be made available from authorized but unissued
shares of Common Stock, or from treasury stock. If any shares of Common Stock
that are the subject of an award are not issued and cease to be issuable for any
reason, such shares will no longer be charged against such maximum share
limitation and may again be made subject to awards under the Plan. In the event
of certain corporate reorganizations, recapitalizations, or other specified
corporate transactions affecting the Company or the Common Stock, proportionate
adjustments may be made to the number of shares available for grant under the
Plan, the applicable maximum share limitations under the Plan, and number of
shares and prices under outstanding awards at the time of the event.
Duration. The Plan has a term of ten years, subject to earlier termination
or amendment by the Board of Directors.
Administration. The Plan will be administered by the Compensation
Committee, or such other committee or subcommittee of the Board of Directors
designated for such purpose (the "Committee"). Subject to the limitations set
forth in the Plan, the Committee has the authority to determine the persons to
whom awards are granted, the types of awards to be granted, the time at which
awards will be granted, the number of shares, units or other rights subject to
each award, the exercise, base or purchase price of an award (if any), the time
or times at which the award will become vested, exercisable or payable, and the
duration of the award.
Eligibility. All employees of the Company and its subsidiaries are
eligible to be granted awards under the Plan, as selected from time to time by
the Committee in its sole discretion.
Stock Options. The Plan authorizes the grant of nonqualified stock options
and options that qualify as incentive stock options under the Internal Revenue
Code. The exercise price of an option may be determined by the Committee and may
be less than the fair market value of a share of Common Stock on the date of
grant. The value of Common Stock (determined at the time of grant) that may be
subject to incentive stock options that become exercisable by any one employee
in any one year is limited to $100,000. The maximum term of stock options
granted under the Plan is ten years from the date of grant. The Committee will
determine the extent to which an option will become and/or remain exercisable in
the event of termination of employment or service of a participant under certain
circumstances, including retirement, death or disability, subject to certain
limitations for incentive stock options. An option may be exercised in whole or
in part at any time during the term thereof by written notice to the Company
together with payment of the aggregate exercise price of the option. In addition
to the exercise price, the participant shall pay the Company in cash the full
amount of all applicable income tax and employment tax amounts required to be
withheld in connection with the exercise of the option.
Stock Appreciation Rights. The Plan authorizes the Committee to grant
awards of stock appreciation rights. A stock appreciation right may be granted
either in tandem with an option or without relationship to an option. A stock
appreciation right entitles the holder, upon exercise, to receive a payment
based on the difference between the base price of the stock appreciation right
and the fair market value of a share of Common Stock on the date of exercise,
multiplied by the number of shares as to which such stock appreciation right
will have been exercised. A stock appreciation right will be exercisable as
determined by the Committee, but in no event after ten years from the date of
grant. The maximum number of shares of Common Stock that may be subject to stock
appreciation rights granted to any one participant during any calendar year is
limited to shares. Stock appreciation rights are payable in cash, in
shares of Common Stock, or in a combination of cash and shares of Common Stock,
in the discretion of the Committee.
Performance Awards. The Plan authorizes the Committee to grant performance
awards, which are units denominated on the date of grant either in shares of
Common Stock ("performance shares") or in specified dollar amounts ("performance
units"). Performance awards are payable upon the achievement of performance
criteria established by the Committee at the beginning of the applicable
performance period. At the time of grant, the Committee establishes the number
of units, the duration of the performance period or periods, the applicable
performance criteria, and, in the case of performance units, the target unit
value or range of unit values for the performance awards. At the end of the
performance period, the Committee determines the
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<PAGE> 57
payment to be made based on the extent to which the performance goals have been
achieved. Performance awards are payable in cash, in shares of Common Stock, or
in a combination of cash and shares of Common Stock, in the discretion of the
Committee.
Phantom Stock. The Plan authorizes the Committee to grant awards of
phantom stock. An award of phantom stock gives the participant the right to
receive payment at the end of a fixed vesting period based on the value of a
share of Common Stock at the time of vesting. Phantom stock units are subject to
such restrictions and conditions to payment as the Committee determines are
appropriate. An award of phantom stock may be granted, at the discretion of the
Committee, together with an award of dividend equivalent rights for the same
number of shares covered thereby. Phantom stock awards are payable in cash or in
shares of Common Stock having an equivalent fair market value on the applicable
vesting dates, or in a combination thereof, in the discretion of the Committee.
Restricted Stock Awards. The Plan authorizes the Committee to make awards
of restricted stock. An award of restricted stock represents shares of Common
Stock that are issued subject to such restrictions on transfer and on incidents
of ownership and such forfeiture conditions as the Committee deems appropriate.
The restrictions imposed upon an award of restricted stock will lapse in
accordance with the vesting requirements specified by the Committee in the award
agreement. Such vesting requirements may be based on the continued employment of
the participant for a specified time period or on the attainment of specified
business goals or performance criteria established by the Committee. The
Committee may, in connection with an award of restricted stock, require the
payment of a specified purchase price. Subject to the transfer restrictions and
forfeiture restrictions relating to the restricted stock award, the participant
will otherwise have the rights of a stockholder of the Company, including all
voting and dividend rights, during the period of restriction unless the
Committee determines otherwise at the time of the grant.
DIRECTOR COMPENSATION
Annual Retainer and Meeting Fees. Members of the Board of Directors who
are employees of the Company, or any of its subsidiaries, are not compensated
for service on the Board of Directors or on any committees of the Board of
Directors. Members of the Board of Directors who are not employees of the
Company or any of its subsidiaries ("nonemployee directors") will receive an
annual retainer fee of $ for each year of service on the Board of
Directors. Nonemployee directors will receive an additional annual retainer fee
of $ for service as a member of a committee of the Board of Directors and
$ for service as a chairman of a committee of the Board of Directors.
Nonemployee directors will also receive a fee of $ per meeting for attending
meetings of the Board of Directors and committees of the Board of Directors. In
addition, nonemployee directors are reimbursed for their reasonable expenses in
attending meetings of the Board of Directors and committees of the Board of
Directors, including travel expenses to and from such meetings.
Directors' Stock Option Plan. The Company has adopted a stock option plan
for nonemployee directors (the "Directors' Stock Option Plan"). Under the
Directors' Stock Option Plan, each nonemployee director will be granted an
option to purchase shares of the Common Stock upon the later of (i) the
consummation of the Offerings or (ii) their commencement of service on the Board
of Directors. Each nonemployee director will thereafter be granted an option to
purchase shares of the Common Stock at each annual meeting of the Company.
In addition, the Board of Directors will have the discretion to make additional
option grants from time to time. Options granted under the Directors' Stock
Option Plan will (i) vest and be exercisable after the first anniversary of
their date of grant, (ii) have exercise prices equal to the fair market value of
a share of the Common Stock on the dates of the option grants and (iii) have ten
year terms of exercise. The Board of Directors has granted Mr. Pierce
options under the Directors' Stock Option Plan.
Directors' Stock Unit Plan. The Company has adopted a stock unit plan for
nonemployee directors (the "Directors' Stock Unit Plan"). Under the Directors'
Stock Unit Plan, nonemployee directors will have 50% of their annual retainer
fee converted to restricted stock units and credited to a stock unit account.
The number of stock units credited to a stock unit account in each year will
equal the dollar value of the annual retainer fee
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<PAGE> 58
being converted, increased by 15% to reflect vesting restrictions, divided by
the fair market value of a share of the Common Stock on the date of conversion.
A nonemployee director's interest in stock units credited to his stock unit
account will vest 50% on the first and second anniversaries of the date of
conversion of such stock units. A nonemployee director will be entitled to
receive a distribution from his stock unit account at a date elected by the
director at the time of conversion (with such date being between two full
calendar years from the conversion date and the termination of their service on
the Board of Directors, as elected by the director) or upon his termination of
service from the Board of Directors, if earlier. Distributions received from a
stock unit account shall be in cash, shares of Common Stock, or some combination
thereof, as elected by the nonemployee director.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
REGISTRATION RIGHTS AGREEMENT
In connection with the Recapitalization and the Offerings, the Company will
enter into a Registration Rights Agreement with its current stockholders. Under
the terms of the Registration Rights Agreement, such stockholders are entitled
to certain "piggy-back" and demand registration rights pursuant to which such
stockholders may have the shares of Common Stock owned by them
registered under the Securities Act for sale to the public. The piggy-back
registration rights require the Company to provide notice to such stockholders
prior to the Company's registration of any securities under the Securities Act
which permits a secondary offering by a selling stockholder. Such stockholders
may then request, subject to limitations imposed by the underwriters of such
offering, inclusion of shares of Common Stock in such registration statement.
The demand rights provide that, on two occasions following the date of this
Prospectus, such stockholders may require the Company to file a Registration
Statement under the Securities Act covering the number of shares of Common Stock
requested by such stockholders to be registered.
AGREEMENT RELATING TO BOARD COMPOSITION
The Company will enter into an agreement with CEP II effective upon
consummation of the Offerings. The agreement will provide that, for as long as
CEP II beneficially owns 30% or more of the outstanding voting stock of the
Company, CEP II may, upon written notice to the Company, require the Company to
expand the number of directors and to appoint designees of CEP II as directors
such that designees of CEP II shall constitute a majority of the members of the
Board of Directors of the Company.
CERTAIN TRANSACTIONS
Messrs. Halpern and Fagan are officers of CGI. Charterhouse Equity Partners
is an affiliate of CGI. CGI is party to a fee arrangement with the Company.
Under the terms of the fee arrangement, upon the consummation of each
acquisition or other investment by the Company or its affiliates of $1 million
or more, and in which CGI or any affiliate thereof shall provide, directly or
indirectly, all or a portion of the equity financing therefor, the Company shall
pay to CGI a transaction fee equal to two percent of the total transaction cost
(the "Fee"). However, with respect to any acquisition or other investment in
which CGI or any affiliate thereof shall provide less than a majority of the
equity financing, the Fee shall be reduced to any amount equal to the product of
(i) the Fee and (ii) a fraction, the numerator of which is the amount of equity
provided by CGI or any affiliate thereof and the denominator of which is the
total equity provided by all parties to the transaction. The fee arrangement
shall terminate upon the consummation of the Offerings.
The Company subleases approximately 8,000 square feet of office space in
Nashville, Tennessee from Michael A. Koban, Jr., the President and Chief
Executive Officer of the Company, for its corporate headquarters under a
three-year sublease which expires on September 30, 2000. The terms of such
sublease are identical to the terms of the lease held by Mr. Koban.
Mr. Pierce, a director of the Company, is a member of the law firm of Dewey
Ballantine LLP. Dewey Ballantine LLP has provided legal services to the Company
in the past on customary terms and is acting as counsel to the Company in
connection with the Offerings.
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<PAGE> 59
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information regarding the beneficial
ownership of the Common Stock as of , 1998 and immediately following the
Offerings by (i) each person who is known by the Company to own beneficially
more than five percent of the Common Stock; (ii) each director and executive
officer of the Company; and (iii) all directors and executive officers of the
Company as a group. To the knowledge of the Company, each of the persons named
in the table has sole voting and investment power as to the shares shown unless
otherwise noted. Unless otherwise noted, the address of each holder of the
Common Stock listed below is the Company's corporate address.
<TABLE>
<CAPTION>
PERCENTAGE OWNED(2)
-----------------------
NUMBER OF SHARES BEFORE THE AFTER THE
NAME BENEFICIALLY OWNED(1) OFFERING OFFERING
- ---- --------------------- ---------- ----------
<S> <C> <C> <C>
Charterhouse Equity Partners II, L.P.(3)..............
Merril M. Halpern(4)..................................
A. Lawrence Fagan(4)..................................
Michael A. Koban, Jr. ................................
Philip D. Wheeler.....................................
Steven L. Blaine......................................
Thomas M. Moore.......................................
Glenn D. Davis........................................
Lee R. Livin..........................................
Morton A. Pierce......................................
All executive officers and directors as a group (8
persons)............................................
</TABLE>
- ---------------
* Less than 1%
(1) Includes shares of Common Stock subject to options which are exercisable
within 60 days.
(2) Shares of Common Stock subject to options which are exercisable within 60
days are considered to be outstanding for the purpose of determining the
percent of the shares held by a holder, but not for the purpose of computing
the percentage held by others.
(3) The address of Charterhouse Equity Partners is c/o Charterhouse Group
International, Inc., 535 Madison Avenue, New York, New York 10022. The
general partner of Charterhouse Equity Partners is CHUSA Equity Investors
II, L.P., whose general partner is Charterhouse Equity II, Inc., a
wholly-owned subsidiary of CGI. As a result of the foregoing, all of the
shares of Common Stock held by Charterhouse Equity Partners would, for
purposes of Section 13(d) of the Securities Exchange Act of 1934, be
considered to be beneficially owned by CGI. The number of shares owned by
Charterhouse Equity Partners excludes the shares held by Chef.
(4) Messrs. Halpern and Fagan are executive officers, directors and stockholders
of CGI. Messrs. Halpern and Fagan disclaim beneficial ownership of the
shares of Common Stock beneficially owned by CGI.
DESCRIPTION OF CAPITAL STOCK
Upon consummation of the Recapitalization and the Offerings, the Company's
authorized capital stock will consist of shares of Common Stock, par value $.01
per share, and shares of Preferred Stock, par value $ per share. Upon
consummation of the Recapitalization and the Offerings, shares of Common
Stock will be issued and outstanding, and no shares of Preferred Stock will be
outstanding. The following summary of certain provisions of the Company's
capital stock describes all material provisions of, but does not purport to be
complete, and is subject to, and qualified in its entirety by, Certificate of
Incorporation and the Bylaws of the Company that are included as exhibits to the
Registration Statement of which this Prospectus forms a part and by the
provisions of applicable law.
COMMON STOCK
The issued and outstanding shares of Common Stock are, and the shares of
Common Stock being offered will be on payment therefor, validly issued, fully
paid and nonassessable. Subject to the prior rights of the holders of any
Preferred Stock, the holders of outstanding shares of Common Stock are entitled
to receive dividends out of assets legally available therefor at such time and
in such amounts as the Board of Directors may from time to time determine. See
"Dividend Policy." The shares of Common Stock are not redeemable or convertible,
and the holders thereof have no preemptive or subscription rights to purchase
any securities of
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<PAGE> 60
the Company. Upon liquidation, dissolution or winding up of the Company, the
holders of Common Stock are entitled to receive pro rata the assets of the
Company which are legally available for distribution, after payment of all debts
and other liabilities and subject to the prior rights of any holders of
Preferred Stock then outstanding. Each outstanding share of Common Stock is
entitled to one vote on all matters submitted to a vote of stockholders. There
are no cumulative voting rights.
The Company has applied to list the Common Stock on the New York Stock
Exchange under the symbol "NHS."
PREFERRED STOCK
The Board may, without any further vote or action by the Company's
stockholders, from time to time, direct the issuance of shares of Preferred
Stock in one or more series with such designations, rights, preferences and
limitations as the Board may determine, including the consideration received
therefor. The Board also has the authority to determine the number of shares
comprising each series, dividend rates, redemption provisions, liquidation
preferences, sinking fund provisions, conversion rights and voting rights
without the approval by the holders of Common Stock. Although it is not possible
to state the effect that any issuance of Preferred Stock might have on the
rights of holders of Common Stock, the issuance of Preferred Stock may have one
or more of the following effects: (i) to restrict Common Stock dividends if
Preferred Stock dividends have not been paid; (ii) to dilute the voting power
and equity interest of holders of Common Stock to the extent that any series of
Preferred Stock has voting rights or is convertible into Common Stock; or (iii)
to prevent current holders of Common Stock from participating in the
distribution of the Company's assets upon liquidation until any preferences
granted to holders of Preferred Stock are satisfied. In addition, the issuance
of Preferred Stock may, under certain circumstances, have the effect of
discouraging a change in control of the Company by, for example, granting voting
rights to holders of Preferred Stock that require approval by the separate vote
of the holders of Preferred Stock for any amendment to the Company's Certificate
of Incorporation or any reorganization, consolidation, merger or other similar
transaction involving the Company. As a result, the issuance of the Preferred
Stock may discourage bids for the Common stock at a premium over the market
price therefor, and could have a materially adverse effect on the market value
of the Common Stock. Upon consummation of the Offerings, there will be no shares
of Preferred Stock outstanding. The Board of Directors does not presently intend
to issue any shares of Preferred Stock.
CERTAIN PROVISIONS OF DELAWARE LAW
Following the Recapitalization, the Company will be governed by the
provisions of Section 203 of the Delaware General Corporation Law. In general,
the law prohibits a public Delaware corporation from engaging in a "business
combination" with an "interested stockholder" for a period of three years after
the date of the transaction in which the person became an interested
stockholder, unless the business combination is approved in a prescribed manner.
"Business combination" includes mergers, asset sales and other transactions
resulting in a financial benefit to the stockholder. An "interested stockholder"
is a person who, together with affiliates and associates, owns (or within three
years, did own) 15% or more of the corporation's voting stock. The statute could
prohibit or delay mergers or other takeover or change in control attempts with
respect to the Company and, accordingly, may discourage attempts to acquire the
Company.
LIMITATIONS ON LIABILITY AND INDEMNIFICATION OF OFFICERS AND DIRECTORS
Following consummation of the Recapitalization and the Offerings, the
Company's Certificate of Incorporation will limit the liability of directors to
the fullest extent permitted by the Delaware law. Delaware law provides that
directors of a corporation will not be personally liable for monetary damages
for breach of their fiduciary duties as directors, including gross negligence,
except liability for (i) breach of the director's duty of loyalty; (ii) acts or
omissions not in good faith or which involve intentional misconduct or a knowing
violation of law; (iii) the unlawful payment of a dividend or unlawful stock
purchase or redemption; and (iv) any transaction from which the director derives
an improper personal benefit. This provision of the Company's Certificate of
Incorporation has no effect on the availability of equitable remedies such as
injunction or rescission. Additionally, this provision will not limit liability
under state or federal securities laws.
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<PAGE> 61
The Certificate of Incorporation also provides that the Company shall indemnify
directors and officers of the Company to the fullest extent permitted by such
law. The Company believes that these provisions will assist the Company in
attracting and retaining qualified individuals to serve as directors.
CERTIFICATE OF INCORPORATION AND BYLAW PROVISIONS AFFECTING CHANGE OF CONTROL
The Company's Certificate of Incorporation and Bylaws provide that the
Board of Directors will be divided into three classes of directors, each class
to be as nearly equal in number as possible. The term of office of one class of
directors expires each year in rotation so that one class is elected at each
annual meeting of stockholders for a full three-year term. The Certificate of
Incorporation provides that the Board of Directors shall consist of not less
than six nor more than 15 members. The number of directors will be fixed from
time to time by resolution of the Board of Directors. The affirmative vote of
the holders of at least 80% of the Company's outstanding voting stock is
required to amend, repeal or adopt any provision inconsistent with the
provisions relating to the staggered Board of Directors. Under the classified
Board of Directors provisions described above, it would take at least two
elections of directors for any individual or group to change a majority of the
members of the Board of Directors. Accordingly, these provisions would tend to
discourage unfriendly takeovers.
Under the Company's Certificate of Incorporation and Bylaws, directors may
be removed only for cause and only by the affirmative vote of the holders of at
least 80% of the Company's outstanding voting stock. Special meetings of
stockholders may be called only by the Board of Directors, and stockholder
action by written consent is prohibited. The effect of these provisions may be
the delaying, deterring or preventing of a future takeover or change in control
of the Company unless such takeover or change in control is approved by the
Board.
The Company will enter into an agreement with CEP II to become effective
upon consummation of the Offerings. The agreement will provide that, for as long
as CEP II beneficially owns 30% or more of the outstanding voting stock of the
Company, CEP II may, upon written notice to the Company, require the Company to
expand the number of directors and to appoint designees of CEP II as directors
such that designees of CEP II shall constitute a majority of the members of the
Board of Directors of the Company.
STOCKHOLDER RIGHTS PLAN
Pursuant to the Rights Agreement, dated as of , 1998 (the
"Rights Agreement"), between the Company and , as Rights Agent
(the "Rights Agent"), each outstanding share of Common Stock (unless and until
the Rights expire or are redeemed or a Distribution Date (as described below)
occurs) is accompanied by one preferred stock purchase right (each, a "Right")
entitling the registered holder to purchase from the Company one two-hundredth
( 1/200) of a share of preferred stock of the Company, designated as Series A
Junior Preferred Stock (the "Preferred Stock") at a price of $ per one two-
hundredth ( 1/200) of a share ("Exercise Price"), subject to adjustment. The
description and terms of the Rights are set forth in the Rights Agreement and
the Rights are not exercisable until the Distribution Date (as defined below)
and will expire at the close of business on , 1998, unless earlier
redeemed or exchanged by the Company, in each case as described below.
The Rights are and will be evidenced by the Common Stock certificates
representing the shares which they accompany, and no separate Right certificates
will be distributed, until the occurrence of a Distribution Date. The Rights
become exercisable upon the close of business on the day (the "Distribution
Date") which is the earlier of (i) the tenth day following a public announcement
that a person or group of affiliated or associated persons (other than by the
Company or certain affiliates) has acquired beneficial ownership of 15% or more
of the shares of any class of the outstanding voting stock of the Company (an
"Acquiring Person") and (ii) the tenth business day after the date of the
commencement or announcement of a person's or group's intention to commence a
tender or exchange offer the consummation of which would result in the ownership
of 15% or more of any class of the Company's outstanding voting stock (even if
no shares are actually
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<PAGE> 62
purchased pursuant to such offer), or such later date as may be determined by a
majority of the Board of Directors and the Continuing Directors (as defined in
the Rights Agreement).
The Preferred Stock is nonredeemable and, unless otherwise provided in
connection with the creation of a subsequent series of preferred stock,
subordinate to any other series of the Company's preferred stock. Each share of
Preferred Stock will be entitled to a minimum quarterly dividend payment of
$1.00 per share but will be entitled to an aggregate dividend of 200 times the
dividend declared on the Company's Common Stock. In the event of the liquidation
of the Company, the holders of Preferred Stock will be entitled to receive a
payment of the greater of (i) $200 per share or (ii) 200 times the payment made
per share of Common Stock. Each share of Preferred Stock will have 200 votes,
voting together with the Common Stock. In the event of any merger, consolidation
or other transaction in which Common Stock is exchanged, each share of Preferred
Stock will be entitled to receive 200 times the amount received per share of
Common Stock. The Exercise Price payable and the number of shares of Preferred
Stock or other securities or property issuable, upon exercise of the Rights, are
subject to customary adjustments from time to time to prevent dilution. The
rights of Preferred Stock as to dividends, liquidation and voting are protected
by anti-dilution provisions. The number of outstanding Rights and the number of
one two-hundredths of a share of Preferred Stock issuable upon exercise of each
Right are also subject to adjustment in the event of a stock split of the Common
Stock or a dividend on the Common Stock payable in Common Stock or subdivisions,
consolidations or combinations of the Common Stock occurring, in any such case,
prior to the Distribution Date.
Unless the transaction is approved by a majority of the Board of Directors
and the Continuing Directors, in the event that, after the time the Rights
become exercisable, the Company were to be acquired in a merger or other
business combination (in which any shares of Common Stock are changed into or
exchanged for other securities or assets other than a merger that follows a cash
tender offer for all outstanding shares of the Company, at a price determined by
a majority of the Continuing Directors to be fair and otherwise in the best
interests of the Company and its stockholders) or more than 50% of the assets or
earning power of the Company and its subsidiaries (taken as a whole) were to be
sold or transferred in one or a series of related transactions, the Rights
Agreement provides that proper provision will be made so that each holder of
record of a Right, other than the Acquiring Person or certain related persons
(whose Rights will thereupon become null and void), will from and after such
date, have the right to receive, upon payment of the Exercise Price, that number
of shares of common stock of the acquiring company having a market value at the
time of such transaction equal to two times the Exercise Price. In addition, in
the event that a person or group of affiliated or associated persons becomes an
Acquiring Person (unless such acquisition is made pursuant to a cash tender
offer determined to be fair to the stockholders of the Company, as described in
the preceding sentence), the Rights Agreement provides that proper provision
will be made so that each holder of record of a Right, other than the Acquiring
Person (whose Rights will thereupon become null and void), will thereafter have
the right to receive, upon payment of the Exercise Price, that number of shares
of the Common Stock (or cash, other securities or property) having a market
value at the time of the transaction equal to two times the Exercise Price (such
market value to be determined with reference to the market value of the
Company's Common Stock as provided in the Rights Agreement).
At any time on or prior to the close of business on the earlier of (i) the
tenth day after the time that a person (or group of affiliated or associated
persons) has become an Acquiring Person (or such later date as a majority of the
Board of Directors and the Continuing Directors may determine) or (ii)
, 2008, the Company may redeem the Rights in whole, but not in part,
at a price of $ per Right (the "Redemption Price"), with the approval of the
Continuing Directors. Immediately upon the effective time of the action of the
Board of Directors of the Company authorizing redemption of the Rights, the
right to exercise the Rights will terminate and the only right of the holders of
Rights will be to receive the Redemption Price.
At any time after a person (or group of affiliated or associated persons)
becomes an Acquiring Person and prior to the acquisition by any such person or
group of 50% or more of any class of outstanding voting stock of the Company,
the Board of Directors of the Company (with the approval of the Continuing
Directors) may exchange the Rights (other than Rights owned by such person or
group which have become void), in whole or
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in part, at an exchange ratio of one share of Common Stock (or a fraction of a
share of Preferred Stock or other consideration having equivalent market value)
per Right (subject to adjustment).
Certain of the provisions described above could discourage potential
acquisition proposals and could delay or prevent a change in control of the
Company. These provisions are intended to enhance the likelihood of continuity
and stability in the composition of the Board of Directors and in the policies
formulated by the Board of Directors and to discourage certain types of
transactions that may involve an actual or threatened change in control of the
Company.
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for the Common Stock is .
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of the Offerings, the Company will have
shares of Common Stock outstanding ( shares if the Underwriters'
over-allotment option is exercised in full). Of these shares, the
shares of Common Stock sold in the Offerings will be freely
tradable without restriction under the Securities Act, except that any shares
purchased by "affiliates" of the Company ("Affiliates"), as that term is defined
in Rule 144 ("Rule 144") under the Securities Act, generally may be sold only in
compliance with the limitations of Rule 144 described below.
SALES OF RESTRICTED SECURITIES
The remaining shares of Common Stock outstanding upon
completion of the Offerings are deemed "Restricted Shares" under Rule 144. Of
the Restricted Shares, up to shares will be eligible for sale in
the public market after the Offerings pursuant to Rule 144(k) under the
Securities Act. An additional Restricted Shares will be eligible
for sale in the public market in accordance with Rule 701 under the Securities
Act beginning 90 days after the date of this Prospectus. Of the remaining
Restricted Shares outstanding, shares will be
eligible for resale under Rule 144 commencing 90 days after the date of this
Prospectus.
In general, under Rule 144 as currently in effect, a stockholder, including
an Affiliate, who has beneficially owned his or her Restricted Shares for at
least one year from the date those Restricted Shares were acquired from the
Company or an Affiliate is entitled to sell, within any three-month period, a
number of shares that does not exceed the greater of one percent of the then
outstanding shares of Common Stock (approximately shares
immediately after the Offerings) or the average weekly trading volume of the
Common Stock in the over-the-counter market during the four calendar weeks
preceding the date on which notice of the sale is filed with the Securities and
Exchange Commission. Sales under Rule 144 are subject to certain manner of sale
provisions, notice requirements and the availability of current public
information about the Company. A person who is not deemed an affiliate of the
Company at any time during the three months preceding a sale and who
beneficially owns shares that were not acquired from the Company or an Affiliate
within the previous two years is entitled to sell such shares under Rule 144(k)
without regard to volume limitations, manner of sale provisions, notice
requirements or the availability of current public information concerning the
Company.
Any employee, officer or director of or consultant to the Company who
received his or her shares pursuant to a written compensatory plan or contract
is entitled to rely on the resale provisions of Rule 701, which, beginning 90
days after the date of this Prospectus, permit persons, other than Affiliates,
to sell their Rule 701 shares without having to comply with the
public-information, holding period, volume limitation or notice provisions of
Rule 144 and permit Affiliates to sell their Rule 701 shares without having to
comply with Rule 144's holding-period restrictions.
Notwithstanding the foregoing, the Company, the Company's executive
officers and directors and CEP II, who in the aggregate will hold
shares of Common Stock and options to purchase
shares of Common Stock after the Offerings, have agreed, subject to certain
exceptions, not to
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directly or indirectly (i) offer, pledge, sell, contract to sell, sell any
option or contract to purchase, purchase any option or contract to sell, grant
any option, right or warrant for the sale of or otherwise dispose of or transfer
any shares of Common Stock or securities convertible into or exchangeable or
exercisable for Common Stock, whether now owned or thereafter acquired by the
person executing the agreement or with respect to which the person executing the
agreement thereafter acquires the power of disposition, or file a registration
statement under the Securities Act with respect to the foregoing or (ii) enter
into any swap or other agreement that transfers, in whole or in part, the
economic consequence of ownership of the Common Stock whether any such swap or
transaction is to be settled by delivery of Common Stock or other securities, in
cash or otherwise, without the prior written consent of Merrill Lynch on behalf
of the Underwriters for a period of 180 days after the date of this Prospectus.
Prior to the Offerings there has been no market for the Common Stock. The
Company can make no predictions as to the effect, if any, that sales of shares
or the availability of shares for sale will have on the market price prevailing
from time to time. Nevertheless, sales of significant amounts of the Common
Stock in the public market, or the perception that such sales may occur, could
adversely affect prevailing market prices. See "Risk Factors -- Shares Eligible
for Future Sale; Registration Rights."
STOCK OPTIONS
Upon consummation of the Offerings, options to purchase a total of
shares of Common Stock pursuant to the Company's 1998 Long-Term
Equity Incentive Plan and Directors' Stock Option Plan with an exercise price
equal to the initial offering price will be outstanding, none of which shares
will become exercisable within 60 days of the date of this Prospectus. Of the
shares subject to options, shares are subject to the 180-day lock
up provision. In addition, the Company expects to register the issuance of up to
shares of Common Stock authorized under its 1998 Long-Term Equity
Incentive Plan, Directors' Stock Option Plan and Directors' Stock Unit Plan
following the Offerings.
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UNDERWRITING
Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch"), Bear,
Stearns & Co. Inc., Credit Suisse First Boston Corporation and Smith Barney Inc.
are acting as representatives (the "U.S. Representatives") of each of the U.S.
Underwriters named below (the "U.S. Underwriters"). Subject to the terms and
conditions set forth in a U.S. purchase agreement (the "U.S. Purchase
Agreement") among the Company and the U.S. Underwriters, and concurrently with
the sale of shares of Common Stock to the International Managers (as
defined below), the Company has agreed to sell to the U.S. Underwriters, and
each of the U.S. Underwriters severally and not jointly has agreed to purchase
from the Company, the number of shares of Common Stock set forth opposite its
name below.
<TABLE>
<CAPTION>
NUMBER OF
U.S. UNDERWRITER SHARES
---------------- ---------
<S> <C>
Merrill Lynch, Pierce, Fenner & Smith Incorporated..........
Bear, Stearns & Co. Inc.....................................
Credit Suisse First Boston Corporation......................
Smith Barney Inc............................................
--------
Total..........................................
========
</TABLE>
The Company has also entered into an international purchase agreement (the
"International Purchase Agreement") with certain underwriters outside the United
States and Canada (the "International Managers" and, together with the U.S.
Underwriters, the "Underwriters") for whom Merrill Lynch International, Bear,
Stearns International Limited, Credit Suisse First Boston (Europe) Limited and
Smith Barney Inc. are acting as lead managers (the "Lead Managers"). Subject to
the terms and conditions set forth in the International Purchase Agreement, and
concurrently with the sale of shares of Common Stock to the U.S.
Underwriters pursuant to the U.S. Purchase Agreement, the Company has agreed to
sell to the International Managers, and the International Managers severally
have agreed to purchase from the Company, an aggregate of shares of Common
Stock. The initial public offering price per share and the total underwriting
discount per share of Common Stock are identical under the U.S. Purchase
Agreement and the International Purchase Agreement.
In the U.S. Purchase Agreement and the International Purchase Agreement the
several U.S. Underwriters and the several International Managers have agreed,
subject to the terms and conditions set forth therein, to purchase all of the
shares of Common Stock being sold pursuant to each such agreement if any of the
shares of Common Stock being sold pursuant to each such agreement are purchased.
Under certain circumstances, under the U.S. Purchase Agreement and the
International Purchase Agreement, the commitments of non-defaulting Underwriters
may be increased. The closings with respect to the sale of shares of Common
Stock to be purchased by the U.S. Underwriters and the International Managers
are conditioned upon one another.
The U.S. Representatives have advised the Company that the U.S.
Underwriters propose initially to offer the shares of Common Stock to the public
at the initial public offering price set forth on the cover page of this
Prospectus, and to certain dealers at such price less a concession not in excess
of $ per share of Common
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Stock. The U.S. Underwriters may allow, and such dealers may reallow, a discount
not in excess of $ per share of Common Stock on sales to certain other
dealers. After the initial public offering, the public offering price,
concession and discount may be changed.
The Company has granted options to the U.S. Underwriters, exercisable for
30 days after the date of this Prospectus, to purchase up to an aggregate of
additional shares of Common Stock at the initial public offering price set
forth on the cover page of this Prospectus, less the underwriting discount. The
U.S. Underwriters may exercise these options solely to cover over-allotments, if
any, made on the sale of the Common Stock offered hereby. To the extent that the
U.S. Underwriters exercise these options, each U.S. Underwriter will be
obligated, subject to certain conditions, to purchase a number of additional
shares of Common Stock proportionate to such U.S. Underwriter's initial amount
reflected in the foregoing table. The Company also has granted options to the
International Managers, exercisable for 30 days after the date of this
Prospectus, to purchase up to an aggregate of additional shares of Common
Stock to cover over-allotments, if any, on terms similar to those granted to the
U.S. Underwriters.
At the request of the Company, the Underwriters have reserved for sale, at
the initial public offering price, up to of the shares offered hereby
to be sold to certain directors, officers, employees, business associates and
related persons of the Company. The number of shares of Common Stock available
for sale to the general public will be reduced to the extent such persons
purchase such reserved shares. Any reserved shares which are not orally
confirmed for purchase within one day of the pricing of the Offerings will be
offered by the Underwriters to the general public on the same terms as the other
shares offered hereby.
The Company, the Company's executive officers and directors and CEP II have
agreed, subject to certain exceptions, not to directly or indirectly (i) offer,
pledge, sell, contract to sell, sell any option or contract to purchase,
purchase any option or contract to sell, grant any option, right or warrant for
the sale of or otherwise dispose of or transfer any shares of Common Stock or
securities convertible into or exchangeable or exercisable for Common Stock,
whether now owned or thereafter acquired by the person executing the agreement
or with respect to which the person executing the agreement thereafter acquires
the power of disposition, or file a registration statement under the Securities
Act with respect to the foregoing or (ii) enter into any swap or other agreement
that transfers, in whole or in part, the economic consequence of ownership of
the Common Stock whether any such swap or transaction is to be settled by
delivery of Common Stock or other securities, in cash or otherwise, without the
prior written consent of Merrill Lynch on behalf of the Underwriters for a
period of 180 days after the date of this Prospectus. See "Shares Eligible for
Future Sale."
The U.S. Underwriters and the International Managers have entered into an
intersyndicate agreement (the "Intersyndicate Agreement") that provides for the
coordination of their activities. Pursuant to the Intersyndicate agreement, the
U.S. Underwriters and the International Managers are permitted to sell shares of
Common Stock to each other for purposes of resale at the initial public offering
price, less an amount not greater than the selling concession. Under the terms
of the Intersyndicate Agreement, the U.S. Underwriters and any dealer to whom
they sell shares of Common Stock will not offer to sell or sell shares of Common
Stock to persons who are non-U.S. or non-Canadian persons or to persons they
believe intend to resell to persons who are non-U.S. or non-Canadian persons,
and the International Managers and any dealer to whom they sell shares of Common
Stock will not offer to sell or sell shares of Common Stock to U.S. persons or
to Canadian persons or to persons they believe intend to resell to U.S. or
Canadian persons, except in the case of transactions pursuant to the
Intersyndicate Agreement.
Prior to the Offerings, there has been no public market for the Common
Stock of the Company. The initial public offering price will be determined
through negotiations between the Company and the U.S. Representatives and the
Lead Managers. The factors considered in determining the initial public offering
price, in addition to prevailing market conditions, are price-earnings ratios of
publicly traded companies that the U.S. Representatives and the Lead Managers
believe to be comparable to the Company, certain financial information of the
Company, the history of, and the prospects for, the Company and the industry in
which it competes, and an assessment of the Company's management, its past and
present operations, the prospects for, and timing of, future revenue of the
Company, the present state of the Company's development, and the above factors
in relation to market values and various valuation measures of other companies
engaged in
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activities similar to the Company. There can be no assurance that an active
trading market will develop for the Common Stock or that the Common Stock will
trade in the public market subsequent to the Offerings at or above the initial
public offering price.
Application has been made to list the Common Stock on the New York Stock
Exchange, under the symbol "NHS". In order to meet the requirements for listing
of the Common Stock on that exchange, the U.S. Underwriters and the
International Managers have undertaken to sell lots of 100 or more shares to a
minimum of 2,000 beneficial owners.
The Underwriters do not expect sales of the Common Stock to any accounts
over which they exercise discretionary authority to exceed 5% of the number of
shares being offered hereby.
The Company has agreed to indemnify the U.S. Underwriters and the
International Managers against certain liabilities, including certain
liabilities under the Securities Act, or to contribute to payments the U.S.
Underwriters and the International Managers may be required to make in respect
thereof.
Until the distribution of the Common Stock is completed, rules of the
Securities and Exchange Commission may limit the ability of the Underwriters and
certain selling group members to bid for and purchase the Common Stock. As an
exception to these rules, the U.S. Representatives are permitted to engage in
certain transactions that stabilize the price of the Common Stock. Such
transactions consist of bids or purchases for the purpose of pegging, fixing or
maintaining the price of the Common Stock.
If the Underwriters create a short position in the Common Stock in
connection with the Offerings, i.e., if they sell more shares of Common Stock
than are set forth on the cover page of this Prospectus, the U.S.
Representatives may reduce that short position by purchasing Common Stock in the
open market. The U.S. Representatives may also elect to reduce any short
position by exercising all or part of the over-allotment option described above.
The U.S. Representatives may also impose a penalty bid on certain
Underwriters and selling group members. This means that if the U.S.
Representatives purchase shares of Common Stock in the open market to reduce the
Underwriters' short position or to stabilize the price of the Common Stock, they
may reclaim the amount of the selling concession from the Underwriters and
selling group members who sold those shares as part of the Offerings.
In general, purchases of a security for the purpose of stabilization or to
reduce a short position could cause the price of the security to be higher than
it might be in the absence of such purchases. The imposition of a penalty bid
might also have an effect on the price of the Common Stock to the extent that it
discourages resales of the Common Stock.
Neither the Company nor any of the Underwriters makes any representation or
prediction as to the direction or magnitude of any effect that the transactions
described above may have on the price of the Common Stock. In addition, neither
the Company nor any of the Underwriters makes any representation that the U.S.
Representatives will engage in such transactions or that such transactions, once
commenced, will not be discontinued without notice.
CERTAIN FEDERAL TAX CONSIDERATIONS
FOR NON-U.S. HOLDERS OF COMMON STOCK
The following is a general discussion of certain United States ("U.S.")
federal income and estate tax consequences of the ownership and disposition of
Common Stock applicable to a beneficial owner thereof that is a "Non-U.S.
Person" (a "Non-U.S. Holder"). As used herein, the term "Non-U.S. Person" means
a person or entity other than (a) a citizen or individual resident of the United
States, (b) a corporation or partnership created or organized in or under the
laws of the United States or any political subdivision thereof, (c) an estate
the income of which is subject to U.S. federal income tax regardless of its
source, or (d) in general, a trust if (i) a court within the United States is
able to exercise primary supervision over the administration of the trust and
(ii) one or more United States persons have the authority to control all
substantial decisions of the trust.
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<PAGE> 68
This discussion is based on the Internal Revenue Code of 1986, as amended
(the "Code"), existing and proposed regulations promulgated thereunder and
administrative and judicial interpretations thereof, all as of the date hereof,
and all of which are subject to change, possibly with retroactive effect. This
discussion does not address all aspects of U.S. federal income and estate
taxation that may be important to Non-U.S. Persons in light of their particular
circumstances (including tax consequences applicable to certain former citizens
or long-term residents of the United States and to certain Non-U.S. Persons that
are, or hold interests in Common Stock through, partnerships or other fiscally
transparent entities (including "hybrid entities")) and does not address United
States state and local or non-United States tax consequences. PROSPECTIVE
NON-U.S. HOLDERS ARE URGED TO CONSULT THEIR OWN TAX ADVISORS WITH RESPECT TO THE
PARTICULAR UNITED STATES FEDERAL INCOME AND ESTATE TAX CONSEQUENCES TO THEM OF
OWNING AND DISPOSING OF COMMON STOCK, AS WELL AS THE TAX CONSEQUENCES ARISING
UNDER THE LAWS OF ANY OTHER TAXING JURISDICTION.
DIVIDENDS
The Company anticipates that it will not pay dividends on shares of Common
Stock for the foreseeable future. See "Dividend Policy." In the event, however,
that the Company does pay dividends on shares of Common Stock, a Non-U.S. Holder
of Common Stock generally will be subject to withholding of U.S. federal income
tax at a rate of 30% of the gross amount of the dividend, or such lower rate as
may be specified by an income tax treaty between the United States and a foreign
country of which the Non-U.S. Holder is treated as a resident within the meaning
of the applicable tax treaty. Under currently effective United States Treasury
regulations, dividends paid to an address in a foreign country are presumed to
be paid to a resident of that country for purposes of the withholding discussed
above (unless the payor has knowledge to the contrary), and, under the current
interpretation of United States Treasury regulations, for purposes of
determining the applicability of a lower rate of withholding tax provided by a
tax treaty. Under United States Treasury regulations published on October 14,
1997, as modified by IRS Notice 98-16 released on March 27, 1998 (the "New
Withholding Regulations"), a Non-U.S. Holder of Common Stock who wishes to claim
the benefit of an applicable treaty rate (and avoid backup withholding as
discussed below) generally will be required to satisfy specified certification
and other requirements with respect to dividends paid after December 31, 1999
(and, in certain circumstances, may be required to satisfy such certification
and other requirements with respect to dividends paid after December 31, 1998).
In addition, the New Withholding Regulations contain special rules regarding the
availability of treaty benefits for payments made to (a) foreign intermediaries,
(b) U.S. or foreign wholly-owned entities that are disregarded for U.S. federal
income tax purposes and (c) partnerships and other entities that are treated as
fiscally transparent in the United States, the applicable income tax treaty
jurisdiction, or both. Prospective Non-U.S. Holders should consult their own tax
advisors as to the effect, if any, of the New Withholding Regulations on an
investment in the Common Stock.
Dividends paid to a Non-U.S. Holder that are either (a) effectively
connected with the Non-U.S. Holder's conduct of a trade or business within the
United States or (b) if a tax treaty applies, attributable to a permanent
establishment maintained in the United States by the Non-U.S. Holder, will not
be subject to the withholding tax (provided in either case the Non-U.S. Holder
files the appropriate documentation with the Company or its agent), but, instead
will be subject to regular U.S. federal income tax at the graduated rates in the
same manner as if the Non-U.S. Holder were a U.S. resident. In addition to such
regular tax, in the case of a Non-U.S. Holder that is a corporation, effectively
connected dividends or, if a tax treaty applies, dividends attributable to a
U.S. permanent establishment of the corporate Non-U.S. Holder, may be subject to
a "branch profits tax" which is imposed, under certain circumstances, at a rate
of 30% (or such lower rate as may be specified by an applicable tax treaty) of
the corporate Non-U.S. Holder's "effectively connected earnings and profits,"
subject to certain adjustments.
A Non-U.S. Holder of Common Stock that is eligible for a reduced rate of
United States withholding tax pursuant to a tax treaty may obtain a refund of
any excess amounts withheld by filing a timely claim for refund with the
Internal Revenue Service ("IRS").
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<PAGE> 69
GAIN ON DISPOSITION OF COMMON STOCK
A Non-U.S. Holder generally will not be subject to U.S. federal income tax
with respect to gain on a sale or other taxable disposition of Common Stock
unless (a) the gain is effectively connected with a trade or business of the
Non-U.S. Holder in the United States or, if a tax treaty applies, attributable
to a United States permanent establishment of the Non-U.S. Holder, (b) in the
absence of a treaty exemption, in the case of a Non-U.S. Holder who is a
nonresident alien individual and holds the Common Stock as a capital asset, such
individual is present in the United States for 183 or more days in the taxable
year of the sale or other disposition and certain other conditions are met, or
(c) the Company is or has been a "U.S. real property holding corporation" for
United States federal income tax purposes at any time within the shorter of the
five-year period preceding such disposition or the period such Non-U.S. Holder
held the Common Stock. A corporation is a "U.S. real property holding
corporation" if the fair market value of the United States real property
interests held by the corporation is 50% or more of the aggregate fair market
value of certain assets of the corporation. Even if the Company is a U.S. real
property holding corporation, or were to become a U.S. real property holding
corporation, provided that the Common Stock is "regularly traded" (within the
meaning of the U.S. federal income tax laws) on an established securities
market, only a Non-U.S. Holder that owns, directly or pursuant to certain
attribution rules, more than 5% of the Common Stock (at any time during the
shorter of the periods described above) will be subject to U.S. federal income
tax on the sale or other taxable disposition of the Common Stock on such
account. All Non-U.S. Holders should consult with their own tax advisers
regarding application of the foregoing rules to them.
INFORMATION REPORTING REQUIREMENTS AND BACKUP WITHHOLDING
Generally, the Company must report annually to the IRS the amount of
dividends paid to a Non-U.S. Holder and the amount, if any, of tax withheld with
respect to such Non-U.S. Holder. A similar report is sent to the Non-U.S.
Holder. Pursuant to tax treaties or certain other agreements, the IRS may make
its reports available to tax authorities in the recipient's country of
residence.
Currently, United States "backup withholding tax" (which generally is a
withholding tax imposed at a rate of 31% on certain payments to persons that
fail to furnish the information required under the United States information
reporting requirements) will generally not apply to dividends paid on Common
Stock to a Non-U.S. Holder at an address outside the United States, unless the
payor has actual knowledge that the payee is a U.S. person. Backup withholding
tax generally will apply to dividends paid on Common Stock at addresses inside
the United States to Non-U.S. Holders who fail to provide certain identifying
information in the manner required.
In addition, information reporting and backup withholding imposed at a rate
of 31% will apply to the proceeds of a disposition of Common Stock paid to or
through a U.S. office of a broker unless the disposing holder, under penalties
of perjury, certifies as to its Non-U.S. Holder or otherwise establishes an
exemption. Generally, U.S. information reporting and backup withholding will not
currently apply to a payment of disposition proceeds if the payment is made
outside the United States through a non-U.S. office of a non-U.S. broker.
However, U.S. information reporting requirements (but not backup withholding)
will apply to a payment of disposition proceeds outside the United States if the
payment is made through an office outside the United States of a broker that is
(a) a U.S. person, (b) a foreign person that derives 50% or more of its gross
income for certain periods from the conduct of a trade or business in the United
States or (c) a "controlled foreign corporation" for U.S. federal income tax
purposes, unless the broker maintains documentary evidence that the holder is a
Non-U.S. Holder and certain other conditions are met, or the holder otherwise
establishes an exemption.
Under the New Withholding Regulations, which generally are effective for
payments made after December 31, 1999 (but which, in certain circumstances, may
apply to payments made after December 31, 1998), the payment of dividends, and
the payment of proceeds from the disposition of Common Stock through brokers
having certain connections with the United States, may be subject to information
reporting and backup withholding at a rate of 31% unless certain IRS
certification requirements are satisfied or an exemption is otherwise
established. Prospective Non-U.S. Holders should consult with their own tax
advisors regarding the application of the New Withholding Regulations to their
particular circumstances.
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Backup withholding is not an additional tax. Rather, the U.S. tax liability
of persons subject to backup withholding will be reduced by a credit for the
amount of tax so withheld. If backup withholding results in an overpayment of
taxes, a refund may be obtained, provided that the required information is
furnished to the IRS.
FEDERAL ESTATE TAX
Shares of Common Stock owned or treated as owned by an individual who is
not a citizen or resident of the United States at the time of his or her death
will be includible in the individual's gross estate for United States federal
estate tax purposes unless an applicable tax treaty provides otherwise, and may
be subject to United States federal estate tax. Estates of non-resident aliens
are generally allowed a statutory credit which has the effect of offsetting the
United States federal estate tax imposed on the first $60,000 of the taxable
estate.
LEGAL MATTERS
The validity of the shares of Common Stock offered hereby will be passed
upon for the Company by Dewey Ballantine LLP, New York, New York. Certain legal
matters relating to the Offering will be passed upon for the Underwriters by
Debevoise & Plimpton, New York, New York. Morton A. Pierce and Gordon E. Warnke,
members of Dewey Ballantine LLP, are stockholders of the Company and Mr. Pierce
is also a director of the Company. See "Management," "Principal Stockholders,"
and "Certain Relationships and Related Transactions."
EXPERTS
The financial statements appearing in this Prospectus and Registration
Statement have been audited by Ernst & Young LLP, independent auditors, as set
forth in their reports thereon appearing elsewhere herein, and are included in
reliance upon such reports given upon the authority of such firm as experts in
accounting and auditing.
AVAILABLE INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"Commission") a Registration Statement on Form S-1 pursuant to the Securities
Act with respect to the Common Stock offered hereby. This Prospectus does not
contain all the information set forth in the Registration Statement, certain
items of which are omitted as permitted by the rules and regulations of the
Commission. Statements contained in this Prospectus as to the contents of any
contract, agreement or other document filed with the Registration Statement as
exhibits are necessarily summaries of such documents, and each such statement is
qualified in its entirety by reference to the copy of the applicable document
filed as an exhibit to the Registration Statement. For further information about
the Company and the securities offered hereby, reference is made to the
Registration Statement and to the consolidated financial statements, schedules
and exhibits filed as a part thereof.
Upon completion of the Offerings, the Company will be subject to the
information requirements of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), and, in accordance therewith, will file reports and other
information with the Commission. The Registration Statement, the exhibits and
schedules forming a part thereof and the reports and other information filed by
the Company with the Commission in accordance with the Exchange Act may be
inspected without charge at the public reference facilities maintained by the
Commission at 450 Fifth Street, N.W., Washington, D.C. 20549 and at the
following regional offices of the Commission: 7 World Trade Center, Suite 1300,
New York, New York 10048; and the Northwestern Atrium Center, 500 West Madison
Street, Suite 1400, Chicago, Illinois, 60661-2511. Copies of such materials or
any part thereof may also be obtained from the Public Reference Section of the
Commission, 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed rates.
Such materials can also be
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inspected at the offices of the NYSE, 20 Broad Street, New York, New York 10005
or on the Commission's Internet web site at http://www.sec.gov.
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
This Prospectus contains forward-looking statements, within the meaning of
Section 27A of the Securities Act of 1933, as amended (the "Securities Act") and
Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"). Such forward-looking statements may be found in the material set forth
under the headings "Prospectus Summary," "Risk Factors," "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
"Business," as well as elsewhere in this Prospectus. All statements which are
not statements of historical fact are intended to be such forward-looking
statements. These statements involve known and unknown risks, uncertainties and
other factors which may cause the actual results, performance or achievement of
the Company or industry results to be materially different from any future
results, performance or achievements expressed or implied by such
forward-looking statements. Such factors include, among others, the following:
general economic and business conditions, both nationally and in regions where
the Company operates; demographic changes; the effect of existing or future
governmental regulation and federal and state legislative and enforcement
initiatives on the Company's business, including the Balanced Budget Act of
1997; changes in Medicare and Medicaid reimbursement levels; the Company's
ability to successfully implement its acquisition and development strategy and
changes in such strategy; the availability and terms of financing to fund the
expansion of the Company's business, including the acquisition of additional
hospitals; the Company's ability to attract and retain qualified management
personnel and to recruit and retain physicians and other health care personnel
to the non-urban markets it serves; the effect of managed care initiatives on
the non-urban markets served by the Company's hospitals and the Company's
ability to enter into managed care provider arrangements on acceptable terms;
the effect of liability and other claims asserted against the Company; the
effect of competition in the markets served by the Company's hospitals and other
factors referenced in this Prospectus. Certain of these factors are discussed in
more detail elsewhere in this Prospectus. Given these uncertainties, prospective
investors are cautioned not to place undue reliance on such forward-looking
statements. The Company disclaims any obligation to update any such factors or
to publicly announce the result of any revisions to any of the forward-looking
statements contained herein to reflect future events or developments.
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INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
NETCARE HEALTH SYSTEMS LLC
Report of Independent Auditors.............................. F-2
Consolidated Balance Sheets at December 31, 1996 and 1997;
and March 31, 1998 (unaudited)............................ F-3
Consolidated Statements of Operations for the period from
March 11, 1996 (date of inception) to December 31, 1996
and the year ended December 31, 1997; and for the three
months ended March 31, 1997 and 1998 (unaudited).......... F-4
Consolidated Statements of Changes in Members' Equity for
the period from March 11, 1996 (date of inception) to
December 31, 1996 and the year ended December 31, 1997;
and for the three months ended March 31, 1998
(unaudited)............................................... F-5
Consolidated Statements of Cash Flows for the period from
March 11, 1996 (date of inception) to December 31, 1996
and the year ended December 31, 1997; and for the three
months ended March 31, 1997 and 1998 (unaudited).......... F-6
Notes to Consolidated Financial Statements.................. F-7
SOUTHERN HEALTH CORPORATION
Report of Independent Auditors.............................. F-20
Combined Statements of Operations for the years ended June
30, 1995 and 1996 and for the period July 1, 1996 to
August 15, 1996........................................... F-21
Combined Statements of Changes in Stockholders' Equity
(Deficit) for the years ended June 30, 1995 and 1996 and
for the period July 1, 1996 to August 15, 1996............ F-22
Combined Statements of Cash Flows for the years ended June
30, 1995 and 1996 and for the period July 1, 1996 to
August 15, 1996........................................... F-23
Notes to Combined Financial Statements...................... F-24
DENTON COMMUNITY HOSPITAL
Report of Independent Auditors.............................. F-28
Statements of Income for the year ended December 31, 1995
and for the period January 1, 1996 to November 12, 1996... F-29
Statements of Changes in Equity of Parent for the year ended
December 31, 1995 and for the period January 1, 1996 to
November 12, 1996......................................... F-30
Statements of Cash Flows for the year ended December 31,
1995 and for the period January 1, 1996 to November 12,
1996...................................................... F-31
Notes to Financial Statements............................... F-32
SAN CLEMENTE HOSPITAL AND MEDICAL CENTER
Report of Independent Auditors.............................. F-36
Balance Sheets at December 31, 1996 and 1997; and March 31,
1998 (unaudited).......................................... F-37
Statements of Operations for the years ended December 31,
1995, 1996 and 1997; and for the three months ended March
31, 1997 and 1998 (unaudited)............................. F-38
Statements of Changes in Net Assets (Deficit) for the years
ended December 31, 1995, 1996 and 1997; and for the three
months ended March 31, 1998 (unaudited)................... F-39
Statements of Cash Flows for the years ended December 31,
1995, 1996 and 1997; and for the three months ended March
31, 1997 and 1998 (unaudited)............................. F-40
Notes to Financial Statements............................... F-41
</TABLE>
F-1
<PAGE> 73
REPORT OF INDEPENDENT AUDITORS
Board of Directors
NetCare Health Systems LLC
We have audited the accompanying consolidated balance sheets of NetCare
Health Systems LLC as of December 31, 1996 and 1997, and the related
consolidated statements of operations, changes in members' equity, and cash
flows for the period from March 11, 1996 (date of inception) to December 31,
1996 and for the year ended December 31, 1997. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
NetCare Health Systems LLC at December 31, 1996 and 1997, and the consolidated
results of its operations and its cash flows for the period from March 11, 1996
(date of inception) to December 31, 1996 and for the year ended December 31,
1997, in conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Nashville, Tennessee
February 16, 1998
F-2
<PAGE> 74
NETCARE HEALTH SYSTEMS LLC
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
------------------- MARCH 31,
1996 1997 1998
----------------------------------
(UNAUDITED --
NOTE 10)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 469 $ 495 $ 930
Patient accounts receivable, net of allowance for doubtful
accounts of $8,935, $8,640 and $8,898 (unaudited) for
1996, 1997 and 1998, respectively...................... 15,382 22,437 22,902
Inventories............................................... 2,118 2,715 2,740
Income tax receivable..................................... 1,375 3,860 3,822
Prepaid expenses and other current assets................. 3,726 2,323 2,205
-------- -------- --------
Total current assets.............................. 23,070 31,830 32,599
Property, plant and equipment:
Land and improvements..................................... 2,025 2,120 2,390
Buildings and improvements................................ 53,798 55,816 55,821
Equipment................................................. 19,325 23,888 24,479
-------- -------- --------
75,148 81,824 82,690
Less accumulated depreciation............................. 336 5,835 7,171
-------- -------- --------
74,812 75,989 75,519
Construction in progress.................................. 204 881 2,165
-------- -------- --------
Net property, plant and equipment........................... 75,016 76,870 77,684
Excess of purchase price over net assets acquired........... 40,626 39,034 38,588
Other assets................................................ 2,921 1,652 1,536
Deferred income taxes....................................... 1,275 144 144
-------- -------- --------
Total assets...................................... $142,908 $149,530 $150,551
======== ======== ========
LIABILITIES AND MEMBERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 4,692 $ 4,445 $ 3,186
Employee compensation and benefits........................ 3,291 4,176 3,834
Accrued interest payable.................................. -- 1,103 1,001
Other accrued liabilities................................. 7,552 4,991 5,147
Current portion of long-term debt......................... 4,054 8,750 9,175
-------- -------- --------
Total current liabilities......................... 19,589 23,465 22,343
Long-term debt, less current maturities..................... 73,895 71,571 71,045
Third-party settlements..................................... 3,265 4,748 6,028
Members' equity............................................. 46,159 49,746 51,135
-------- -------- --------
Total liabilities and members' equity............. $142,908 $149,530 $150,551
======== ======== ========
</TABLE>
See accompanying notes.
F-3
<PAGE> 75
NETCARE HEALTH SYSTEMS LLC
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PRO FORMA SHARE AND PER-SHARE DATA)
<TABLE>
<CAPTION>
PERIOD FROM
MARCH 11, 1996 THREE MONTHS ENDED
(DATE OF INCEPTION) YEAR ENDED MARCH 31,
TO DECEMBER 31, DECEMBER 31, ----------------------
1996 1997 1997 1998
-------------------------------------------------------------
(UNAUDITED -- NOTE 10)
<S> <C> <C> <C> <C>
Net patient revenue....................... $30,532 $128,517 $31,988 $34,267
Other revenue............................. 892 1,824 460 364
------- -------- ------- -------
Total revenue................... 31,424 130,341 32,448 34,631
Expenses:
Salaries, wages and benefits............ 15,161 54,783 13,181 14,787
Supplies and other...................... 6,591 27,177 6,493 6,881
Provision for bad debts................. 3,562 13,282 3,618 3,074
Purchased services...................... 1,808 8,450 1,987 1,999
Professional services................... 1,386 3,690 913 1,162
Depreciation and amortization........... 2,179 7,588 1,747 1,801
Rent and lease expense.................. 796 2,927 696 745
Interest expense........................ 2,013 6,681 1,540 1,631
------- -------- ------- -------
33,496 124,578 30,175 32,080
------- -------- ------- -------
Income (loss) before income taxes and
extraordinary charge.................... (2,072) 5,763 2,273 2,551
Income tax (provision) benefit............ 204 (2,387) (909) (1,188)
------- -------- ------- -------
Income (loss) before extraordinary
charge.................................. (1,868) 3,376 1,364 1,363
Extraordinary charge on early
extinguishment of debt (net of tax
benefit of $321)........................ 525 -- -- --
------- -------- ------- -------
Net income (loss)............... $(2,393) $ 3,376 $ 1,364 $ 1,363
======= ======== ======= =======
Unaudited Pro Forma Earnings Per Share
(see Note 10):
Basic earnings per share................
Weighted average shares.................
</TABLE>
See accompanying notes.
F-4
<PAGE> 76
NETCARE HEALTH SYSTEMS LLC
CONSOLIDATED STATEMENTS OF CHANGES IN MEMBERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
TOTAL
CHARTERHOUSE NETCARE DEFERRED MEMBERS'
EQUITY PARTNERS II, L.P. MANAGEMENT LLC COMPENSATION EQUITY
------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Initial Capitalization March 11,
1996 (date of inception)........ $ 600 $ 600 $ -- $ 1,200
Issuance Costs.................... (148) -- -- (148)
Capital contribution to effect
Southern Health Corporation
acquisition on August 16, 1996,
net of expenses................. 36,500 -- -- 36,500
Capital contribution to effect
Denton Community Hospital
acquisition on November 13,
1996, net of expenses........... 11,000 -- -- 11,000
Net loss.......................... (2,362) (31) -- (2,393)
------- ------ ------ -------
Balance at December 31, 1996...... 45,590 569 -- 46,159
Deferred compensation accrual..... -- 423 (423) --
Deferred compensation
amortization.................... -- -- 211 211
Net income........................ 3,332 44 -- 3,376
------- ------ ------ -------
Balance at December 31, 1997...... 48,922 1,036 (212) 49,746
Deferred compensation amortization
(Unaudited -- Note 10).......... -- -- 26 26
Net income (Unaudited -- Note
10)............................. 1,345 18 -- 1,363
------- ------ ------ -------
Balance at March 31, 1998
(Unaudited -- Note 10).......... $50,267 $1,054 $ (186) $51,135
======= ====== ====== =======
</TABLE>
See accompanying notes.
F-5
<PAGE> 77
NETCARE HEALTH SYSTEMS LLC
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
PERIOD FROM
MARCH 11, 1996
(DATE OF THREE MONTHS ENDED
INCEPTION) TO YEAR ENDED MARCH 31,
DECEMBER 31, DECEMBER 31, -------------------
1996 1997 1997 1998
---------------------------------------------------
(UNAUDITED -- NOTE
10)
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss)................................. $ (2,393) $ 3,376 $ 1,364 $ 1,363
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Extraordinary charge on early extinguishment of
debt......................................... 846 -- -- --
Depreciation.................................... 336 5,558 1,338 1,239
Amortization.................................... 1,843 2,030 409 562
Provision for bad debts......................... 3,562 13,282 3,618 3,074
Deferred income taxes........................... (509) 2,101 -- --
Deferred compensation expense................... -- 211 -- 26
Changes in operating assets and liabilities, net
of effect of acquisitions:
Patient accounts receivable.................. (4,390) (20,397) (5,230) (3,539)
Inventories.................................. (63) (406) (35) (25)
Income tax receivable........................ (1,375) (1,887) -- 38
Prepaid expenses and other current assets.... (1,791) 1,403 (1,962) 118
Accounts payable............................. (1,099) (789) (1,165) (1,259)
Employee compensation and other benefits..... 728 818 569 (342)
Other accrued liabilities.................... 6,570 (713) 3,235 54
Third-party settlements...................... 1,144 (688) (483) 1,280
-------- -------- ------- -------
Net cash provided by operating
activities............................ 3,409 3,899 1,658 2,589
INVESTING ACTIVITIES:
Acquisition of Southern Health Corporation........ (48,163) -- -- --
Acquisition of Denton Community Hospital.......... (44,597) -- -- --
Acquisition of Stone County Hospital.............. -- (123) (123) --
Purchases of property, plant and equipment........ (441) (4,346) (1,550) (2,053)
Change in other assets............................ (2,361) 676 109 --
Change in deferred income taxes................... (766) 562 -- --
-------- -------- ------- -------
Net cash used in investing activities... (96,328) (3,231) (1,564) (2,053)
FINANCING ACTIVITIES:
Capital contributions, net of recorded expenses... 48,552 -- -- --
Proceeds from bridge note......................... 15,000 -- -- --
Proceeds from long-term debt...................... 82,242 7,000 1,000 2,000
Payment of bridge note............................ (15,000) -- -- --
Payment of principal on long-term debt............ (37,406) (7,642) (1,121) (2,101)
-------- -------- ------- -------
Net cash provided by (used in) financing
activities............................ 93,388 (642) (121) (101)
-------- -------- ------- -------
Increase in cash and cash equivalents............. 469 26 (27) 435
Cash and cash equivalents at beginning of
period.......................................... -- 469 469 495
-------- -------- ------- -------
Cash and cash equivalents at end of period........ $ 469 $ 495 $ 442 $ 930
======== ======== ======= =======
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid..................................... $ 2,251 $ 5,809 $ 939 $ 1,609
======== ======== ======= =======
Income tax payments............................... $ -- $ 2,988 $ -- $ 121
======== ======== ======= =======
</TABLE>
F-6
<PAGE> 78
NETCARE HEALTH SYSTEMS LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
(INFORMATION PERTAINING TO THE THREE-MONTH PERIODS ENDING
MARCH 31, 1997 AND 1998 IS UNAUDITED)
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
NetCare Health Systems LLC ("NetCare LLC", or the "Company") is a Delaware
limited liability company and is the sole shareholder of NetCare Health Systems,
Inc. ("NetCare"), a Delaware corporation that operates hospitals and ancillary
health care facilities. The Company was formed in November 1995 and initially
funded in March 1996 and, through its wholly-owned subsidiary, at December 31,
1997, operated seven general acute care hospitals and four adjacent nursing home
facilities in three states (see Note 2). The members of NetCare LLC are
Charterhouse Equity Partners II ("Charterhouse Equity Partners"), Chef Nominees
Limited ("Chef" and together with Charterhouse Equity Partners, "CEP II") and
NetCare Management LLC ("Management LLC").
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiary. All material intercompany accounts
and transactions have been eliminated.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with a maturity of 90
days or less when purchased to be cash equivalents.
PATIENT ACCOUNTS RECEIVABLE
The Company's primary concentration of credit risk is patient accounts
receivable, which consist of amounts owed by various governmental agencies,
insurance companies and private patients. The Company manages the receivables by
regularly reviewing its accounts and contracts and by providing appropriate
allowances for uncollectible amounts. Medicare, Medicaid and CHAMPUS programs
comprised approximately 27%, 11% and 1% of patient receivables, respectively, at
both December 31, 1996 and 1997. Receivables from Medicaid primarily include
amounts from the states of Georgia, Mississippi and Texas. Remaining receivables
relate primarily to various commercial insurance carriers and HMO/PPO programs.
INVENTORIES
Inventories are stated at the lower of cost (first-in, first-out) or
market.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are stated at cost. Routine maintenance and
repairs are charged to expense as incurred. Expenditures that increase values,
change capacities or extend useful lives are capitalized. Depreciation is
computed by the straight-line method over the estimated useful lives of the
assets, which approximate 4 to 40 years.
The Company is currently engaged in an expansion project at one of its
hospitals which is expected to be completed by December 31, 1998. At December
31, 1997 approximately $500 had been expended for this project and is included
in construction in progress on the accompanying consolidated balance sheet. The
additional estimated cost to complete the project is approximately $6,000.
F-7
<PAGE> 79
NETCARE HEALTH SYSTEMS LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
EXCESS OF PURCHASE PRICE OVER NET ASSETS ACQUIRED
Excess of purchase price over net assets acquired is being amortized on a
straight-line basis over 30 years. To the extent that operating results indicate
the probability that the carrying values of certain long-lived assets and the
related identifiable intangible assets have been impaired, the Company would
prepare projections of the undiscounted cash flows from operations of the
acquired entity over the remaining amortization period. If the projections
indicated that the recorded cost would not be recoverable, such cost amounts
would be reduced to estimated fair value. As of December 31, 1997, in the
opinion of management, there has been no such impairment.
At December 31, 1996 and 1997, excess of purchase price over net assets
acquired was $35,800 and $41,665. Accumulated amortization on such amounts was
$614 and $2,085, respectively.
OTHER ASSETS
Deferred loan costs are included in other noncurrent assets and are
amortized over the term of the related debt by the interest method. At December
31, 1996 and 1997, deferred loan costs were $2,053 and $2,088, respectively.
Accumulated amortization on such amounts was $39 and $348, respectively.
RISK MANAGEMENT
The Company maintains self-insured medical and dental plans for employees.
Claims are accrued under these plans as the incidents that give rise to them
occur. Unpaid claim accruals are based on the estimated ultimate cost of
settlement, including claim settlement expenses, in accordance with an average
lag time and past experience. The Company has entered into reinsurance
agreements for certain plans with independent insurance companies to limit its
losses on claims. Under the terms of these agreements, the insurance companies
will reimburse the Company based on the level of reinsurance which ranges from
$60 per individual claim up to $3,600. These reimbursements are included in
salaries, wages and benefits in the accompanying consolidated statements of
operations.
INCOME TAXES
The Company operates as a Limited Liability Company and accordingly, no
provision has been made for federal or state income taxes in these financial
statements for NetCare LLC because any such income or loss would be included in
the individual tax returns of the owners (see Note 4).
Income taxes computed for the Company's subsidiary are based on the
liability method of accounting. Deferred tax assets and liabilities are
determined based on differences between financial reporting and tax bases of
assets and liabilities and are measured using the enacted tax rates and laws
that will be in effect when the differences are expected to reverse.
FAIR VALUES OF FINANCIAL INSTRUMENTS
Cash and Cash Equivalents: -- The carrying amount reported in the balance
sheet for cash and cash equivalents approximates fair value.
Patient Accounts Receivable and Accounts Payable: -- The carrying amount
reported in the balance sheet for accounts receivable and accounts payable
approximates fair value.
Long-Term Debt: -- The carrying amount reported in the balance sheet for
long-term obligations approximates fair value. The fair value of the Company's
long-term obligations is estimated using discounted
F-8
<PAGE> 80
NETCARE HEALTH SYSTEMS LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED)
cash flow analysis, based on the Company's current incremental rates for similar
types of borrowing arrangements.
NET PATIENT REVENUE
The Company has agreements with third-party payors that provide for
payments to the Company at amounts different from its established rates. A
summary of the payment arrangements with major third-party payors follows:
- Medicare. Inpatient acute care services rendered to Medicare program
beneficiaries are paid at prospectively determined rates per diagnosis.
These rates vary according to a patient classification system that is
based on clinical, diagnostic, and other factors. Inpatient nonacute
services, certain outpatient services and medical education costs
related to Medicare beneficiaries are paid based on a cost reimbursement
methodology. The Company is reimbursed for cost reimbursable items at a
tentative rate with final settlement determined after submission of
annual cost reports by the Company and audits thereof by the Medicare
fiscal intermediary. The Company's classification of patients under the
Medicare program and the appropriateness of their admission are subject
to an independent review. The Company's Medicare cost reports have been
audited by the Medicare fiscal intermediary through 1995.
- Medicaid. Inpatient and outpatient services rendered to Medicaid
program beneficiaries are reimbursed either under contracted rates or
reimbursed for cost reimbursable items at a tentative rate with final
settlement determined after submission of annual cost reports by the
Company and audits thereof by Medicaid. The Company's Medicaid cost
reports have been audited by the Medicaid fiscal intermediary through
1994.
- Other. The Company also has entered into payment agreements with
certain commercial insurance carriers, health maintenance organizations
and preferred provider organizations. The basis for payment to the
Company under these agreements includes prospectively determined rates
per discharge, discounts from established charges, and prospectively
determined daily rates.
Final determination of amounts earned under the Medicare and Medicaid
programs often occur in subsequent years because of audits by the programs,
rights of appeal and the application of numerous technical provisions.
Net patient revenue is net of contractual adjustments and policy discounts
of $17,331 and $92,408 for the period from March 11, 1996 (date of inception) to
December 31, 1996 and for the year ended December 31, 1997, respectively.
EQUITY-BASED COMPENSATION
The Company, from time to time, grants interest in Members' Equity to
employees. The Company accounts for such Members' Equity grants in accordance
with APB Opinion No. 25, Accounting for Stock Issued to Employees, and
accordingly, recognizes no compensation expense for the Members' Equity grants
when the Members' Equity equals, or is greater than, the market price of the
underlying Members' Equity on the date of grant.
F-9
<PAGE> 81
NETCARE HEALTH SYSTEMS LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
RECLASSIFICATIONS
Certain prior period amounts have been reclassified in order to conform to
current period presentation. These reclassifications had no effect on the
results of operations previously reported.
2. ACQUISITIONS
1997 ACTIVITIES
On January 1, 1997, the Company acquired certain assets and liabilities of
Stone County Hospital, a 50-bed general acute-care hospital located in Wiggins,
Mississippi for $123 in cash and the assumption of $3,013 in debt. Of the $3,013
in debt assumed, $2,635 is in the form of General Obligation Hospital Bonds and
$378 is in the form of a note payable to Stone County (see Note 3). The purchase
price was allocated to property, plant and equipment.
1996 ACTIVITIES
Southern Health Corporation
On August 16, 1996, the Company purchased in exchange for cash all the
outstanding stock of Southern Health Corporation ("Southern Health") for $48,163
($80,650 purchase price less the assumption of $32,487 in Southern Health
long-term debt).
The purchase price was allocated as follows:
<TABLE>
<S> <C>
Fair value of assets acquired:
Excess of purchase price over net assets acquired......... $ 40,500
Patient accounts receivable............................... 10,214
Inventories............................................... 1,236
Prepaid expenses and other current assets................. 1,724
Other assets.............................................. 1,665
Property, plant and equipment............................. 34,208
Liabilities assumed:
Accounts payable.......................................... (5,029)
Employee compensation and benefits........................ (2,242)
Other accrued liabilities................................. (589)
Long-term debt............................................ (32,487)
Third-party settlements................................... (1,037)
--------
Net cash paid..................................... $ 48,163
========
</TABLE>
The acquisition was financed through a contribution of $36,500 from CEP II
and a bridge loan of $15,000 from Charterhouse Equity Partners (see Note 8).
F-10
<PAGE> 82
NETCARE HEALTH SYSTEMS LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. ACQUISITIONS (CONTINUED)
Denton Community Hospital
On November 13, 1996, the Company acquired certain assets and liabilities
of Denton Community Hospital, a 110-bed general acute care hospital located in
Denton, Texas for $44,596. The purchase price was allocated as follows:
<TABLE>
<S> <C>
Fair value of assets acquired:
Patients accounts receivable.............................. $ 4,340
Inventories............................................... 819
Prepaid expenses and other current assets................. 212
Property, plant and equipment............................. 40,703
Liabilities assumed:
Accounts Payable.......................................... (762)
Employee compensation and benefits........................ (322)
Other accrued liabilities................................. (394)
-------
Net cash paid..................................... $44,596
=======
</TABLE>
The acquisition of Denton Community Hospital was financed through a
contribution of $11,000 from CEP II borrowings under the Company's Credit
Agreement (see Note 3).
OTHER INFORMATION
The foregoing acquisitions were accounted for using the purchase method of
accounting. The operating results of the acquired companies have been included
in the accompanying consolidated statements of operations from the respective
dates of acquisition.
The following represents the unaudited pro forma results of operations as
if the above noted acquisitions had occurred as of January 1, 1996. The pro
forma results of operations do not purport to represent what the Company's
results would have been had such transactions in fact occurred at January 1,
1996.
<TABLE>
<CAPTION>
DECEMBER 31,
1996
-------------
<S> <C>
Total revenue............................................... $118,211
Net loss.................................................... $ (682)
</TABLE>
3. LONG-TERM DEBT
A summary of the Company's long-term debt follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
1996 1997
-----------------
<S> <C> <C>
Bank Credit Agreement:
Eurodollar Term Loans..................................... $75,000 $70,000
Alternate Base Rate Term Loans............................ -- 1,000
Alternate Base Rate Revolving Loans....................... 2,000 6,000
------- -------
77,000 77,000
General obligation hospital bonds........................... -- 2,545
Other debt.................................................. 949 776
------- -------
77,949 80,321
Less current maturities..................................... 4,054 8,750
------- -------
$73,895 $71,571
======= =======
</TABLE>
F-11
<PAGE> 83
NETCARE HEALTH SYSTEMS LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. LONG-TERM DEBT (CONTINUED)
BANK CREDIT AGREEMENT
On November 13, 1996, the Company entered into a credit agreement (the
"1996 Credit Agreement") with a group comprised of eleven banks, with The Chase
Manhattan Bank as the agent, for the purpose of financing the acquisition of
Denton Community Hospital (see Note 2) and other potential future acquisitions,
refinancing the then outstanding principal balance due under the Southern Health
Amended and Restated Credit Agreement with NationsCredit Commercial Corporation
("Amended and Restated Credit Agreement"), repaying the outstanding principal
balance of the bridge loan from Charterhouse Equity Partners (see Notes 2 and
8), financing working capital, and for general corporate purposes. Under the
1996 Credit Agreement, the Company initially borrowed $75,000 in the form of a
term loan and may initially borrow, on a revolving basis, an aggregate maximum
principal amount of up to $50,000. Commencing March 31, 2002 and each quarter
thereafter, the aggregate maximum principal amount available on a revolving
basis under the 1996 Credit Agreement shall be reduced as follows:
<TABLE>
<S> <C>
March 31, 2002.............................................. $47,500
June 30, 2002............................................... 45,000
September 30, 2002.......................................... 42,167
December 31, 2002........................................... 39,334
March 31, 2003.............................................. 36,501
</TABLE>
Amounts borrowed in the form of term loans and revolving loans under the
1996 Credit Agreement may be in the form of Eurodollar Loans, Alternate Base
Rate Loans, or a combination thereof.
The credit facility is collateralized by the assignment of the common stock
of NetCare and its subsidiaries.
Interest on any Alternate Base Rate Loan is equal to the Alternate Base
Rate (the greater of the Federal Funds Effective Rate plus 0.5%, or prime) plus
the Alternate Base Rate margin (based upon the Company's total debt ratio and
interest coverage ratio and in any event no greater than 0.75%). Interest on
Eurodollar Loans is equal to the adjusted LIBOR rate plus the LIBOR rate margin
(based upon the Company's total debt ratio and interest coverage ratio and in
any event no greater than 1.75% and no less than 1%). The interest rate on the
outstanding principal balance of Eurodollar Term Loans and Alternate Base Rate
Loans under the 1996 Credit Agreement at December 31, 1997 and March 31, 1998
was approximately 7.6% and 9.3%, respectively.
The 1996 Credit Agreement contains various financial covenants which
include (i) limitations on additional debt, (ii) limitations on sales of assets,
mergers, consolidations and acquisitions, (iii) limitations on capital
expenditures, (iv) restrictions on payments of dividends and (v) maintenance of
certain financial ratios. At December 31, 1997, the Company was in compliance
with all covenants of the 1996 Credit Agreement.
Outstanding principal amounts under the term loans are payable in quarterly
installments. Outstanding principal amounts under the revolving loans are due
May 13, 2003. In addition, any outstanding principal amounts under the revolving
loans in excess of the aggregate maximum principal amount at the end of any
quarter are immediately payable.
GENERAL OBLIGATION HOSPITAL BONDS
In connection with the acquisition of Stone County Hospital (see Note 2),
the Company assumed the outstanding principal balance under the General
Obligation Hospital Bonds, Series 1993, of Stone County, Mississippi (the
"Bonds"). The outstanding principal balance of the Bonds is payable in
installments on December 1 of each year through 2013, unless called on or after
December 1, 2003 by Stone County,
F-12
<PAGE> 84
NETCARE HEALTH SYSTEMS LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. LONG-TERM DEBT (CONTINUED)
GENERAL OBLIGATION HOSPITAL BONDS (CONTINUED)
Mississippi, and interest is payable semiannually. The Bonds are secured by the
fixed assets of Stone County Hospital. The interest rate on the outstanding
balance of the General Obligation Hospital Bonds at December 31, 1997 was
approximately 8.1%.
OTHER DEBT
The Company and its subsidiaries and affiliates are liable to various
vendors for notes payable and equipment leases with outstanding principal
balances of $949 and $776 at December 31, 1996 and 1997, respectively. Interest
rates on the notes payable and capital leases range from 4% to 10% and are
payable in installments through July 1999.
Future maturities of long-term debt are as follows:
<TABLE>
<CAPTION>
GENERAL
1996 OBLIGATION
CREDIT HOSPITAL OTHER
AGREEMENT BONDS DEBT TOTAL
----------------------------------------
<S> <C> <C> <C> <C>
1998............................................... $ 8,000 $ 95 $655 $ 8,750
1999............................................... 11,000 100 121 11,221
2000............................................... 13,000 110 -- 13,110
2001............................................... 14,500 115 -- 14,615
2002............................................... 16,000 120 -- 16,120
Thereafter......................................... 14,500 2,005 -- 16,505
------- ------ ---- -------
77,000 2,545 776 80,321
Less current portion............................... 8,000 95 655 8,750
------- ------ ---- -------
$69,000 $2,450 $121 $71,571
======= ====== ==== =======
</TABLE>
In November 1996, the Company recorded an extraordinary charge of $525 (net
of tax benefit of $321) due to the write-off of unamortized loan costs related
to the early extinguishment of the outstanding principal balance of $27,000
under the Amended and Restated Credit Agreement.
F-13
<PAGE> 85
NETCARE HEALTH SYSTEMS LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
4. INCOME TAXES
Significant components of the Company's deferred tax assets and liabilities
are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1996 1997
------------------
<S> <C> <C>
Deferred tax assets:
Accrued liabilities and reserves.......................... $ 518 $ 432
Accrued vacation and bonuses.............................. 433 482
Net operating losses...................................... 537 636
Minimum tax credit........................................ 560 87
Differences in book and tax provision for bad debts....... 1,313 --
Book over tax depreciation/amortization................... 426 437
------- -------
Total deferred tax assets......................... 3,787 2,074
Deferred Tax Liability:
Differences in book and tax provision for bad debts....... -- (1,930)
Less valuation allowance.................................... (2,512) --
------- -------
Net deferred tax assets (liabilities)....................... $ 1,275 $ 144
======= =======
</TABLE>
Significant components of the income tax (benefit) provision attributable
to operations are as follows:
<TABLE>
<CAPTION>
PERIOD FROM
MARCH 11, 1996
(DATE OF
INCEPTION) TO YEAR ENDED
DECEMBER 31, DECEMBER 31,
1996 1997
------------------------------
<S> <C> <C>
Current:
Federal................................................ $ (60) $ 87
State.................................................. 44 199
----- ------
Total current............................................ (16) 286
----- ------
Deferred:
Federal................................................ (511) 2,046
State.................................................. 2 55
----- ------
Total deferred........................................... (509) 2,101
----- ------
Income tax (benefit) provision........................... $(525) $2,387
===== ======
</TABLE>
The Company's consolidated effective tax rate differed from the federal
statutory rate as set forth below:
<TABLE>
<CAPTION>
PERIOD FROM
MARCH 11, 1996
(DATE OF
INCEPTION) TO YEAR ENDED
DECEMBER 31, DECEMBER 31,
1996 1997
----------------- -----------------
AMOUNT PERCENT AMOUNT PERCENT
--------------------------------------
<S> <C> <C> <C> <C>
Tax at U.S. statutory rates....................... $(1,026) (34)% $ 1,959 34%
State taxes, net of federal benefits.............. (121) (4) 231 4
Nondeductible goodwill............................ 198 7 487 8
Increase (decrease) in valuation allowance........ 407 13 (407) (7)
Other............................................. 17 -- 117 2
------- --- ------- --
Total................................... $ (525) (18)% $ 2,387 41%
======= === ======= ==
</TABLE>
F-14
<PAGE> 86
NETCARE HEALTH SYSTEMS LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
4. INCOME TAXES (CONTINUED)
At December 31, 1997, the Company has net operating loss carryovers of
approximately $1,000 for federal income tax purposes and $7,200 for state income
tax purposes that expire between the years 2011 and 2012.
The valuation allowance increased by $407 in 1996, because management
believed that the Company would not likely have future taxable income to be
offset by the future tax deductions attributable to the deferred tax assets. The
valuation allowance was eliminated in 1997, because the Company was able to
realize the deferred tax asset attributable to the allowance for doubtful
accounts as a result of the Company's election to change its method of
accounting for bad debts for tax purposes.
The Company recorded a valuation allowance of approximately $2,100 in the
acquisition of Southern Health Corporation. The valuation was eliminated in 1997
due to the accounting method change for bad debts and due to the resolution of
other uncertainties surrounding the realization of certain deferred tax assets.
The amount of goodwill recorded on the acquisition was adjusted to reflect the
decrease in the valuation allowance.
The Consolidated Statement of Operations classification of the income tax
provision (benefit) is as follows:
<TABLE>
<CAPTION>
PERIOD FROM
MARCH 11, 1996
(DATE OF
INCEPTION) TO YEAR ENDED
DECEMBER 31, DECEMBER 31,
1996 1997
---------------------------------
<S> <C> <C>
Income tax provision (benefit) before extraordinary
charge................................................. $(204) $2,387
Extraordinary charge..................................... (321) --
----- ------
$(525) $2,387
===== ======
</TABLE>
There were no distributions or allocations of the Company's net income or
losses to its members. All taxes were accrued and paid by the subsidiary,
NetCare (see Note 1).
5. COMMITMENTS AND CONTINGENCIES
General and Professional Liability
The Company carries general and professional liability insurance from an
unrelated commercial insurance carrier for per occurrence losses up to $1,000
with policy limits of $3,000 in the aggregate, on a claims-made basis for
professional liability and on an occurrence basis for general liability. In
addition, the Company has an umbrella policy with the insurance carrier with
coverage up to $10,000 per occurrence and in the aggregate. At December 31, 1996
and 1997, there were no asserted claims against the hospitals or nursing homes
that management expects to exceed current insurance coverage.
Litigation
The Company is presently, and from time to time, subject to other various
claims and lawsuits arising in the normal course of business. In the opinion of
management, the ultimate resolution of these matters will not have a material
adverse effect on the Company's financial position or results of operations.
Employment Agreements
In March 1996, the Company executed employment agreements with three of the
Company's senior executive officers. Such agreements have an initial term of
three years commencing April 1996 and are automatically renewable for successive
terms of one year each. The agreements provide for minimum salary
F-15
<PAGE> 87
NETCARE HEALTH SYSTEMS LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. COMMITMENTS AND CONTINGENCIES (CONTINUED)
levels, adjusted annually based upon performance criteria, as well as for
participation in bonus plans which are payable if specific management goals are
attained.
6. HEALTHCARE REGULATION
Current Operations
Laws and regulations governing the Medicare, Medicaid and other federal
health care programs are complex and subject to interpretation. The Company
believes that it is in compliance with all applicable laws and regulations in
all material respects and is not aware of any pending or threatened
investigations involving allegations of potential wrongdoing other than those
discussed below under Potential Liability to the Federal Government. While no
such regulatory inquiries have been made, other than those discussed below under
Potential Liability to the Federal Government, compliance with such laws and
regulations can be subject to future government review and interpretation as
well as significant regulatory action including fines, penalties, and exclusion
from the Medicare, Medicaid and other federal health care programs.
Risks Associated With Liabilities Of Acquired Businesses
The Company has acquired and will continue to acquire businesses with prior
operating histories. Acquired companies may have unknown or contingent
liabilities, including liabilities for failure to comply with health care laws
and regulations, such as billing and reimbursement, fraud and abuse and similar
anti-referral laws. The Company has from time to time identified certain past
practices of acquired companies that do not conform to its standards. Although
the Company institutes policies designed to conform such practices to its
standards following completion of acquisitions, there can be no assurance that
the Company will not become liable for past activities that may later be
asserted to be improper by private plaintiffs or government agencies. Although
the Company generally seeks to obtain indemnification from prospective sellers
covering such matters, there can be no assurance that any such matter will be
covered by indemnification or, if covered, that such indemnification will be
adequate to cover potential losses and fines.
Potential Liability to the Federal Government
The OIG of the HHS and the Department of Justice have from time to time
established enforcement initiatives that focus on specific billing practices or
other suspected areas of abuse. Current initiatives include a nationwide
Medicare/Medicaid audit project regarding hospital laboratory billing practices,
referred to as the "laboratory unbundling" project. Three of the Company's
hospitals have been audited by the federal government. The government has issued
a notice of payment due for two of these facilities and has required a
self-audit for the third facility. The Company estimates the aggregate potential
liability for all hospitals to be less than $500 which has been accrued by the
Company at December 31, 1997. Each of the facilities was acquired by the Company
during the period that is subject to the audit. The pre-acquisition portion of
each facility's liability may be allocable to the seller of such facility.
However, it is not possible at this time to determine what, if any, amount is
subject to indemnity by the seller, because factors such as prior claims of
indemnity will affect the Company's right to recover from the sellers. Should
indemnity be available from any of the sellers, the amount of the liability
would be less than estimated.
7. MEMBERS' EQUITY
In February 1996, two senior executives from NetCare each purchased 250
shares of NetCare common stock for $250. In March 1996, the 500 shares of
outstanding NetCare common stock were contributed by the senior executive
officers to NetCare Management LLC ("NetCare Management"), a Delaware Limited
Liability Company. In addition, $100 in cash was contributed to NetCare
Management, of which $25 was contributed by one of NetCare's senior executive
officers, $50 was contributed by a director of NetCare and
F-16
<PAGE> 88
NETCARE HEALTH SYSTEMS LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. MEMBERS' EQUITY (CONTINUED)
$25 was contributed by an independent third party. Immediately following this
transaction, the 500 shares of NetCare common stock and the $100 in cash was
contributed by NetCare Management to the Company. In addition, CEP II
contributed $600 in the aggregate to the Company.
Upon formation of the Company the members entered into an operating
agreement which, under certain circumstances, calls for additional capital
contributions of up to $48,800 by CEP II. The operating agreement also calls for
a preferential return of 12.5% on the amount of all capital contributions by a
member, less any distributions ("Unrecovered Contributions"). Such amount is
compounded semiannually. Distributions from the Company are made as follows; (i)
to members in an amount sufficient to satisfy any related income tax
liabilities; (ii) to members in an amount proportionate to Unrecovered
Contributions plus accrued preferential return; (iii) 100% to the members in the
following order; 80% to CEP II and 20% to NetCare Management. Profits and losses
are allocated in a similar manner. For the period from March 7, 1996 (date of
inception) to December 31, 1996 and for the year ended December 31, 1997,
preferential return on members' capital accounts exceeded net income by $4,433
and $2,954 respectively. In the event the net income of the Company exceeds the
preferential return in future years, such amount will be first allocated to
members in a manner consistent with (ii) above up to an amount equal to the
amount by which the preferential return exceeded net income (loss) in 1996 and
1997.
In the event of a dissolution, liquidation or winding up of the Company,
including an initial public offering of common stock, the net assets of the
Company will be used to first pay any expenses of the dissolution, liquidation
or winding up, and will then be distributed in the same manner as distributions.
In the event of an initial public offering of common stock, member distributions
will be paid in shares of common stock of the surviving entity as outlined
above.
Certain members of NetCare's management have been granted interests in the
Company through NetCare Management, resulting in deferred compensation of $423.
Such interests vest over three years or immediately upon an event of
liquidation, dissolution or winding up of the Company. Deferred compensation
amortization is included in salaries, wages and benefits in the accompanying
Consolidated Statements of Operations.
8. RELATED PARTY TRANSACTIONS
In August 1996, CEP II contributed $36,500 to the Company to fund the
acquisition of Southern Health. In addition, Charterhouse Equity Partners
provided $15,000 in bridge loan financing to the Company for the purpose of the
Southern Health acquisition. Interest on the term loan was at 11.25% and was
paid off as outlined below.
In addition, CEP II contributed $11,000 to the Company to fund the
acquisition of Denton Community Hospital in November 1996. Simultaneously, the
Company repaid the $15,000 bridge loan to Charterhouse Equity Partners, together
with $417 in accrued interest thereon.
The Company's operating agreement provides that CGI shall receive a
transaction fee for any acquisition by the Company of $1,000 or more in which
CGI or its affiliates directly or indirectly provides all or a portion of the
equity financing therefor. The transaction fee is equivalent to 2% of the total
transaction cost. In connection with the acquisitions of Southern Health and
Denton Community Hospital, the Company paid transaction fees to CGI in the
amount of $1,400 and $892, respectively, which have been capitalized as costs of
the respective acquisitions.
One of the Company's Directors is a partner in a law firm which provides
services to the Company. Expense related to such services (including amounts
capitalized) amounted to $455 and $62 during 1996 and 1997, respectively all of
which was accrued at December 31, 1996 and 1997, respectively.
F-17
<PAGE> 89
NETCARE HEALTH SYSTEMS LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
9. RETIREMENT PLAN
The Company has a defined contribution plan covering all full-time
employees who have completed one year of service, as defined, and are age
twenty-one or older. Participants may contribute up to 17% of their annual
compensation, as defined, up to a maximum of $10. Employer contributions amount
to 50% of employee contributions, up to 3% of the individual participants'
annual compensation, as defined. Retirement plan expense was $86 and $504 for
the years ended December 31, 1996 and 1997, respectively.
10. UNAUDITED INFORMATION
INTERIM FINANCIAL INFORMATION
The consolidated balance sheet as of March 31, 1998, the related
consolidated statements of operations and cash flows for the three months ended
March 31, 1997 and 1998, and the consolidated statement of changes in members'
equity for the three months ended March 31, 1998 ("interim financial
statements") have been prepared by the Company and are unaudited. The interim
financial statements include all adjustments consisting of only normal recurring
adjustments necessary for a fair statement of the results of the interim
periods.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted from the interim financial statements. The
interim financial statements should be read in conjunction with the Company's
December 31, 1997 audited consolidated financial statements appearing herein.
The results for the three months ended March 31, 1998 may not be indicative of
operating results for the full year.
EVENTS SUBSEQUENT TO MARCH 31, 1998
Recapitalization and Public Offering of Common Stock
The LLC intends to reorganize (the "Recapitalization") prior to the
effectiveness of the contemplated initial public offering of NetCare's common
stock (the "Offerings"). The Recapitalization will result in the members of the
LLC exchanging 100 percent of their interest in NetCare Health Systems LLC for
all the outstanding stock of the NetCare Health Systems, Inc.
The Company is in the registration process under the Securities Act of 1933
for its initial public offering of common stock. The net proceeds from the
Offerings are planned to be used to reduce the balance of the outstanding Bank
Credit Agreement, fund acquisitions and working capital requirements.
The balances in Members' Equity are planned to be converted into shares of
common stock prior to the completion of the registration process.
F-18
<PAGE> 90
NETCARE HEALTH SYSTEMS LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Pro Forma Earnings Per Share Based on Historical Net Income
The following table sets forth the computation of Pro Forma basic and
diluted earnings per share assuming the conversion of Members' Equity into
Common Stock on January 1, 1997.
<TABLE>
<CAPTION>
THREE-MONTHS
YEAR ENDED ENDED
DECEMBER 31, 1997 MARCH 31, 1998
----------------------------------
<S> <C> <C>
Numerator:
Numerator for basic and diluted earnings per share........
Denominator:
Denominator for basic earnings per
share -- weighted-average shares.......................
Effect of dilutive securities:
Stock options.............................................
Warrants..................................................
-------- --------
Denominator for diluted earnings:
Per share -- adjusted weighted-average shares and assumed
conversions............................................
-------- --------
Basic earnings per share.................................... $ $
Diluted earnings per share.................................. $ $
</TABLE>
The computation of historical earnings per share is based upon the assumed
conversion of members' equity into weighted average shares of Common
Stock, which includes shares issued to NetCare LLC. The Company had no
potential dilutive shares of Common Stock at December 31, 1997 or March 31,
1998.
Acquisitions
In April 1998, the Company acquired the operations of Central Texas
Hospital in Cameron, Texas by assuming the hospital's operating lease. In
addition, in May 1998 the Company acquired Holly Springs Memorial Hospital in
Holly Springs, Mississippi for $4,150 in cash. The acquisition of Holly Springs
was financed through a $1,500 contribution from CEP II and borrowing under the
Company's Credit Agreement. In June 1998 the Company acquired San Clemente
Hospital and Medical Center in San Clemente, California for $8,300 in cash. The
acquisition was financed through a $5,000 contribution from CEP II and
borrowings under the Company's Credit Agreement. The foregoing acquisitions were
accounted for under the purchase method of accounting. The operating results of
these acquisitions will be included in the Company's Consolidated Statements of
Operations from the respective dates of acquisition.
The above acquisitions were accounted for using the purchase method of
accounting. The following Pro Forma information reflects the operations of San
Clemente, Central Texas Hospital and Holly Springs Memorial Hospital as if the
respective transactions had occurred as of January 1, 1996 and assumes a full
year of operations for Denton Community Hospital, Stone County Hospital and
Southern Health for 1996. The Pro Forma results of operations do not purport to
represent what the Company's results would have been had such transactions
actually occurred at January 1, 1996.
<TABLE>
<CAPTION>
YEARS ENDED
------------------------------------- THREE MONTHS ENDED
DECEMBER 31, 1996 DECEMBER 31, 1997 MARCH 31, 1998
----------------------------------------------------------
<S> <C> <C> <C>
Total revenue................................ $150,896 $162,799 $42,609
Net income (loss)............................ $ (4,203) $ 530 $ 543
</TABLE>
F-19
<PAGE> 91
REPORT OF INDEPENDENT AUDITORS
Board of Directors
Southern Health Corporation
We have audited the accompanying combined statements (see Note 1) of
operations, changes in stockholders' equity (deficit) and cash flows of Southern
Health Corporation for the years ended June 30, 1995 and 1996 and for the period
July 1, 1996 to August 15, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the combined results of operations and cash flows for
Southern Health Corporation for the years ended June 30, 1995 and 1996 and the
period July 1, 1996 to August 15, 1996, in conformity with generally accepted
accounting principles.
ERNST & YOUNG LLP
Birmingham, Alabama
May 25, 1998
F-20
<PAGE> 92
SOUTHERN HEALTH CORPORATION
COMBINED STATEMENTS OF OPERATIONS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30, PERIOD
------------------- JULY 1, 1996 TO
1995 1996 AUGUST 15, 1996
-------------------------------------
<S> <C> <C> <C>
Net patient revenue......................................... $49,782 $64,602 $8,698
Other revenue............................................... 1,416 970 147
------- ------- ------
Total revenue............................................... 51,198 65,572 8,845
Expenses:
Salaries, wages and benefits.............................. 23,240 32,344 4,430
Supplies and other........................................ 11,411 14,372 1,687
Provision for bad debts................................... 3,555 2,905 968
Purchased services........................................ 2,590 3,504 727
Professional services..................................... 2,966 3,195 346
Depreciation and amortization............................. 2,669 3,359 382
Rent and lease expense.................................... 461 1,001 197
Interest expense.......................................... 1,702 3,055 371
------- ------- ------
48,594 63,735 9,108
------- ------- ------
Income (loss) before income taxes........................... 2,604 1,837 (263)
Provision for (benefit from) income taxes................... 1,217 1,183 (97)
------- ------- ------
Net income (loss)................................. $ 1,387 $ 654 $ (166)
======= ======= ======
</TABLE>
See accompanying notes.
F-21
<PAGE> 93
SOUTHERN HEALTH CORPORATION
COMBINED STATEMENTS OF
CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS)
<TABLE>
<CAPTION>
RETAINED
COMMON EARNINGS
STOCK OF COMMON COMMON (DOLLAR
SOUTHERN STOCK OF STOCK OF AMOUNTS
HEALTH SOUTHERN MCE IN
MANAGEMENT HEALTH HOSPITAL TREASURY THOUSANDS)
-----COMPANY-----------CORPORATION-----------COMPANY---------------STOCK------------(DEFICIT)--
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
------- ------- ------- ------- ------- ------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at June 30,
1994............... 3 $3 6 $6 3 $ 3 -- $ -- $ (633)
Issuance of common
shares............. -- -- 3 3 -- -- -- -- --
Merger of entities... -- -- -- -- (3) (3) -- -- --
Distributions to
shareholders....... -- -- -- -- -- -- -- -- (24)
Net income........... -- -- -- -- -- -- -- -- 1,387
-- -- --- -- ---- --- -------- -------- ------
Balance at June 30,
1995............... 3 3 9 9 -- -- -- -- 730
Purchase of treasury
stock.............. -- -- -- -- -- -- (3) (10,281) --
Net income........... -- -- -- -- -- -- -- -- 654
-- -- --- -- ---- --- -------- -------- ------
Balance at June 30,
1996............... 3 3 9 9 -- -- (3) (10,281) 1,384
Net loss............. -- -- -- -- -- -- -- -- (166)
-- -- --- -- ---- --- -------- -------- ------
Balance at August 15,
1996............... 3 $3 9 $9 -- $-- (3) $(10,281) $1,218
== == === == ==== === ======== ======== ======
<CAPTION>
TOTAL
STOCKHOLDERS'
EQUITY
---(DEFICIT)---
<S> <C>
Balance at June 30,
1994............... $ (621)
Issuance of common
shares............. 3
Merger of entities... (3)
Distributions to
shareholders....... (24)
Net income........... 1,387
--------
Balance at June 30,
1995............... 742
Purchase of treasury
stock.............. (10,281)
Net income........... 654
--------
Balance at June 30,
1996............... (8,885)
Net loss............. (166)
--------
Balance at August 15,
1996............... $ (9,051)
========
</TABLE>
See accompanying notes.
F-22
<PAGE> 94
SOUTHERN HEALTH CORPORATION
COMBINED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30, PERIOD
------------------- JULY 1, 1996 TO
1995 1996 AUGUST 15, 1996
-------------------------------------
<S> <C> <C> <C>
Net income (loss)........................................... $ 1,387 $ 654 $ (166)
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation.............................................. 2,669 3,359 382
Amortization.............................................. -- -- --
Provision for bad debts................................... 3,555 2,905 968
Gain on disposal of assets................................ (38) -- --
Changes in operating assets and liabilities:
Accounts receivable.................................... (3,404) (4,775) (1,273)
Inventories and other current assets................... 216 (506) (225)
Other assets........................................... (530) (184) 71
Accounts Payable....................................... 659 746 (1,062)
Federal and state income taxes payable................. 135 (337) --
Other current liabilities.............................. (1,073) 99 2,070
Third-party settlements................................ 575 346 (1,057)
-------- -------- -------
Net cash provided by (used in) operating
activities...................................... 4,151 2,307 (292)
INVESTING ACTIVITIES:
Purchases of property, plant and equipment.................. (3,253) (3,892) (240)
Proceeds from disposal of assets............................ 158 -- --
Acquisition of Hiawassee.................................... (3,206) -- --
Acquisition of Dahlonega.................................... (6,700) -- --
-------- -------- -------
Net cash used in investing activities....................... (13,001) (3,892) (240)
FINANCING ACTIVITIES:
Proceeds from notes payable................................. 26,845 11,881 --
Payments on notes payable................................... (14,939) (1,031) (525)
Purchase of treasury stock.................................. -- (10,281) --
Deferred financing costs.................................... (1,172) -- 23
Distributions to shareholders............................... (24) -- --
Merger of entities.......................................... (3) -- --
Issuance of common shares................................... 3 -- --
-------- -------- -------
Net cash provided by (used in) financing activities......... 10,710 569 (502)
-------- -------- -------
Increase (decrease) in cash and cash equivalents............ 1,860 (1,016) (1,034)
Cash and cash equivalents at beginning of period............ 619 2,479 1,463
-------- -------- -------
Cash and cash equivalents at end of period.................. $ 2,479 $ 1,463 $ 429
======== ======== =======
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid............................................... $ 1,306 $ 2,927 $ 357
======== ======== =======
Income tax payments......................................... $ 1,081 $ 1,564 $ --
======== ======== =======
</TABLE>
See accompanying notes.
F-23
<PAGE> 95
SOUTHERN HEALTH CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS
JUNE 30, 1996
(DOLLAR AMOUNTS IN THOUSANDS)
1. ORGANIZATION
Southern Health Corporation ("Southern Health" or the "Company") is an
entity organized for the purpose of operating and managing medical care
facilities primarily in rural areas. The combined financial statements of
Southern Health include the accounts of Southern Health and its subsidiaries and
affiliates as follows:
- Southern Health Management Company ("SHMC") -- an affiliate of the
controlled group of Southern Health that previously provided management
services to uncontrolled health facilities.
- Southern Health Corporation -- provides management and administrative
services to the various Southern Health affiliates.
- Medical Care Enterprises Hospital Company, Inc. ("MCE") -- a sub-S
entity that previously provided management services to the various
Southern Health affiliates. MCE was merged with the Company on December
31, 1994.
- Pickens Health Care Association, Inc. ("PHCA") -- an affiliate of the
controlled group of Southern Health. This entity operates Mountainside
Medical Center and Nursing Home in Jasper, Georgia.
- Southern Health Corporation of Ellijay, Inc. ("Ellijay") -- a subsidiary
which operates North Georgia Medical Center and an affiliated nursing
home in Ellijay, Georgia.
- Southern Health Corporation of Houston, Inc. ("Houston") -- a subsidiary
which operates Trace Regional Hospital and an affiliated nursing home
and physician's practice in Houston, Mississippi.
- Southern Health Corporation of Hiawassee, Inc. ("Hiawassee") -- a
subsidiary formed during fiscal year 1995 to operate Chatuge Regional
Medical Center and an affiliated nursing home in Hiawassee, Georgia (see
Note 8).
- Southern Health Corporation of Dahlonega, Inc. ("Dahlonega") -- a
subsidiary formed during fiscal year 1995 to operate Chestatee Regional
Hospital in Dahlonega, Georgia (see Note 8).
- Southern Health Corporation and Affiliated Companies Medical Plan Trust
("Health Trust") -- trust fund organized to pay employee health
insurance claims.
- Southern Health Corporation and Affiliated Companies Worker's
Compensation Trust ("Workers' Comp Trust") -- trust fund organized to
pay employee worker's compensation claims.
All significant intercompany accounts and transactions have been
eliminated.
On August 16, 1996, the stockholders of Southern Health sold 100% of their
common shares to NetCare Health Systems, Inc.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NET PATIENT REVENUE
Net patient revenue is reported as the estimated net realizable amounts
from patients, third-party payors and others for services rendered, including
estimated retroactive adjustments under reimbursement agreements with
third-party payors. Retroactive adjustments are accrued on an estimated basis in
the period the related services are rendered and adjusted in future periods as
final settlements are determined.
F-24
<PAGE> 96
SOUTHERN HEALTH CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PROPERTY, PLANT AND EQUIPMENT
Depreciation is computed under the straight-line method over the estimated
useful lives of the assets. The estimated life of buildings is 40 years and the
general range of useful lives for land improvements and equipment is 5 to 20
years.
DEFERRED FINANCING COSTS
Deferred financing costs incurred in conjunction with the refinancing of
certain of the Company's notes payable and capital lease obligations during 1995
are being amortized under the straight-line method, which approximates the
interest method, over the term of the repayment of the Greyrock note (see Note
4).
OTHER ASSETS
A non-compete agreement relating to the purchase of Dahlonega (see Note 9)
is being amortized using the straight-line method over the three-year term of
the agreement.
INCOME TAXES
Southern Health and its subsidiaries file a consolidated federal income tax
return. SHMC and PHCA (affiliates) file separate income tax returns.
Income taxes of Southern Health are computed based on the liability method
of accounting. Deferred tax assets and liabilities are determined based on
differences between financial reporting and tax bases of assets and liabilities
and are measured using the enacted tax rates and laws that will be in effect
when the differences are expected to reverse.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and the
accompanying notes. Actual results could differ from those estimates.
STOCK-BASED COMPENSATION
The Company, from time to time, grants stock options for a fixed number of
common shares to employees. The Company accounts for stock option grants in
accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees,
and accordingly, recognizes no compensation expense for the stock option grants
when the exercise price of the options equals, or is greater than, the market
price of the underlying stock on the date of grant.
3. ACQUISITION OF FACILITIES
On September 22, 1994, Southern Health entered into an agreement to
purchase substantially all of the assets of Chatuge Regional Hospital and
Nursing Home in Hiawassee, Georgia from the Hospital Authority of Towns County
for approximately $3,206. The purchase was funded through a $2,800 bank note
with the balance of $406 paid in cash.
On January 31, 1995, Southern Health entered into an agreement to purchase
substantially all of the assets of Chestatee Regional Hospital in Dahlonega,
Georgia from Saint Joseph's Health System, Inc. ("St. Joseph's") for
approximately $6,700. The purchase was funded through the proceeds of the
Greyrock note. Southern Health and St. Joseph's entered into a three year
non-compete agreement whereby
F-25
<PAGE> 97
SOUTHERN HEALTH CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
3. ACQUISITION OF FACILITIES (CONTINUED)
St. Joseph's agreed not to compete with the Company in Lumpkin and Dawson
Counties, Georgia. This agreement was allocated as $1,700 of the purchase price
of the hospital.
The acquisitions of Chatuge Regional Hospital and Nursing Home and
Chestatee Regional Hospital were accounted for using the purchase method of
accounting. The following represents the unaudited pro forma results of
operations as if the above-noted acquisitions had occurred as of July 1, 1994.
The Pro Forma results of operations do not purport to represent what the
Company's results would have been had such transactions actually occurred at
July 1, 1994.
<TABLE>
<CAPTION>
YEAR ENDED
JUNE 30, 1995
-------
<S> <C>
Total revenue............................................... $57,470
Net income.................................................. $ 1,389
</TABLE>
4. OPERATING LEASES
The Company has entered into several noncancellable operating leases which
resulted in lease expense of approximately $4,611, $1,001 and $197 for the years
ended June 30, 1995 and 1996, and the period July 1, 1996 to August 15, 1996,
respectively.
5. COMMITMENTS AND CONTINGENCIES
The Company and its subsidiaries and affiliates have malpractice insurance
with retroactive dates of coverage from either the inception of the Company or
dates of acquisition of the applicable facilities. As of June 30, 1996, there
were no asserted malpractice claims against the hospitals or nursing homes
operated by Southern Health that management expected to exceed current insurance
coverage.
The Company is presently, from time to time, subject to other various
claims and lawsuits arising in the normal course of business. In the opinion of
management, the ultimate resolution of these matters will not have a material
adverse effect on the Company's financial position or results of operations.
6. HEALTHCARE REGULATION
Laws and regulation governing the Medicare and Medicaid programs are
complex and subject to interpretation. The Company believes that it is in
compliance with all applicable laws and regulations and is not aware of any
pending or threatened investigation involving allegations of potential
wrongdoing. While no such regulatory inquiries have been made, compliance with
such laws and regulations can be subject to future government review and
interpretation as well as significant regulatory action including fines,
penalties, and exclusion from the Medicare and Medicaid programs.
7. INCOME TAXES
Income tax expense differs from the normal relationship to financial
statement income principally due to temporary differences including depreciation
and bad debt expense. Deferred taxes are generated primarily by differences in
tax and financial reporting for depreciation of fixed assets and deductions for
bad debt expense and vacation pay. The valuation allowance increased by $699 for
the year ended June 30, 1996.
F-26
<PAGE> 98
SOUTHERN HEALTH CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
7. INCOME TAXES (CONTINUED)
Significant components of the provision for income taxes consisted of the
following:
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30, PERIOD
------------------- JULY 1, TO
1995 1996 AUGUST 15, 1996
-------------------------------------
<S> <C> <C> <C>
Current:
Federal........................................... $1,034 $1,005 $(87)
State............................................. 183 178 (10)
------ ------ ----
1,217 1,183 (97)
Deferred............................................ -- -- --
------ ------ ----
$1,217 $1,183 $(97)
====== ====== ====
</TABLE>
The company's combined effective tax rate differed from the federal
statutory rate as set forth below:
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30, PERIOD JULY 1
------------------------------ TO AUGUST 15,
1995 1996 1996
------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Tax at U.S. Statutory Rates............. 887 34% 625 34% (89) (34)%
State taxes, net of federal benefits.... 156 6 110 6 (11) (4)
Increase in valuation allowance......... 170 6 445 24 -- --
Other................................... 4 -- 3 -- 3 1
----- -- ----- -- --- ---
1,217 46% 1,183 64% (97) (37)%
===== == ===== == === ===
</TABLE>
8. 401(K) RETIREMENT PLAN
The Company has a defined contribution retirement plan covering all
full-time employees who have completed one year of service and are age
twenty-one or older. Participants may contribute 2% to 15% of their
compensation. Employer contributions amount to 25% of employee contributions.
The Company contributed $72 and $175 to the plan during the fiscal years ended
June 30, 1995 and 1996, respectively. The Company made no contributions for the
period July 1, 1996 to August 15, 1996.
F-27
<PAGE> 99
REPORT OF INDEPENDENT AUDITORS
Board of Directors
Denton Community Hospital
We have audited the accompanying statements of income, changes in equity of
Parent, and cash flows for the year ended December 31, 1995 and for the period
January 1, 1996 to November 12, 1996 of Denton Community Hospital (the
"Hospital"). These financial statements are the responsibility of the Hospital's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the results of operations and cash flows of Denton
Community Hospital for the year ended December 31, 1995 and for the period
January 1, 1996 to November 12, 1996, in conformity with generally accepted
accounting principles.
ERNST & YOUNG LLP
Nashville, Tennessee
January 23, 1997
F-28
<PAGE> 100
DENTON COMMUNITY HOSPITAL
STATEMENTS OF INCOME
(IN THOUSANDS)
<TABLE>
<CAPTION>
PERIOD
YEAR ENDED JANUARY 1, 1996 TO
DECEMBER 31, NOVEMBER 12,
1995 1996
---------------------------------
<S> <C> <C>
Net patient revenue......................................... $42,251 $33,401
Other revenue............................................... 427 742
------- -------
Total revenue..................................... 42,678 34,143
Expenses:
Salaries, wages and benefits.............................. 13,258 10,842
Supplies and Other........................................ 10,405 8,098
Provision for bad debts................................... 5,131 4,852
Purchased services........................................ 2,994 2,303
Professional services..................................... 152 104
Rent and lease expense.................................... 3,895 1,446
Depreciation.............................................. 1,429 1,753
Interest expense.......................................... 533 1,646
Management fees........................................... 2,510 2,485
------- -------
40,307 33,529
------- -------
Income before income taxes.................................. 2,371 614
Income tax provision........................................ 922 254
------- -------
Net income........................................ $ 1,449 $ 360
======= =======
</TABLE>
See accompanying notes.
F-29
<PAGE> 101
DENTON COMMUNITY HOSPITAL
STATEMENTS OF CHANGES IN EQUITY OF PARENT
(IN THOUSANDS)
<TABLE>
<S> <C>
Balance at January 1, 1995.................................. $ 9,385
Net income................................................ 1,449
Dividend to Parent........................................ (2,366)
-------
Balance at December 31, 1995................................ 8,468
Net income................................................ 360
-------
Balance at November 12, 1996................................ $ 8,828
=======
</TABLE>
See accompanying notes.
F-30
<PAGE> 102
DENTON COMMUNITY HOSPITAL
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
PERIOD
YEAR ENDED JANUARY 1, 1996 TO
DECEMBER 31, NOVEMBER 12,
1995 1996
-------------------------------
<S> <C> <C>
OPERATING ACTIVITIES:
Net income.................................................. $ 1,449 $ 360
Adjustments to reconcile net income to net
Cash provided by operating activities:
Depreciation........................................... 1,429 1,753
Provision for bad debts................................ 5,131 4,852
Changes in operating assets and liabilities:
Accounts receivable.................................. (4,958) (3,868)
Other current assets................................. (15) (268)
Other current liabilities............................ 1,011 (1,468)
Third-party settlements.............................. 633 200
------- -------
Net cash provided by operating activities................... 4,680 1,561
INVESTING ACTIVITIES:
Deposit received on sale of Hospital........................ -- 500
Purchases of property and equipment, net.................... (1,052) (266)
Decrease in other assets, net............................... 17 6
------- -------
Net cash (used in) provided by investing activities......... (1,035) 240
FINANCING ACTIVITIES:
Payment of debt............................................. -- (1,168)
Net transfers to parent..................................... (3,537) (878)
------- -------
Net cash used in financing activities....................... (3,537) (2,046)
------- -------
Increase (decrease) in cash................................. 108 (245)
Cash at beginning of year................................... 126 234
------- -------
Cash at end of year......................................... $ 234 $ (11)
======= =======
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid............................................. $ 533 $ 1,646
======= =======
Income tax payments....................................... $ 922 $ 356
======= =======
NONCASH TRANSACTIONS:
Acquisition of property and equipment through assumption
of debt and increases in intercompany balances......... $ -- $16,097
======= =======
Noncash distributions to Parent........................... $ 2,366 $ --
======= =======
</TABLE>
See accompanying notes.
F-31
<PAGE> 103
DENTON COMMUNITY HOSPITAL
NOTES TO FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS)
NOVEMBER 12, 1996
1. ORGANIZATION
Denton Community Hospital (the "Hospital"), until November 12, 1996, was a
division of HCA Health Services of Texas, Inc., which is an indirect
wholly-owned subsidiary of Columbia/HCA Healthcare Corporation ("Columbia" or
the "Parent"), one of the largest health care services companies in the United
States. Columbia operates over 300 acute care and psychiatric hospitals and over
100 ambulatory surgery centers located in 36 states and two foreign countries.
The Hospital provides health care services to patients in and around the Denton,
Texas area. The Hospital receives payment for patient services from the federal
government primarily under the Medicare program, state governments under their
respective Medicaid programs, health maintenance organizations, preferred
provider organizations and other private insurers and directly from patients.
The purpose of these financial statements is to comply with Article 3 of
Regulation S-X for filing under the Securities Act of 1933.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REVENUE
Revenue is based on established billing rates less allowances and discounts
for patients covered by Medicare, Medicaid and various other discount
arrangements. Payments received under these programs and arrangements, which are
based on either predetermined rates or the cost of services, are generally less
than the Hospital's customary charges, and the differences are recorded as
contractual adjustments or policy discounts at the time service is rendered.
Revenue is net of contractual adjustments and policy discounts of $43,515
and $37,153 for the year ended December 31, 1995 and the period January 1, 1996
to November 12, 1996, respectively. The provision for doubtful accounts is
included in operating expenses.
MANAGEMENT FEES
Management fees represent an allocation of home office and regional
expenses of Columbia.
PROPERTY AND EQUIPMENT
Depreciation is computed by the straight-line method over the estimated
useful life of the assets. Depreciation expense was approximately $1,429 and
$1,753 for the year ended December 31, 1995 and the period January 1, 1996 to
November 12, 1996, respectively.
INCOME TAXES
Columbia files consolidated federal and state income tax returns which
include the accounts of the Hospital. The provision for income taxes is
determined utilizing maximum federal and state statutory rates applied to income
before income taxes adjusted for nonallowable amortization of cost in excess of
net assets acquired. Income tax benefits or liabilities are charged to the
intercompany account balance. All income tax payments are made by the Hospital
through Columbia.
GENERAL AND PROFESSIONAL LIABILITY RISKS
Columbia assumes the liability for all general and professional liability
claims incurred and maintains the related reserve; accordingly, no reserve for
liability risks is recorded on the accompanying balance sheets. The cost of
general and professional liability coverage is allocated by Columbia's captive
insurance company to the
F-32
<PAGE> 104
DENTON COMMUNITY HOSPITAL
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
GENERAL AND PROFESSIONAL LIABILITY RISKS (CONTINUED)
Hospital based on actuarially determined estimates. The cost for the year ended
December 31, 1995 and the period January 1, 1996 to November 12, 1996, was
approximately $697 and $739, respectively.
The Hospital participates in a self-insured program for workers'
compensation and health insurance administered by Columbia. The cost, based on
the Hospital's experience, was approximately $871 and $762 for the year ended
December 31, 1995 and the period January 1, 1996 to November 12, 1996,
respectively.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
RECLASSIFICATIONS
Certain prior period amounts have been reclassified in order to conform to
current period presentation. These reclassifications had no effect on the
results of operations previously reported.
3. RETIREMENT PLANS
The Hospital participates in Columbia's defined contribution retirement
plans, which cover substantially all employees. Benefits are determined as a
percentage of a participant's earned income. Retirement expense was
approximately $73 and $289 for the year ended December 31, 1995 and the period
January 1, 1996 to November 12, 1996, respectively.
4. INTERCOMPANY BALANCES
Certain debt balances were allocated to the Hospital by Columbia. All
principal and interest payments on the debt allocated from Columbia were made by
the Hospital through Columbia. The Hospital is charged interest on the allocated
debt at 8.25%.
During 1996, the Hospital was charged interest on other intercompany debt
balances at 10% based on the outstanding balance at month-end pursuant to a
borrowing agreement with Columbia. For intercompany receivable balances, if any,
the Hospital received interest income at a rate approximating 10%. Interest
expense, net of any interest income, under these arrangements is included in the
Statements of Income.
5. LEASES
Rent and lease expense consists primarily of amounts paid under operating
lease agreements for buildings and equipment.
HOSPITAL LEASE
Certain real property and improvements and equipment constituting the
Hospital (the "leased assets") were leased in accordance with the Second
Restated Hospital Lease Agreement (the "Restated Agreement") dated as of January
13, 1992. The original term of the lease as agreed upon in the initial lease
agreement dated July 15, 1987 commenced May 31, 1989 and in accordance with the
Restated Agreement would have continued to December 31, 2001. Annual rental
payments associated with the Restated Agreement consisted of an annual base rent
("base rent") plus an annual contingent rent equal to the Hospital's pre-tax
profit
F-33
<PAGE> 105
DENTON COMMUNITY HOSPITAL
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
5. LEASES (CONTINUED)
HOSPITAL LEASE (CONTINUED)
generated in excess of a function of the Hospital's return on investment as
defined in the Restated Agreement ("bonus rent").
Concurrent with entering into the Restated Agreement, Columbia entered into
an option agreement which secured Columbia's right to purchase the leased assets
at fair market value as defined in the option agreement. Effective February 6,
1996, the Restated Agreement was terminated as Columbia exercised its option and
purchased the leased assets for $16,097 including the assumption of the related
debt of $8,756.
FUTURE MINIMUM RENTAL COMMITMENTS
Future minimum rental commitments under noncancellable operating leases
(with an initial or remaining term in excess of one year) at November 12, 1996
are as follows:
<TABLE>
<S> <C>
1997........................................................ $378
1998........................................................ 378
1999........................................................ 45
----
Total minimum rental commitments.................. $801
====
</TABLE>
6. INCOME TAXES
Significant components of the income tax (benefit) provision attributable
to operations are as follows:
<TABLE>
<CAPTION>
FEBRUARY 1, 1996 TO
DECEMBER 31, 1995 NOVEMBER 12, 1996
----------------------------------------
<S> <C> <C>
Current:
Federal............................................ $ 939 $ 1,358
State.............................................. 80 116
------ -------
Total Current.............................. 1,019 1,474
------ -------
Deferred:
Federal............................................ (90) (1,124)
State.............................................. (7) (96)
------ -------
Total Deferred............................. (97) (1,220)
------ -------
Income tax (benefit) provision....................... $ 922 $ 254
====== =======
</TABLE>
The Company's consolidated effective tax rate differed from the federal
statutory rate as set forth below:
<TABLE>
<CAPTION>
JANUARY 1, 1996 TO
DECEMBER 31, 1995 NOVEMBER 12, 1996
----------------- -------------------
AMOUNT PERCENT AMOUNT PERCENT
----------------------------------------
<S> <C> <C> <C> <C>
Tax at U.S. statutory rates..................... $830 35% $215 35%
State taxes, net of federal benefits............ 71 3 18 3
Other........................................... 21 1 21 3
---- -- ---- --
$922 39% $254 41%
==== == ==== ==
</TABLE>
F-34
<PAGE> 106
DENTON COMMUNITY HOSPITAL
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
7. COMMITMENTS AND CONTINGENCIES
Final determination of amounts earned under prospective payment and
cost-reimbursement activities is subject to review by appropriate governmental
authorities or their agents. In the opinion of management, adequate provision
has been made for any adjustments that may result from such reviews.
The Hospital is subject to claims and suits arising in the ordinary course
of business. In the opinion of management, the ultimate resolution of such
pending legal proceedings will not have a material effect on the Hospital's
results of operations.
8. SUBSEQUENT EVENTS
In connection with a Federal Trade Commission consent order resulting from
Columbia's merger with Health Trust, Inc. -- The Hospital Company, Columbia
executed a definitive sales agreement in August 1996 to divest the Hospital to
NetCare Health Systems, Inc. The sale of the Hospital was consummated effective
November 12, 1996. Columbia received $500 as a portion of the proceeds from the
sale.
F-35
<PAGE> 107
REPORT OF INDEPENDENT AUDITORS
Board of Directors
San Clemente Hospital and Medical Center
We have audited the accompanying balance sheets of San Clemente Hospital
and Medical Center (the "Hospital") (a division of Samaritan Health Systems) as
of December 31, 1996 and 1997 and the related statements of operations and
changes in net assets (deficit), and cash flows for each of the three years in
the period ended December 31, 1997. These financial statements are the
responsibility of the Hospital's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of San Clemente Hospital and
Medical Center at December 31, 1996 and 1997, and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
1997, in conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Nashville, Tennessee
June 1, 1998
F-36
<PAGE> 108
SAN CLEMENTE HOSPITAL AND MEDICAL CENTER
BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
----------------- MARCH 31,
1996 1997 1998
---------------------------------
(UNAUDITED --
NOTE 7)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 347 $ 257 $ --
Patient accounts receivable, less allowance for doubtful
accounts of $945, $2,430 and $3,296 (unaudited) for
1996, 1997 and 1998, respectively...................... 5,379 6,172 5,136
Inventories............................................... 367 386 451
Prepaid expenses and other current assets................. 192 72 120
------- ------- -------
Total current assets.............................. 6,285 6,887 5,707
Property and equipment, at cost:
Land and improvements..................................... 8,645 2,665 3,869
Building and improvements................................. 10,825 6,996 8,164
Equipment................................................. 7,251 5,431 2,268
------- ------- -------
26,721 15,092 14,301
Less accumulated depreciation............................... (6,393) (7,740) (8,128)
------- ------- -------
20,328 7,352 6,173
Construction in Progress.................................... 1,340 511 1,437
------- ------- -------
Net property and equipment............................. 21,668 7,863 7,610
Due from Samaritan.......................................... 83 342 818
Other assets................................................ 15 -- --
------- ------- -------
Total assets...................................... $28,051 $15,092 $14,135
======= ======= =======
LIABILITIES AND NET ASSETS (DEFICIT)
Current liabilities:
Notes Payable............................................. $13,167 $ 170 $ --
Accounts payable.......................................... 619 565 723
Employee compensation and benefits........................ 631 609 339
Other accrued liabilities................................. 207 359 344
------- ------- -------
Total current liabilities......................... 14,624 1,703 1,406
Third-party settlements..................................... 1,053 835 720
Due to Columbia............................................. 8,136 17,778 18,902
Net assets (deficit)........................................ 4,238 (5,224) (6,893)
------- ------- -------
Total liabilities and net assets (deficit)........ $28,051 $15,092 $14,135
======= ======= =======
</TABLE>
See accompanying notes.
F-37
<PAGE> 109
SAN CLEMENTE HOSPITAL AND MEDICAL CENTER
STATEMENTS OF OPERATIONS
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
---------------------------- ----------------------
1995 1996 1997 1997 1998
-----------------------------------------------------
(UNAUDITED -- NOTE 7)
<S> <C> <C> <C> <C> <C>
Net patient revenue.............................. $20,135 $21,234 $ 20,934 $6,206 $ 5,223
Other revenue.................................... 351 339 240 77 42
------- ------- -------- ------ -------
Total Revenue.......................... 20,486 21,573 21,174 6,283 5,265
Expenses:
Salaries and benefits.......................... 11,371 10,795 11,736 2,837 3,020
Supplies and other............................. 2,564 2,454 2,901 665 681
Provision for bad debts........................ 1,386 1,444 3,307 552 1,151
Purchased services............................. 1,324 2,975 3,826 862 660
Management fees................................ 364 687 1,499 370 393
Repairs and maintenance........................ 1,202 643 745 222 134
Rent and lease expense......................... 577 661 604 160 204
Depreciation................................... 1,546 1,690 1,346 294 388
Interest expense............................... 2,114 1,391 1,657 449 439
Other operating expenses....................... 1,019 1,964 1,925 438 449
Write-down of long lived assets................ -- -- 18,631 -- --
------- ------- -------- ------ -------
23,467 24,704 48,177 6,849 7,519
------- ------- -------- ------ -------
Excess of expenses over revenues................. $(2,981) $(3,131) $(27,003) $ (566) $(2,254)
======= ======= ======== ====== =======
</TABLE>
See accompanying notes.
F-38
<PAGE> 110
SAN CLEMENTE HOSPITAL AND MEDICAL CENTER
STATEMENTS OF CHANGES IN NET ASSETS (DEFICIT)
(IN THOUSANDS)
<TABLE>
<S> <C>
Balance at January 1, 1995.................................. $ 4,218
Transfers from affiliates................................. 3,150
Excess of expenses over revenues.......................... (2,981)
--------
Balance at December 31, 1995................................ 4,387
Transfers from affiliates................................. 2,982
Excess of expenses over revenues.......................... (3,131)
--------
Balance at December 31, 1996................................ 4,238
Transfers from affiliates................................. 17,541
Excess of expenses over revenues.......................... (27,003)
--------
Balance at December 31, 1997................................ (5,224)
Transfers from affiliates (Unaudited -- Note 7)........... 585
Excess of expenses over revenues (Unaudited -- Note 7).... (2,254)
--------
Balance at March 31, 1998 (Unaudited -- Note 7)............. $ (6,893)
========
</TABLE>
See accompanying notes.
F-39
<PAGE> 111
SAN CLEMENTE HOSPITAL AND MEDICAL CENTER
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
---------------------------- -------------------
1995 1996 1997 1997 1998
--------------------------------------------------
(UNAUDITED -- NOTE
7)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Excess of expenses over revenues............... $(2,981) $(3,131) $(27,003) $ (566) $(2,254)
Adjustments to reconcile excess of expenses
over revenues to net cash used in operating
activities:
Depreciation................................. 1,546 1,690 1,346 294 388
Provision for doubtful accounts.............. 1,386 1,444 3,307 552 1,151
Write-down of long-lived assets.............. -- -- 18,631 -- --
Changes in operating assets and liabilities:
Accounts receivable....................... (2,388) (2,431) (4,100) (1,780) (115)
Inventories............................... 206 (160) (20) (31) (65)
Prepaid expenses and other current
assets.................................. 35 (90) 135 (62) (48)
Accounts payable.......................... (483) (120) (54) (596) 159
Other current liabilities................. (614) 551 130 (420) (285)
Third-party settlements................... 592 (1,808) (218) (147) (115)
------- ------- -------- ------- -------
Net cash used in operating activities.......... (2,701) (4,055) (7,846) (2,756) (1,184)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment, net....... (339) (631) (1,572) (116) (136)
Increase in other long-term assets............. (66) -- -- -- --
------- ------- -------- ------- -------
Net cash used in investing activities.......... (405) (631) (1,572) (116) (136)
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on notes payable............ (105) -- -- (273) --
Transfer from (to) affiliate................... -- -- (55) 1,289 415
Increase (decrease) in due from Samaritan...... 1,259 (2,018) (259) (69) (476)
Increase is due to Columbia.................... 1,936 6,877 9,642 2,981 1,124
------- ------- -------- ------- -------
Net cash provided by financing activities...... 3,090 4,859 9,328 3,928 1,063
------- ------- -------- ------- -------
INCREASE (DECREASE) IN CASH.................... (16) 173 (90) 1,056 (257)
CASH AT BEGINNING OF YEAR...................... 190 174 347 347 257
------- ------- -------- ------- -------
CASH (BANK OVERDRAFT) AT END OF YEAR........... $ 174 $ 347 $ 257 $ 1,403 $ --
======= ======= ======== ======= =======
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid.................................. $ 1,181 $ 999 $ 454 $ 227 $ --
======= ======= ======== ======= =======
NONCASH TRANSACTIONS:
Principal payments on notes payable by
Samaritan.................................... $ 2,633 $ 2,633 $ 12,997 $ -- $ --
======= ======= ======== ======= =======
Purchases of property and equipment by
Samaritan and Columbia....................... $ 517 $ 349 $ 4,600 $ -- $ 170
======= ======= ======== ======= =======
</TABLE>
See accompanying notes.
F-40
<PAGE> 112
SAN CLEMENTE HOSPITAL AND MEDICAL CENTER
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997
(INFORMATION PERTAINING TO THE THREE MONTH PERIODS ENDING
MARCH 31, 1997 AND 1998 IS UNAUDITED)
(DOLLAR AMOUNTS IN THOUSANDS)
1. ORGANIZATION
San Clemente Hospital and Medical Center (the "Hospital") is an acute care
hospital with a transitional care unit, located in San Clemente, California
where it provides services to patients who reside locally. Through May 14, 1995,
the Hospital was a division of Samaritan Health System ("Samaritan"), an Arizona
non-profit corporation. Beginning May 15, 1995, the Hospital operated under an
affiliation agreement (the "Affiliation Agreement") between Samaritan and
Columbia/HCA Healthcare Corporation ("Columbia"). The Affiliation Agreement was
for a term of three years during which time the Hospital was managed by
Columbia. The Affiliation Agreement expired on June 1, 1998.
Effective June 1, 1998, the Affiliation Agreement between Samaritan and
Columbia expired at which time the inventories and property and equipment of the
Hospital were sold to, and certain employee related liabilities were assumed by
NetCare Health Systems, Inc. for $8,250.
The purpose of these financial statements is to comply with Article 3 of
the Regulation S-X for filing under the Securities Act of 1933.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with a maturity of 90
days or less when purchased to be cash equivalents. Carrying values of cash and
cash equivalents approximate fair value due to the short-term nature of these
instruments.
PATIENT ACCOUNTS RECEIVABLE
The Company's primary concentration of credit risk is patient accounts
receivable, which consist of amounts owed by various governmental agencies,
insurance companies and private patients. The Company manages the receivables by
regularly reviewing its accounts and contracts and by providing appropriate
allowances for uncollectable amounts.
The Hospital grants credit without collateral to its patients, most of who
are local residents and are insured under third-party payor agreements.
Agreements with payors include (i) Medicare, (ii) MediCal, (iii) private payors
including commercial carriers and health maintenance organizations, and (iv)
others. The following table summarizes the percent of gross accounts receivable
from all payors.
<TABLE>
<CAPTION>
1996 1997
------------
<S> <C> <C>
Medicare.................................................... 22% 23%
MediCal..................................................... 8 6
Private..................................................... 37 39
Other....................................................... 33 32
--- ---
100% 100%
=== ===
</TABLE>
The Hospital recognizes that revenues and receivables from government
agencies are significant to the Hospital's operations, but management does not
believe that there are significant credit risks associated with these
governmental agencies. Private and other amounts due consist of receivables from
various payors, including individuals involved in diverse activities subject to
differing economic conditions and do not represent any concentrated credit risk
to the Hospital. Management continually monitors and adjusts its allowances
associated with these receivables.
F-41
<PAGE> 113
SAN CLEMENTE HOSPITAL AND MEDICAL CENTER
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PATIENT ACCOUNTS RECEIVABLE (CONTINUED)
Laws and regulations governing the Medicare and MediCal programs are
complex and subject to interpretation. The Hospital believes that it is in
compliance with all applicable laws and regulations and is not aware of any
pending or threatened investigations involving allegations of potential
wrongdoing. While no such regulatory inquiries have been made, compliance with
such laws and regulations can be subject to future government review and
interpretation as well as significant regulatory action including fines,
penalties, and exclusion from the Medicare and MediCal programs.
THIRD-PARTY SETTLEMENTS
Final Determination of amounts earned under prospective payment and
cost-reimbursement activities is subject to review by appropriate governmental
authorities or their agents. In the opinion of management, adequate provision
has been made for any adjustments that may result from such reviews.
NET PATIENT REVENUE
Net patient revenue includes amounts estimated by management to be
reimbursable by Medicare and Medicaid under provisions of cost or prospective
reimbursement formulas in effect. Amounts received are generally less than the
established billing rates of the Hospital and the differences (contractual
allowances) are reported as deductions from patient service revenue. The effects
of other arrangements for providing services at less than established rates are
also reported as deductions from patient service revenue.
Net patient revenue is net of contractual adjustments and policy discounts
of approximately $18,972, $23,538, and $26,457 for the years ended December 31,
1995, 1996, and 1997, respectively.
The Hospital receives payment for services rendered from federal and state
agencies (under Medicare, MediCal and Champus programs), managed care health
plans, commercial insurance companies, employers and patients. Revenues derived
from individual payors representing over 10% of revenue only included Medicare
and was 39%, 51%, and 51% in 1995, 1996, and 1997, respectively.
DUE TO COLUMBIA
Amounts due to Columbia represent the net excess of funds transferred to or
paid on behalf of the Hospital over funds transferred to the centralized cash
management account of Columbia. Generally, this balance is increased by
automatic cash transfers from the account to reimburse the Hospital's bank
accounts for operating expenses and to pay the Hospital's debt, completed
construction project additions, fees and services provided by Columbia,
including information systems services, and other operating expenses, such as
payroll, interest, insurance, and income taxes. Generally, the balance is
decreased through daily cash deposits by the Hospital to the account.
The Hospital is charged interest on the debt balances at rates generally
ranging from 8% to 9% based on the outstanding balance at month-end pursuant to
a borrowing agreement with Columbia. Interest expense, net of any interest
income, under these arrangements is included in the accompanying statement of
operations.
TRANSFERS FROM AFFILIATES
Pursuant to the Affiliation Agreement, Samaritan was obligated to pay the
debt service payments of the Hospital. In addition, Columbia and Samaritan
agreed to fund the Hospital's capital expenditures and improvements during the
term of the Affiliation Agreement. Such debt service payments and capital
expenditures are included in the accompanying statements of changes in net
assets. Capital expenditures and
F-42
<PAGE> 114
SAN CLEMENTE HOSPITAL AND MEDICAL CENTER
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
improvements incurred by the Hospital which at December 31, 1997 remained to be
reimbursed by Samaritan pursuant to the Affiliation Agreement are included in
the accompanying balance sheets as amounts due from Samaritan.
INVENTORIES
Inventories consist principally of pharmaceuticals and supplies and are
stated at the lower of cost (first-in, first-out) or market.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Routine maintenance and repairs
are charged to expense as incurred. Expenditures that increase values, change
capacities or extend useful lives are capitalized. Depreciation is computed by
the straight-line method over the estimated useful lives of the assets, which
approximate 3 to 40 years.
INCOME TAXES
Samaritan Health System is a not-for-profit corporation as described in
Section 501(c)(3) of the Internal Revenue Code. Accordingly, the Hospital, as a
division of Samaritan, is exempt from federal income taxes on related income
pursuant to Section 501(a) of the Code.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
3. WRITE-DOWN OF LONG-LIVED ASSETS
Inventories, property and equipment of the Hospital were sold to, and
certain employee related liabilities were assumed by NetCare Health Systems,
Inc. ("NetCare") at a price substantially less than the carrying value (see Note
1). As a result of this indicator of impairment, the Hospital evaluated the
carrying value of the assets. Based on this evaluation, the Hospital made the
determination to adjust the related assets to fair market value by recording a
write-down of approximately $18,631 in 1997. Fair value was based on the asset
purchase price paid by NetCare.
4. NOTES PAYABLE
At December 31, 1996, notes payable consisted primarily of certain Senior
Secured Notes (the "Notes") with Connecticut General Life Insurance Company
("CIGNA"), bearing interest at 11.38%, with principal due in annual installments
of $2,633. The Notes, which were repaid in full in June 1997, were secured by
first deeds of trust on certain property and equipment of the Hospital.
5. RETIREMENT PLAN
The Hospital participates in Columbia's defined contribution retirement
plans, which cover substantially all employees. Benefits are determined as a
percentage of a participant's earned income. Retirement expense was
approximately $239, $249, and $244 for the years ended December 31, 1995, 1996,
and 1997, respectively.
F-43
<PAGE> 115
SAN CLEMENTE HOSPITAL AND MEDICAL CENTER
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
6. COMMITMENTS AND CONTINGENCIES
Final determination of amounts earned under prospective payment and
cost-reimbursement activities is subject to review and audit by appropriate
governmental authorities or their agents. In the opinion of management, adequate
provision has been made for any adjustments that may result from such reviews.
Columbia assumes the liability for all general and professional liability
claims incurred and maintains the related reserve; accordingly, no reserve for
liability risks is recorded on the accompanying balance sheet. The cost of
general and professional liability coverage is allocated by Columbia's captive
insurance company to the Hospital based on actuarially determined estimates. The
cost for the years ended December 31, 1995, 1996, and 1997 was approximately
$409, $412, and $364, respectively.
Throughout 1995, the Hospital participated in the workers' compensation
insurance plan administered by Samaritan. The cost was approximately $468 for
the year ended December 31, 1995. In 1996, the Hospital began participating in a
self-insured program for workers' compensation administered by Columbia. The
cost, based on the Hospital's experience, was approximately $181 and $178 for
the years ended December 31, 1996 and 1997, respectively.
The Hospital is subject to claims and suits arising in the ordinary course
of business. In the opinion of management, the ultimate resolution of such
pending legal proceedings will not have a material effect on the Hospital's
results of operations or financial position.
7. UNAUDITED INTERIM FINANCIAL INFORMATION
The balance sheet as of March 31, 1998, the related statements of
operations and changes in net assets and cash flows for the three months ended
March 31, 1997 and 1998, (interim financial statements) have been prepared by
the Hospital and are unaudited. The interim financial statements include all
adjustments consisting of only normal recurring adjustments necessary for a fair
statement of the results of the interim periods.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted from the interim financial statements. The
interim financial statements should be read in conjunction with the Hospital's
December 31, 1997 audited financial statements appearing here in. The results
for the three months ended March 31, 1998 may not be indicative of operating
results for the full year.
F-44
<PAGE> 116
======================================================
NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS IN
CONNECTION WITH THE OFFERING COVERED BY THIS PROSPECTUS. IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE COMPANY OR THE UNDERWRITERS. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER
TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, THE COMMON STOCK IN ANY
JURISDICTION WHERE, OR TO ANY PERSON TO WHOM, IT IS UNLAWFUL TO MAKE SUCH OFFER
OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE AN IMPLICATION THAT THERE HAS
NOT BEEN ANY CHANGE IN THE FACTS SET FORTH IN THIS PROSPECTUS OR IN THE AFFAIRS
OF THE COMPANY SINCE THE DATE HEREOF.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary.................... 1
Risk Factors.......................... 7
Use of Proceeds....................... 14
Dividend Policy....................... 14
Capitalization........................ 15
Dilution.............................. 16
Selected Financial and Other Data..... 17
Pro Forma Condensed Consolidated
Financial Statements................ 19
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 27
Business.............................. 35
Management............................ 50
Certain Relationships and Related
Transactions........................ 54
Principal Stockholders................ 55
Description of Capital Stock.......... 55
Shares Eligible for Future Sale....... 59
Underwriting.......................... 61
Certain Federal Tax Considerations for
Non-U.S. Holders of Common Stock.... 63
Legal Matters......................... 66
Experts............................... 66
Available Information................. 66
Disclosure Regarding Forward-Looking
Statements.......................... 67
Index to Financial Statements......... F-1
</TABLE>
UNTIL , 1998 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL
DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPATING
IN THE DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS DELIVERY
REQUIREMENT IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS
WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR
SUBSCRIPTIONS.
======================================================
======================================================
SHARES
NETCARE HEALTH
SYSTEMS, INC.
COMMON STOCK
------------------------
PROSPECTUS
------------------------
MERRILL LYNCH & CO.
BEAR, STEARNS & CO. INC.
CREDIT SUISSE FIRST BOSTON
SALOMON SMITH BARNEY
, 1998
======================================================
<PAGE> 117
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF ANY OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.
[ALTERNATE PAGE FOR INTERNATIONAL PROSPECTUS]
SUBJECT TO COMPLETION
PRELIMINARY PROSPECTUS DATED JUNE 18, 1998
PROSPECTUS
SHARES
NETCARE HEALTH SYSTEMS, INC.
COMMON STOCK
------------------------
All of the shares of Common Stock offered hereby are being
sold by NetCare Health Systems, Inc. ("NetCare or the "Company"). Of the
shares of Common Stock offered hereby, shares are being offered for sale
initially outside the United States and Canada by the International Managers and
shares are being offered for sale initially in a concurrent offering in the
United States and Canada by the U.S. Underwriters. The initial public offering
price and the underwriting discount per share will be identical for both
offerings. See "Underwriting."
Prior to the Offerings, there has been no public market for the Common
Stock. It is currently estimated that the initial public offering price will be
between $ and $ per share. For a discussion relating to factors to
be considered in determining the initial public offering price, see
"Underwriting." Application has been made to list the Common Stock on the New
York Stock Exchange under the symbol "NHS".
SEE "RISK FACTORS" BEGINNING ON PAGE FOR A DISCUSSION OF
CERTAIN FACTORS THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE
COMMON STOCK OFFERED HEREBY.
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS
THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
=====================================================================================================================
PRICE TO UNDERWRITING PROCEEDS TO
PUBLIC DISCOUNT(1) COMPANY(2)
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Per Share................................ $ $ $
- ---------------------------------------------------------------------------------------------------------------------
Total(3)................................. $ $ $
=====================================================================================================================
</TABLE>
(1) The Company has agreed to indemnify the several Underwriters against certain
liabilities, including certain liabilities under the Securities Act of 1933,
as amended. See "Underwriting."
(2) Before deduction of expenses payable by the Company, estimated at
$ .
(3) The Company has granted the International Managers and the U.S. Underwriters
options to purchase up to an additional shares and
shares of Common Stock, respectively, in each case exercisable within 30
days after the date hereof, solely to cover over-allotments, if any. If such
options are exercised in full, the total Price to Public, Underwriting
Discount and Proceeds to Company will be $ , $ and
$ respectively. See "Underwriting."
------------------------
The shares of Common Stock are offered by the several Underwriters, subject
to prior sale, when, as and if issued to and accepted by them, subject to
approval of certain legal matters by counsel for the Underwriters and certain
other conditions. The Underwriters reserve the right to withdraw, cancel or
modify such offer and to reject orders in whole or in part. It is expected that
delivery of the shares of Common Stock will be made in New York, New York, on or
about , 1998.
------------------------
MERRILL LYNCH INTERNATIONAL
BEAR, STEARNS INTERNATIONAL LIMITED
CREDIT SUISSE FIRST BOSTON
SALOMON SMITH BARNEY INTERNATIONAL
------------------------
The date of this Prospectus is , 1998.
<PAGE> 118
[ALTERNATE PAGE FOR INTERNATIONAL PROSPECTUS]
UNDERWRITING
Merrill Lynch International, Bear, Stearns International Limited, Credit
Suisse First Boston (Europe) Limited and Smith Barney Inc. are acting as lead
managers (the "Lead Managers") for each of the International Managers named
below (the "International Managers"). Subject to the terms and conditions set
forth in an international purchase agreement (the "International Purchase
Agreement") among the Company and the International Managers, and concurrently
with the sale of shares of Common Stock to the U.S. Underwriters (as
defined below), the Company has agreed to sell to the International Managers,
and each of the International Managers severally and not jointly has agreed to
purchase from the Company, the number of shares of Common Stock set forth
opposite its name below.
<TABLE>
<CAPTION>
NUMBER OF
INTERNATIONAL MANAGER SHARES
--------------------- ---------
<S> <C>
Merrill Lynch International.................................
Bear, Stearns International Limited.........................
Credit Suisse First Boston (Europe) Limited.................
Smith Barney Inc............................................
--------
Total..........................................
========
</TABLE>
The Company has also entered into a U.S. purchase agreement (the "U.S.
Purchase Agreement") with certain underwriters in the United States and Canada
(the "U.S. Underwriters" and, together with the International Managers, the
"Underwriters") for whom Merrill Lynch, Pierce, Fenner & Smith Incorporated
("Merrill Lynch"), Bear, Stearns & Co. Inc., Credit Suisse First Boston
Corporation and Smith Barney Inc. are acting as representatives (the "U.S.
Representatives"). Subject to the terms and conditions set forth in the U.S.
Purchase Agreement, and concurrently with the sale of shares of Common
Stock to the International Managers pursuant to the International Purchase
Agreement, the Company has agreed to sell to the U.S. Underwriters, and the U.S.
Underwriters severally have agreed to purchase from the Company, an aggregate of
shares of Common Stock. The initial public offering price per share and
the total underwriting discount per share of Common Stock are identical under
the International Purchase Agreement and the U.S. Purchase Agreement.
In the International Purchase Agreement and the U.S. Purchase Agreement,
the several International Managers and the several U.S. Underwriters,
respectively, have agreed, subject to the terms and conditions set forth
therein, to purchase all of the shares of Common Stock being sold pursuant to
each such agreement if any of the shares of Common Stock being sold pursuant to
such agreement are purchased. Under certain circumstances, under the
International Purchase Agreement and the U.S. Purchase Agreement, the
commitments of non-defaulting Underwriters may be increased. The closings with
respect to the sale of shares of Common Stock to be purchased by the
International Managers and the U.S. Underwriters are conditioned upon one
another.
The Lead Managers have advised the Company that the International Managers
propose initially to offer the shares of Common Stock to the public at the
initial public offering price set forth on the cover page of this Prospectus,
and to certain dealers at such price less a concession not in excess of $
per share of Common
<PAGE> 119
[ALTERNATE PAGE FOR INTERNATIONAL PROSPECTUS]
Stock. The International Managers may allow, and such dealers may reallow, a
discount not in excess of $
per share of Common Stock on sales to certain other dealers. After the initial
public offering, the public offering price, concession and discount may be
changed.
The Company has granted options to the International Managers, exercisable
for 30 days after the date of this Prospectus, to purchase up to an aggregate of
additional shares of Common Stock at the initial public offering price set
forth on the cover page of this Prospectus, less the underwriting discount. The
International Managers may exercise these options solely to cover
over-allotments, if any, made on the sale of the Common Stock offered hereby. To
the extent that the International Managers exercise these options, each
International Manager will be obligated, subject to certain conditions, to
purchase a number of additional shares of Common Stock proportionate to such
International Manager's initial amount reflected in the foregoing table. The
Company also has granted options to the U.S. Underwriters, exercisable for 30
days after the date of this Prospectus, to purchase up to an aggregate of
additional shares of Common Stock to cover over-allotments, if any, on terms
similar to those granted to the International Managers.
At the request of the Company, the Underwriters have reserved for sale, at
the initial public offering price, up to of the shares offered hereby
to be sold to certain directors, officers, employees, business associates and
related persons of the Company. The number of shares of Common Stock available
for sale to the general public will be reduced to the extent such persons
purchase such reserved shares. Any reserved shares which are not orally
confirmed for purchase within one day of the pricing of the Offerings will be
offered by the Underwriters to the general public on the same terms as the other
shares offered hereby.
The Company, the Company's executive officers and directors and CEP II have
agreed, subject to certain exceptions, not to directly or indirectly (i) offer,
pledge, sell, contract to sell, sell any option or contract to purchase,
purchase any option or contract to sell, grant any option, right or warrant for
the sale of or otherwise dispose of or transfer any shares of Common Stock or
securities convertible into or exchangeable or exercisable for Common Stock,
whether now owned or thereafter acquired by the person executing the agreement
or with respect to which the person executing the agreement thereafter acquires
the power of disposition, or file a registration statement under the Securities
Act with respect to the foregoing or (ii) enter into any swap or other agreement
that transfers, in whole or in part, the economic consequence of ownership of
the Common Stock whether any such swap or transaction is to be settled by
delivery of Common Stock or other securities, in cash or otherwise, without the
prior written consent of Merrill Lynch on behalf of the Underwriters for a
period of 180 days after the date of this Prospectus. See "Shares Eligible for
Future Sale."
The International Managers and the U.S. Underwriters have entered into an
intersyndicate agreement (the "Intersyndicate Agreement") that provides for the
coordination of their activities. Pursuant to the Intersyndicate Agreement, the
International Managers and the U.S. Underwriters are permitted to sell shares of
Common Stock to each other for purposes of resale at the initial public offering
price, less an amount not greater than the selling concession. Under the terms
of the Intersyndicate Agreement, the U.S. Underwriters and any dealer to whom
they sell shares of Common Stock will not offer to sell or sell shares of Common
Stock to persons who are non-U.S. or non-Canadian persons or to persons they
believe intend to resell to persons who are non-U.S. or non-Canadian persons,
and the International managers and any dealer to whom they sell shares of Common
Stock will not offer to sell or sell shares to Common Stock to U.S. persons or
to Canadian persons or to persons they believe intend to resell to U.S. or
Canadian persons, except in the case of transactions pursuant to the
Intersyndicate Agreement.
Prior to the Offerings, there has been no public market for the Common
Stock of the Company. The initial public offering price will be determined
through negotiations between the Company and the U.S. Representatives and the
Lead Managers. The factors considered in determining the initial public offering
price, in addition to prevailing market conditions, are price-earnings ratios of
publicly traded companies that the U.S. Representatives and the Lead Managers
believe to be comparable to the Company, certain financial information of the
Company, the history of, and the prospects for, the Company and the industry in
which it competes, and an assessment of the Company's management, its past and
present operations, the prospects for, and timing of, future revenues of the
Company, the present state of the Company's development, and the above factors
in relation to market values and various valuation measures of other companies
engaged in activities similar to the Company. There can be no assurance that an
active trading market will develop for the
<PAGE> 120
[ALTERNATE PAGE FOR INTERNATIONAL PROSPECTUS]
Common Stock or that the Common Stock will trade in the public market subsequent
to the Offerings at or above the initial public offering price.
Application has been made to list the Common Stock on the New York Stock
Exchange, under the symbol "NHS." In order to meet the requirements for listing
of the Common Stock on that exchange, the U.S. Underwriters and the
International Managers have undertaken to sell lots of 100 or more shares to a
minimum of 2,000 beneficial owners.
The Underwriters do not expect sales of the Common Stock to any accounts
over which they exercise discretionary authority to exceed 5% of the number of
shares being offered hereby.
The Company has agreed to indemnify the International Managers and the U.S.
Underwriters against certain liabilities, including certain liabilities under
the Securities Act, or to contribute to payments the U.S. Underwriters and the
International Managers may be required to make in respect thereof.
Until the distribution of the Common Stock is completed, rules of the
Securities and Exchange Commission may limit the ability of the Underwriters and
certain selling group members to bid for and purchase the Common Stock. As an
exception to these rules, the U.S. Representatives are permitted to engage in
certain transactions that stabilize the price of the Common Stock. Such
transactions consist of bids or purchases for the purpose of pegging, fixing or
maintaining the price of the Common Stock.
If the Underwriters create a short position in the Common Stock in
connection with the Offerings, i.e., if they sell more shares of Common Stock
than are set forth on the cover page of this Prospectus, the U.S.
Representatives may reduce that short position by purchasing Common Stock in the
open market. The U.S. Representatives may also elect to reduce any short
position by exercising all or part of the over-allotment option described above.
The U.S. Representatives may also impose a penalty bid on certain
Underwriters and selling group members. This means that if the U.S.
Representatives purchase shares of Common Stock in the open market to reduce the
Underwriters' short position or to stabilize the price of the Common Stock, they
may reclaim the amount of the selling concession from the Underwriters and
selling group members who sold those shares as part of the Offerings.
In general, purchases of a security for the purpose of stabilization or to
reduce a short position could cause the price of the security to be higher than
it might be in the absence of such purchases. The imposition of a penalty bid
might also have an effect on the price of the Common Stock to the extent that it
discourages resales of the Common Stock.
Neither the Company nor any of the Underwriters makes any representation or
prediction as to the direction or magnitude of any effect that the transactions
described above may have on the price of the Common Stock. In addition, neither
the Company nor any of the Underwriters makes any representation that the U.S.
Representatives will engage in such transactions or that such transactions, once
commenced, will not be discontinued without notice.
Each International Manager has agreed that (i) it has not offered or sold
and, prior to the expiration of the period of six months from the Closing Date,
will not offer or sell any shares of Common Stock to persons in the United
Kingdom, except to persons whose ordinary activities involve them in acquiring,
holding, managing or disposing of investments (as principal or agent) for the
purposes of their businesses or otherwise in circumstances which do not
constitute an offer to the public in the United Kingdom within the meaning of
the Public Offers of Securities Regulations 1995; (ii) it has complied and will
comply with all applicable provisions of the Financial Services Act 1986 with
respect to anything done by it in relation to the Common Stock in, from or
otherwise involving the United Kingdom; and (iii) it has only issued or passed
on and will only issue or pass on in the United Kingdom any document received by
it in connection with the issuance of Common Stock to a person who is of a kind
described in Article 11(3) of the Financial Services Act 1986 (Investment
Advertisements) (Exemptions) order 1996, as amended, or is a person to whom such
document may otherwise lawfully be issued or passed on.
No action has been or will be taken in any jurisdiction (except in the
United States) that would permit a public offering of the shares of Common Stock
or the possession, circulation or distribution of this Prospectus or any other
material relating to the Company or shares of Common Stock in any jurisdiction
where action for
<PAGE> 121
[ALTERNATE PAGE FOR INTERNATIONAL PROSPECTUS]
that purpose is required. Accordingly, the shares of Common Stock may not be
offered or sold, directly or indirectly, and neither this Prospectus nor any
other offering material or advertisements in connection with the shares of
Common Stock may be distributed or published, in or from any country or
jurisdiction except in compliance with any applicable rules and regulations of
any such country or jurisdiction.
Purchasers of the shares offered hereby may be required to pay stamp taxes
and other charges in accordance with the laws and practices of the country of
purchase in addition to the offering price set forth on the cover page hereof.
<PAGE> 122
[ALTERNATE PAGE FOR INTERNATIONAL PROSPECTUS]
======================================================
NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS IN
CONNECTION WITH THE OFFERING COVERED BY THIS PROSPECTUS. IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE COMPANY OR THE UNDERWRITERS. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER
TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, THE COMMON STOCK IN ANY
JURISDICTION WHERE, OR TO ANY PERSON TO WHOM, IT IS UNLAWFUL TO MAKE SUCH OFFER
OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE AN IMPLICATION THAT THERE HAS
NOT BEEN ANY CHANGE IN THE FACTS SET FORTH IN THIS PROSPECTUS OR IN THE AFFAIRS
OF THE COMPANY SINCE THE DATE HEREOF.
IN THIS PROSPECTUS, REFERENCES TO "DOLLARS" AND "$" ARE TO UNITED STATES
DOLLARS.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary.................... 1
Risk Factors.......................... 7
Use of Proceeds....................... 14
Dividend Policy....................... 14
Capitalization........................ 15
Dilution.............................. 16
Selected Financial and Other Data..... 17
Pro Forma Condensed Consolidated
Financial Statements................ 19
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 27
Business.............................. 35
Management............................ 50
Certain Relationships and Related
Transactions........................ 54
Principal Stockholders................ 55
Description of Capital Stock.......... 55
Shares Eligible for Future Sale....... 59
Underwriting.......................... 61
Certain Federal Tax Considerations for
Non-U.S. Holders of Common Stock.... 63
Legal Matters......................... 66
Experts............................... 66
Available Information................. 66
Disclosure Regarding Forward-Looking
Statements.......................... 67
Index to Financial Statements......... F-1
</TABLE>
UNTIL , 1998 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL
DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPATING
IN THE DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS DELIVERY
REQUIREMENT IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS
WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR
SUBSCRIPTIONS.
======================================================
======================================================
SHARES
NETCARE HEALTH
SYSTEMS, INC.
COMMON STOCK
------------------------
PROSPECTUS
------------------------
MERRILL LYNCH INTERNATIONAL
BEAR, STEARNS
INTERNATIONAL LIMITED
CREDIT SUISSE FIRST BOSTON
SALOMON SMITH BARNEY INTERNATIONAL
, 1998
======================================================
<PAGE> 123
PART II.
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table sets forth the various expenses in connection with the
offering of the Registrant's common stock, $.01 par value per share (the "Common
Stock") pursuant to this Registration Statement that will be paid fully by the
Registrant. All amounts shown are estimates, except the Securities and Exchange
Commission registration fee, the NASD filing fee and the New York Stock Exchange
listing fees.
<TABLE>
<S> <C>
Securities and Exchange Commission registration fee......... $33,925
NASD filing fee............................................. 12,000
NYSE listing fee............................................ *
"Blue Sky" fees and expenses................................ *
Printing, engraving and postage expenses.................... *
Accounting fees and expenses................................ *
Legal fees and expenses..................................... *
Transfer agent fees and expenses............................ *
Miscellaneous............................................... *
-------
Total............................................. *
=======
</TABLE>
- ---------------
* To be filed by amendment.
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Section 145 of the General Corporation Law of the State of Delaware
("Section 145") provides that a Delaware corporation may indemnify any persons
who are, or are threatened to be made, parties to any threatened, pending or
completed action, suit or proceeding, whether civil, criminal, administrative or
investigative (other than an action by or in the right of such corporation), by
reason of the fact that such person was an officer, director, employee or agent
of such corporation, or is or was serving at the request of such corporation as
a director, officer, employee or agent of another corporation or enterprise. The
indemnification may include expenses (including attorneys' fees), judgments,
fines and amounts paid in settlement actually and reasonably incurred by such
person in connection with such action, suit or proceeding, provided such person
acted in good faith and in a manner he reasonably believed to be in or not
opposed to the corporation's best interests and, with respect to any criminal
action or proceeding, had no reasonable cause to believe that that his conduct
was illegal. A Delaware corporation may indemnify any persons who are, or are
threatened to be made, a party to any threatened, pending or completed action or
suit by or in the right of the corporation by reason of the fact that such
person was a director, officer, employee or agent of such corporation, or is or
was serving at the request of such corporation as a director, officer, or agent
of another corporation or enterprise. The indemnity may include expenses
(including attorneys' fees) actually and reasonably incurred by such person in
connection with the defense or settlement of such action or suit, provided such
person acted in good faith and in a manner he reasonably believed to be in or
not opposed to the corporation's best interests except that no indemnification
is permitted without judicial approval if the officer or director is adjudged to
be liable to the corporation. Where an officer or director is successful on the
merits or otherwise in the defense of any action referred to above, the
corporation must indemnify him against the expenses which such officer or
director has actually and reasonably incurred.
The Company's Certificate of Incorporation provides for the indemnification
of directors and officers of the Company to the fullest extent permitted by
Section 145.
In that regard, the Certificate of Incorporation provides that the Company
shall indemnify any person who was or is a party or is threatened to be made a
party to any threatened, pending or completed action, suit or proceeding,
whether civil, administrative or investigative (other than action by or in the
right of the corporation) by reason of the fact that he is or was a director or
officer of the Company, or is or was serving at the request of the Company as a
director, officer or member of another corporation, partnership, joint venture,
II-1
<PAGE> 124
trust or other enterprise, against expenses (including attorneys' fees),
judgments, fines and amounts paid in settlement actually and reasonably incurred
by him in connection with such action, suit or proceeding if he acted in good
faith and in a manner he reasonably believed to be in or not opposed to the best
interests of such corporation and, with respect to any criminal action or
proceeding, had no reasonable cause to believe his conduct was unlawful.
Indemnification in connection with an action or suit by or in the right of such
corporation to procure a judgment in its favor is limited to payment of expenses
(including attorneys' fees) actually and reasonably incurred in connection with
the defense or settlement of such an action or suit except that no such
indemnification may be made in respect of any claim, issue or matter as to which
such person shall have been adjudged to be liable for negligence or misconduct
in the performance of his duty to the indemnifying corporation unless and only
to the extent that the Court of Chancery of Delaware or the court in which such
action or suit was brought shall determine that, despite the adjudication of
liability but in consideration of all the circumstances of the case, such person
is fairly and reasonably entitled to indemnity for such expenses which the court
shall deem proper.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
The following information relates to securities of the Company issued or
sold within the past three years that were not registered under the Securities
Act:
On March 11, 1996, in connection with the Company's initial capitalization,
the Company sold (i) 250 shares of Common Stock to Michael A. Koban, Jr. for a
purchase price of $250,000 and (ii) 250 shares of Common Stock to Philip D.
Wheeler for a purchase price of $250,000. Each of the sales described above was
conducted in reliance upon the exemption from registration under the Securities
Act set forth in Section 4(2) thereof, as a transaction not involving a public
offering.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) List of Exhibits.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTIONS
- ------- ------------
<C> <C> <S>
1.1 -- Form of U.S. Underwriting Agreement.*
1.2 -- Form of International Purchase Agreement.*
3.1 -- Restated Certificate of Incorporation of NetCare Health
Systems, Inc.*
3.2 -- Bylaws, as amended to date, of NetCare Health Systems, Inc.*
4.1 -- Specimen Common Stock Certificate, par value $.01 per
share.*
4.2 -- Form of Common Stock Registration Rights Agreement, dated
, 1998 among NetCare Health Systems, Inc. and
. and .*
4.3 -- Form of Rights Agreement, dated as of , 1998
between NetCare Health Systems, Inc. and as
Rights Agent.*
5.1 -- Opinion of Dewey Ballantine LLP.*
10.1 -- Form of Employment Agreement, dated as of , 1998
between NetCare Health Systems, Inc. and .*
10.2 -- Form of Long-Term Equity Incentive Plan effective
, 1998.*
10.3 -- Form of Directors' Stock Option Plan effective ,
1998.*
10.4 -- Form of Directors' Stock Unit Plan, effective ,
1998.*
10.5 -- Form of Directors' Retirement Plan, effective ,
1998.*
11.1 -- Statement re: computation of per share earnings.*
21.1 -- Subsidiaries of the NetCare Health Systems, Inc.*
23.1 -- Consents of Ernst & Young LLP.
23.2 -- Consent of Dewey Ballantine LLP (included in Exhibit 5.1).
24.1 -- Powers of Attorney (included on signature page hereto).
27.1 -- Financial Data Schedule.
27.2 -- Financial Data Schedule.
</TABLE>
- ---------------
* To be filed by amendment.
(b) Financial Statement Schedules.
Schedule III Valuation and Qualifying Accounts
II-2
<PAGE> 125
ITEM 17. UNDERTAKINGS.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the registrant of expenses incurred
or paid by a director, officer or controlling person of the registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of counsel the matter has
been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Act and will be governed by the final adjudication of
such issue.
The undersigned registrant hereby undertakes to provide to the underwriters
at the closing specified in the underwriting agreements certificates in such
denominations and registered in such names as required by the underwriters to
permit prompt delivery to each purchaser.
The undersigned registrant hereby undertakes that:
1. For purposes of determining any liability under the Securities Act
of 1933, the information omitted from the form of prospectus filed
as part of this registration statement in reliance upon Rule 430A
and contained in a form of prospectus filed by the registrant
pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities
Act shall be deemed to be part of this registration statement as of
the time it was declared effective.
2. For the purpose of determining any liability under the Securities
Act of 1933, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement
relating to the securities offered therein, and the offering of
such securities at that time shall be deemed to be the initial bona
fide offering thereof.
II-3
<PAGE> 126
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Nashville, State of
Tennessee, on June 18, 1998.
NETCARE HEALTH SYSTEMS, INC.
By: /s/ MICHAEL A. KOBAN, JR.
------------------------------------
Michael A. Koban, Jr.
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Act of 1933, as amended,
this Registration Statement has been signed below on June 18, 1998 by the
following persons in the capacities indicated.
Each person in so signing also makes, constitutes and appoints Michael A.
Koban, Jr. and Philip D. Wheeler each of them acting alone, his true and lawful
attorney-in-fact, with full power of substitution, to execute and cause to be
filed with the Securities and Exchange Commission pursuant to the requirements
of the Securities Act of 1933, as amended, any and all amendments and
post-effective amendments to this Registration Statement, and including any
registration statement for the same offering that is to be effective upon filing
pursuant to rule 462(b) under the Securities Act of 1933, as amended, with
exhibits thereto and other documents in connection therewith, and hereby
ratifies and confirms all that said attorney-in-fact or his substitute or
substitutes may do or cause to be done by virtue hereof.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
/s/ MICHAEL A. KOBAN, JR. President, Chief Executive June 18, 1998
- ----------------------------------------------------- Officer and Director
Michael A. Koban, Jr.
/s/ PHILIP D. WHEELER Executive Vice President, Chief June 18, 1998
- ----------------------------------------------------- Administrative Officer and
Philip D. Wheeler Director
/s/ STEVEN L. BLAINE Executive Vice President, Chief June 18, 1998
- ----------------------------------------------------- Operating Officer and Director
Steven L. Blaine
/s/ GLENN D. DAVIS Vice President, Treasurer and June 18, 1998
- ----------------------------------------------------- Chief Financial Officer
Glenn D. Davis
/s/ MERRIL M. HALPERN Chairman of the Board of June 18, 1998
- ----------------------------------------------------- Directors
Merril M. Halpern
/s/ A. LAWRENCE FAGAN Director June 18, 1998
- -----------------------------------------------------
A. Lawrence Fagan
/s/ MORTON A. PIERCE Director June 18, 1998
- -----------------------------------------------------
Morton A. Pierce
</TABLE>
II-4
<PAGE> 127
Board of Directors
NetCare Health Systems LLC
We have audited the consolidated financial statements of NetCare Health
Systems LLC as of December 31, 1996, and 1997 and for the period from March 11,
1996 (date of inception) to December 31, 1996 and for the year ended December
31, 1997, and have issued our report thereon dated February 16, 1998 (included
elsewhere in this Registration Statement). Our audits also included the
financial statement schedule listed in Item 16(b) of this Registration
Statement. This schedule is the responsibility of the Company's management. Our
responsibility is to express an opinion based on our audits.
In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
ERNST & YOUNG LLP
Nashville, Tennessee
February 16, 1998
S-1
<PAGE> 128
Board of Directors
NetCare Health Systems LLC
We have audited the combined statements of operations, changes in
stockholders' equity (deficit) and cash flows of Southern Health Corporation for
the two years ended June 30, 1996 and the period July 1, 1996 to August 15,
1996, and have issued our report thereon dated May 25, 1998 (included elsewhere
in this Registration Statement). Our audits also included the financial
statement schedule listed in Item 16(b) of this Registration Statement. This
schedule is the responsibility of the Company's management. Our responsibility
is to express an opinion based on our audits.
In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
ERNST & YOUNG LLP
Birmingham, Alabama
May 25, 1998
S-2
<PAGE> 129
SCHEDULE III
NETCARE HEALTH SYSTEMS
VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
ADDITIONS
-----------------------
<S> <C> <C> <C> <C> <C>
(1) (2)
<CAPTION>
BALANCE CHARGED TO
OF CHARGED TO OTHER BALANCE
BEGINNING COSTS AND ACCOUNTS- DEDUCTIONS- AT END OF
DESCRIPTION OF PERIOD EXPENSES DESCRIBE DESCRIBE PERIOD
- -------------------------------------- --------- ---------- --------- ---------- ---------
<S> <C> <C> <C> <C> <C>
NetCare:
Allowance for doubtful accounts:
12/31/97............................ 8,935,000 13,281,643 0 13,576,643 8,640,000
12/31/96............................ 0 3,562,037 7,442,208 2,069,245 8,935,000
Southern Health:
For the period from
7/1/96 - 8/15/96.................... 4,083,216 968,000 0 0 5,051,216
6/30/96............................. 3,822,862 2,905,085 0 2,644,731 4,083,216
6/30/95............................. 1,482,259 3,555,279 0 1,214,976 3,822,562
</TABLE>
- ---------------
(1) Allowances as a result of acquisitions
(2) Uncollectible accounts written off
S-3
<PAGE> 1
EXHIBIT 23.1
Consent of Independent Auditors
We consent to the reference to our firm under the caption "Experts" and to the
use of our report dated May 25, 1998, with respect to the combined financial
statements and schedule of Southern Health Corporation in the Registration
Statement (Form S-1) and related Prospectus of NetCare Health Systems LLC for
the registration of its common stock.
Ernst & Young LLP
Birmingham, Alabama
June 16, 1998
<PAGE> 2
EXHIBIT 23.1
Consent of Independent Auditors
We consent to the reference to our firm under the caption "Experts" and to the
use of our reports dated (i) February 16, 1998, with respect to the
consolidated financial statements and schedule of NetCare Health Systems LLC,
(ii) January 23, 1997 with respect to the financial statements of Denton
Community Hospital, and (iii) June 1, 1998 with respect to the financial
statements of San Clemente Hospital and Medical Center in the Registration
Statement (Form S-1) and related Prospectus of NetCare Health Systems LLC for
the registration of its common stock.
Ernst & Young LLP
Nashville, Tennessee
June 16, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 495
<SECURITIES> 0
<RECEIVABLES> 31,077
<ALLOWANCES> 8,640
<INVENTORY> 2,715
<CURRENT-ASSETS> 31,830
<PP&E> 82,705
<DEPRECIATION> 5,835
<TOTAL-ASSETS> 149,530
<CURRENT-LIABILITIES> 23,465
<BONDS> 71,571
0
0
<COMMON> 0
<OTHER-SE> 49,746
<TOTAL-LIABILITY-AND-EQUITY> 149,530
<SALES> 128,517
<TOTAL-REVENUES> 130,341
<CGS> 0
<TOTAL-COSTS> 104,615
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 13,282
<INTEREST-EXPENSE> 6,681
<INCOME-PRETAX> 5,763
<INCOME-TAX> 2,387
<INCOME-CONTINUING> 3,376
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,376
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 930
<SECURITIES> 0
<RECEIVABLES> 31,800
<ALLOWANCES> 8,898
<INVENTORY> 2,740
<CURRENT-ASSETS> 32,599
<PP&E> 84,855
<DEPRECIATION> 7,171
<TOTAL-ASSETS> 150,551
<CURRENT-LIABILITIES> 22,343
<BONDS> 71,045
0
0
<COMMON> 0
<OTHER-SE> 51,135
<TOTAL-LIABILITY-AND-EQUITY> 150,551
<SALES> 34,267
<TOTAL-REVENUES> 34,631
<CGS> 0
<TOTAL-COSTS> 27,375
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 3,074
<INTEREST-EXPENSE> 1,631
<INCOME-PRETAX> 2,551
<INCOME-TAX> 1,188
<INCOME-CONTINUING> 1,363
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,363
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
